<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended September 30, 1998
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 333-33639
EVERCOM, INC.
(Exact name of registrant as specified in its charter)
Delaware 75-2680266
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
---------------
8201 Tristar Drive
Irving, Texas 75063
(972) 988-3737
(Address, including zip code, and telephone number, including area code, of
Registrant's principal executive offices)
---------------
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
As of September 30, 1998, 15,900 shares of Class A common stock, par value
$0.01 per share, were issued and outstanding and 400 shares of Class B common
stock, par value $0.01 per share, were issued and outstanding.
<PAGE>
EVERCOM, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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PART I - FINANCIAL INFORMATION
<S> <C>
Item 1. Financial Statements......................................................................... 3
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................................... 11
Item 3. Quantitative and Qualitative Disclosures about Market Risk................................... 19
PART II - OTHER INFORMATION
Item 1. Legal Proceedings............................................................................ 20
Item 2. Changes in Securities and Use of Proceeds.................................................... 20
Item 3. Defaults Upon Senior Securities.............................................................. 20
Item 4. Submission of Matters to a Vote of Security Holders.......................................... 20
Item 5. Other Information............................................................................ 20
Item 6. Exhibits and Reports on Form 8-K............................................................. 21
</TABLE>
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<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
EVERCOM, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------- -------------
(UNAUDITED)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents......................................................... $ 7,777,996 $ 2,112,568
Accounts receivable............................................................... 17,401,907 43,786,720
Refundable income taxes........................................................... 600,388 410,625
Inventories....................................................................... 1,690,930 3,146,085
Prepaid expenses and other current assets......................................... 2,309,661 437,772
Deferred income tax asset......................................................... 1,059,752 1,286,080
------------ ------------
Total current assets........................................................... 30,840,634 51,179,850
PROPERTY AND EQUIPMENT.............................................................. 24,007,039 29,245,257
INTANGIBLE AND OTHER ASSETS......................................................... 134,540,767 124,052,626
------------ ------------
TOTAL.......................................................................... $189,388,440 $204,477,733
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Accounts payable.................................................................. $ 6,933,874 $ 24,538,281
Accrued expenses.................................................................. 24,678,158 26,260,847
Income taxes payable.............................................................. 619,514
Current portion of long-term debt................................................. 5,545,363 10,947,318
------------ ------------
Total current liabilities...................................................... 37,157,395 62,365,960
LONG-TERM DEBT...................................................................... 160,040,938 167,801,672
OTHER LONG-TERM LIABILITIES......................................................... 1,150,000 1,291,667
DEFERRED INCOME TAXES............................................................... 1,059,752 1,286,080
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' DEFICIT:
Preferred stock, $.01 par value; 6,000 shares authorized, 5,925
shares issued and outstanding (cumulative liquidation value
of $5,925,000)................................................................. 59 59
Common stock, $.01 par value; 50,000 shares authorized, 16,200 and 16,300 shares
issued and outstanding as of December 31, 1997 and
September 30, 1998, respectively................................................ 162 163
Additional paid-in capital........................................................ 22,036,963 21,881,462
Accumulated deficit............................................................... (32,056,829) (50,149,330)
------------ ------------
Total stockholders' deficit.................................................... (10,019,645) (28,267,646)
------------ ------------
TOTAL.......................................................................... $189,388,440 $204,477,733
============ ============
</TABLE>
See notes to consolidated financial statements.
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<PAGE>
EVERCOM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTH PERIOD ENDED NINE MONTH PERIOD ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- -------------------------
1997 1998 1997 1998
------------ ---------- ---------- ---------
<S> <C> <C> <C> <C>
OPERATING REVENUE.................................... $23,324,410 $60,564,379 $53,406,700 $164,169,127
OPERATING EXPENSES:
Telecommunication costs............................ 9,165,023 26,192,025 21,570,606 69,984,810
Facility commissions............................... 6,258,410 18,638,901 14,419,123 51,983,735
Field operations and maintenance................... 1,207,754 2,037,557 2,373,432 5,784,215
Selling, general and administrative................ 2,135,256 5,988,435 4,462,349 14,305,004
Depreciation....................................... 454,743 1,543,809 1,071,827 4,233,484
Amortization of intangibles........................ 3,049,188 6,324,118 7,787,607 19,241,182
Restructuring costs................................ 1,401,868 1,401,868
----------- ----------- ----------- ------------
Total operating expense......................... 22,270,374 62,126,713 51,684,944 166,934,298
----------- ----------- ----------- ------------
OPERATING INCOME (LOSS).............................. 1,054,036 (1,562,334) 1,721,756 (2,765,171)
OTHER (INCOME) EXPENSE:
Interest expense, net.............................. 3,388,445 4,904,852 7,320,330 14,668,487
Other (income), net................................ (106,862) (39,962) (126,082) (198,917)
----------- ----------- ----------- ------------
Total other (income) expense.................... 3,281,583 4,864,890 7,194,248 14,469,570
----------- ----------- ----------- ------------
LOSS BEFORE INCOME TAXES AND......................... (2,227,547) (6,427,224) (5,472,492) (17,234,741)
EXTRAORDINARY LOSS..................................
INCOME TAX (BENEFIT) EXPENSE......................... 192,487 375,164 (657,127) 857,760
----------- ----------- ----------- ------------
NET LOSS BEFORE EXTRAORDINARY LOSS................... (2,420,034) (6,802,388) (4,815,365) (18,092,501)
EXTRAORDINARY LOSS ON DEBT
EXTINGUISHMENT...................................... 4,395,681
----------- ----------- ----------- ------------
NET LOSS............................................. (2,420,034) (6,802,388) (9,211,046) (18,092,501)
Preferred Stock Dividends............................ 118,500 118,500 355,500 355,500
----------- ----------- ----------- ------------
NET LOSS APPLICABLE TO COMMON STOCK.................. $(2,538,534) $(6,920,888) $(9,566,546) $(18,448,001)
=========== =========== =========== ============
</TABLE>
See notes to consolidated financial statements.
