<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
---------------
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to sections 13 of 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended June 30, 1999
OR
[_] Transition report pursuant to sections 13 of 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 of (I.R.S. Employer
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 June 30, 1999, 16,033 shares of Class A common stock, par value $0.01
per share, 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
PAGE
----
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.............................................. 3
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations...................................... 12
Item 3. Quantitative and Qualitative Disclosures about Market Risk........ 23
PART II - OTHER INFORMATION
Item 1. Legal Proceedings................................................. 24
Item 2. Changes in Securities and Use of Proceeds......................... 24
Item 3. Defaults Upon Senior Securities................................... 24
Item 4. Submission of Matters to a Vote of Stockholders................... 24
Item 5. Other Information................................................. 24
Item 6. Exhibits and Reports on Form 8-K.................................. 25
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<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
EVERCOM, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31, June 30,
1998 1999
---------------- ----------------
(Unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ...................................................... $ 1,691,762 $ 235,034
Accounts receivable ............................................................ 39,070,959 44,807,957
Refundable income taxes ........................................................ 435,593 510,347
Inventories .................................................................... 2,360,280 2,228,671
Prepaid expenses and other current assets ...................................... 392,448 308,640
Deferred income tax asset ...................................................... 1,442,122 1,755,776
---------------- -----------------
Total current assets ........................................................ 45,393,164 49,846,425
PROPERTY AND EQUIPMENT ........................................................... 29,485,944 28,766,291
INTANGIBLE AND OTHER ASSETS ...................................................... 116,586,808 107,364,168
---------------- -----------------
TOTAL ....................................................................... $ 191,465,916 $ 185,976,884
================ =================
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Accounts payable ............................................................... $ 21,856,484 $ 18,330,208
Accrued expenses ............................................................... 23,798,055 23,281,107
Current portion of long-term debt .............................................. 10,607,729 11,012,487
---------------- -----------------
Total current liabilities ................................................... 56,262,268 52,623,802
LONG-TERM DEBT ................................................................... 169,375,000 168,687,499
OTHER LONG-TERM LIABILITIES........................................................ 500,000 1,043,363
DEFERRED INCOME TAXES ............................................................ 1,442,122 1,755,776
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' DEFICIT:
Preferred stock, Senior preferred stock, $.01 par value; 6,000
shares authorized, 5,925 shares issued and outstanding as of
December 31, 1998 (cumulative liquidation value of $5,925,000).
Senior and First Preferred Series A, $.01 par value; 6,000 and
5,000 shares authorized, 5,925 and 5,000 shares issued and
outstanding, respectively (cumulative liquidation value of
$5,925,000 and $5,000,000, respectively) as of June 30, 1999................... 59 109
Common stock, $.01 par value; 50,000 shares authorized, 16,333 shares and
16,433 issued and outstanding as of December 31, 1998 and June 30, 1999,
respectively ................................................................. 163 164
Additional paid-in capital ..................................................... 21,829,562 26,517,417
Accumulated deficit ............................................................ (57,943,258) (64,651,246)
---------------- -----------------
Total stockholders' deficit ................................................. (36,113,474) (38,133,556)
---------------- -----------------
TOTAL ....................................................................... $ 191,465,916 $ 185,976,884
================ =================
</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 Six Month Period
Ended June 30, Ended June 30,
-----------------------------------------------------------------------------------
1998 1999 1998 1999
------------------ ------------------ ------------------ ------------------
<S> <C> <C> <C> <C>
OPERATING REVENUE............................ $ 54,380,134 $ 60,160,064 $ 103,604,748 $ 119,335,358
OPERATING EXPENSES:
Telecommunication costs.................... 23,706,103 26,451,252 43,792,785 53,312,623
Facility commissions....................... 17,571,587 18,085,177 33,344,834 36,112,894
Field operations and maintenance........... 1,714,105 1,705,658 3,746,658 3,343,433
Selling, general, and administrative....... 4,233,741 4,316,684 8,316,569 8,638,538
Depreciation............................... 1,377,480 1,758,398 2,689,675 3,465,392
Amortization of intangibles................ 6,390,631 5,575,332 12,917,064 11,337,457
------------------ ------------------ ------------------ ------------------
Total operating expenses................ 54,993,647 57,892,501 104,807,585 116,210,337
------------------ ------------------ ------------------ ------------------
OPERATING INCOME (LOSS)...................... (613,513) 2,267,563 (1,202,837) 3,125,021
OTHER EXPENSE (INCOME):
Interest expense, net...................... 5,043,547 4,856,603 9,763,635 9,736,767
Other (income), net........................ (12,400) (158,955)
------------------ ------------------ ------------------ ------------------
Total other (income) expense............ 5,031,147 4,856,603 9,604,680 9,736,767
------------------ ------------------ ------------------ ------------------
LOSS BEFORE INCOME TAXES..................... (5,644,660) (2,589,040) (10,807,517) (6,611,746)
INCOME TAX EXPENSE........................... 269,908 82,395 482,596 96,242
------------------ ------------------ ------------------ ------------------
NET LOSS..................................... $ (5,914,568) $ (2,671,435) $ (11,290,113) $ (6,707,988)
PREFERRED STOCK DIVIDENDS AND ACCRETION OF
DISCOUNT................................... 118,500 363,542 237,000 502,472
------------------ ------------------ ------------------ ------------------
NET LOSS APPLICABLE TO COMMON STOCK.......... $ (6,033,068) $ (3,034,977) $ (11,527,113) $ (7,210,460)
================== ================== ================== ==================
</TABLE>
See notes to consolidated financial statements.
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<PAGE>
EVERCOM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Six Month Period
Ended June 30,
--------------------------------
1998 1999
--------------- ---------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss..................................................................................... $ (11,290,113) $ (6,707,988)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation .............................................................................. 2,689,675 3,465,392
Amortization of intangible assets, including deferred financing costs ...................... 13,581,766 11,841,900
Changes in operating assets and liabilities, net of effects of acquisitions:
Accounts receivable ..................................................................... (17,356,798) (5,878,042)
Inventories ............................................................................. (1,205,171) 131,609
Prepaid expenses and other assets ....................................................... 43,202 750,861
Accounts payable ........................................................................ 10,494,733 (3,526,276)
Accrued expenses ........................................................................ 3,607,032 38,242
Income taxes ............................................................................ 878,368 (74,754)
--------------- ---------------
Net cash provided by operating activities .............................................. 1,442,694 40,944
--------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Decrease in restricted cash ................................................................ 1,919,312
Capital expenditures ....................................................................... (6,852,626) (4,007,064)
Cash outflows for acquisitions ............................................................. (8,272,425) (1,766,210)
--------------- ---------------
Net cash used in investing activities .................................................. (13,205,739) (5,773,274)
--------------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from the issuance of debt ......................................................... 9,000,000 5,500,000
Payment of debt issuance costs ............................................................. (336,992)
Repayment of debt .......................................................................... (21,709) (5,782,743)
Payment of preferred dividends ............................................................. (474,000)
Proceeds from the issuance of preferred stock and warrants, net of expenses ................ 4,895,337
--------------- ---------------
Net cash provided by financing activities ............................................. 8,504,291 4,275,602
--------------- ---------------
DECREASE IN CASH AND CASH EQUIVALENTS ...................................................... (3,258,754) (1,456,728)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ............................................. 7,777,996 1,691,762
--------------- ---------------
CASH AND CASH EQUIVALENTS, END OF PERIOD ................................................... $ 4,519,242 $ 235,034
=============== ===============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest .................................................................... $ 8,806,228 $ 9,425,237
=============== ===============
Cash paid for income taxes ................................................................ $ 26,144 $ 170,996
=============== ===============
NONCASH TRANSACTIONS:
Dividends payable ......................................................................... $ 237,000 $ 357,431
=============== ===============
Issuance of debt for acquisition of assets ................................................ $ 950,000 $ --
=============== ===============
Stock issued for acquisition of assets .................................................... $ -- $ 150,000
=============== ===============
</TABLE>
See notes to consolidated financial statements.
