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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
________________
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1999
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 ______
EVERCOM, INC.
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(Exact Name of Registrant as Specified in Its Charter)
Delaware 75-2680266
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
8201 Tristar Drive
Irving, Texas 75063
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code -- 972/988-3737
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Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on Which Registered
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11 % Series B Senior Notes Not Applicable
Due June 30, 2007
Securities registered pursuant to Section 12(g) of the Act:
None
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(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
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Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_] Not Applicable.
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As of December 31, 1999, the voting and non-voting common equity held by
non-affiliates of the registrant had a market value of $0.
As of March 30, 2000, 16,033 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.
DOCUMENTS INCORPORATED BY REFERENCE
Exhibits to the following documents filed with the Securities and Exchange
Commission have been incorporated by reference in Part IV of this Annual Report
on Form 10-K:
1. Registration Statement on Form S-4 (File No. 333-33639);
2. Quarterly Report on Form 10-Q, dated as of August 14, 1998;
3. Quarterly Report on Form 10-Q, dated as of November 16, 1998;
4. Quarterly Report on Form 10-Q/A, dated as of November 18, 1998;
5. Annual Report on Form 10-K, dated as of March 29, 1999;
6. Quarterly Report on Form 10-Q, dated as of May 12, 1999;
7. Quarterly Report on Form 10-Q, dated as of August 13, 1999; and
8. Quarterly Report on Form 10-Q, dated as of November 10, 1999.
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EVERCOM, INC.
Table of Contents
Form 10-K Report
December 31, 1999
<TABLE>
<CAPTION>
Part I Page
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Item 1. Business................................................................................... 5
Item 2. Properties................................................................................. 13
Item 3. Legal Proceedings.......................................................................... 13
Item 4. Submission of Matters to a Vote of Security Holders........................................ 14
Part II
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Item 5. Market for Registrant's Common Equity and Related Stockholder Matters...................... 15
Item 6. Selected Financial Data.................................................................... 16
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations................................................................................. 18
Item 7A. Quantitative and Qualitative Disclosures About Market Risk................................. 27
Item 8. Financial Statements and Supplementary Data................................................ 29
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure................................................................................. 54
Part III
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Item 10. Directors and Executive Officers of the Registrant......................................... 55
Item 11. Executive Compensation..................................................................... 55
Item 12. Security Ownership of Certain Beneficial Owners and Management............................. 55
Item 13. Certain Relationships and Related Transactions............................................. 55
Part IV
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Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K........................... 56
Signatures.............................................................................................. 60
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PART I
ITEM 1. BUSINESS
General
Evercom, Inc. (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. As of December 31, 1999, the Company
served 2,017 correctional facilities in 44 states.
The Company's inmate telecommunications business consists of owning,
operating, servicing, and maintaining a system of automated operator switches
and telephones located in correctional facilities. Generally, inmates may make
only collect, prepaid, and debit calls from correctional facilities, which
generates revenue per phone line in excess of industry averages for a typical
business phone line. The Company generally enters into multi-year agreements
with correctional facilities pursuant to which the Company serves as exclusive
provider of telecommunications services to inmates within the facility. In
exchange for the exclusive service rights, the Company pays a percentage of its
revenues from each correctional facility to that facility as a commission.
Typically, the Company installs and retains ownership of the telephones and
related equipment.
Significant costs typically associated with providing telecommunication
services to correctional facilities include uncollectible accounts, network, and
billing expenses. The Company has developed an integrated call management and
billing system to help control these expenses. This system limits inmates to
collect, prepaid, or debit calls; validates and evaluates the payment history
and account status of each number dialed; confirms that the destination number
has not been blocked; and processes call records for billing through a third
party. To facilitate billing, the Company has entered into 29 separate
agreements with regional bell operating companies ("RBOCs") and local exchange
carriers ("LECs"), allowing the Company to bill directly through the RBOCs and
LECs rather than utilizing third party billing services.
The Company uses its experience in billing, collection, and control of
uncollectible accounts to offer specialized billing and collection services to
other inmate telecommunications service providers. In May 1998, the Company
entered into a contract with a major RBOC, under which the Company performs all
of the validation, billing, and collection services for the RBOC's inmate calls,
and began processing call traffic under the contract. Under the terms of the
contract, the Company receives call traffic from 439 facilities. The Company
began providing similar services to another RBOC in 1999. In addition, the
Company offers call processing services for a major interexchange carrier
("IXC").
The Company was formed in December 1996 to consummate the acquisitions of
AmeriTel Pay Phones, Inc. ("AmeriTel") and Talton Telecommunications Corporation
and its subsidiary ("Talton Telecommunications"). The Company was formed by an
affiliate of Engles Urso Follmer Capital Corporation ("EUF"), a private
investment banking and consulting firm. In addition to the acquisition of its
predecessors, AmeriTel and Talton Telecommunications, the Company also acquired
the operations of Tri-T, Inc. ("Tataka") on April 2, 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 Company ("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, Saratoga Telephone Co. Inc.
("Saratoga") on July 1, 1998, and 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") on June 1, 1999
(collectively, the "Acquisitions").
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Special Note Regarding Forward-Looking Information
Certain statements in this Annual Report on Form 10-K 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. 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. The risks, uncertainties, and other factors to which
forward-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 Company, from the Securities and Exchange
Commission at prescribed rates, and at the web-site www.sec.gov. Such factors
include, without limitation, the following: competitors with greater resources;
risks associated with uncollectible accounts; risks associated with anticipated
growth; risks associated with market growth stagnating or declining; lack of
patents and possible infringements; technological change and new services;
control by principal shareholders; changes in the telecommunications industry;
availability of key personnel; and changes in, or the failure to comply with,
governmental regulations. 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.
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 of such
terms or other comparable terminology. 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. All forward-
looking statements included in this Annual Report on Form 10-K are based on
information available to the Company on the date hereof, and the Company is
under no duty to update any of the forward-looking statements after the date
hereof.
Industry Overview
The U.S. has one of the highest incarceration rates of any country in the
world. According to the United States Bureau of Justice Statistics, the number
of inmates incarcerated in federal and state prisons and in city and county
correctional facilities increased from approximately 1.1 million in June 30,
1990 to approximately 1.9 million at December 31, 1999. Of this total, the
Company estimates approximately two-thirds were housed in state and federal
prisons, with the remainder in city and county facilities. The United States
Bureau of Justice Statistics also reports that the number of inmates
incarcerated in the U.S. increased by 4.7% between 1998 and 1999.
The inmate telecommunications industry places unique demands on
telecommunications systems and service providers. Security and public safety
concerns associated with inmate telephone use require that correctional
facilities use call processor technology, which allows the facilities to control
inmate access to certain telephone numbers and to monitor inmate telephone
activity. In addition, concerns regarding fraud and the called parties' failure
to pay for inmate collect calls require systems and procedures unique to this
industry.
Inmate telephones in the U.S. are operated by a large and diverse group of
service providers. Large telecommunications companies such as RBOCs, other LECs,
and IXCs such as AT&T Corp. ("AT&T"), MCI WorldCom, and Sprint Corporation
provide inmate telecommunications in addition to other services. In addition,
independent public pay telephone and inmate telephone companies also focus on
this market segment. The Company estimates that, as of December 31, 1999, the
inmate telecommunications market represented approximately $1.7 billion in
gross revenues annually.
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Companies compete for the right to serve as the exclusive provider of
inmate calling services within a particular correctional facility. Most city or
county correctional facilities (typically fewer than 250 beds) award contracts
on a facility-by-facility basis, while most state prison systems award contracts
on a system-wide basis. Generally, contracts are awarded pursuant to a
competitive bidding process.
The Company targets the corrections industry by tracking when the
telecommunications contracts for significant inmate facilities in the U.S. are
up for bid. The Company monitors which federal, state, county, and city
contracts are coming up for renewal and how much revenue is expected to be
generated by each of those contracts.
Operations
Contracts
The Company has contracts to provide inmate telecommunications services on
an exclusive basis to correctional facilities ranging in size from small,
municipal jails to large, state-operated facilities, as well as other types of
confinement facilities, including juvenile detention centers, private
correctional facilities, and halfway houses. The Company's contracts have multi-
year terms, and typically contain renewal options. The Company's contracts
generally provide for either (i) automatic renewal unless terminated by written
notice a specified period of time before the end of a contract term or (ii) a
submission of a competitive bid.
Marketing and Customer Service
The Company has historically focused its marketing efforts on local and
county correctional facilities. Local and county facilities house inmates for
shorter durations than federal and state prisons and generally have higher
inmate call volumes. The Company's competitors in bidding for contracts to serve
local and county correctional facilities are usually small, regionally-focused
independent providers. For larger local and county correctional facility
contracts, the Company may also compete with the local RBOC.
The Company seeks new contracts by participating in competitive bidding
processes and by negotiating directly with correctional facilities. The Company
markets its inmate telecommunications services through a sales staff largely
made up of former law enforcement officials and others with experience in the
corrections and telecommunications industries who understand the specialized
needs of correctional facilities. The Company's marketing strategy emphasizes
the knowledge, experience, and reputation of the Company in the inmate
telecommunications industry, its high level of service, and the additional
specialized products and services offered by the Company to its correctional
facility customers. In addition to conducting in-person sales calls on the
operators of correctional facilities, the Company participates in trade shows
and is active in local law enforcement associations.