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<PAGE>
EVERCOM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
NINE MONTH PERIOD
ENDED SEPTEMBER 30,
----------------------------------
1997 1998
--------------- ---------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss......................................................................................... $ (9,211,046) $(18,092,501)
Adjustments to reconcile net loss to net cash (used in) provided by
operating activities:
Depreciation.................................................................................... 1,071,827 4,233,484
Amortization of intangible assets, including deferred financing costs and
bond discount................................................................................. 8,292,220 20,145,275
Extraordinary loss on debt extinguishment....................................................... 4,395,681
Deferred income taxes........................................................................... (1,295,508)
Changes in operating assets and liabilities, net of effects of acquisitions:
Accounts receivable........................................................................... (3,414,072) (26,534,813)
Inventories................................................................................... (43,034) (1,278,164)
Prepaid expenses and other.................................................................... (256,669) (602,828)
Accounts payable.............................................................................. (402,748) 17,604,407
Accrued expenses.............................................................................. 2,900,035 5,165,401
Income taxes.................................................................................. (988,294) 809,277
------------ ------------
Net cash provided by operating activities................................................... 1,048,392 1,449,538
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
(Increase) Decrease in restricted cash............................................................. (1,693,000) 1,919,312
Capital expenditures............................................................................... (4,456,785) (10,302,164)
Cash outflows for acquisitions..................................................................... (21,576,079) (10,470,803)
------------ ------------
Net cash used in investing activities....................................................... (27,725,864) (18,853,655)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from the issuance of debt................................................................. 118,200,000 15,000,000
Repayment of advances.............................................................................. (850,400)
Repayment of debt.................................................................................. (67,422,318) (2,787,311)
Payment of deferred financing and acquisition costs................................................ (6,956,703)
Payment of preferred dividends..................................................................... (474,000)
------------ ------------
Net cash provided by financing activities................................................... 42,970,579 11,738,689
------------ ------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS.................................................... 16,293,107 (5,665,428)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD...................................................... 294,494 7,777,996
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD .......................................................... $ 16,587,601 $ 2,112,568
============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest ........................................................................... $ 3,764,113 $ 17,183,491
============ ============
Cash paid for income taxes ....................................................................... $ 1,495,902 $ 467,370
============ ============
NONCASH TRANSACTIONS:
Dividends payable ................................................................................ $ 355,500 $ 355,500
============ ============
Issuance of stock for acquisition of assets ...................................................... $ 900,000 $ -
============ ============
Issuance of debt for acquisition of assets ....................................................... $ 300,000 $ 950,000
============ ============
Amounts payable for acquisition costs ............................................................ $ 3,386,919 $ -
============ ============
Exercise of common stock options issued in connection with acquisition ........................... $ - $ 200,000
============ ============
</TABLE>
See notes to consolidated financial statements.
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<PAGE>
EVERCOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. CONSOLIDATED FINANCIAL STATEMENTS
The consolidated financial statements as of September 30, 1998 and for the
three and nine month periods ended September 30, 1997 and 1998 of Evercom, Inc.
and subsidiaries (formerly Talton Holdings, Inc.) (the "Company") have been
prepared by the Company without audit.
In the opinion of management, all necessary adjustments (which include only
normal recurring adjustments) to present fairly, in all material respects, the
consolidated financial position, results of operations and cash flows as of and
for the respective periods, have been made. Certain information and footnote
disclosures normally included in annual consolidated financial statements
prepared in accordance with generally accepted accounting principles have been
omitted pursuant to the rules and regulations of the Securities and Exchange
Commission. These financial statements should be read in conjunction with the
Company's 1997 consolidated financial statements contained in its Form 10-K as
filed with the Securities and Exchange Commission on March 31, 1998.
COMPREHENSIVE INCOME
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income," became effective as of the first quarter of 1998. This
statement requires companies to report and display comprehensive income and its
components (revenues, expenses, gains and losses). Comprehensive income includes
all changes in equity during a period except those resulting from investments by
owners and distributions to owners. For the Company, comprehensive income is the
same as net loss reported in the statements of consolidated operations, since
there were no other items of comprehensive income for the periods presented.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133
requires recognition of all derivative financial instruments as either assets or
liabilities in consolidated balance sheets at fair value and determines the
method(s) of gain/loss recognition. SFAS No. 133 is effective for fiscal years
beginning after June 15, 1999. The Company is currently evaluating the effect
that it may have on the consolidated financial statements.
SOFTWARE DEVELOPED OR OBTAINED FOR INTERNAL USE
In March 1998, the American Institute of Certified Public Accountants
("AICPA") released Statement of Position ("SOP") No. 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use." SOP 98-1
requires the capitalization of certain expenditures for software that is
purchased or internally developed. SOP No. 98-1 is effective for fiscal years
beginning after December 31, 1999. The Company believes that the adoption of
this SOP will have no material effect on the financial position, results of
operations or cash flows of the Company.
COSTS OF START-UP ACTIVITIES
In April 1998, the AICPA released SOP 98-5, "Reporting on the Costs of Start-
Up Activities." SOP 98-5 generally requires costs of start-up activities to be
expensed instead of being capitalized and amortized. SOP 98-5 is effective for
fiscal years beginning after December 31, 1999. The Company expects that the
adoption of this pronouncement will have no material effect on the financial
position, results of operations or cash flows of the Company.
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<PAGE>
2. ACCOUNTS RECEIVABLE
Accounts receivable consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------- --------------
(UNAUDITED)
<S> <C> <C>
Trade accounts receivable, net of advance payments received of $187,647
and $693,311 at December 31, 1997 and September 30, 1998, respectively ............... $21,809,811 $49,518,894
Advance commissions receivable .......................................................... 272,921 1,765,586
Receivables related to acquisitions ..................................................... 456,875 114,017
Universal service fund receivable ....................................................... 828,204
Receivable from affiliate ............................................................... 135,424
Employees and other ..................................................................... 178,989 563,308
----------- -----------
22,718,596 52,925,433
Less allowance for unbillable and uncollectible chargebacks ............................. (5,316,689) (9,138,713)
----------- -----------
$17,401,907 $43,786,720
=========== ===========
</TABLE>
At December 31, 1997 and September 30, 1998, the Company had advanced
commissions to certain inmate facilities of $1,290,732 and $3,019,399
(unaudited) which are recoverable from such facilities as a reduction of earned
commissions at specified monthly amounts. Amounts included in accounts
receivable represent the estimated recoverable amounts during the next fiscal
year with the remaining balance recorded in other assets.
3. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------ -------------
(UNAUDITED)
<S> <C> <C>
Leasehold improvements .................................................................. $ 493,836 $ 826,031
Telephone system equipment .............................................................. 24,480,777 32,176,087
Vehicles ................................................................................ 249,868 419,307
Office equipment ........................................................................ 1,075,751 2,350,509
----------- -----------
26,300,232 35,771,934
Less accumulated depreciation ........................................................... (2,293,193) (6,526,677)
----------- -----------
$24,007,039 $29,245,257
=========== ===========
</TABLE>
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<PAGE>
4. INTANGIBLE AND OTHER ASSETS
Intangible and other assets consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------ ------------
(UNAUDITED)
<S> <C> <C>
Intangible assets:
Acquired telephone contracts ....................................................... $ 59,064,429 $ 63,337,702
Noncompete agreements .............................................................. 403,611 568,611
Deferred loan costs ................................................................ 8,299,067 8,299,067
Goodwill ........................................................................... 79,970,642 84,416,834
Other intangibles .................................................................. 526,385 601,982
------------ ------------
148,264,134 157,224,196
Less accumulated amortization ....................................................... (15,157,562) (35,302,837)
------------ ------------
Total intangible assets .............................................................. 133,106,572 121,921,359
Deposits ............................................................................. 416,384 389,544
Universal service fund receivable - long term ........................................ 487,910
Other assets - noncurrent portion of commission advances to facilities ............... 1,017,811 1,253,813
------------ ------------
$134,540,767 $124,052,626
============ ============
</TABLE>
5. ACCRUED EXPENSES
Accrued expenses consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------ ------------
(UNAUDITED)
<S> <C> <C>
Facility commissions .............................................................. $ 5,456,245 $ 7,313,712
Billing and collection fees ....................................................... 1,148,171 2,265,605
Uncollectible call chargebacks .................................................... 990,135 4,241,752
Accrued acquisition and financing costs ........................................... 8,599,778 5,085,566
Accrued interest .................................................................. 6,557,651 3,273,613
Accrued excise taxes payable ...................................................... 1,166,003 1,738,793
Accrued dividends on preferred stock .............................................. 474,000 355,500
Accrued restructuring costs ....................................................... 1,305,030
Other ............................................................................. 286,175 681,276
----------- -----------
$24,678,158 $26,260,847
=========== ===========
</TABLE>
The accrual for uncollectible call chargebacks represents a reserve for
amounts collected from the various local exchange carriers ("LECs") or third-
party billing services which are expected to be charged back to the Company in
future periods.