-5-
<PAGE>
EVERCOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. CONSOLIDATED FINANCIAL STATEMENTS
The consolidated financial statements as of June 30, 1999 and for the three
and six-month periods ended June 30, 1998 and 1999 of Evercom, Inc. and its
subsidiaries (the "Company") have been prepared by the Company without audit.
As of January 1, 1999, the Company merged five of its wholly owned
subsidiaries (AmeriTel Pay Phones, Inc., Talton Telecommunications Corporation,
Talton Telecommunications of Carolina, Inc., Talton STC, Inc., and MOG
Communications, Inc.) into Talton Invision, Inc., another of the Company's
wholly owned subsidiaries. Concurrent with the merger, the Company amended
Talton Invision, Inc.'s Certificate of Incorporation to continue its existence
as Evercom Systems, Inc.
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 1998 consolidated financial statements contained in its Form 10-K as
filed with the Securities and Exchange Commission on March 29, 1999.
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 December 31, 2000. The Company is currently evaluating the
effect that SFAS No. 133 may have on the consolidated financial statements.
-6-
<PAGE>
2. ACCOUNTS RECEIVABLE
Accounts receivable consist of the following:
<TABLE>
<CAPTION>
December 31, June 30,
1998 1999
------------ ------------
(Unaudited)
<S> <C> <C>
Trade accounts receivable, net of advance payments received of $141,460
and $108,505 at December 31, 1998 and June 30, 1999, respectively............. $ 42,308,582 $ 45,034,871
Advance commissions receivable................................................... 2,020,020 1,486,001
Receivables related to acquisitions.............................................. 141,044 242,173
Recoverable Universal Service Fund fees - current portion........................ 1,089,800 1,255,256
Receivables from joint venture partner........................................... 419,643
Employees and other.............................................................. 329,749 176,052
------------ ------------
46,308,838 48,194,353
Less allowance for unbillable and uncollectible chargebacks...................... (7,237,879) (3,386,396)
------------ ------------
$ 39,070,959 $ 44,807,957
============ ============
</TABLE>
At December 31, 1998 and June 30, 1999, the Company had advanced
commissions to certain inmate facilities of $2,495,558 and $1,694,384
(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, June 30,
1998 1999
------------ ------------
(Unaudited)
<S> <C> <C>
Leasehold improvements........................................................... $ 834,051 $ 859,201
Telephone system equipment....................................................... 33,776,168 36,406,618
Vehicles......................................................................... 431,807 431,807
Office equipment................................................................. 2,419,992 2,510,131
------------ ------------
$ 37,462,018 $ 40,207,757
Less accumulated depreciation.................................................... (7,976,074) (11,441,466)
------------ ------------
$ 29,485,944 $ 28,766,291
============ ============
</TABLE>
-7-
<PAGE>
4. INTANGIBLE AND OTHER ASSETS
Intangible and other assets consist of the following:
<TABLE>
<CAPTION>
December 31, June 30,
1998 1999
------------ ------------
(Unaudited)
<S> <C> <C>
Intangible assets:
Acquired telephone contracts................................................... $ 63,835,844 $ 66,751,375
Noncompete agreements.......................................................... 568,611 568,611
Deferred loan costs............................................................ 8,299,067 8,636,059
Goodwill....................................................................... 84,530,834 84,530,834
Other intangibles.............................................................. 694,493 728,283
------------ ------------
$157,928,849 $161,215,162
Less accumulated amortization................................................... (42,640,007) (54,481,907)
------------ ------------
Total intangible assets.......................................................... 115,288,842 106,733,255
Deposits......................................................................... 400,540 422,530
Recoverable Universal Service Fund fees - noncurrent portion..................... 421,888
Other assets - noncurrent portion of commission advances to facilities........... 475,538 208,383
------------ ------------
$116,586,808 $107,364,168
============ ============
</TABLE>
5. ACCRUED EXPENSES
Accrued expenses consist of the following:
<TABLE>
<CAPTION>
December 31, June 30,
1998 1999
------------ ------------
(Unaudited)
<S> <C> <C>
Facility commissions......................................... $ 8,007,248 $ 7,424,008
Billing and collection fees.................................. 1,804,790 1,940,770
Uncollectible call chargebacks............................... 5,267,345 5,830,421
Accrued acquisition and financing costs...................... 3,941,666 3,029,045
Accrued interest............................................. 218,646 25,733
Accrued excise taxes payable................................. 2,072,856 2,387,749
Accrued dividends on preferred stock......................... 474,000 831,431
Accrued restructure costs.................................... 654,245 243,188
Accrued payroll and bonuses.................................. 778,633 819,114
Other........................................................ 578,626 749,648
------------ ------------
$ 23,798,055 $ 23,281,107
============ ============
</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 that are expected to be charged back to the Company in
future periods.
Restructuring Costs. During 1998, management authorized and committed to a
restructuring plan. The plan provides for the consolidation of certain
operations, including closing a number of office locations, reducing the
workforce by approximately 21 employees and eliminating certain management
positions. Based on the finalization of estimates included within the plan and
the undertaking of certain actions in accordance with the plan, management made
revisions to the original estimates during the fourth quarter of 1998. The
revisions primarily resulted from the final determination of the number of
employees terminated, which resulted in 19 terminations, the unexpected
subletting of certain facilities, and a refinement of expected legal and other
costs.
-8-
<PAGE>
Although certain specific actions of the plan were modified, the overall
restructuring plan is expected to be completed at a total cost of approximately
$200,000 less than the original provision.