The Company provides and installs the inmate telephone system in each
correctional facility at no cost to the operator of the facility and generally
performs all maintenance activities. The Company utilizes a geographically
dispersed staff of field service technicians and independent telecommunications
services contractors, which allows the Company to respond quickly to service
interruptions. In addition, the Company has the ability to make some repairs
remotely through electronic communication with the installed equipment without
the need of an on-site service call.
Products and Services
The Company has developed its products and services to meet the needs of
the inmate telecommunications market. The Company offers the following products
and services as part of its core inmate telecommunications business:
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. Inmate Collect Call Services. The Company provides collect call
services on an exclusive basis to its inmate facility customers during
the term of the facility's contract. The majority of calls made by
inmates from correctional facilities are collect calls, with the
balance of the calls being prepaid and debit card calls. The Company's
collect call revenues comprise a majority of the Company's total
revenues.
. Prepaid and Debit Card Services. The Company also provides both prepaid
and debit card services to inmates and called parties. The Company
sells debit cards to correctional facilities at a discount to their
face value, which facilities in turn sell the cards at face value to
inmates at those facilities. Prepaid call services allow the recipient
of an inmate call to pay in advance for collect calls placed to the
recipient, while debit card services allow inmates to pay in advance
for telephone calls placed by that inmate. Both prepaid and debit card
services have minimal associated uncollectible account expenses and
minimal billing and collection costs. The Company's prepaid and debit
card services revenues comprise a small percentage of the Company's
revenues, but these revenues are expected to increase as a percentage
of total revenue.
. Billing Services. The Company uses its experience in billing and
collections and management of uncollectible accounts to offer
specialized billing and collection services for other inmate
telecommunications service providers. The Company is pursuing
opportunities to market these services to RBOCs, LECs, IXCs, and other
inmate telecommunications providers. In May 1998, the Company entered
into a contract with a major RBOC, under which the Company performs all
of the validation, billing, and collection services for the RBOC's
inmate calls, and began processing call traffic under this 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,
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. The
contract term is three years and has no minimum volume commitment. The
Company began providing similar services to another RBOC in 1999.
. Additional Value-Added Services. The Company offers value-added
services on a customized, facility by facility basis. These services
include the use of the Company's computer-based specialized law
enforcement management system ("LEMS"), which includes jail management,
victim notification, and prisoner profile software packages. LEMS is a
key selling point for the Company to potential customers and will also
be marketed to its existing customers. The Company also offers jail
training services that include Company-sponsored training seminars for
jail personnel on a variety of topics, including safety and fraud
detection.
Billing Arrangements
The Company uses direct and third party billing agreements to bill and
collect phone charges. Under direct billing agreements with LECs, the LEC
includes collect call charges for the Company's services on the local telephone
bill sent to the called party. The Company generally receives payment from the
LEC for such calls 30 to 60 days after the end of the month in which the call is
submitted to the LEC for billing. The payment received by the Company is net of
a service fee, write-offs of uncollectible accounts, and an estimated reserve
for future uncollectible accounts.
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Unlike many smaller independent service providers with lower
telecommunications traffic, the Company has been able to enter into direct
billing agreements in most of its markets because of the Company's high market
penetration. The Company's increased telecommunications traffic has enabled the
Company to enter into 29 direct billing arrangements that enabled the Company to
direct bill approximately 96% of its collect call revenues in December 1999.
In the absence of a direct billing arrangement, the Company bills and
collects its fees through a third-party billing and collection clearinghouse
that in turn has a billing and collection agreement with the LEC. When the
Company employs a third-party billing and collection clearinghouse, the account
proceeds are forwarded by the various LECs to the clearinghouse, which then
forwards the proceeds to the Company, less a processing fee that varies from 2%
to 3% of billed revenues. The Company also has a central billing office that
receives all call records and then enters them into the Company's call activity
database.
The Company's specialized call management and billing system integrates its
direct billing arrangements with LECs with its call blocking, validation, and
customer inquiry procedures. This system has also provided the Company with the
opportunity to market its billing and collection services to third parties. In
May 1998 the Company entered into a contract with a major RBOC, under which the
Company performs all of the validation, billing, and collection services for
inmate call records supplied by the RBOC. The Company entered into a similar
agreement with a second RBOC in 1999. In addition, the Company provides call
processing services for a major IXC.
Systems
The Company currently utilizes a call management and billing system that
consists of purchased and internally developed software applications on
specialized equipment. This system limits inmates to collect, prepay, or debit
calls, validates and verifies the payment history and account status of each
number dialed for billing purposes, and confirms that the destination number has
not been blocked. The Company also installs its internally developed call
management system ("CAM") within new facilities that require special features
such as call monitoring and recording capability.
The Company's database of telephone numbers and call activity provides
valuable data to assist the Company in reducing unbillable and uncollectible
accounts and allows the Company to provide extensive call activity reports to
correctional facilities and enforcement authorities. These include reports of
frequently called numbers, calls of longer than normal duration, and calls by
more than one inmate to the same number, which can assist law enforcement
authorities in connection with ongoing investigations.
Other Operations
The Company owns, operates, services, and maintains a system of
microprocessor controlled public pay telephones that are ancillary to its inmate
telecommunications business, and occasionally installs public pay telephones as
an accommodation to, or pursuant to a contract requirement imposed by, its
correctional facility customers.
Competition
In the inmate telecommunications business, the Company competes with
numerous independent providers of inmate telephone systems, including RBOCs,
LECs, and IXCs. Many of the Company's competitors are larger and better
capitalized with significantly greater financial resources than the Company. The
Company believes that the principal competitive factors in the inmate
telecommunications industry are (i) rates of commissions paid to the
correctional facilities; (ii) system features and functionality; (iii) system
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reliability and service; (iv) the ability to customize inmate call processing
systems to the specific needs of the particular correctional facility; and (v)
relationships with correctional facilities.
Inmate telephones in the U.S. are operated by a large and diverse group of
service providers. Large telecommunications companies such as RBOCs, other LECs,
and IXCs such as AT&T, MCI WorldCom, and Sprint Corporation provide inmate
telecommunications in addition to other services. In addition, independent
public pay telephone and inmate telephone companies also focus on this market
segment.
Regulation
The inmate telephone industry is regulated at the federal level by the
Federal Communications Commission (the "FCC") and at the state level by the
public utility commissions of the various states. In addition, from time to
time, legislation may be enacted by Congress or the various state legislatures
that affects the telecommunications industry generally and the inmate telephone
industry specifically. Court decisions interpreting applicable laws and
regulations may also have a significant effect on the inmate telephone industry.
Changes in existing laws and regulations, as well as the adoption of new laws
and regulations applicable to the activities of the Company or other
telecommunications business, could have a material adverse effect on the
Company.
Federal Regulation
Prior to 1996, the federal government's role in the regulation of the
inmate telephone industry was limited. The enactment of the Telecommunications
Act of 1996 (the "Telecom Act"), however, marked a significant change in the
scope of federal regulation of inmate telephone service. Section 276 of the
Telecom Act directed the FCC to implement rules to overhaul the regulation of
the provision of pay telephone service, which Congress defined to include the
provision of inmate telephone service.
Before adoption of the Telecom Act, LECs generally included inmate
telephone operations as part of their regulated local exchange telephone company
operations. This allowed the LECs to pool revenue and expenses from their
monopoly local exchange operations with revenue and expenses from their inmate
telephone operations. This commingling of operations made possible the
subsidization of the LECs' inmate operations through other regulated revenues.
The LECs were also able to shift certain costs from their inmate operations to
their local exchange monopoly accounts. In particular, the LECs were able to
pool the bad debt from their inmate operations with their other bad debt.
Because independent inmate telephone service providers act as their own carrier,
they bear the risk of fraudulent calling and uncollectible calls and other bad
debt. Bad debt is substantially higher in the inmate telephone industry than in
other segments of the telecommunications industry. The LECs' practice of pooling
bad debt shifts the high costs of bad debt from inmate telephone operations to
the expense accounts of other LEC operations, presenting a vehicle for the
cross-subsidization of the LECs' inmate operations, which, in turn, has allowed
the LECs to offer commissions to correctional facilities that are significantly
higher than those that independent inmate telephone providers can offer.
Section 276 directed the FCC to adopt regulations to end the LECs'
subsidization of their inmate telephone operations from regulated revenues.
Congress also directed the FCC to ensure that the LECs could not discriminate in
favor of their own operations to the competitive detriment of independent inmate
telephone providers. Finally, Congress required the FCC to ensure that all
inmate telephone providers were fairly compensated for "each and every" call
made from their telephones.
To carry out its Congressional mandate, the FCC adopted regulations
requiring all LECs to transfer their inmate telephone operations from their
regulated accounts to the LECs' unregulated accounts no later than April 15,
1997. The FCC's rules implementing Section 276 are designed to eliminate cross-
subsidization and cost-shifting. However, since the bad debt arises from the
charges for collect calls, which have traditionally been regulated carrier
activities, the rules did not prevent shifting of bad debt from inmate
operations to the LEC's regulated accounts.