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<PAGE>
6. LONG-TERM DEBT
The following is a summary of long-term debt:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------ ------------
(UNAUDITED)
<S> <C> <C>
Senior Notes ..................................................................... $115,000,000 $115,000,000
Senior Credit Agreement:
Revolving loan facility ....................................................... 2,000,000 10,500,000
Term loan facility ............................................................ 48,500,000 52,250,000
Note payable, with interest of 8.0%, due at maturity on
February 19, 1999 and subordinate to borrowings of
the Senior Notes and Senior Credit Agreement ................................... 950,000
Other.............................................................................. 86,301 48,990
------------ ------------
165,586,301 178,748,990
Less current portion of long-term debt ........................................... (5,545,363) (10,947,318)
------------ ------------
$160,040,938 $167,801,672
============ ============
</TABLE>
The term loan facility is due in quarterly installments of $2,750,000 in
December 31, 1998, decreasing to $2,406,250 on March 31, 1999, and increasing to
$3,093,750 on March 31, 2000, and $3,437,500 on March 31, 2001, with the
remaining unpaid balance due on December 31, 2002.
On June 30, 1998, the Company entered into an interest rate cap agreement
that has been designated as a hedge against the Company's variable interest rate
exposure under the Company's revolving and term loan agreement (the "Senior
Credit Agreement"). At September 30, 1998, the interest rate cap has an
aggregate notional amount of $30.0 million, which matures in June 2001, and caps
interest on the London Interbank Offering Rate ("LIBOR") portion of the term
loan at 7.5%, plus the applicable LIBOR margin.
7. ACQUISITIONS
Effective January 1, 1998, the Company entered into an agreement to
purchase substantially all of the net assets of the inmate payphone division of
ILD Teleservices, Inc. for a cash purchase price of $2.6 million. The
acquisition was funded with borrowings under the Senior Credit Agreement.
Effective February 1, 1998, the Company entered into an agreement to
purchase the stock of MOG Communications, Inc. for a cash purchase price of $1.9
million and a note of $950,000. The acquisition was funded with borrowings under
the Senior Credit Agreement.
Effective July 1, 1998, the Company entered into an agreement to purchase
Saratoga Telephone Company for a cash purchase price of $2.0 million. The
acquisition was funded with borrowings under the Senior Credit Agreement.
8. STOCK OPTIONS
On June 30, 1998, the Company's Board of Directors adopted a Stock
Incentive Plan (the "Plan"). The Plan provides for options to be granted to key
employees and officers of the Company for the purchase of 81 shares of common
stock at an exercise price of $2,000 per share. The options granted under the
Plan have a vesting period of four to five years and expire after ten years from
the date of grant.
In connection with certain employment agreements in 1998, the Company
granted 396 options to purchase common stock at an exercise price of $2,000 per
share. The options vest ratably over the terms of the employment agreements and
expire ten years from the date of issuance.
In connection with an employment agreement with an executive, the Company
granted 500 options to purchase common stock at an exercise price of $2,000 per
share. The options vest over three years and expire ten years from the date of
issuance.
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<PAGE>
9. COMMON STOCK
In September 1998, an employee exercised his option, received in connection
with a previous acquisition to purchase 100 shares of Class A Common Stock for
$2,000 per share.
10. RESTRUCTING COST
In the third quarter of 1998, management authorized and committed to a plan
of restructure. The plan provides for the consolidation of certain operations
including the closing of a number of office locations and reducing the workforce
by approximately 21 employees and certain management positions. Restructuring
reserves were established totaling $1.4 million. Of this amount, $0.9 million
was reserved for severance and related costs, $0.3 million for office leases and
$0.2 million for legal and other costs.
******
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<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Certain statements contained in this Quarterly Report on Form 10-Q
constitute forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended, which involve known and unknown risks, uncertainties,
and other factors that may cause the actual results, levels of activity,
performance, or achievements of the Company, or industry results, to be
materially different from any future results, levels of activity, performance,
or achievements expressed or implied by such forward-looking statements.
Forward-looking statements include all statements relating to future events and
all statements of belief and opinion with respect to matters that are not
historical facts. All forward-looking statements included in this Form 10-Q are
based on information available to the Company on the date hereof, and the
Company assumes no obligation to update such forward-looking statements. The
risks, uncertainties, and other factors to which forward-looking statements are
subject include, among others, those set forth under the caption "Risk Factors"
in the Prospectus of the Company dated September 10, 1998, which is available
from the Securities and Exchange Commission at prescribed rates and at the
Securities and Exchange Commission's website, www.sec.gov. Such risk factors
include, without limitation, competitors with greater resources, risks
associated with uncollectible accounts, and risks associated with anticipated
growth. All subsequent written or oral forward-looking statements attributable
to the Company or persons acting on its behalf are expressly qualified in their
entirety by such factors. Although the Company believes that the assumptions and
expectations reflected in such forward-looking statements are reasonable, as a
result of the foregoing and other factors, no assurance can be given as to
future results, levels of activity, or achievements, and neither the Company nor
any other person will be responsible for the accuracy or completeness of such
forward-looking statements. In some cases, forward-looking statements can be
identified by terminology such as "may," "will," "should," "expects," "plans,"
"anticipates," "believes," "estimates," "predicts," "potential," or "continue"
or the negative or such terms or other comparable terminology.
OVERVIEW
The Company is the largest independent provider of collect, prepaid, and
debit calling services to local, county, state, and private correctional
facilities in the United States. As of September 30, 1998, the Company served
2,149 correctional facilities in 43 states, of which 50 were private facilities.
The Company has a high level of market penetration in many states, providing
inmate telecommunications services to over 75% of the county correctional
facilities in seven states, and to over 50% of the county correctional
facilities in an additional 12 states.
Dennis L. Whipple became Chief Executive Officer, Chairman, and a Director
of the Company in September 1998. From June 1995 until March 1998, Mr. Whipple
served as President of ALLTEL Communications, Inc. Mr. Whipple served as Chief
Executive Officer and President of Contel Cellular, Inc. from 1991 through 1995.
Prior to joining Contel Cellular, Inc., Mr. Whipple held various positions with
GTE from 1971 through 1991, most recently as Corporate Vice President of
Marketing and Business Development.
The Company derives substantially all of its revenues from its operation of
inmate telecommunications systems located in correctional facilities in 43
states. The Company's inmate telecommunications services consist of collect
call, prepaid, and debit card services. The Company enters into multi-year
agreements (generally 3 to 5 years) with the correctional facilities, pursuant
to which the Company serves as the exclusive provider of telecommunications
services to inmates within each facility. In exchange for the exclusive service
rights, the Company pays a percentage of its revenue from each correctional
facility as a commission to that facility. The Company installs and generally
retains ownership of the telephones and the associated equipment and provides
additional services to correctional facilities that are tailored to the
specialized needs of the corrections industry and to the requirements of the
individual correctional facility, such as call activity reporting and call
blocking. The Company also generates revenues from public pay telephones that
are ancillary to its inmate telephone business.