Original restructuring reserves were established totaling $1.4 million, of which
$200,000 was reversed in the fourth quarter. Of the adjusted amount, $600,000
was reserved for severance and related costs, $200,000 for the office leases,
and $400,000 for legal and other costs.
<TABLE>
<CAPTION>
Amounts
Charged to Amounts Amounts
Earnings in Incurred in Incurred in
1998 1998 1999
-------------- -------------- --------------
<S> <C> <C> <C>
Severance and related costs........................... $ 614,678 $252,885 $313,315
Leased facilities..................................... 217,902 68,449 75,271
Legal and other costs................................. 379,685 236,685 22,472
---------- -------- --------
$1,212,265 $558,019 $411,058
========== ======== ========
</TABLE>
6. LONG-TERM DEBT
The following is a summary of long-term debt:
<TABLE>
<CAPTION>
December 31, June 30,
1998 1999
------------ ------------
(Unaudited)
<S> <C> <C>
Senior Notes........................................................... $115,000,000 $115,000,000
Senior Credit Facility:
Revolving loan facility............................................ 14,500,000 14,500,000
Term loan acquisition facility..................................... 49,500,000 44,687,500
Additional term loan facility...................................... 5,500,000
Note payable, with interest of 8.0%, due at maturity on
February 19, 1999 and subordinate to borrowings under
the Senior Notes and Senior Credit Facility........................ 950,000
Other.................................................................. 32,729 12,486
------------ ------------
179,982,729 179,699,986
Less current portion of long-term debt................................. (10,607,729) (11,012,487)
------------ ------------
$169,375,000 $168,687,499
============ ============
</TABLE>
In March 1999, the Company amended its revolving and term loan agreement (the
"Senior Credit Facility"), as discussed further in footnote 7. Under the terms
of the Senior Credit Facility, the term loan acquisition facility is due in
quarterly installments of $2,406,250, 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. The additional term loan facility is due on December 31,
2002.
-9-
<PAGE>
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 Senior Credit Facility. At June 30, 1999, 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, up to the aggregate notional amount, at 7.5%, plus the
applicable LIBOR margin.
7. EQUITY OFFERING AND SENIOR CREDIT FACILITY AMENDMENT
In March 1999 the Company raised $5.0 million of equity from its existing
stockholders and warrant holders and/or their affiliates through the issuance of
5,000 investment units at $1,000 per unit. Each unit consists of one share of
newly authorized First Preferred Series A Stock and a warrant to acquire one
share of the Company's Class A common stock for $1,000 per share. The warrants
will expire if not exercised before December 31, 2007. In determining the value
of the First Preferred Series A Stock and the warrants, the net proceeds were
allocated based on their relative fair values.
The First Preferred Series A Stock is entitled to receive dividends at the
applicable First Preferred Series A Rate, payable quarterly commencing on April
1, 1999. Dividends are payable out of funds legally available therefore, will be
payable only when, as, and if declared by the Company's Board of Directors,
shall be cumulative, and, if undeclared or unpaid, shall bear interest at the
applicable First Preferred Series A Rate until paid. The First Preferred Series
A Rate is eight percent per annum through March 31, 2001, will be ten percent
per annum from April 1, 2001 through June 30, 2001, and thereafter will increase
by 0.5% for each additional three month period, up to a maximum of 16% per
annum. The First Preferred Series A Stock ranks senior to all classes of common
stock but ranks junior to the Company's Senior Preferred Stock (the "Senior
Preferred Stock") with respect to dividend rights and rights upon liquidation.
In conjunction with the March 1999 equity offering, the preferred dividend rates
on the Senior Preferred Stock were modified to mirror the preferred dividend
rates on the First Preferred Series A Stock.
As a result of the issuance of the First Preferred Series A Stock and warrants
discussed above, the Company was required to obtain a waiver from its Senior
Credit Facility group of lenders that waived the lenders' rights to the proceeds
raised by the Company from the issuance.
Also in March 1999, and in conjunction with the issuance of the First Preferred
Series A Stock and warrants, the Company amended its Senior Credit Facility.
The Senior Credit Facility, as amended in March 1999, includes a $55.0 million
term loan acquisition facility, a $5.5 million additional term loan facility,
and a $25.0 million revolving loan facility (which includes a $5.0 million
letter of credit facility). The Company borrowed the additional $5.5 million in
March 1999 and concurrently repaid $5.0 million under the revolving loan
facility of the Senior Credit Facility. Scheduled principal payments under the
term loan facilities may not be reborrowed. Under the terms of the Senior Credit
Facility, the term loan acquisition facility is amortized on a quarterly basis
over five years beginning September 30, 1998, the additional term loan facility
matures on December 31, 2002, and the revolving loan facility expires on
December 31, 2002.
Amounts borrowed under the additional term loan facility bear interest, at the
option of the Company, at either (i) the Base Rate (as defined in the Senior
Credit Facility) plus 250 basis points or (ii) LIBOR plus 350 basis points
through the remainder of 1999.
-10-
<PAGE>
8. ACQUISITION
Effective June 1, 1999, the Company entered into an agreement to purchase
substantially all of the net assets of the inmate payphone divisions of Alliance
Tel-Com, Inc., KR&K Communications, Inc., U.S. Connect, Inc., Tele-
Communications, Inc., and Lake-Tel, Inc. (collectively, "Alliance"), which are
all part of an affiliated group of companies. The purchase price consisted of
100 shares of the Company's common stock, a contingent payment of up to an
additional 440 shares of the Company's common stock if certain financial
objectives are met, assumption of $275,000 of liabilities, and a cash payment of
$10.
-11-
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis of the Company's financial condition
and results of operations should be read in conjunction with the financial
statements and the notes thereto contained elsewhere in this report. Certain
information contained in the discussion and analysis set forth below includes
forward-looking statements that involve risks and uncertainties. See "Special
Note Regarding Forward-Looking Information; Risk Factors."
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 U.S. The Company derives substantially all of its revenues from its
operation of inmate telecommunications systems located in correctional
facilities in approximately 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 three to five years) with 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. Typically, the Company installs and
retains ownership of the telephones and related 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. In May 1998, the
Company began providing validation, billing, and collection services for the
inmate calls of a major regional bell operating company ("RBOC"), and began
processing call traffic under the contract. Under the terms of the agreement,
the Company acquires at a discount the related accounts receivable from the RBOC
for the calls that the Company processes. When the receivables are purchased,
the Company accepts responsibility for all validation, 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 discounted
accounts receivable. Because the Company's revenues associated with this
contract represent only a percentage of the face value of the receivables
purchased, the associated uncollectible account expense and billing and
collection fees represent a much higher percentage of revenue as compared to the
Company's traditional inmate business. Consequently, the Company's
telecommunications costs represent a higher percentage of revenue under this
contract. There are minimal selling, general, and administrative ("SG&A") costs
associated with this contract. The contract term is three years and has no
minimum volume commitment. The Company pays no facility commissions under this
agreement.