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The FCC also addressed the one-time transfer of existing inmate telephone
operation assets from the LECs' regulated accounts to the unregulated accounts
established for inmate telephone operations. The FCC ordered the transfer of
those assets at their net book value rather than at their fair market value. The
inmate telecommunications industry had argued to the FCC that the transfer
should be accomplished at the assets' fair market value, including the value of
the contracts between the LECs' inmate operations and correctional facilities.
The net book value of those assets is much lower than their fair market value.
As a result of the below market valuation of the assets, the LECs' inmate
telephone operations may be able to post nominally higher returns on their
assets than they would otherwise be able to and hence relieve operating
pressures for returns on assets. This also could result in a competitive
advantage for the LECs with respect to access to capital markets compared with
the Company and other independent inmate telephone providers.
To eliminate discrimination, the FCC required, among other things, that the
LECs' inmate telephone operations take any tariffed services from its regulated
operations at the tariffed rate for the service, rather than the actual cost of
the service. Before the Telecom Act, the LECs' inmate operations were able to
take these services at some variant of their underlying costs without regard to
the tariffed rate being charged to independent providers. Under the Telecom Act,
the LECs' inmate operations must take tariffed services on an arm's length
basis, at tariffed rates that are subject to regulatory approval. Further, the
rates for the tariffed services offered to both the LECs' inmate telephone
operations and independent inmate telephone providers must be developed on a
consistent basis. The test that the FCC has mandated for the pricing of services
to both independent inmate telephone providers and the LECs' own inmate
operations will require a re-examination of existing rates and may lead to a
rate reduction for services in some instances, while it is also possible that
the rate re-examination may result in some rate increases. In either event, the
requirement for a consistent methodology for developing rates should
substantially reduce LEC opportunities for unfavorable rate discrimination
against independent inmate telephone providers like the Company.
The FCC did allow the LECs to offer certain non-tariffed services, for
example, repair and installation services, to the LECs' inmate operations on a
cost-sharing basis, which could result in some cost advantage to the LECs'
inmate operations. The LECs are free to price these services at full market
rates to independent inmate telephone providers. Independent inmate telephone
providers are not, however, dependent on the LEC for these services, as they are
with telephone lines; independent inmate telephone providers can provide
services like repair and installation with their own staff or contractors.
To ensure "fair compensation" for inmate telephone providers, the FCC held
that it was not required to prescribe compensation for collect calls because
inmate providers act as their own carriers and collect the revenue from those
calls directly from called parties. The inmate telephone industry had argued to
the FCC, however, that because of state-mandated ceilings on the rates for
intrastate collect calls, inmate telephone providers could not recover adequate
revenue for those calls, and accordingly, had sought an "inmate system
compensation charge" in addition to the charges collected for carrying the call.
See "--State Regulation."
Many aspects of the FCC's rules implementing Section 276 are currently the
subject of further proceedings by the FCC. In particular, two important issues
are back before the FCC as the result of a court challenge in which the FCC
voluntarily sought, and the court granted, a remand to the FCC for further
proceedings. The first of those issues is the FCC's decision not to prescribe
compensation for inmate collect calls. If the FCC ultimately decides to
prescribe compensation, the Company could potentially benefit from the ability
to collect additional revenue. It is not possible to predict whether the FCC
will prescribe compensation and the degree to which the Company could benefit,
if at all, would depend on the exact compensation scheme ultimately prescribed
by the FCC for inmate collect calls.
The second important issue before the FCC on remand is the FCC's decision
to include only inmate telephone equipment and not the collect calling service
itself in the inmate telephone services that the RBOCs must provide on a
nonregulated basis. As a result of this ruling, the RBOCs have to some
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extent remained able to subsidize and discriminate in favor of their inmate
calling operations. In particular, so long as the RBOCs can continue to define
their inmate collect calling service as part of their regulated operations, they
may be commingling that bad debt with bad debt from other services. It cannot be
predicted how the FCC will rule on this issue on remand.
Because of the further proceedings pending before the FCC, the ultimate
effects of the rule changes mandated by the Telecom Act are uncertain. In
particular, the extent to which the FCC's rules designed to eliminate
subsidization and discrimination by the LECs prove to be effective will
significantly affect the level of competition faced by the Company in the inmate
telecommunications market.
Apart from its proceedings to implement the Telecom Act, the FCC also
adopted new regulations for interstate calls requiring inmate telephone service
providers to announce to called parties, before the called party incurs any
charges, that rate quotes may be obtained by dialing no more than two digits or
remaining on the line. The Company was required to comply with these new rules
by October 1, 1999. The Company believes it is substantially in compliance with
these new rules and is working towards 100% compliance. Although management does
not believe it to be likely, regulatory authorities do have authority to impose
fines and other sanctions for any violation of these rules. These new
regulations could result in an increase in the Company's costs by slightly
increasing the non-billable network hold time for collect calls. In addition,
the announcement of rate quotes may lead to called parties refusing to accept
calls. The exact effect of the new regulations is difficult to predict as it
will depend in large part on how frequently called parties opt to receive a rate
quote.
Significantly, the FCC adopted the rate disclosure option in lieu of the
so-called "Billed Party Preference" proposal that had been pending before the
FCC for several years. Under that plan, inmate telephone service providers would
have been required to send their interstate inmate collect calls to the called
party's pre-subscribed carrier, thereby bypassing the opportunity for the inmate
telephone service provider to receive revenue from the calls. The Company
believes that the rate quote regulations adopted by the Commission are a
preferable alternative to Billed Party Preference, which would potentially have
had a much more adverse effect on the Company's business.
State Regulation
The most significant state involvement in the regulation of inmate
telephone service is the limit on the maximum rates that can be charged for
intrastate collect calls set by most states, referred to as "rate ceilings."
Since collect calls are generally the only kind of calls that can be made by
inmates in correctional facilities, the state-imposed rate ceilings on those
calls can have a significant effect on the Company's business.
In many states, the rate ceilings on inmate collect calls within the
originating LEC's service area are tied to the rates charged by the LEC and
subject to state regulatory approval. Thus, where the LEC chooses not to raise
its rates, independent inmate telephone providers are precluded from raising
theirs. Prior to the passage of the Telecom Act, the LECs had less incentive to
raise their rates than independent inmate telephone providers because the LECs
were able to subsidize their inmate telephone operations and discriminate in
their favor, as described above. See "--Federal Regulation." It is possible that
as a result of the FCC's new rules designed to eliminate such subsidies, some
LECs may choose to file with their state commissions to raise their rates for
inmate collect calls. If this occurs, the Company and other independent inmate
telephone providers could also raise their rates. It is difficult to predict the
extent to which the LECs will raise their rates.
For calls going outside the originating LEC's service area, there may be
state rate ceilings tied to the rates of the largest IXCs. In some cases, these
rate ceilings can also make sufficient cost recovery difficult. In general, the
cost recovery problems that arise from rate ceilings tied to IXC rates are not
as severe as the difficulties created by rate ceilings tied to LEC rates.
12
<PAGE>
In its rulemaking implementing the Telecom Act, the FCC declined to address
these state rate ceilings. The FCC ruled that inmate telephone providers must
first seek relief from the state rate ceilings at the state level. The outcome
of any such proceedings at the state level, if undertaken, is uncertain.
Further, it is uncertain whether the FCC would intervene or if so, how, in the
event a state failed to provide relief. This issue is part of the currently
pending FCC remand proceeding.
In addition to imposing rate caps, the states regulate other aspects of the
inmate calling industry. While the degree of regulatory oversight varies
significantly from state to state, state regulations generally establish minimum
technical and operating standards to ensure that public interest considerations
are met. Among other things, most states have established rules that govern
registration requirements, notice to called parties of the identity of the
service provider in the form of postings or verbal announcements, and
requirements for rate quotes upon request. In some jurisdictions, in order for
the Company to operate its inmate telephones and public pay telephones, it is
necessary to become certificated and to file tariffs with the appropriate state
regulatory authority.
Tradenames
The Company has two registered trademarks, Security Telecom Corporation(R)
and STC(R) and has developed or acquired a number of additional unregistered
tradenames that it uses in its business. Although the use of these trademarks
and tradenames has created goodwill in certain markets, management does not
believe that the loss of these trademarks and tradenames would have a material
adverse effect on the Company's operations. The Company also has a registration
application pending for the tradename Evercom and certain derivatives thereof.
Environmental
The Company is subject to certain federal, state, and local environmental
regulations. Management does not expect environmental compliance to have a
material effect on the Company's capital expenditures, earnings, or competitive
position in the foreseeable future.
Employees
As of December 31, 1999, the Company had approximately 273 employees.
ITEM 2. PROPERTIES
The Company's principal executive offices are located in, and a portion of
its operations are conducted from, leased premises located at 8201 Tristar
Drive, Irving, Texas 75063. The Company also has four additional regional
facilities from which it conducts its operations located in Selma, Alabama;
Louisville, Kentucky; Lee's Summit, Missouri; and Raleigh, North Carolina all of
which are leased.