The Company accumulates call activity data from its various installations
and bills its revenues related to this call activity through LECs or through
third-party billing services. In addition, the Company accrues the related
telecommunications costs for validating, transmitting, billing and collection,
and line and long-distance charges, along with commissions payable to the
facilities, and allowances for uncollectible accounts based on historical
experience.
The Company's traditional inmate business consists of collect, prepaid and
debit calling services provided to correctional facilities. The Company began
providing validation, billing, and collections services for the inmate calls of
a major regional bell operating company ("RBOC") in May of 1998. Under the terms
of the agreement the Company acquires at a discount the related accounts
receivable from the RBOC. When the receivables are purchased, the Company
accepts responsibility for all uncollectible accounts and billing and
collections costs, with no recourse to the RBOC. However, under the terms of the
agreement, all purchased receivables must be processed and validated through the
Company's call management and billing system. The Company's revenues from this
service equal the difference between the face value of the receivables purchased
and the amount it pays the RBOC for the accounts receivable. Because the
Company's revenues associated with this contract represent only a percentage of
the face value of the receivable purchased, the associated uncollectible account
expense and billing & collection fees represent a much higher percentage of
revenue as compared to the Company's traditional inmate business. Consequently,
the Company's telecommunication costs represent a higher percentage of revenue
under this contract. The contract term is three years and has no minimum volume
commitment. The Company pays no facility commission under this agreement.
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<PAGE>
The Company's principal operating expenses consist of (i) telecommunication
costs; (ii) commissions paid to correctional facilities, which are typically
calculated as a percentage of either gross or net revenues, fixed for the term
of the agreements with the facilities, and in some cases are subject to monthly
minimum amounts; (iii) field operations and maintenance costs, which consist
primarily of field service on the Company's installed base of inmate telephones;
and (iv) selling, general, and administrative costs.
Telecommunication Costs. The principal components of telecommunication
costs are long distance transmission costs, local access costs, third party
billing costs, and costs of uncollectible accounts. Historically, long distance
costs have consisted of charges for minutes of use purchased from interexchange
carriers ("IXCs"). The Company recently entered into an agreement to lease lines
connecting urban areas and correctional facilities in the state of North
Carolina. Given the Company's relatively high level of traffic in North
Carolina, management believes that transmission via leased lines will be more
economical than acquiring minutes of use. Local access charges consist of
monthly line and usage charges paid to RBOCs and other LECs for interconnection
to the local network for local calls, which are computed on a flat monthly
charge plus, for certain LECs, on a per message or per minute usage rate based
on the time and duration of the call. Third party billing charges consist of
payments to LECs and other billing service providers for billing and collecting
revenues from called parties. The Company believes that it experiences faster
payments and lower expenses associated with uncollectible accounts when using
direct billing than when using other billing service providers. Expenses
associated with uncollectible accounts are a significant cost in providing
inmate telecommunications services.
Commissions. The Company pays a percentage of its revenue from each
facility to that facility as a commission. Commissions are generally set for the
duration of the Company's multi-year contract with the facility. Commission
rates are the principal basis of competition for obtaining and retaining
contracts. Commissions paid by the Company as a percentage of its traditional
inmate business revenues have increased from 26.8% in the third quarter of 1997
to 33.5% in the third quarter of 1998. This increase is primarily due to the
higher facility commissions on contracts obtained by the Company through
acquisitions, competition in larger facilities, and increased commission rates
on renewals. Commissions are expected to gradually increase as a percentage of
revenues in the future. The overall commission percentage to total revenue of
30.8% in the third quarter of 1998 includes the effect of the billing and
collection services provided under the Company's agreement with a major RBOC
under which no commissions are paid.
Field Operations and Maintenance. Field operations and maintenance consist
of maintenance costs associated with inmate phones and related equipment. These
costs are relatively small and more constant components of operating expenses.
Selling, general, and administrative ("SG&A") costs. SG&A expenses consist
of corporate overhead and selling expense. These costs are also relatively small
and more constant components of operating expenses. The Company's restructuring
activities described below are expected to realize monthly savings of
approximately approximately $200,000 of SG&A.
Company History. The Company became the holding company for the
operations of AmeriTel Pay Phones, Inc. ("AmeriTel") and Talton
Telecommunications Corporation and subsidiary ("Talton Telecommunications"),
effective December 1, 1996. The Company also acquired the operations of Tri-T,
Inc. ("Tataka") on April 4, 1997, Security Telecom Corporation ("STC") on June
27, 1997, Correctional Communications Corporation ("CCC") on July 31, 1997, the
inmate payphone division of Communications Central, Inc. ("Invision") on October
6, 1997, the inmate payphone division of North American InTeleCom ("NAI") on
December 1, 1997, the inmate payphone division of Peoples Telephone Corporation
("PTC") on December 18, 1997, the inmate payphone division of ILD Teleservices,
Inc. ("ILD") on January 1, 1998, MOG Communications, Inc. ("MOG") on February 1,
1998 and Saratoga Telephone Co. Inc. ("Saratoga") on July 1, 1998 (collectively,
the "Acquisitions"). The Acquisitions were accounted for using the purchase
method of accounting as of their respective acquisition dates and, accordingly,
only the results of operations of the acquired companies subsequent to their
respective acquisition dates are included in the operating results of the
Company.
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<PAGE>
Restructuring Costs. The Company is currently integrating its acquired
operations into its existing operations, which resulted in a restructuring
charge in September 1998 of $1.4 million. Management expects that these
restructuring activities, which will include a reduction in the size of the
Company's workforce and the closing of certain of the Company's offices, will
result in monthly savings of approximately $200,000 to the Company, although
there can be no assurance in this regard. See Note 10 to the Consolidated
Financial Statements.
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<PAGE>
RESULTS OF OPERATIONS
The following table sets forth, for the three months and nine months ended
September 30, 1997 and 1998, respectively, the results of operations of the
Company.