In July of 1999, the Company began providing validation, billing and collection
services for the inmate calls of an additional RBOC.
-12-
<PAGE>
The Company's principal operating expenses consists of (i) telecommunication
costs; (ii) commissions paid to correctional facilities, which are typically
expressed 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) SG&A costs.
Telecommunications 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").
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, 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 rather than when using other
billing services 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 facilities. Commission rates are the
principal basis of competition for obtaining and retaining contracts. The
Company's ability to offer attractive commission rates to facilities depends on
its ability to control its operating expenses. Generally, contracts for larger
facilities have higher commission rates, but these higher commission rates are
typically offset as a percentage of revenue by lower network charges, field
maintenance, and SG&A expenses. The commission rates paid by the Company have
increased from 23.8% in 1995 to 30.1% for the three months ended June 30, 1999.
This is due primarily to higher facility commissions on contracts obtained by
the Company through acquisitions, competition for larger facilities, and
increased commission rates on renewals. Commission rates are expected to
gradually increase as a percentage of revenues in the future. The overall
commission percentage to total revenues of 30.1% for the three months ended June
30, 1999 includes the effect of the validation, 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 expenses consist of corporate
overhead and selling expenses. These costs are also relatively small and more
constant components of operating expenses.
Effective December 1, 1996, the Company became the holding company for the
operations of AmeriTel Pay Phones, Inc. and Talton Telecommunications
Corporation and its subsidiary. The Company also acquired the operations of
Tri-T, Inc. on April 4, 1997, Security Telecom Corporation on June 27, 1997,
Correctional Communications Corporation on July 31, 1997, the inmate payphone
division of Communications Central, Inc. on October 6, 1997, the inmate payphone
division of North American InTeleCom on December 1, 1997, the inmate payphone
division of Peoples Telephone Company on December 19, 1997, the inmate payphone
division of ILD Teleservices, Inc. ("ILD") on January 1, 1998, MOG
Communications, Inc. ("MOG") on February 1, 1998, Saratoga Telephone Company,
Inc. ("Saratoga") on July 1, 1998, and Alliance as of June 1, 1999
(collectively, the "Acquisitions").
-13-
<PAGE>
Results of Operations
The following table sets forth, for the three months and six months ended June
30, 1998 and 1999, respectively, the results of operations of the Company.
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
------------------------------------- ---------------------------------------
1998 1999 1998 1999
------------------ ----------------- ------------------- ------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
(Dollars in thousands)
Operating revenue.................... $ 54,380 100.0% $ 60,160 100.0% $103,605 100.0% $119,335 100.0%
Operating expenses:
Telecommunication costs........... 23,706 43.6 26,451 44.0 43,793 42.3 53,313 44.7
Facility commissions.............. 17,572 32.3 18,085 30.1 33,345 32.2 36,113 30.3
Field operations & maintenance.... 1,714 3.1 1,706 2.8 3,747 3.6 3,343 2.8
Selling, general &
administrative................... 4,234 7.8 4,317 7.2 8,316 8.0 8,639 7.2
Depreciation...................... 1,377 2.5 1,758 2.9 2,690 2.6 3,465 2.9
Amortization of intangibles....... 6,391 11.8 5,575 9.3 12,917 12.5 11,337 9.5
-------- ------ -------- ------ -------- ------ -------- ------
Total operating expenses....... 54,994 101.1 57,892 96.2 104,808 101.2 116,210 97.4
-------- ------ -------- ------ -------- ------ -------- ------
Operating income (loss).............. (614) (1.1) 2,268 3.8 (1,203) (1.2) 3,125 2.6
Other (income) expense:
Interest expense, net............ 5,043 9.3 4,857 8.1 9,764 9.4 9,737 8.1
Other, net....................... (12) 0.0 - 0.0 (159) (0.1) - 0.0
-------- ------ -------- ------ -------- ------ -------- ------
Total other (income) expense......... 5,031 9.3 4,857 8.1 9,605 9.3 9,737 8.1
-------- ------ -------- ------ -------- ------ -------- ------
Loss before income taxes............. (5,645) (10.4) (2,589) (4.3) (10,808) (10.5) (6,612) (5.5)
Income tax expense................... 270 0.5 82 0.1 483 0.4 96 0.1
-------- ------ -------- ------ -------- ------ -------- ------
Net loss............................. $ (5,915) (10.9)% $ (2,671) (4.4)% $(11,291) (10.9)% $ (6,708) (5.6)%
======== ====== ======== ====== ======== ====== ======== ======
EBITDA............................... $ 7,166 13.2% $ 9,601 16.0% $ 14,563 14.1% $ 17,927 15.0%
======== ====== ======== ====== ======== ====== ======== ======
</TABLE>
Three Months Ended June 30, 1999 Compared to Three Months Ended June 30, 1998
Operating Revenues. The Company's operating revenues increased by $5.8
million, or 10.7%, from $54.4 million for the three months ended June 30, 1998
to $60.2 million for the three months ended June 30, 1999. The increase in
operating revenues was primarily due to the validation, billing and collection
services for the inmate calls of a major RBOC, the acquisition by the Company of
Saratoga in the third quarter of 1998, and new contract installations.
Operating Expenses. Total operating expenses increased $2.9 million, from
$55.0 million for the three months ended June 30, 1998 to $57.9 million for the
three months ended June 30, 1999. Operating expenses as a percentage of
operating revenues decreased 4.9% from 101.1% for the three months ended June
30, 1998 to 96.2% for the three months ended June 30, 1999. The decrease in
operating expenses as a percentage of revenues is primarily due to the factors
discussed below.
-14-
<PAGE>
Telecommunication costs increased by $2.8 million, from $23.7 million for the
three months ended June 30, 1998 to $26.5 million for the three months ended
June 30, 1999. Telecommunication costs represented 43.6% of operating revenues
for the three months ended June 30, 1998 and 44.0% of operating revenues for the
three months ended June 30, 1999. The dollar increase is primarily due to the
Company's acquisition of Saratoga, new contract installations, and new billing
services provided to a major RBOC commencing in May 1998. Telecommunication
costs as a percentage of revenue increased due to (i) the growth in the billing
services business that has a larger component of telecommunication costs as a
percentage of revenue than the Company's traditional inmate business, as further
explained in the "Overview" and (ii) higher uncollectible accounts caused by the
Company's acquisition and consolidation activities. These higher uncollectibles
were a result of some of the Company's systems not being fully integrated until
May 1999. The increase in telecommunication costs as a percentage of revenue was
partially offset by network savings resulting from new contracts with long
distance carriers.