ITEM 3. 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.
From time to time, inmate telecommunications providers are parties to
proceedings initiated by inmates, consumer protection advocates or individual
called parties alleging that excessive rates are being charged with respect to
inmate collect calls. The Company is currently named in such proceedings in
various jurisdictions. The plaintiffs in such proceedings generally seek class
action certification against all inmate telecommunications providers as
defendants, with all recipients of calls from inmate facilities, as plaintiffs.
The Company recently obtained dismissal of one such proceeding and is seeking
dismissal in the other proceedings in which it is named.
13
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were presented to the security holders in the fourth quarter of 1999.
14
<PAGE>
PART II
-------
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
There is currently no established public trading market for the
Registrant's issued and outstanding capital stock.
As of December 31, 1999, there were fifty-two holders of the Company's
Class A common stock (the "Common Stock") and four holders of the Company's
Class B common stock (the "Class B Common Stock").
There have been no cash dividends declared on the Common Stock from the
period January 1, 1996 through December 31, 1999. The Indenture (the
"Indenture") governing the Company's Series A and Series B Senior Notes Due 2007
and the Company's senior credit facility, as amended and restated (the "Senior
Credit Facility") contain certain restrictive covenants that are likely to
materially limit the future payment of dividends on the Common Stock. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
The following table sets forth information with respect to all securities
sold by the Company for the Company's last fiscal year that were not registered
under the Securities Act of 1933, as amended (the "Securities Act"). All
securities sold and not registered were sold in transactions not involving a
public offering under Section 4(2) of the Securities Act.
<TABLE>
<CAPTION>
SECURITIES SOLD DATE PERSON ACQUIRING AMOUNT CONSIDERATION USE OF PROCEEDS TERMS OF
SECURITIES CONVERSION OF
EXERCISE
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
First Preferred Series A 3/12/99 Company Shareholders 5,000 shares $5,000,000 Working Capital
And Affiliates
Warrants 3/12/99 Company Shareholders 5,000 warrants Additional consideration $1,000 strike
And Affiliates for First Preferred price per
Issuance share
Class A Common 6/01/99 Alliance Tel-Com, Inc. 100 shares Additional consideration Acquisition of
for asset acquisition business
</TABLE>
15
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA - (in thousands)
The following selected consolidated financial data of the Company for each
of the three years ended December 31, 1999 have been derived from the Company's
audited financial statements.
The selected financial data should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the consolidated financial statements and the notes thereto
included elsewhere in this Form 10-K.
16
<PAGE>
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------------
1997 1998 1999
-------- -------- --------
<S> <C> <C> <C>
Operating Data:
Operating revenues $ 91,773 $225,293 $236,801
Operating expenses:
Telecommunication costs 37,871 99,843 104,376
Facility commissions 25,724 71,206 71,359
Field operations and maintenance 4,543 7,817 6,428
Selling, general and administrative 8,540 17,661 17,214
Depreciation and impairment 2,219 6,692 7,200
Amortization of intangibles 14,243 26,339 21,527
Restructuring and other charges 400 1,743 (69)
-------- -------- --------
Total operating expenses 93,540 231,301 228,035
-------- -------- --------
Operating Income (loss) (1,767) (6,008) 8,766
Other (income) expenses:
Interest expense, net 11,138 19,638 19,458
Other (income), net (76) (236) (7)
-------- -------- --------
Total other (income) expense 11,062 19,402 19,451
-------- -------- --------
Loss before income taxes and
extraordinary loss (12,829) (25,410) (10,685)
Income tax (benefit) expense (642) 476 450
-------- -------- --------
Loss before extraordinary item (12,187) (25,886) (11,135)
Extraordinary item 4,740 - -
-------- -------- --------
Net loss $(16,927) $(25,886) $(11,135)
======== ======== ========
OTHER DATA:
EBITDA (1) $ 14,771 $ 27,259 $ 37,500
Net cash provided by operating
activities 6,048 4,258 15,898
Net cash used in investing activities (90,757) (23,384) (12,138)
Net cash provided by (used in) financing
activities 92,193 13,039 (3,463)
Capital expenditures (2) 8,063 13,592 8,397
Ratio of earnings to fixed charges(3) -- -- --
Deficiency of earnings to fixed charges 12,829 25,410 10,685
BALANCE SHEET DATA
(AT END OF YEAR):
Cash and cash equivalents $ 7,778 $ 1,692 $ 1,988
Total assets 189,388 191,466 172,109
Total debt (including current
maturities) 166,736 180,483 172,666
Total stockholders' equity (deficit) (10,020) (36,113) (42,998)
</TABLE>
- -----------------
(1) For the purpose of this Form 10-K, EBITDA means income before interest,
income taxes, depreciation, and amortization. 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-K 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 flow as an indicator
of the Company's operating performance.
(2) Capital expenditures include only amounts expended for purchases of
property and equipment and the implementation of facility contracts and
excludes cash outflows for acquisitions.
17
<PAGE>
(3) Earnings are defined as earnings (loss) before income taxes from continuing
operations and fixed charges. Fixed charges are defined as interest expense
and a portion of rental expense representing the interest factor, which the
Company estimates to be one-third of rental expense, and amortization of
deferred financing expense. This calculation is a prescribed earnings
coverage ratio intended to present the extent to which earnings are
sufficient to cover fixed charges, as defined.
ITEM 7. 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."
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 44 states. As of December 31, 1999, the Company served 2,017
correctional facilities.
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 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. 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 RBOC. 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 August of
18
<PAGE>
1999 the Company began providing validation, billing and collection services to
a second RBOC. Under this agreement, the Company charges the RBOC a transaction
fee and charges back all uncollectible accounts to the RBOC.
The Company's principal operating expenses consist 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.
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 IXCs. The
Company has entered into an agreement to lease lines connecting urban areas and
correctional facilities. 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, and 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. 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. The Company's ability to offer increasingly 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 by lower network charges,
field maintenance, and SG&A expenses as a percentage of revenue. The commission
rates paid by the Company have increased in each period, from 23.8% in 1995 to
33.8% in 1999. This increase 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% in 1999 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 expenses consist of corporate
overhead and selling expense. These costs are also relatively small and more
constant components of operating expenses.
Restructuring Costs. The Company integrated its acquired operations into
its existing operations, which resulted in a restructuring charge of $1.2
million in 1998.
Company History. The Company became the holding company for the operations
of its predecessors, AmeriTel and Talton Telecommunications, effective December
1, 1996. The Company also acquired the operations of Tataka on April 2, 1997,
STC on June 27, 1997, CCC on July 31, 1997, InVision on October 6, 1997, NAI on
December 1, 1997, PTC on December 18, 1997, ILD on January 1, 1998, MOG on
February 1, 1998, Saratoga on July 1, 1998, and Alliance on June 1, 1999. The
Company has completed the Acquisitions, which have been accounted for using the
purchase method of accounting,
19
<PAGE>
and the Company's results of operations therefore reflect the operations of
these companies only subsequent to the effective dates of their respective
acquisitions.
Results of Operations
The following table sets forth, for the periods indicated, the combined
historical results of operations of the Company.
20
<PAGE>
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------------------------------------
1997 1998 1999
----------------------- -------------------- ------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Operating revenues............................ $ 91,773 100.0% $225,293 100.0% $236,801 100.0%
Operating expenses:
Telecommunication costs.................... 37,871 41.3 99,843 44.3 104,376 44.1
Facility commissions....................... 25,724 28.0 71,206 31.6 71,359 30.1
Field operations and maintenance........... 4,543 5.0 7,817 3.5 6,428 2.7
Selling, general, and administrative....... 8,540 9.3 17,661 7.8 17,214 7.3
Depreciation and impairment................ 2,219 2.4 6,692 3.0 7,200 3.0
Amortization of intangibles................ 14,243 15.5 26,339 11.7 21,527 9.1
Restructuring and other charges............ 400 0.4 1,743 0.8 (69) 0.0
----------------------- --------------------- ------------------
Total operating expenses...................... 93,540 101.9 231,301 102.7 228,035 96.3
----------------------- --------------------- ------------------
Operating income (loss)....................... (1,767) (1.9) (6,008) (2.7) 8,766 3.7
Other (income) expense:
Interest expense, net...................... 11,138 12.1 19,638 8.7 19,458 8.2
Other, net................................. (76) 0.0 (236) (0.1) (7) (0.0)
----------------------- --------------------- ------------------
Total other expense........................... 11,062 12.1 19,402 8.6 19,451 8.2
----------------------- --------------------- ------------------
Loss before income taxes and
extraordinary item........................... (12,829) (14.0) (25,410) (11.3) (10,685) (4.5)
Income tax (benefit).......................... (642) (0.7) 476 0.2 450 0.2
----------------------- --------------------- ------------------
Loss before extraordinary loss................ (12,187) (13.3) (25,886) (11.5) (11,135) (4.7)
Extraordinary item............................ 4,740 5.1 -- -- -- --
----------------------- --------------------- ------------------
Net loss...................................... $(16,927) (18.4)% $(25,886) (11.5)% $(11,135) (4.7)%
======================= ===================== ==================
EBITDA........................................ $ 14,771 16.1% $ 27,259 12.1% $ 37,500 15.8%
</TABLE>
Year Ended December 31, 1999 (Consolidated Results of Operations of the Company)
compared to year ended December 31, 1998 (Consolidated Results of Operations of
the Company).