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
------------------------------------------------ ------------------------------------------
1997 1998 1997 1998
-------------------- ------------------------- ------------------- --------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Operating revenues ..................$23,324 100.0% $60,564 100.0% $53,407 100.0% $164,169 100.0%
Operating expenses:
Telecommunication costs ............ 9,165 39.3 26,192 43.3 21,571 40.4 69,985 42.6
Facility commissions ............... 6,258 26.8 18,639 30.8 14,419 27.0 51,984 31.7
Field operations and maintenance ... 1,208 5.2 2,038 3.4 2,373 4.4 5,784 3.5
Selling, general and administrative.. 2,135 9.1 5,988 9.9 4,462 8.3 14,305 8.7
Depreciation ....................... 455 2.0 1,544 2.5 1,072 2.0 4,233 2.6
Amortization of intangibles.......... 3,049 13.1 6,324 10.4 7,788 14.6 19,241 11.7
Restructuring costs ................ 1,402 2.3 1,402 0.9
------- ----- ------- ----- ------- ----- -------- ------
Total operating expenses .......... 22,270 95.5 62,127 102.6 51,685 96.7 166,934 101.7
------- ----- ------- ----- ------- ----- -------- ------
Operating income (loss) ............. 1,054 4.5 (1,563) (2.6) 1,722 3.3 (2,765) (1.7)
Other (income) expense:
Interest expense, net .............. 3,388 14.5 4,905 8.1 7,320 13.7 14,669 8.9
Other, net ......................... (106) (0.4) (40) (0.1) (126) (0.2) (199) (0.1)
------- ----- ------- ----- ------- ----- -------- ------
Total other (income) expense ........ 3,282 14.1 4,865 8.0 7,194 13.5 14,470 8.8
------- ----- ------- ----- ------- ----- -------- ------
Loss before income taxes ............ (2,228) (9.6) (6,428) (10.6) (5,472) (10.2) (17,235) (10.5)
Income tax expense (benefit) ........ 192 0.8 375 0.6 (657) (1.2) 858 0.5
------- ----- ------- ----- ------- ----- -------- ------
Loss before extraordinary loss ...... (2,420) (10.4) (6,803) (11.2) (4,815) (9.0) (18,093) (11.0)
Extraordinary loss .................. 4,396 8.2
------- ----- ------- ----- ------- ----- -------- ------
Net loss ............................$(2,420) (10.4)% $(6,803) (11.2)% $(9,211) (17.2)% $(18,093) (11.0)%
======= ===== ======= ====== ======= ===== ======== ======
EBITDA ..............................$ 4,664 20.0% $ 6,345 10.5% $10,708 20.0% $ 20,908 12.7%
======= ===== ======= ====== ======= ===== ======== ======
</TABLE>
THREE MONTHS ENDED SEPTEMBER 30, 1998, AS COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 1997
Operating Revenues. The Company's operating revenues increased by $37.3
million, or 159.7%, from $23.3 million for the three months ended September 30,
1997 to $60.6 million for the three months ended September 30, 1998. The
increase in operating revenues was primarily due to acquisitions by the Company
of CCC, Invision and PTC from July to December in 1997 and ILD, MOG and Saratoga
in 1998. Since its inception, the Company has acquired contracts for 1,888
facilities through the Acquisitions and has added additional facilities by
winning new contracts for county, local, and state facilities, including bids
for new contracts in the states of North Carolina, North Dakota, and Alaska. As
of September 30, 1998, the Company served 2,149 correctional facilities in 43
states, of which 50 were private facilities. The Company has been informed that
the State of Alabama would not be renewing its contract with the Company. The
Company estimates that this will result in lower revenue and EBITDA in fiscal
year 1999 of $8.2 million and $1.5 million, respectively, when compared to
fiscal year 1998.
Operating Expenses. Total operating expenses increased by $39.8 million, or
178.5% from $22.3 million for the three months ended September 30, 1997 to $62.1
million for the three months ended September 30, 1998. Operating expenses as a
percentage of operating revenues increased by 7.1% from 95.5% for the three
months ended September 30, 1997 to 102.6% for the three months ended September
30, 1998. The increase in operating expenses as a percentage of revenues is
primarily due to factors discussed below.
Telecommunication costs increased by $17.0 million, from $9.2 million for the
three months ended September 30, 1997 to $26.2 million for the three months
ended September 30, 1998. Telecommunication costs represented 39.3% of
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<PAGE>
operating revenues for the three months ended September 30, 1997 and 43.3% of
operating revenues for the three months ended September 30, 1998, an increase of
4.0%. The Company's telecommunication costs in its traditional inmate business
increased from 39.3% for the third quarter of 1997 to 41.0% for the third
quarter of 1998. The percentage increase is due in part to higher levels of
uncollectible accounts associated with the Company's acquisitions subsequent to
June 30, 1997, which are located in geographic regions that exhibit higher
uncollectible rates. The percentage increase is also due to the increase in
competitive local exchange carrier ("CLEC") activity. These CLECs increased the
Company's unbillable expenses, because in most cases the CLECs are unable to
bill the Company's traffic. The Company is responding to this problem by
offering prepaid services to these customers. The Company's overall
telecommunication costs as a percentage of revenue of 43.3% for the third
quarter of 1998 includes the effect of its billing and collection services
provided to a major RBOC. These billing and collection services exhibit higher
telecommunication costs as a percentage of revenue than the Company's
traditional inmate business. For further discussion of these services provided
to a major RBOC, please refer to the "Overview" in Item 2.
Facility commissions increased by $12.3 million, from $6.3 million for the
three months ended September 30, 1997 to $18.6 million for the three months
ended September 30, 1998. Facility commissions represented 26.8% of operating
revenues for the three months ended September 30, 1997 and 30.8% of operating
revenues for the three months ended September 30, 1998, an increase of 4.0%. The
commission rates paid by the Company as a percent of its traditional inmate
business revenues have increased from 26.8% in the third quarter of 1997 to
33.5% in the third quarter of 1998. This increase was primarily due to increased
facility commissions under contracts obtained by the Company through
acquisitions, the competition in larger facilities, and increased commission
rates on renewals. Facility commissions are expected to gradually increase as a
percentage of revenue in the future. The overall commission percentage to total
revenue of 30.8% in the third quarter of 1998 includes the effect of the billing
and collection services provided to a major RBOC as discussed in the "Overview"
in Item 2.
Field operations and maintenance costs increased by $0.8 million, from $1.2
million for the three months ended September 30, 1997 to $2.0 million for the
three months ended September 30, 1998. Field operations and maintenance costs
represented 5.2% of operating revenues for the three months ended September 30,
1997 and 3.4% of operating revenues for the three months ended September 30,
1998, a decrease of 1.8%. The dollar increase is primarily due to costs
associated with servicing the acquired facilities and the new contract
facilities. The Company is integrating the field service and maintenance
organizations of its acquired companies.
SG&A increased by $3.9 million, from $2.1 million for the three months ended
September 30, 1997 to $6.0 million for the three months ended September 30,
1998. SG&A represented 9.1% of operating revenues for the three months ended
September 30, 1997 and 9.9% of operating revenues for the three months ended
September 30, 1998, an increase of 0.8%. The dollar increase in SG&A is
primarily due to the increased infrastructure necessary to support the
Acquisitions.
Total depreciation and amortization costs increased by $4.4 million, from $3.5
million for the three months ended September 30, 1997 to $7.9 million for the
three months ended September 30, 1998. Depreciation and amortization costs
represented 15.1% of operating revenues for the three months ended September 30,
1997 and 12.9% of operating revenues for the three months ended September 30,
1998, a decrease of 2.2%. The dollar increase is primarily due to additional
amortization expense associated with the inmate facility contracts acquired in
the Acquisitions. Amortization resulting from purchase accounting of the
Acquisitions is and will continue to be a substantial portion of the Company's
operating expenses and will increase if the Company consummates other
acquisitions.
The Company is integrating its acquired operations into its existing
operations, which resulted in a restructuring charge of $1.4 million in
September 1998. Management expects that these consolidation activities, which
include a reduction in the size of the Company's workforce and the closing of
certain of the Company's offices, will result in monthly savings to the Company,
although there can be no assurance in this regard.
Other (Income) Expense. Other (income) expense, consisting primarily of
interest expense, increased by $1.6 million from $3.3 million for the three
months ended September 30, 1997 to $4.9 million for the three months ended
September 30, 1998. The increase was primarily due to interest expense
associated with the indebtedness incurred by the Company in connection with the
Acquisitions.