Facility commissions increased by $0.5 million, from $17.6 million for the
three months ended June 30, 1998 to $18.1 million for the three months ended
June 30, 1999. Facility commissions represented 32.3% of operating revenues for
the three months ended June 30, 1998 and 30.1% of operating revenues for the
three months ended June 30, 1999, a decrease of 2.2%. The decrease as a
percentage of operating revenues is primarily due to the effect of the new
billing services provided to a major RBOC, as further explained in the
"Overview." Commission expense as a percentage of revenue for the Company's
traditional inmate business was 32.3% and 33.7% for the three months ended June
30, 1998 and 1999, respectively. Commission rates are expected to gradually
increase in the future.
Field operations and maintenance costs were $1.7 million for the three
months ended June 30, 1998 and 1999, respectively. Field operations and
maintenance costs represented 3.1% of operating revenues for the three months
ended June 30, 1998 and 2.8% of operating revenues for the three months ended
June 30, 1999, a decrease of 0.3%. The decrease as a percentage of operating
revenues is primarily due to the savings associated with the consolidation of
the Company's operations during 1998.
SG&A costs increased by $0.1 million, from $4.2 million for the three
months ended June 30, 1998 to $4.3 million for the three months ended June 30,
1999. SG&A represented 7.8% of operating revenues for the three months ended
June 30, 1998 and 7.2% of operating revenues for the three months ended June 30,
1999, a decrease of 0.6%. The decrease in SG&A as a percentage of operating
revenues is primarily due to the consolidation of the Company's operations
during 1998.
Depreciation and amortization costs decreased by $0.5 million, from $7.8
million for the three months ended June 30, 1998 to $7.3 million for the three
months ended June 30, 1999. Depreciation and amortization costs represented
14.3% of operating revenues for the three months ended June 30, 1998 and 12.2%
of operating revenues for the three months ended June 30, 1999, a decrease of
2.1%. The decrease as a percentage of operating revenues is primarily due to
amortization expense associated with the acquisitions of inmate facility
contracts by the Company. The Company amortizes acquired inmate facility
contracts over each contract's remaining term at the acquisition date. As the
contract terms expire, the acquired inmate facility contracts become fully
amortized and amortization expense declines.
Operating Income (Loss). The Company's operating income increased by $2.9
million, from a loss of $0.6 million for the three months ended June 30, 1998 to
operating income of $2.3 million for the three months ended June 30, 1999,
substantially due to the decrease in amortization of intangibles and the other
factors described above. The Company's operating income margin increased from a
negative operating margin of 1.1% for the three months ended June 30, 1998 to a
positive operating margin of 3.8% for the three months ended June 30, 1999,
primarily as a result of the factors described above.
Other (Income) Expense. Other (income) expense, consisting primarily of
interest expense, decreased by $0.1 million from $5.0 million for the three
months ended June 30, 1998 to $4.9 million for the three months ended June 30,
1999. The decrease was primarily due to lower interest expense associated with
indebtedness incurred by the Company in connection with the Acquisitions.
Net Loss. The Company's net loss decreased by $3.2 million, from $5.9
million for the three months ended June 30, 1998 to $2.7 million for the three
months ended June 30, 1999, primarily as a result of the factors described
above.
EBITDA. Earnings before interest, taxes, depreciation, and amortization
("EBITDA") increased by $2.4 million from $7.2 million for the three months
ended June 30, 1998 to $9.6 million for the three months ended
-15-
<PAGE>
June 30, 1999. EBITDA as a percentage of operating revenues increased from 13.2%
for the three months ended June 30, 1998 to 16.0% for the three months ended
June 30, 1999, primarily due to the factors described above. 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. Two of
the Company's subsidiaries are subject to state income taxes. Consequently, the
Company accrues income tax expense even in a loss period.
Six Months Ended June 30, 1999 Compared to Six Months Ended June 30, 1998
Operating Revenues. The Company's operating revenues increased by $15.7
million, or 15.2%, from $103.6 million for the six months ended June 30, 1998 to
$119.3 million for the six months ended June 30, 1999. The increase in operating
revenues was primarily due to the validation, billing and collection services
for the inmate calls of a major RBOC, the acquisition by the Company of MOG and
Saratoga in the first quarter and third quarter of 1998, respectively, and new
contract installations.
Operating Expenses. Total operating expenses increased $11.4 million, from
$104.8 million for the six months ended June 30, 1998 to $116.2 million for the
six months ended June 30, 1999. Operating expenses as a percentage of operating
revenues decreased 3.8% from 101.2% for the six months ended June 30, 1998 to
97.4% for the six months ended June 30, 1999. The decrease in operating expenses
as a percentage of revenues is primarily due to the factors discussed below.
Telecommunication costs increased by $9.5 million, from $43.8 million for
the six months ended June 30, 1998 to $53.3 million for the six months ended
June 30, 1999. Telecommunication costs represented 42.3% of operating revenues
for the six months ended June 30, 1998 and 44.7% of operating revenues for the
six months ended June 30, 1999. The dollar increase is primarily due to the
Company's acquisition of MOG and Saratoga, new contract installations, and new
billing services provided to a major RBOC commencing in May 1998.
Telecommunication costs as a percentage of revenue increased due to the growth
in the billing services business that has a larger component of
telecommunication costs as a percentage of revenue than the Company's
traditional inmate business, as further explained in the "Overview." The
increase was also due to (i) higher uncollectible accounts caused by the
Company's acquisition and consolidation activities and (ii) an increase in
competitive local exchange carrier ("CLEC") activity. In most cases CLECs are
unable to bill the Company's traffic, which limits the Company's ability to
collect receivables from CLEC customers. The Company is responding to this
problem by offering prepaid services to these customers. The increase in
telecommunication costs as a percentage of revenue was partially offset by
network savings resulting from new contracts with long distance carriers.
Facility commissions increased by $2.8 million, from $33.3 million for the
six months ended June 30, 1998 to $36.1 million for the six months ended June
30, 1999. Facility commissions represented 32.2% of operating revenues for the
six months ended June 30, 1998 and 30.3% of operating revenues for the six
months ended June 30, 1999, a decrease of 1.9%. The decrease as a percentage of
operating revenues is primarily due to the effect of the new billing services
provided to a major RBOC, as further explained in the "Overview." Commission
expense as a percentage of revenue for the Company's traditional inmate business
was 32.2% and 33.8% for the six months ended June 30, 1998 and 1999,
respectively. Commission rates are expected to gradually increase in the future.
-16-
<PAGE>
Field operations and maintenance costs decreased by $0.4 million, from $3.7
million for the six months ended June 30, 1998 to $3.3 million for the six
months ended June 30, 1999. Field operations and maintenance costs represented
3.6% of operating revenues for the six months ended June 30, 1998 and 2.8% of
operating revenues for the six months ended June 30, 1999, a decrease of 0.8%.
The decrease as a percentage of operating revenues is primarily due to the
savings associated with the consolidation of the Company's operations during
1998.