Operating Revenues. The Company's operating revenues increased by $11.5
million, or 5.1%, from $225.3 million for the year ended December 31, 1998 to
$236.8 million for the year ended December 31, 1999. The increase in operating
revenues was primarily due to growth in billing services provided to two major
RBOCs and acquisitions by the Company of Alliance in 1999 and Saratoga in 1998.
As of December 31, 1999 the Company served 2,017 correctional facilities in 44
states. The Company's contract with the State of Alabama was not renewed,
resulting in a reduction in revenue and EBITDA in fiscal year 1999 of $7.1
million and $1.3 million, respectively, when compared to fiscal year 1998.
Operating Expenses. Total operating expenses decreased by $3.3 million from
$231.3 million in 1998 to $228.0 million in 1999. Operating expenses as a
percentage of operating revenues decreased by 6.4% from 102.7% for the year
ended December 31, 1998 to 96.3% for the year ended December 31, 1999. The
decrease in operating expenses as a percentage of revenues is primarily due to
factors discussed below.
Telecommunication costs increased by $4.6 million, from $99.8 million in
1998 to $104.4 million in 1999. Telecommunication costs represented 44.3% of
operating revenues in 1998 and 44.1% of operating revenues in 1999, a decrease
of 0.2%. The percentage decrease is primarily due to savings generated from new
long distance contracts. These savings were partially offset by higher
uncollectible expenses resulting from the Company's consolidation efforts in
1999.
The Company's overall telecommunications costs as a percentage of revenues
of 44.1% for 1999 and 44.3% for 1998 include the effect of the Company's billing
and collection services provided to a major
21
<PAGE>
RBOC as discussed in "Overview." These billing and collection services exhibit
higher telecommunication costs as a percentage of revenue than the Company's
traditional inmate business.
Facility commissions increased by $0.2 million, from $71.2 million in 1998
to $71.4 million in 1999. Facility commissions represented 31.6% of operating
revenues in 1998 and 30.1% in 1999, a decrease of 1.5%. The overall commission
percentage to total revenue of 30.1% in 1999 includes the effect of the billing
and collection services provided to a major RBOC as discussed in "Overview."
Commission expense as a percentage of revenue for the Company's traditional
inmate business was 33.7% and 33.8% for the years ended December 31, 1998 and
1999, respectively. Facility commissions are expected to gradually increase as a
percentage of revenue in the future.
Field operations and maintenance costs decreased by $1.4 million, from $7.8
million in 1998 to $6.4 million in 1999. Field operations and maintenance costs
represented 3.5% of operating revenues in 1998 and 2.7% of operating revenues in
1999, a decrease of 0.8%. This decrease is due to the consolidation and
integration activities completed by the Company in 1998 and 1999.
SG&A costs decreased by $0.5 million, from $17.7 million in 1998 to $17.2
million in 1999. SG&A represented 7.8% of operating revenues in 1998 and 7.3% of
operating revenues in 1999, a decrease of 0.5%. This decrease is mainly due to
the consolidation and integration activities completed by the Company in 1998
and 1999.
Total depreciation and amortization costs decreased by $4.3 million, from
$33.0 million in 1998 to $28.7 million in 1999. Depreciation and amortization
costs represented 14.7% of operating revenues in 1998 and 12.1% of operating
revenues in 1999, a decrease of 2.6%. The decrease as a percentage of operating
revenues is primarily due to amortization 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 overall amortization expense declines. Amortization expense
will continue to be a substantial portion of the Company's operating expenses.
The Company integrated its acquired operations into its existing
operations, which resulted in a restructuring charge of $1.2 million in 1998.
In December 1998, the Company wrote-off approximately $0.5 million related to
the postponement of the Company's initial public offering.
Other (Income) Expense. Other (income) expense, consisting primarily of
interest expense, remained relatively constant at $19.4 million in 1998 and
$19.5 million in 1999.
Net Loss. The Company's net loss decreased by $14.8 million, from $25.9
million in 1998 to $11.1 million in 1999 as a result of the factors described
above.
EBITDA. EBITDA increased by $10.2 million from $27.3 million in 1998 to
$37.5 million in 1999. EBITDA as a percentage of operating revenues increased
from 12.1% in 1998 to 15.8% in 1999 due to the factors described above.
22
<PAGE>
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-K 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 performance. Several of the Company's subsidiaries are
subject to state income taxes. Consequently, the Company accrues income tax
expense even in a loss period.
Year Ended December 31, 1998 (Consolidated Results of Operations of the Company)
compared to year ended December 31, 1997 (Consolidated Results of Operations of
the Company).
Operating Revenues. The Company's operating revenues increased by $133.5
million, or 145.5%, from $91.8 million for the year ended December 31, 1997 to
$225.3 million for the year ended December 31, 1998. The increase in operating
revenues was primarily due to acquisitions by the Company of CCC, InVision, and
PTC between July and December 1997 and of ILD, MOG and Saratoga in 1998. As of
December 31, 1998 the Company served 2,073 correctional facilities in 43 states.
Operating Expenses. Total operating expenses increased by $137.8 million,
or 147.3%, from $93.5 million in 1997 to $231.3 million in 1998. Operating
expenses as a percentage of operating revenues increased by 0.8% from 101.9% for
the year ended December 31, 1997 to 102.7% for the year ended December 31, 1998.
The increase in operating expenses as a percentage of revenues is primarily due
to factors discussed below.
Telecommunication costs increased by $61.9 million, from $37.9 million in
1997 to $99.8 million in 1998. Telecommunication costs represented 41.3% of
operating revenues in 1997 and 44.3% of operating revenues in 1998, an increase
of 3.0%. 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 expense, because in most cases the CLECs are unable to bill
the Company's traffic. The Company responded to this problem by offering prepaid
services to these customers. The Company's overall telecommunications costs as a
percentage of revenues of 44.3% for 1998 include the effect of the Company's
billing and collection services provided to a major RBOC as discussed in
"Overview". These billing and collection services exhibit higher
telecommunication costs as a percentage of revenue than the Company's
traditional inmate business.
Facility commissions increased by $45.5 million, from $25.7 million in 1997
to $71.2 million in 1998. Facility commissions represented 28.0% of operating
revenues in 1997 and 31.6 % in 1998, an increase of 3.6%. This increase as a
percentage of revenue is 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 31.6% in 1998
includes the effect of the billing and collection services provided to a major
RBOC as discussed in "Overview".
Field operations and maintenance costs increased by $3.3 million, from $4.5
million in 1997 to $7.8 million in 1998. Field operations and maintenance costs
represented 5.0% of operating revenues in 1997 and 3.5% of operating revenues in
1998, a decrease of 1.5%. The dollar increase is primarily due to costs
associated with servicing the acquired facilities and the new contract
facilities. Field operations and maintenance costs as a percentage of revenue
was 3.3% for the fourth quarter 1998 compared to 3.4% for the third quarter
1998. This decrease is due to the integration activities completed by the
Company in the fourth quarter.
23
<PAGE>
SG&A costs increased by $9.2 million, from $8.5 million in 1997 to $17.7
million in 1998. SG&A represented 9.3% of operating revenues in 1997 and 7.8% of
operating revenues in 1998, a decrease of 1.5%. The dollar increase in SG&A
costs is primarily due to the increased infrastructure necessary to support the
Acquisitions. SG&A costs as a percentage of revenue was 7.3% for the fourth
quarter 1998 compared to 8.0% for the third quarter 1998. This percentage
decrease is primarily due to the integration activities completed by the Company
in the fourth quarter.
Total depreciation and amortization costs increased by $16.5 million, from
$16.5 million in 1997 to $33.0 million in 1998. Depreciation and amortization
costs represented 17.9% of operating revenues in 1997 and 14.7% of operating
revenues in 1998, a decrease of 3.2%. The dollar increase is primarily due to
additional amortization expense associated with the inmate facility contracts
acquired in the Acquisitions.
The Company integrated its acquired operations into its existing
operations, which resulted in a restructuring charge of $1.4 million in
September 1998. The restructuring charge was lowered by $0.2 million in the
fourth quarter 1998, primarily due to the final determination of the number of
employees terminated, the unanticipated subletting of certain facilities, and a
refinement of expected legal and other costs. In December 1998, the Company
wrote-off approximately $0.5 million related to the postponement of the
Company's initial public offering.
Other (Income) Expense. Other (income) expense, consisting primarily of
interest expense, increased by $8.3 million from $11.1 million in 1997 to $19.4
million in 1998. The increase was primarily due to interest expense associated
with the indebtedness incurred by the Company in connection with the
Acquisitions.
Net Loss. The Company's net loss increased by $9.0 million, from $16.9
million in 1997 to $25.9 million in 1998 as a result of the factors described
above.