Extraordinary Loss. The Company incurred an extraordinary loss of $4.4 million
in 1997 due to the write-off of the unamortized deferred loan costs and the
unamortized discount related to the senior subordinated notes originally issued
by Canadian Imperial Bank of Commerce ("CIBC"), which were repaid in connection
with the acquisitions of AmeriTel and Talton Telecommunications with the net
proceeds of the June 1997 offering ("Offering") of $115,000,000 principal amount
of 11% Senior Notes due 2007 ("Senior Notes").
-15-
<PAGE>
Net Loss. The Company's net loss increased by $4.4 million, from $2.4 million
for the three months ended September 30, 1997 to $6.8 million for the three
months ended September 30, 1998 as a result of the factors described above.
EBITDA. Earnings before interest, income taxes, depreciation and amortization
("EBITDA") increased by $1.6 million from $4.7 million for the three months
ended September 30, 1997 to $6.3 million for the three months ended September
30, 1998. EBITDA as a percentage of operating revenues decreased from 20.0% for
the three months ended September 30, 1997 to 10.5% for the three months ended
September 30, 1998 due to the factors described above. Without consideration of
the restructuring charge, the Company's EBITDA for the third quarter of 1998
would be $17.7 million, representing 12.7% of revenue. Although EBITDA is not a
measure of performance calculated in accordance with generally accepted
accounting principles, the Company has included information concerning EBITDA in
this Form 10-Q because it is commonly used by certain investors and analysts as
a measure of a company's ability to service its debt obligations and is a
component of the Company's debt compliance ratios. EBITDA should not be used as
an alternative to, or be considered more meaningful than, operating income, net
income or cash flows as an indicator of the Company's operating income. Several
of the Company's subsidiaries are subject to state income taxes. Consequently,
the Company accrues income tax expense even in a loss period.
NINE MONTHS ENDED SEPTEMBER 30, 1998, AS COMPARED TO NINE MONTHS ENDED SEPTEMBER
30, 1997
Operating Revenues. The Company's operating revenues increased by $110.8
million, or 207.4%, from $53.4 million for the nine months ended September 30,
1997 to $164.2 million for the nine months ended September 30, 1998. The
increase in operating revenues was primarily due to acquisitions by the Company
of STC, CCC, Invision, and PTC from July to December in 1997 and ILD, MOG and
Saratoga in 1998. Since its inception the Company has acquired contracts for
1,888 facilities through the Acquisitions and has added additional facilities by
winning new contracts for county, local, and state facilities, including bids
for new contracts in the states of North Carolina, North Dakota, and Alaska. As
of September 30, 1998 the Company served 2,149 correctional facilities in 43
states, of which 50 were private facilities. The Company has been informed that
the State of Alabama would not be renewing its contract with the Company. The
Company estimates that this will result in lower revenue and EBITDA in fiscal
year 1999 of $8.2 million and $1.5 million, respectively, when compared to
fiscal year 1998.
Operating Expenses. Total operating expenses increased by $115.2 million, or
222.8%, from $51.7 million for the nine months ended September 30, 1997 to
$166.9 million for the nine months ended September 30, 1998. Operating expenses
as a percentage of operating revenues increased by 5.0% from 96.7% for the nine
months ended September 30, 1997 to 101.7% for the nine months ended September
30, 1998. The increase in operating expenses as a percentage of revenues is
primarily due to the factors discussed below.
Telecommunication costs increased by $48.4 million, from $21.6 million for the
nine months ended September 30, 1997 to $70.0 million for the nine months ended
September 30, 1998. Telecommunication costs represented 40.4% of operating
revenues for the nine months ended September 30, 1997 and 42.6% of operating
revenues for the nine months ended September 30, 1998, an increase of 2.2%. The
Company's telecommunication costs in its traditional inmate business increased
from 40.4% for the nine months ended September 30, 1997, to 41.3% for the nine
months ended September 30, 1998. The percentage increase is due in part to
higher levels of uncollectible accounts associated with the Company's
acquisitions subsequent to June 30, 1997, which are located in geographic
regions that exhibit higher uncollectible rates. The percentage increase is also
due to increases in CLEC activity. These CLECs increased the Company's
unbillable expense, because in most cases the CLECs are unable to bill the
Company's traffic. The Company is responding to this problem by offering prepaid
services to these customers. The Company's overall telecommunication costs as a
percentage of revenues of 42.6%, includes the effect of its billing and
collection services provided to a major RBOC. These billing and collection
services exhibit higher telecommunication costs as a percentage of revenue than
the Company's traditional inmate business. For further discussion of these
services provided to a major RBOC, please refer to the "Overview" in Item 2.
Facility commissions increased by $37.6 million, from $14.4 million for the
nine months ended September 30, 1997 to $52.0 million for the nine months ended
September 30, 1998. Facility commissions represented 27.0% of operating revenues
for the nine months ended September 30, 1997 and 31.7% of operating revenues for
the nine months ended September 30, 1998, an increase of 4.7%. The increase is
primarily due to higher commission rates for contracts obtained as a result of
the Acquisitions and higher commission rates resulting from competitive bid
situations. The commission rates paid by the Company as a percentage of its
traditional inmate business revenues have increased from 27.0% for the nine
months ended September 30, 1997 to 32.9% for the nine months ended September 30,
1998. This increase was primarily due to increased facility commissions under
contracts obtained by the Company through acquisitions, the competition in
larger facilities, and increased commission rates on renewals. Facility
commissions are expected to gradually increase as a percentage of revenue in the
future. The overall commission percentage to total revenue of 31.7% for the
nine months ended September 30, 1998 includes the effect of the billing and
collection services provided to a major RBOC as discussed in the "Overview" in
Item 2.
Field operations and maintenance costs increased by $3.4 million, from $2.4
million for the nine months ended September 30, 1997 to $5.8 million for the
nine months ended September 30, 1998. Field operations and maintenance costs
represented 4.4% of operating revenues for the nine months ended September 30,
1997 and 3.5% of operating revenues for the nine months ended September 30,
1998, a decrease of 0.9%. The dollar increase is primarily due to costs
associated
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<PAGE>
with servicing the acquired facilities and the new contract facilities. The
Company is integrating the field service and maintenance organizations of its
acquired companies.
SG&A increased by $9.8 million, from $4.5 million for the nine months ended
September 30, 1997 to $14.3 million for the nine months ended September 30,
1998. SG&A represented 8.3% of operating revenues for the nine months ended
September 30, 1997 and 8.7% of operating revenues for the nine months ended
September 30, 1998, an increase of 0.4%. The dollar increase in SG&A is
primarily due to the increased infrastructure necessary to support the
Acquisitions.
Total depreciation and amortization costs increased by $14.6 million, from
$8.9 million for the nine months ended September 30, 1997 to $23.5 million for
the nine months ended September 30, 1998. Depreciation and amortization costs
represented 16.6% of operating revenues for the nine months ended September 30,
1997 and 14.3% of operating revenues for the nine months ended September 30,
1998, a decrease of 2.3%. The dollar increase is primarily due to additional
amortization expense associated with the inmate facility contracts acquired in
the Acquisitions. Amortization resulting from purchase accounting of the
Acquisitions is and will continue to be a substantial portion of the Company's
operating expenses and will increase if the Company consummates other
acquisitions.
The Company is integrating its acquired operations into its existing
operations, which resulted in a restructuring charge of $1.4 million in
September 1998. Management expects that these consolidation activities, which
include a reduction in the size of the Company's workforce and the closing of
certain of the Company's offices, will result in monthly savings to the Company,
although there can be no assurance in this regard.