SG&A costs increased by $0.3 million, from $8.3 million for the six months
ended June 30, 1998 to $8.6 million for the six months ended June 30, 1999. SG&A
represented 8.0% of operating revenues for the six months ended June 30, 1998
and 7.2% of operating revenues for the six months ended June 30, 1999, a
decrease of 0.8%. The decrease in SG&A as a percentage of operating revenues is
primarily due to the consolidation of the Company's operations during 1998.
Depreciation and amortization costs decreased by $0.8 million, from $15.6
million for the six months ended June 30, 1998 to $14.8 million for the six
months ended June 30, 1999. Depreciation and amortization costs represented
15.1% of operating revenues for the six months ended June 30, 1998 and 12.4% of
operating revenues for the six months ended June 30, 1999, a decrease of 2.7%.
The decrease as a percentage of operating revenues is primarily due to
amortization expense associated with the acquisitions of inmate facility
contracts by the Company. The Company amortizes acquired inmate facility
contracts over each contract's remaining term at the acquisition date. As the
contract terms expire, the acquired inmate facility contracts become fully
amortized and amortization expense declines.
Operating Income (Loss). The Company's operating income increased by $4.3
million, from a loss of $1.2 million for the six months ended June 30, 1998 to
operating income of $3.1 million for the six months ended June 30, 1999,
substantially due to the decrease in amortization of intangibles and the other
factors described above. The Company's operating income margin increased from a
negative operating margin of 1.2% for the six months ended June 30, 1998 to a
positive operating margin of 2.6% for the six months ended June 30, 1999,
primarily as a result of the factors described above.
Other (Income) Expense. Other (income) expense, consisting primarily of
interest expense, increased by $0.1 million from $9.6 million for the six months
ended June 30, 1998 to $9.7 million for the six months ended June 30, 1999.
Net Loss. The Company's net loss decreased by $4.6 million, from $11.3
million for the six months ended June 30, 1998 to $6.7 million for the six
months ended June 30, 1999, primarily as a result of the factors described
above.
EBITDA. EBITDA increased by $3.3 million from $14.6 million for the six
months ended June 30, 1998 to $17.9 million for the six months ended June 30,
1999. EBITDA as a percentage of operating revenues increased from 14.1% for the
six months ended June 30, 1998 to 15.0% for the six months ended June 30, 1999,
primarily due to the factors described above. 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. Two of the Company's
subsidiaries are subject to state income taxes. Consequently, the Company
accrues income tax expense even in a loss period.
-17-
<PAGE>
Liquidity and Capital Resources
The Company expects that its principal sources of liquidity will be cash
flow from operations and borrowings under the revolving loan facility of the
Senior Credit Facility. The Company anticipates that its principal uses of
liquidity will be to provide working capital and meet debt service requirements.
Management expects that cash flow from operations, along with additional
borrowings under existing credit facilities, will be sufficient to meet the
Company's operating requirements for the next twelve months. The Company
currently anticipates that interest payments of approximately $18.5 million and
$18.0 million for each of the fiscal years ending December 31, 1999 and
December 31, 2000 respectively, will be required under the terms of the Senior
Notes and the Senior Credit Facility. As of June 30, 1999, the Company had
approximately $9.0 million of unused borrowing capacity under the Senior Credit
Facility. The Company anticipates that its primary capital expenditures for the
remainder of 1999 will be approximately $5.7 million for capital items required
to implement new contracts and contract renewals entered into by the Company.
In March 1999 the Company raised $5.0 million of equity from its existing
stockholders and warrant holders and/or their affiliates through the issuance of
5,000 investment units at $1,000 per unit. Each unit consists of one share of
newly authorized First Preferred Series A Stock and a warrant to acquire one
share of the Company's Class A common stock for $1,000 per share.
The First Preferred Series A Stock is entitled to receive dividends at the
applicable First Preferred Series A Rate, payable quarterly commencing on April
1, 1999. Dividends are payable out of funds legally available therefore, will be
payable only when, as, and if declared by the Company's Board of Directors,
shall be cumulative, and, if undeclared or unpaid, shall bear interest at the
applicable First Preferred Series A Rate until paid. The First Preferred Series
A Rate is eight percent per annum through March 31, 2001, will be ten percent
per annum from April 1, 2001 through June 30, 2001, and thereafter will increase
by 0.5% for each additional three month period, up to a maximum of 16% per
annum. The First Preferred Series A Stock ranks senior to all classes of common
stock but ranks junior to the Senior Preferred Stock with respect to dividend
rights and rights upon liquidation. The warrants have a strike price of $1,000
per share and will expire if not exercised before December 31, 2007. As a result
of the issuance of the First Preferred Series A Stock and warrants, the Company
was required to obtain a waiver from its Senior Credit Facility group of lenders
that waived the lenders' rights to the proceeds raised by the Company from the
issuance.
In conjunction with the March 1999 equity offering, the preferred dividend
rates on the Senior Preferred Stock were modified to mirror the preferred
dividend rates on the First Preferred Series A Stock.
Also in March 1999, and in conjunction with the issuance of the First
Preferred Series A Stock and warrants, the Company amended its Senior Credit
Facility. The amendment increased the Company's borrowing capacity under the
term loan facility of the Senior Credit Facility by $5.5 million, which bears
interest at similar rates to the existing borrowings under the Senior Credit
Facility. The Company borrowed the additional $5.5 million in March 1999 and
concurrently repaid $5.0 million under the revolving loan facility of the Senior
Credit Facility.
Net cash provided by operating activities was $40,944 for the six months
ended June 30, 1999, as compared to $1.4 million for the six months ended June
30, 1998. Cash flows from the Company's operations were affected by the change
in operating assets and liabilities, primarily due to the timing of receivables
collections, establishment of reserves by the Company's LECs and the timing of
vendor payments.
-18-
<PAGE>
Cash used in investing activities was $5.8 million for the six months ended
June 30, 1999, as compared to $13.2 million for the six months ended June 30,
1998, consisting primarily of both cash outflows for investments in new business
and customer contract renewals and the payment of $1.8 million of acquisition
costs relating to the acquisitions made by the Company in 1997 and 1998.
Cash provided by financing activities was $4.3 million for the six months
ended June 30, 1999, as compared to $8.5 million for the six months ended June
30, 1998, consisting primarily of $5.0 million of new equity, $5.5 million of
new borrowings under the Senior Credit Facility, and offset by repayments of
principal under the Senior Credit Facility and repayment of a $0.9 million note
relating to the acquisition of MOG.