EBITDA. EBITDA increased by $12.5 million from $14.8 million in 1997 to
$27.3 million in 1998. EBITDA as a percentage of operating revenues decreased
from 16.1% in 1997 to 12.1% in 1998 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-K 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
performance. 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 liquidity will be to
provide working capital, meet debt service requirements, and to repay principal
under the Senior Credit Facility (as defined). The Company expects that its
principal sources of funds will be cash flow from operations and borrowings
under the Senior Credit Facility. The Company anticipates that its primary
capital expenditures will be for capital items required to implement new
contracts entered into by the Company and alternative network solutions,
although the Company does not have material commitments for capital
expenditures. Management believes that cash flow from operations (if any) and
from the Senior Credit Facility will be sufficient to fund the requirements of
the Company for at least the next 12 months.
In March 1999 the Company raised $5 million of equity from its existing
shareholders and warrant holders and/or their affiliates through the issuance of
5,000 investment units at a price of $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 Common Stock for $1,000 per share. The First Preferred
Series A Stock will be entitled to receive dividends at the applicable First
Preferred Series A Rate, payable quarterly
24
<PAGE>
commencing on April 1, 1999. Such dividends will be payable out of funds legally
available therefor, are payable only when, as, and if declared by the Board of
Directors, are 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 will be 8% per annum through March 31, 2001, 10% 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 the Company's common
stock but ranks junior to the Senior Preferred Stock of the Company (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
sooner exercised, on 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 original 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 and restated 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 will bear 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 million under the revolving portion of the
Senior Credit Facility.
As of March 20, 2000, the Company had $12.8 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 candidates. 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, or both.
Net cash provided by operating activities was $15.9 million for the year
ended December 31, 1999, as compared to net cash provided by operating
activities of $4.3 million for the year ended December 31, 1998. Net cash
provided by operating activities was $6.0 million for the year ended December
31, 1997. Net cash provided by operating activities in 1999 increased from 1998
primarily due to a $10.5 million increase in operating income, before
consideration of depreciation and amortization. Additionally, working capital
investments were required to integrate the Company's 1998 acquisitions. Similar
working capital investments for acquisitions were not required in 1999.
Cash used in investing activities was $12.1 million for the year ended
December 31, 1999, as compared to $23.4 million for the year ended December 31,
1998. Cash used in investing activities in 1999 consisted primarily of $8.4
million for new business, contract renewals and infrastructure improvements.
Also in 1999, the Company paid $3.7 million in deferred purchase prices and
costs primarily relating to acquisitions in prior years. Cash used in investing
activities of $23.4 million in 1998 consisted primarily of $7.0 million to fund
the acquisitions of Saratoga, ILD, and MOG, $4.7 million in payments related to
acquisitions made in 1997 and $13.6 million for new business contract renewals
and infrastructure improvements. Cash used in investing activities in 1997 of
$90.8 million consisted primarily of cash outflows for acquisitions.
Cash used in financing activities was $3.5 million for the year ended
December 31, 1999, as compared to cash provided by financing activities of $13.0
million in 1998. Cash used in financing activities in 1999 consisted primarily
of repayments of $12.6 million of borrowings under the Senior Credit Facility
and repayment of a $950,000 note payable relating to the MOG acquisition,
offset by new
25
<PAGE>
borrowings under the Senior Credit Facility of $5.5 million under the new term
loan facility and $4.9 million of net proceeds raised by the issuance of new
preferred stock in March of 1999. Cash provided by financing activities of $13.0
million in 1998 consisted primarily of new borrowings under the Senior Credit
Facility offset by $5.6 million of repayments of the term loan portion of the
Senior Credit Facility and $0.5 million of preferred dividends paid. Cash
provided by financing activities in 1997 consisted primarily of the issuance of
the Senior Notes, the borrowing of $50.5 million under the Senior Credit
Facility and offset by the repayment of amounts borrowed under the Company's
previous credit facility, the Senior Subordinated Notes, and subordinated notes
issued in connection with the acquisition of Talton Telecommunications (the
"Talton Notes").
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 the Canadian Imperial Bank of Commerce ("CIBC") reference rate and 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 London Inter-Bank Offering ("LIBO")
rate 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 LIBO rate 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. Scheduled
principal payments on the term loan facility are approximately $12.4 million,
$13.8 million, and $19.3 million during the years ended 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.
As of December 31, 1999, the Company had approximately $172.7 million of
long-term indebtedness outstanding, including (i) $115.0 million of the Senior
Notes outstanding at an interest rate of 11.0%, (ii) $56.9 million of
indebtedness under the Senior Credit Facility, and (iii) $0.8 million of other
indebtedness consisting primarily of deferred acquisitions costs and capital
leases. As of December 31, 1999, the Company had available borrowing capacity
under the revolving credit portion of its Senior Credit Facility of
approximately $11.8 million, subject to borrowing base limitations and certain
conditions.
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 on its loan under the Senior Credit Facility. At December 31, 1999, the
interest rate cap has an aggregate notional amount of $30.0 million, which
matures in June 2001, and caps interest on the LIBO rate portion of the term
loan, up to the aggregate notional amount, at 7.5%, plus the applicable LIBO
rate margin.
The Senior Credit Facility and the 11% Series B Senior Notes contain
numerous restrictive covenants including, among others, limitations on the
ability of the Company to incur additional indebtedness, to create liens and
other encumbrances, to make certain payments and investments, to sell or
otherwise dispose of assets, or to merge or consolidate with another entity. The
Senior Credit Facility also requires the Company to meet certain financial tests
on a consolidated basis, some of which may be more restrictive in future years.
The Company's failure to comply with its obligations under the Senior Credit
Facility, or in agreements relating to indebtedness incurred in the future,
could result in an event of default under such agreements, which could permit
acceleration of the related debt and acceleration of debt under other financing
arrangements that may contain cross-acceleration or cross-default provisions. In
addition, because interest under the Senior Credit Facility accrues at floating
rates, the Company remains subject to interest rate risk with respect to a
significant portion of its indebtedness.
26
<PAGE>
Income Taxes
Since the Company's acquisitions of AmeriTel, Talton Telecommunications,
MOG, and Saratoga were stock purchases, the Company was required to retain the
tax bases of AmeriTel, Talton Telecommunications, MOG, and Saratoga in the
assets acquired. As a result, the Company will not be entitled to a tax
deduction for the amortization of goodwill or the depreciation and amortization
of certain other tangible and intangible assets related to these acquisitions.
The Company has provided deferred income tax liabilities for differences in the
financial accounting and tax bases of its tangible and identifiable intangible
assets. However, in accordance with the requirements of Statement of Financial
Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes," future
amortization of non-deductible goodwill will be treated as a permanent
difference in the Company's financial statements.
Accounting Pronouncements
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," was issued in June 1998, and 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, 2000. The Company
is currently evaluating the effect that it may have on the Company's
consolidated financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company uses fixed and variable rate debt to partially finance budgeted
expenditures. These agreements expose the Company to market risk associated with
changes in interest rates. The Company does not hold or issue derivative
financial instruments for trading purposes. 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 risk exposure under the Senior
Credit Facility. At December 31, 1999, the interest rate cap has an aggregate
notional amount of $30.0 million, which matures in June 2001 and caps interest
on the LIBO rate portion of the term portion of the term loan of the Senior
Credit Facility at 7.5%, plus the applicable LIBO rate margin.
27
<PAGE>
The following table presents the carrying and fair value of the Company's
debt along with average interest rates. Fair values are calculated as the net
present value of the expected cash flows of the financial instrument.
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Expected Maturity
Date.............. 2000 2001 2002 2003 2004 Thereafter Total Fair
Value
Variable Rate
Debt (1).......... $12,434,468 $13,776,766 $30,750,000 $ 56,961,234 $ 56,961,234
Fixed Rate
Debt (2).......... $115,000,000 $115,000,000 $109,250,000
Interest Rate CAP $ (43,000)
</TABLE>
_________________
(1) The average interest rate on variable debt is 8.88%.
(2) The interest rate on the fixed rate debt is 11%.
28
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Financial Statements and Schedules
Page
----
Evercom, Inc. and Subsidiaries ........................................