Other (Income) Expense. Other (income) expense, consisting primarily of
interest expense, increased by $7.3 million from $7.2 million for the nine
months ended September 30, 1997 to $14.5 million for the nine months ended
September 30, 1998. The increase was primarily due to interest expense
associated with the indebtedness incurred in connection with the Acquisitions.
Extraordinary Loss. The Company incurred an extraordinary loss of $4.4 million
in 1997 due to the write-off of the unamortized deferred loan costs and the
unamortized discount related to the senior subordinated notes originally issued
by CIBC, which were repaid in connection with the acquisitions of AmeriTel and
Talton Telecommunications with the net proceeds of the Offering.
Net Loss. The Company's net loss increased by $8.9 million, from $9.2 million
for the nine months ended September 30, 1997 to $18.1 million for the nine
months ended September 30, 1998 as a result of the factors described above.
EBITDA. EBITDA increased by $10.2 million from $10.7 million for the nine
months ended September 30, 1997 to $20.9 million for the nine months ended
September 30, 1998. EBITDA as a percentage of operating revenues decreased from
20.0% for the nine months ended September 30, 1997 to 12.7% for the nine months
ended September 30, 1998 due to the factors described above. Without
consideration of the restructuring charge, the Company's EBITDA for the nine
months ended September 30, 1998 would be $22.3 million, representing 13.6% of
revenue. Although EBITDA is not a measure of performance calculated in
accordance with generally accepted accounting principles, the Company has
included information concerning EBITDA in this Form 10-Q because it is commonly
used by certain investors and analysts as a measure of a company's ability to
service its debt obligation and is a component of the Company's debt compliance
ratios. EBITDA should not be used as an alternative to, or be considered more
meaningful than, operating income, net income or cash flows as an indicator of
the Company's operating income. Several of the Company's subsidiaries are
subject to state income taxes. Consequently, the Company accrues income tax
expense even in a loss period.
LIQUIDITY AND CAPITAL RESOURCES
The Company anticipates that its principal uses of cash will be for capital
expenditures for new contracts, capital expenditures to renew existing
contracts, capital expenditures for alternative network solutions, funding of
working capital requirements, debt service requirements, and repayment of
principal under the Senior Credit Agreement. The Company expects that its
principal sources of funds will be cash flow from operations and borrowings
under the Senior Credit Agreement.
Net cash provided by operating activities was $1.4 million for the nine months
ended September 30, 1998, as compared to $1.0 million provided by operating
activities for the nine months ended September 30, 1997. Net cash
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<PAGE>
provided by operating activities consisted primarily of earnings before
depreciation and amortization offset by working capital requirements associated
with the addition of new inmate facility contracts.
Cash used in investing activities was $18.9 million for the nine months ended
September 30, 1998, as compared to $27.7 million for the nine months ended
September 30, 1997. Net cash used in investing activities consisted primarily of
cash outflows for the Company's acquisitions of MOG, ILD and Saratoga and
additional capital expenditures for new business activities.
Cash provided by financing activities was $11.7 million for the nine months
ended September 30, 1998, as compared to $43.0 million for the nine months ended
September 30, 1997. Net cash provided by financing activities consisted
primarily of borrowings under the Company's Senior Credit Agreement to fund the
MOG, ILD and Saratoga acquisitions and for additional capital expenditures for
new business activities.
As of September 30, 1998, the Company had approximately $180.0 million of
long-term indebtedness outstanding (including the current portion), a deficit in
stockholders' equity of $28.3 million, and $2.1 million of cash.
The Company expects that its principal sources of cash will be cash flow from
operations and borrowings under the revolving portion of the Senior Credit
Agreement. Management expects that cash flow from operations along with
additional borrowings under existing and future credit facilities will be
sufficient to meet the Company's requirements for the next 12 months. The
Company currently anticipates that interest payments of approximately $19.0
million per year through December 31, 2000 will be required under the terms of
the Senior Notes and the Senior Credit Agreement. As of September 30, 1998, the
Company has approximately $11.7 million of unused borrowing capacity under the
Senior Credit Agreement. The Company anticipates that its primary capital
expenditures for the remainder of 1998 will be approximately $3.0 million for
capital items required to implement new contracts entered into by the Company.
As of September 30, 1998, the Company had approximately $180.0 million of
long-term indebtedness outstanding (including the current portion), including
(i) $115.0 million of Senior Notes outstanding at an interest rate of 11.0%,
(ii) $62.8 million of indebtedness from the Senior Credit Agreement and (iii)
$2.2 million of other indebtedness consisting primarily of acquisition costs and
capital leases.
The Company intends to pursue additional acquisitions to expand its base of
installed inmate telephones and consider acquisition opportunities from time to
time. There can be no assurance that the Company will have sufficient available
capital resources to realize its acquisition strategy. Such future acquisitions,
depending on their size and the form of consideration, may require the Company
to seek additional debt or equity financing.
COMPREHENSIVE INCOME
SFAS No. 130, "Reporting Comprehensive Income," became effective as of the
first quarter of 1998. This statement requires companies to report and display
comprehensive income and its components (revenues, expenses, gains and losses).
Comprehensive income includes all changes in equity during a period except those
resulting from investments by owners and distributions to owners. For the
Company, comprehensive income is the same as net loss reported in the statements
of consolidated operations, since there were no other items of comprehensive
income for the periods presented.
CHANGES IN ACCOUNTING STANDARDS
SFAS No. 131, "Disclosures About Segments of an Enterprise and Related
Information," will become effective in 1998. This statement establishes
standards for defining and reporting business segments. The Company is
currently determining its reportable segments. The adoption of SFAS No. 131
will not affect the Company's consolidated financial position, results of
operations or cash flows.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133
requires recognition of all derivative financial instruments as either assets or
liabilities in consolidated balance sheets at fair value and determines the
method(s) of gain/loss recognition. SFAS No. 133 is effective for fiscal years
beginning after June 15, 1999. The Company is currently evaluating the effect
that it may have on the consolidated financial statements.
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<PAGE>
In March 1998, the American Institute of Certified Public Accountants
("AICPA") released Statement of Position ("SOP") No. 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use." SOP 98-1
requires the capitalization of certain expenditures for software that is
purchased or internally developed. SOP No. 98-1 is effective for fiscal years
beginning after December 31, 1999. The Company believes that the adoption of
this SOP will have no material effect on the financial position, results of
operations or cash flows of the Company.
In April 1998, the AICPA released SOP 98-5, "Reporting on the Costs of Start-
Up Activities." SOP 98-5 generally requires costs of start-up activities to be
expensed instead of being capitalized and amortized. SOP 98-5 is effective for
fiscal years beginning after December 31, 1999. The Company expects that the
adoption of this pronouncement will have no material effect on the financial
position, results of operations or cash flows of the Company.
Information Systems and the Year 2000
Some computers, software, and other equipment include computer code in which
calendar year data is abbreviated to only two digits. As a result, some of these
systems will not operate correctly after 1999 because they may interpret "00" to
mean 1900, rather than 2000. These problems are widely expected to increase in
frequency and severity as the year 2000 approaches, and are commonly referred to
as the "Year 2000 Problem."