The Senior Credit Facility consists of (a) a $55.0 million term loan
acquisition facility, (b) a $5.5 million additional term loan facility, and (c)
a $25.0 million revolving loan facility (which includes a $5.0 million letter of
credit facility). Scheduled principal payments under the term loan facilities
may not be reborrowed. Amounts borrowed under the Senior Credit Facility bear
interest, at the option of the Company, at either (i) the Base Rate (i.e., the
higher of Canadian Imperial Bank of Commerce's ("CIBC") reference rate or the
overnight federal funds rate plus 0.5%) plus a margin that varies from 75 to 225
basis points, depending on the Company's Total Debt to EBITDA Ratio (as defined
in the Senior Credit Facility); or (ii) the LIBOR plus a margin that varies from
200 to 350 basis points, depending on the Company's Total Debt to EBITDA Ratio.
The Senior Credit Facility requires quarterly interest payments to be made
on base rate loans and periodic interest-only payments based on the applicable
interest period on LIBOR loans, at least quarterly, in each case until maturity.
In addition, the Senior Credit Facility requires mandatory prepayments out of
the proceeds of certain equity or debt offerings, asset dispositions, receipt of
insurance proceeds not applied as provided in the Senior Credit Facility, and
receipts of funds from certain escrow accounts. Remaining scheduled principal
payments on the term loan facility are approximately $4.8 million, $12.4
million, $13.8 million, and $19.3 million during the years ended 1999, 2000,
2001, and 2002, respectively. All outstanding principal and interest under the
Senior Credit Facility is due December 31, 2002. The Senior Credit Facility is
secured by substantially all the assets of the Company and its subsidiaries.
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 Senior Credit Facility. At June 30, 1999, the interest rate
cap has an aggregate notional amount of $30.0 million, which matures in June
2001, and caps interest on the LIBOR portion of the term loan, up to the
aggregate notional amount, at 7.5%, plus the applicable LIBOR margin.
As of December 31, 1998 and June 30, 1999, the Company had outstanding
letters of credit of $2.8 million and $1.5 million, respectively, to certain
states for performance bonds related to inmate contracts.
As of June 30, 1999, the Company had approximately $180.7 million of
indebtedness outstanding, including the current portion, a deficit in
stockholders' equity of $38.1 million, and $0.2 million of cash.
As of June 30, 1999, the Company's indebtedness included (i) $115.0 million
of 11.0% Senior Notes due 2007 (the "Senior Notes"), (ii) $64.7 million of
indebtedness under the Senior Credit Facility, and (iii) $1.0 million of other
indebtedness.
As of August 6, 1999, the Company had $9.0 million of available borrowing
capacity under the Senior Credit Facility.
The Company intends to evaluate additional acquisitions to expand its base
of installed inmate telephones and value added services and will continue to
evaluate possible acquisition opportunities. There can be no assurance that the
Company will have sufficient available capital resources to realize its
acquisition strategy.
-19-
<PAGE>
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
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 December 31, 2000. The Company is currently evaluating the
effect that SFAS No. 133 may have on the consolidated financial statements.
Information Systems and the Year 2000
The following statements and all other statements made in this Quarterly
Report on Form 10-Q with respect to the Company's Year 2000 processing
capabilities or readiness are "Year 2000 Readiness Disclosures" in conformance
with the Year 2000 Information and Readiness Disclosure Act of 1998 (Public Law
105-271, 112 Stat. 2386).
Some computers, software, and other equipment include computer code in
which calendar year data is abbreviated to only two digits. As a result of this
design decision, some of these systems could fail to operate or fail to produce
correct results if "00" is interpreted 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."
Assessment. The Year 2000 Problem affects computers, software, and other
equipment used, operated, or maintained by the Company. Accordingly, the Company
has organized a program team comprised of internal and external staff
responsible for monitoring the assessment and remediation status of the
Company's Year 2000 projects and reporting such status to the Company's Senior
Management. This project team has assessed the potential effect of, and costs of
remediating, the Year 2000 Problem for the Company's internal systems.
For reporting purposes, the Company is using a methodology involving the
following six phases: Discovery, Assessment, Planning, Remediation, Testing, and
Implementation. At June 30, 1999, the Discovery, Assessment, Planning,
Remediation, and Testing phases were substantially complete for all program
areas. The target completion date for the remaining priority item, except for
Law Enforcement Management System ("LEMS") II, is as follows: Implementation -
August 1999. LEMS II target completion date is September 15, 1999.
Internal Infrastructure. The Company believes that it has identified most
of the major computers, software applications, and related other equipment used
in connection with its internal operations that must be modified, upgraded, or
replaced in order to minimize the possibility of a material disruption to its
business from the Year 2000 Problem. The Company has commenced the process of
modifying, upgrading, and replacing major systems that have been assessed as
adversely affected, and expects to complete this process
-20-
<PAGE>
before the occurrence of any material disruption of its business. However, there
can be no assurance in this regard.
Systems Other than Information Technology Systems. In addition to computers
and related systems, the operation of office and facilities equipment, such as
fax machines, photocopiers, telephone switches, security systems, elevators, and
other common devices may be affected by the Year 2000 Problem. The Company is
currently assessing the potential effect of, and costs of remediating, the Year
2000 compliance on its office and facilities equipment.
The Company estimates the total cost to the Company of completing any
required modifications, upgrades, or replacements of these internal systems to
be approximately $0.6 million, almost all of which the Company believes will be
incurred during 1999. This estimate is being monitored and will be revised as
additional information becomes available.
Based on the activities described above, the Company does not believe that
the Year 2000 Problem will have a material adverse effect on the Company's
business or results of operations. In addition, the Company has not deferred any
material information technology projects as a result of its Year 2000 Problem
activities.
Customers and Suppliers. The Company has initiated communications with its
customers and third party suppliers of the major computers, software, and other
equipment used, operated, or maintained by the Company to identify and, to the
extent possible, resolve issues involving the Year 2000 Problem. However, the
Company has limited or no control over the actions of these customers and third
party suppliers. Thus, while the Company expects that it will be able to resolve
any significant Year 2000 Problems with these systems, there can be no assurance
that these customers and suppliers will resolve any or all Year 2000 Problems
with these systems before the occurrence of a material disruption to the
business of the Company or any of its clients. Any failure of these third
parties to timely resolve Year 2000 Problems with their systems could have a
material adverse effect on the Company's business, financial condition, and
results of operations.
Most Likely Consequences of Year 2000 Problem. The Company expects to
identify and resolve all Year 2000 Problems that could have a material adverse
effect on its business operations. However, management believes that it is not
possible to determine with complete certainty that all Year 2000 Problems
affecting the Company or its clients have been identified or corrected. The
number of devices that could be affected and the interactions among these
devices are simply too numerous. In addition, no one can accurately predict how
many Year 2000 Problem-related failures will occur or the severity, duration, or
financial consequences of these perhaps inevitable failures. As a result,
management believes that the following consequences are possible:
- a significant number of operational inconveniences and
inefficiencies for the Company and its clients that will divert
management's time and attention and financial and human resources
from ordinary business activities;
- a lesser number of serious systems failures that will require
significant efforts by the Company or its clients to prevent or
alleviate material business disruptions;
- several routine business disputes and claims for pricing
adjustments or penalties by clients due to Year 2000 Problems,
which will be resolved in the ordinary course of business; and
- a few serious business disputes alleging that the Company failed
to comply with the terms of contracts or industry standards of
performance, some of which could result in litigation or contract
termination.