Independent Auditors' Report ........................................ 30
Consolidated Balance Sheets for December 31, 1998 and 1999 .......... 31
Consolidated Statements of Operations for the three
years ended December 31, 1999 .................................... 32
Consolidated Statements of Stockholders' Equity (Deficit)
for the three years ended December 31, 1999 ...................... 33
Consolidated Statements of Cash Flows for the three
years ended December 31, 1999 .................................... 34
Notes to Consolidated Financial Statements .......................... 35
SUPPLEMENTARY DATA:
Consolidated Valuation and Qualifying Accounts for each of the
three years ended December 31, 1999 .............................. 53
29
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and
Stockholders of Evercom, Inc. and Subsidiaries:
We have audited the accompanying consolidated balance sheets of Evercom, Inc.
and subsidiaries (the "Company") as of December 31, 1999 and 1998, and the
related consolidated statements of operations, stockholders' equity (deficit)
and cash flows for each of the three years in the period ended December 31,
1999. Our audits also included the financial statement schedule listed in the
Index at Item 8. These financial statements and financial statement schedule are
the responsibility of the Company's management. Our responsibility is to express
an opinion on the consolidated financial statements and financial statement
schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the consolidated financial position of the Company as of
December 31, 1999 and 1998, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1999 in
conformity with generally accepted accounting principles. Also, in our opinion,
such financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
DELOITTE & TOUCHE LLP
Dallas, Texas
March 24, 2000
30
<PAGE>
EVERCOM, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
--------------------------------------------
ASSETS 1998 1999
------------------ ------------------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 1,691,762 $ 1,987,732
Accounts receivable, net 39,070,959 38,262,832
Refundable income taxes 435,593 364,204
Inventories 2,360,280 3,512,073
Prepaid expenses and other current assets 392,448 380,797
Deferred income tax assets 1,442,122 1,496,528
------------------ ------------------
Total current assets 45,393,164 46,004,166
PROPERTY AND EQUIPMENT 29,485,944 28,375,357
INTANGIBLE AND OTHER ASSETS 116,586,808 97,729,033
------------------ ------------------
TOTAL $191,465,916 $172,108,556
================== ==================
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Accounts payable $ 21,856,484 $ 19,492,283
Income taxes payable 250,000
Accrued expenses 23,798,055 21,201,463
Current portion of long-term debt 10,607,729 12,434,468
------------------ ------------------
Total current liabilities 56,262,268 53,378,214
LONG-TERM DEBT 169,375,000 159,526,766
OTHER LONG-TERM LIABILITIES 500,000 705,000
DEFERRED INCOME TAXES 1,442,122 1,496,528
COMMITMENTS AND CONTINGENCIES (See notes)
STOCKHOLDERS' EQUITY (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 December 31, 1999. 59 109
Common stock, $.01 par value; 50,000 shares authorized; 16,333 shares
and 16,433 shares issued and outstanding as of December 31, 1998
and December 31, 1999, respectively 163 164
Additional paid-in capital 21,829,562 26,080,416
Accumulated deficit (57,943,258) (69,078,641)
------------------ ------------------
Total stockholders' equity (deficit) (36,113,474) (42,997,952)
------------------ ------------------
TOTAL $191,465,916 $172,108,556
================== ==================
</TABLE>
See notes to consolidated financial statements.
31
<PAGE>
EVERCOM INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------------------------------------------
1997 1998 1999
--------------------- --------------------- ----------------------
<S> <C> <C> <C>
OPERATING REVENUE $ 91,773,041 $225,292,986 $236,800,742
OPERATING EXPENSES:
Telecommunication costs 37,871,217 99,842,779 104,376,362
Facility commissions 25,723,997 71,205,505 71,359,313
Field operations and maintenance 4,542,757 7,817,165 6,428,038
Selling, general and administrative 8,540,629 17,661,406 17,213,817
Depreciation and impairment 2,218,694 6,691,954 7,199,737
Amortization of intangibles 14,243,332 26,338,961 21,526,471
Restructure and other charges (income) 399,817 1,743,290 (68,615)
--------------------- --------------------- ----------------------
Total operating expenses 93,540,443 231,301,060 228,035,123
--------------------- --------------------- ----------------------
OPERATING INCOME (LOSS) (1,767,402) (6,008,074) 8,765,619
OTHER (INCOME) EXPENSE:
Interest expense, net 11,137,877 19,637,507 19,457,642
Other (income), net (76,392) (235,623) (6,640)
--------------------- --------------------- ----------------------
Total other (income) expense 11,061,485 19,401,884 19,451,002
--------------------- --------------------- ----------------------
LOSS BEFORE INCOME TAXES AND
EXTRAORDINARY LOSS (12,828,887) (25,409,958) (10,685,383)
INCOME TAX (BENEFIT) EXPENSE (641,670) 476,471 450,000
--------------------- --------------------- ----------------------
LOSS BEFORE EXTRAORDINARY ITEM (12,187,217) (25,886,429) (11,135,383)
EXTRAORDINARY LOSS ON DEBT EXTINGUISHMENT 4,739,757
--------------------- --------------------- ----------------------
NET LOSS (16,926,974) (25,886,429) (11,135,383)
PREFERRED STOCK DIVIDENDS
AND ACCRETION OF DISCOUNT 474,000 474,000 1,233,613
--------------------- --------------------- ----------------------
NET LOSS APPLICABLE TO COMMON STOCK $(17,400,974) $(26,360,429) $(12,368,996)
===================== ===================== ======================
</TABLE>
See notes to consolidated financial statements
32
<PAGE>
EVERCOM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK ADDITIONAL
------------------ ------------------- PAID-IN ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL (DEFICIT) TOTAL
-------- -------- -------- --------- ----------- --------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, JANUARY 1, 1997 5,925 $ 59 15,300 $153 $21,610,972 $(15,129,855) $ 6,481,329
Preferred dividends (474,000) (474,000)
Issuance of common stock 900 9 899,991 900,000
Net loss (16,926,974) (16,926,974)
------- -------- -------- -------- ----------- ----------- -----------
BALANCE, DECEMBER 31, 1997 5,925 59 16,200 162 22,036,963 (32,056,829) (10,019,645)
Preferred dividends (474,000) (474,000)
Issuance of common stock 133 1 266,599 266,600
Net loss (25,886,429) (25,886,429)
-------- -------- -------- -------- ----------- ----------- -----------
BALANCE, DECEMBER 31, 1998 5,925 59 16,333 163 21,829,562 (57,943,258) (36,113,474)
Preferred dividends (794,432) (794,432)
Issuance of preferred stock 5,000 50 4,895,287 4,895,337
Issuance of common stock 100 1 149,999 150,000
Net loss (11,135,383) (11,135,383)
------- ------- ------- ------- ----------- ----------- -----------
BALANCE, DECEMBER 31, 1999 10,925 $109 16,433 $164 $26,080,416 $(69,078,641) $(42,997,952)
======= ======= ======= ======= =========== =========== ===========
</TABLE>
See notes to consolidated financial statements.
33
<PAGE>
EVERCOM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------------------
1997 1998 1999
------------- ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(16,926,974) $(25,886,429) $(11,135,383)
Adjustments to reconcile net loss to net
cash provided by operating activities:
Depreciation and impairment 2,218,694 6,691,954 7,199,737
Amortization of intangible assets, including deferred
financing costs and bond discount 14,804,641 27,482,445 22,554,290
Extraordinary loss on debt extinguishment 4,739,757
Deferred income taxes (1,295,508)
Changes in operating assets and liabilities, net
of effects of acquisitions:
Accounts receivable (6,974,425) (22,232,694) 893,098
Inventories (723,013) (606,359) (1,151,793)
Prepaid expenses and other assets (87,536) 134,130 647,947
Accounts payable 1,574,179 14,782,610 (2,489,201)
Accrued expenses 9,694,953 3,728,009 (942,522)
Income taxes (976,546) 164,795 321,389
------------- ------------ ------------
Net cash provided by operating activities 6,048,222 4,258,461 15,897,562
------------- ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
(Increase) Decrease in restricted cash (1,919,312) 1,919,312
Capital expenditures (8,062,724) (13,591,974) (8,396,973)
Cash outflows for acquisitions (80,775,395) (11,711,061) (3,741,469)
------------- ------------ ------------
Net cash used in investing activities (90,757,431) (23,383,723) (12,138,442)
------------- ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from the issuance of debt 168,709,966 19,000,000 5,500,000
Repayment of advances (1,001,024)
Repayment of debt (67,630,581) (5,553,572) (13,521,495)
Payments of deferred financing costs (7,885,650) (336,992)
Payments of preferred dividends (474,000)
Proceeds from the issuance of common and
preferred stock, net of expenses 66,600 4,895,337
------------- ------------ ------------
Net cash provided by (used in) financing activities 92,192,711 13,039,028 (3,463,150)
------------- ------------ ------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 7,483,502 (6,086,234) 295,970
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 294,494 7,777,996 1,691,762
------------- ------------ ------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 7,777,996 $ 1,691,762 $ 1,987,732
============= ============ ============
SUPPLEMENTAL INFORMATION:
Cash paid for interest $ 4,202,059 $ 25,102,184 $ 18,532,282
============= ============ ============
Cash paid for income taxes $ 1,552,973 $ 311,676 $ 128,611
============= ============ ============
Noncash transactions:
Issuance of subordinated notes, preferred
stock and common stock for acquisitions $ 900,000 $ 950,000 $ 150,000
============= ============ ============
Dividends payable $ 474,000 $ 474,000 $ 794,432
============= ============ ============
Amounts payable for acquisition costs $ 8,369,421 $ -- $ --
============= ============ ============
Amounts payable for deferred financing costs $ 757,493 $ -- $ --
============= ============ ============
Issuance of stock for forgiveness of
acquisition liability $ -- $ 200,000 $ --
============= ============ ============
</TABLE>
See notes to consolidated financial statements.
34
<PAGE>
EVERCOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS - Evercom, Inc. and subsidiaries (the "Company") owns, operates and
maintains telephone systems under contracts with correctional facilities in
44 states throughout the United States. The Company was incorporated on
November 20, 1996, and effective December 1, 1996, acquired all of the
outstanding equity interests of Talton Telecommunications Corporation and
AmeriTel Pay Phones, Inc. The Company has grown through numerous subsequent
acquisitions, as discussed in Note 2.