The Company believes that it has identified all significant computers,
software applications, and related other equipment used in connection with its
internal operations that will require modification to reduce the possibility of
a material disruption to its business from the Year 2000 Problem. Internal
resources and outside consultants are being used to make the required
modifications and test Year 2000 compliance. The Company plans on completing the
testing process of all significant applications by February 1999. This effort
will be made by the Company's internal technical staff and outside consultants.
The Company does not expect to incur material expenses related to this effort.
In addition, the Company does not separately allocate costs associated with the
Year 2000 Problem. These costs are expensed as incurred. The Company has also
commenced the process of modifying, upgrading, and replacing major systems that
have been assessed as adversely affected, and expects to complete this process
before the occurrence of any material disruption of its business. However, there
can be no assurance in this regard.
The Year 2000 Problem also affects some of the Company's customers and major
suppliers of computers, software and other equipment. The Company has discussed
the Year 2000 Problem with some of these customers and suppliers. However, the
Company has limited or no control over the actions of these customers and
suppliers. Accordingly, the Company cannot guarantee that these customers and
suppliers will resolve any or all Year 2000 Problems. If the Company's customers
and suppliers fail to resolve Year 2000 Problems, the Company's business could
be materially disrupted and there could be a material adverse effect on
the business. The Company has not yet formulated a Year 2000 contingency plan.
The discussion of the Company's efforts and management's expectations
relating to Year 2000 compliance constitutes forward-looking statements. The
Company's ability to achieve Year 2000 compliance and the level of incremental
costs associated therewith could be adversely impacted by, among other things,
the availability and cost of programming and testing resources, vendors' ability
to modify proprietary software and unanticipated problems identified in the
ongoing compliance review.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
This item is not applicable to the Registrant.
-19-
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is from time to time a party to legal proceedings that arise in
the ordinary course of business. Management does not believe that the
resolution of any threatened or pending legal proceedings will have a material
adverse affect on the Company.
From time to time, inmate telecommunications providers are parties to
proceedings initiated by consumer protection advocates or individual call
parties alleging that excessive rates are being charged with respect to inmate
collect calls. One such proceeding is currently pending in the United States
District Court in the State of Kentucky. The Company has not been named in the
proceeding; however, the plaintiffs in such proceeding are seeking class action
certification as to all inmate telecommunications providers as defendants, and
all recipients of calls from inmate facilities, as plaintiffs. The proceeding is
in its preliminary stages.
In addition, the Company has received notice from two parties that certain
features of the Company's call processor technology may infringe upon certain
parties' patents.
The Company was unsuccessful in obtaining a Federal Board of Prisons contract
and has appealed the award. There can be no assurances that the Company will be
successful in appealing this award.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
This item is not applicable to the Registrant.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There have been no matters to a vote of the holders of securities of the
Company since the Company became subject to the reporting requirements of the
Securities Exchange Act of 1934, as amended.
ITEM 5. OTHER INFORMATION
None.
-20-
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
<TABLE>
<CAPTION>
Exhibit
No. Description of Exhibit
------- ----------------------
<S> <C>
3.1 Certificate of Incorporation of the Company (filed as Exhibit 3.1 to
the Company's Registration Statement No. 333-33639 and incorporated
herein by reference).
3.2 Bylaws of the Company (filed as Exhibit 3.2 to the Company's
Registration Statement No. 333-33639 and incorporated herein by
reference).
3.3 Certificate of Amendment to Restate Certificate of Incorporation of
the Company (filed as Exhibit 3.3 to the Company's Quarterly Report
on Form 10-Q for the quarter ended June 30, 1998 and incorporated
herein by reference).
10.1* Letter Agreement, dated as of April 17, 1998, between the Company and
Keith S. Kelson.
27.1* Financial Data Schedule.
</TABLE>
- --------
* Filed herewith.
The agreements set forth above described the contents of certain exhibits
thereunto which are not included. However, such exhibits will be furnished to
the Commission upon request.
(b) Reports on Form 8-K
(1) On August 24, 1998, the Company filed a Form 8-K (pursuant to
Item 5 of Form 8-K) in connection with a press release issued
by the Company on July 23, 1998 regarding the Company's name
change to Evercom, Inc. and announcing Donald B. "Sandy"
Vaello as Chief Operating Officer.
-21-
<PAGE>
SIGNATURES
Pursuant to the requirement of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
EVERCOM, INC.
By: /s/ DENNIS L. WHIPPLE
-----------------------
Dennis L. Whipple
Chief Executive Officer
By: /s/ JEFFREY D. CUSHMAN
------------------------
Jeffrey D. Cushman
Chief Financial Officer
Date: November 16, 1998
-22-
<PAGE>
EXHIBIT 10.1
[LETTERHEAD OF TALTON HOLDINGS, INC. APPEARS HERE]
April 17, 1998
Mr. Keith Kelson
6906 Parkridge Blvd.
Suite #319
Irving, TX 75063
Dear Keith
The Board of Directors (Board) has authorized me to offer you the position of
Vice-President of Finance for Talton Holdings, Inc. (THI). This position is a
very important executive officer position that will be responsible for the
financial management and accounting function for our billing division as well as
all activities dealing with THI's SEC reporting. We will identify specific
performance objectives during the first month of your employment.
In addition to the Vice-President of Finance for THI, you will be appointed as
Vice-President, Assistant Secretary, and Assistant Treasurer of THI.
Compensation for this position will consist of salary, bonus and stock options.
The starting salary is $100,000 per year. You will also be eligible to earn an
annual bonus of 40% of salary, based upon attainment of agreed upon personal
objectives and THI attaining its financial objectives. We will guarantee $25,000
of the first year bonus that will be paid no later than January 15th, 1999. When
the Board of Directors approves the THI stock option program in 1998, you will
receive options to acquire 50 shares of THI stock at a price of $2,000 per share
which will vest over a three to five year period in accordance to the plan. The
Board intends to establish a formal stock option program in 1998. In the event
that THI shall cancel your employment for any reason except gross misconduct,
you will receive a severance payment equal to 12 months salary.
You will be eligible to participate in all THI benefit programs and will receive
three weeks vacation as well as all THI holidays. Your start date will be April
27, 1998.
I am excited about you joining the THI team and contributing the success of the
company. Please sign below to indicate your acceptance of this offer.
Sincerely,
/s/ JEFFREY D. CUSHMAN /s/ KEITH KELSON
- ------------------------------ -----------------------------
Jeffrey D. Cushman Keith Kelson
Chief Financial Officer
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 2,112,568
<SECURITIES> 0
<RECEIVABLES> 52,925,433
<ALLOWANCES> (9,138,713)
<INVENTORY> 3,146,085
<CURRENT-ASSETS> 51,179,850
<PP&E> 35,771,934
<DEPRECIATION> (6,526,677)
<TOTAL-ASSETS> 204,477,733
<CURRENT-LIABILITIES> 62,365,960
<BONDS> 169,093,339
0
59
<COMMON> 163
<OTHER-SE> (28,267,868)
<TOTAL-LIABILITY-AND-EQUITY> 204,477,733
<SALES> 164,169,127
<TOTAL-REVENUES> 164,169,127
<CGS> 166,934,298
<TOTAL-COSTS> 166,934,298
<OTHER-EXPENSES> 14,469,570
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 14,668,487
<INCOME-PRETAX> (17,234,741)
<INCOME-TAX> 857,760
<INCOME-CONTINUING> (18,092,501)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (18,092,501)
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