-21-
<PAGE>
Contingency Plans. The Company is currently developing contingency plans to
be implemented if its efforts to identify and correct Year 2000 Problems
affecting its internal systems are not effective. Depending on the systems
affected, these plans could include accelerated replacement of affected
equipment or software; short - to medium- term use of backup sites, equipment,
and software; increased work hours for Company personnel; use of contract
personnel to correct on an accelerated schedule any Year 2000 Problems that
arise or to provide manual workarounds for information systems; and other
similar approaches. If the Company is required to implement any of these
contingency plans, it could have a material adverse effect on the Company's
financial condition and results of operations.
Disclaimer. The discussion of the Company's efforts, and management's
expectations, relating to Year 2000 compliance are 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.
Special Note Regarding Forward-Looking Information; Risk Factors
Certain statements in this Quarterly Report on Form 10-Q constitute forward
looking statements. These forward-looking statements are all statements that are
not statements of historical fact or that might otherwise be considered opinion,
belief, or projection. In some cases, you can identify these statements by
terminology such as "may," "will," "should," "expects," "plans," "anticipates,"
"believes," "estimates," "intends," "predicts," "potential," or "continue" or
the negative of those terms and other comparable terminology. These forward-
looking statements 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. 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, performance, or
achievements, and neither the Company nor any other person assumes
responsibility for the accuracy and completeness of such forward-looking
statements. These statements are only predictions, and in evaluating those
statements, you should specifically consider the risks outlined below. Actual
performance or results may differ materially and adversely. All forward-looking
statements included in this Quarterly Report on Form 10-Q are based on
information available to us on the date hereof, and we are under no duty to
update any of the forward-looking statements after the date hereof.
Among the factors that could cause actual results, levels of activity,
performance, and achievements of the Company to differ from those contemplated
by forward-looking statements are the risk factors discussed in our annual
report on Form 10-K for the year ended December 31, 1998. A copy of such annual
report may be obtained from the Securities and Exchange Commission at
http://www.sec.gov or by written request to the Company.
-22-
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required hereunder for the Company is not significantly
different from the information set forth in Item 7A Quantitative and Qualitative
Disclosures About Market Risk included in the 1998 Form 10-K and is therefore
not presented herein.
-23-
<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 effect on the Company.
None of the Company's internally developed call processing technology has
been patented. Accordingly, such technology and intellectual property rights
could infringe on other parties' intellectual property rights and could be
contested or challenged. The Company has received notice from two parties that
certain features of the Company's call processing technology may infringe upon
such parties' patents. Should the Company's call processor or any material
feature thereof be determined to violate applicable patents, the Company would
be required to cease using these features or to obtain appropriate licenses for
the use of such technology.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Effective June 1, 1999, the Company acquired all of the net assets of
Alliance for a purchase price of 100 shares of the Company's common stock, a
contingent payment of up to an additional 440 shares of the Company's common
stock if certain financial objectives are met, assumption of $275,000 of
liabilities, and a cash payment of $10 paid to a limited number of persons in a
private transaction. No underwriters were involved in the transaction, and the
Company did not pay any underwriting discounts or commissions. The issuance of
shares in this transaction was exempt from the registration requirements of the
Securities Act of 1933 pursuant to Section 4(2) thereof.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS
During the period subject to this Quarterly Report on Form 10-Q, the annual
meeting of the Company's stockholders was held, at which the Company's Board of
Directors was elected.
Votes for: 16,270.33 Votes Against: 275.00 Did Not Vote: 988.00
ITEM 5. OTHER INFORMATION
None.
-24-
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit
No. Description of Exhibit
- -------------------- ---------------------------------------------------------
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 Restated Certificate of
Incorporation of the Company, dated as of July 23, 1998
(filed as Exhibit 3.3 to the Company's Quarterly Report on
Form 10-Q, dated as of August 14, 1998 and incorporated
herein by reference).
3.4 Certificate of Amendment to Restated Certificate of
Incorporation of the Company, dated as February 11, 1999
(filed as Exhibit 3.4 to the Company's Quarterly Report on
Form 10-Q, dated as of May 13, 1999 and incorporated
herein by reference).
10.1* Amendment to Employment Agreement, dated as of June 1,
1999 by and between the Company and Dennis L. Whipple.
27.1* Financial Data Schedule
- ----------
* Filed herewith.
(b) Reports on Form 8-K
No reports on Form 8-K have been filed during the period subject to this
Quarterly Report on Form 10-Q.
-25-
<PAGE>
SIGNATURES
Pursuant to the requirements 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 WHIPPLE
-------------------
Dennis Whipple
Chief Executive Officer
By:/s/ JEFFREY D. CUSHMAN
-----------------------
Jeffrey D. Cushman
Chief Financial Officer
Date: August 13, 1999
-26-
<PAGE>
Exhibit 10.1
------------
AMENDMENT TO EMPLOYMENT AGREEMENT
THIS AMENDMENT TO EMPLOYMENT AGREEMENT (this "Amendment") is made and
entered into as of June 1, 1999, by and between EVERCOM, INC., a Delaware
corporation (the "Company") and DENNIS L. WHIPPLE (the "Executive").
RECITALS:
--------
WHEREAS, the Company and the Executive have entered into that certain
Employment Agreement (the "Employment Agreement") dated as of September 7, 1998.
(Unless the context otherwise requires, all capitalized terms used herein which
are not otherwise defined herein shall have the meanings set forth in the
Employment Agreement).
WHEREAS, by scrivener's error, the Employment Agreement erroneously set
forth the parties' agreement with respect to the Severance Payment, and the
parties desire to amend the Employment Agreement to correct this error.
NOW, THEREFORE, it is hereby agreed as follows:
1. The second sentence of Section 5(b) is hereby amended by inserting the
phrase "or in 1999" after the phrase "in 1998". Accordingly, the Severance
Payment in 1999 shall be $1,200,000.
2. The Employment Agreement, as amended hereby, is ratified and confirmed.
3. This Amendment shall be binding upon and shall inure to the benefit of
the parties hereto, their heirs, personal representatives, successors and
assigns.
IN WITNESS WHEREOF, the parties have executed this Amendment as of the date
first above written.
COMPANY: EXECUTIVE:
- ------- ---------
EVERCOM, INC.,
a Delaware corporation /s/ DENNIS L. WHIPPLE
------------------------
DENNIS L. WHIPPLE
By: /s/ JEFFREY D. CUSHMAN
-----------------------
Name: Jeffrey D. Cushman
Title: CFO/Vice-President
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