The Company accumulates call activity from its various installations and
bills its revenues related to this call activity through major local
exchange carriers ("LECs") or through third-party billing services for
smaller volume LECs, all of which are granted credit in the normal course of
business with terms of between 30 and 60 days. The Company also provides
validation, billing and collection services for the inmate calls of two
major regional bell operating companies. The Company performs ongoing credit
evaluations of its customers and maintains allowances for unbillable and
uncollectible losses based on historical experience.
The Company operates in only one business segment as its operating
activities are related to the operation and processing of collect, prepaid
and debit calling services to local, county, state and private correctional
facilities in the United States.
PREPARATION OF FINANCIAL STATEMENTS - The preparation of financial
statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions, such as estimates of
allowances and reserves for unbillable and uncollectible chargebacks that
affect the reported amounts of assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
PRINCIPLES OF CONSOLIDATION - The accompanying consolidated financial
statements include the accounts of the Company and its wholly owned
subsidiaries, Talton Telecommunications Corporation, Talton
Telecommunications of Carolina, Inc., AmeriTel Pay Phones, Inc., Talton STC
Inc., Talton InVision, Inc., MOG Communications, Inc., Saratoga Telephone
Company, Inc., and One Source Telecommunications, Inc. As of January 1,
1999, the company merged all of the subsidiaries into Talton Invision, Inc.
Concurrent with the merger, the Company amended Talton Invision, Inc.'s
Certificate of Incorporation to continue its existence as Evercom Systems,
Inc.
CASH AND CASH EQUIVALENTS - Cash and cash equivalents include cash on hand
and investments with a remaining maturity at date of purchase of three
months or less.
ACCOUNTS RECEIVABLE - Trade accounts receivable represent amounts billed for
calls placed through the Company's telephone systems to the various LECs or
third-party billing services, net of advance payments received, and an
allowance for unbillable and uncollectible calls, based on historical
experience, for estimated chargebacks to be made by the LECs. Under account
advance agreements with various third-party billing services, advance
payments equal to a percentage of the outstanding billed receivables are
remitted to the Company when calls are submitted to the third-party billing
service, and the Company grants a lien to the third-party billing service on
the related accounts receivable for the advance. The remainder of the billed
receivable is paid to the Company, net of the advance amount, after the
third-party billing service has collected the amounts receivable from the
respective LECs. Interest is charged on the advance payment at varying
rates.
INVENTORIES - Inventories are stated at the lower of cost, as determined
primarily using the weighted average cost method, or market. Inventory is
primarily composed of equipment for
35
<PAGE>
installation on new contracts and supplies and parts for the telephone
systems serviced by the Company.
PROPERTY AND EQUIPMENT - Property and equipment are stated at cost.
Depreciation and amortization is provided on a straight-line basis over the
estimated useful lives of the related assets. The following is a summary of
useful lives for major categories of property and equipment.
ASSET USEFUL LIFE
Leasehold improvements Lesser of life or lease term
Telephone system equipment 3.5 to 7.5 years
Vehicles 3 years
Office equipment 3 to 7 years
Maintenance and repairs are expensed when incurred and major repairs that
extend an asset's useful life are capitalized. When items are retired or
disposed, the related carrying value and accumulated depreciation are
removed from the respective accounts, and the net difference less any amount
realized from the disposition is reflected in earnings.
INTANGIBLE AND OTHER ASSETS - Intangible and other assets primarily include
amounts allocated to acquired facility contracts, noncompete agreements,
goodwill and other intangible assets, which are stated at cost, along with
the long-term portion of customer advances. Amortization of intangible
assets is provided on a straight-line basis over the estimated useful lives
of the related assets. The following is a summary of useful lives for major
categories of intangible assets:
INTANGIBLE ASSET USEFUL LIFE
Acquired facility contracts Contract term
Noncompete agreements Agreement term
Deferred loan costs Loan term
Other assets and intangibles 2 to 5 years
Goodwill 20 years
Acquired facility contracts consist primarily of costs allocated to
locations acquired in acquisitions of facility contract rights from other
service providers, along with signing bonuses paid to the facilities under
new facility installations and other incremental direct costs paid to obtain
the facility contracts.
Other assets and intangibles include costs incurred to obtain direct billing
agreements with LECs, and licensing fees to obtain state licenses to conduct
business.
The Company periodically assesses the net realizable value of its intangible
assets, as well as all other long-term assets, by comparing the expected
future net operating cash flow, undiscounted and without interest charges,
to the carrying amount of the underlying assets. The Company would evaluate
a potential impairment if the recorded value of these assets exceeded the
associated future net operating cash flows. Any potential impairment loss
would be measured as the amount by which the carrying value exceeds the fair
value of the asset. Fair value of assets would be measured by market value,
if an active market exists, or by a forecast of expected future net
operating cash flows, discounted at a rate commensurate with the risk
involved. As discussed in Note 4, the Company recorded an impairment
loss on a portion of its telephone system equipment in 1998.
INCOME TAXES - The Company accounts for income taxes using the liability
method in accordance with the provisions of Statement of Financial
Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes." Under
this method, deferred tax assets and liabilities are provided for temporary
differences between the financial statement and tax bases of the assets and
liabilities using current tax rates.
36
<PAGE>
REVENUE RECOGNITION - Revenues related to collect, prepaid and debit calling
services are recognized during the period in which the calls are made. In
addition, during the same period, the Company accrues the related
telecommunication costs for validating, transmitting, billing and
collection, and line and long-distance charges, along with commissions
payable to the facilities and allowances for unbillable and uncollectible
calls, based on historical experience.
Revenues related to the validation, billing and collection services provided
to other entities are recognized in the period in which the calls are
processed through the Company's system. During the same period, the Company
accrues the related telecommunications costs for validating, transmitting,
and billing and collection costs, along with allowances for unbillable and
uncollectible calls, based on historical experience.
FACILITY COMMISSIONS - Under the terms of the Company's telephone system
contracts with correctional facilities, the Company pays commissions to
these facilities generally based on call volume revenues that are accrued
during the period the revenues are generated
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 the net loss reported in the statements of consolidated operations for
each of the three years ended December 31, 1999, since there were no other
items of comprehensive income for the periods presented.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS - SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities," was issued in June 1998, and
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, 2000. The Company is currently
evaluating the effect that the statement may have on the Company's
consolidated financial statements.
2. ACQUISITIONS
Effective December 1, 1996, the Company acquired all of the outstanding
equity interests of Talton Telecommunications Corporation and AmeriTel Pay
Phones, Inc. The aggregate net purchase price was approximately $47.9
million, which was funded with the net proceeds from the issuance of common
and preferred stock and the proceeds from the issuance of long-term debt.
Since certain of the stockholders of the Company held ownership interests in
Talton Telecommunications and AmeriTel Pay Phones, Inc., their continuing
ownership interest in the Company has been accounted for at their prior
historical basis, which has resulted in a reduction in stockholders' deficit
of approximately $14.9 million and a corresponding reduction in the fair
values assigned to tangible and identifiable intangible assets, in
accordance with the provisions of Emerging Issue Task Force Issue No. 88-16,
"Basis in Leveraged Buyout Transactions."
Effective April 4, 1997, the Company acquired substantially all of the net
assets of Tri-T, Inc. (d.b.a. Tataka) for cash of $0.8 million, which was
funded primarily by borrowings under the Senior Credit Facility.
Effective June 27, 1997, the Company acquired substantially all of the net
assets of Security Telecom Corporation for cash of $9.9 million and issuance
of 900 shares of the Company's Class A common stock. The Company financed
the acquisition with a portion of the proceeds from the Senior Notes (as
defined). Approximately $2.5 million of the purchase price was withheld at
closing, pending certain
37
<PAGE>
regulatory approvals and final adjustments. In conjunction with the
acquisition of Security Telecom Corporation, the Company entered into an
agreement with an employee of Security Telecom Corporation giving the em
ployee the right to receive cash of $200,000 or to purchase up to 100 shares
of the Company's Class A common stock for $2,000 per share. The employee
exercised this right in September 1998.
Effective July 31, 1997, the Company acquired all of the net assets of
Correctional Communications Corporation for a cash purchase price of $10.3
million. Approximately $0.5 million of the purchase price is held in an
escrow account pending resolution of certain consents and indemnities. The
acquisition agreement also provides for a contingent payment of up to $1.5
million if certain financial performance benchmarks are achieved in the
future. The $1.5 million contingency will be accounted for as an adjustment
to the purchase price when the contingency is resolved. The Company financed
the acquisition with a portion of the proceeds from the Senior Notes.
Effective October 6, 1997, the Company entered into an agreement to purchase
substantially all of the net assets of the inmate pay phone division of
Communications Central Inc. for $40 million in cash and assumption of $2.0
million in liabilities subject to various adjustments as defined in the
agreement and subject to a provision for working capital of approximately
$1.2 million provided to the Company pursuant to the purchase agreement. The
Company financed the acquisition with the remaining proceeds from the Senior
Notes and borrowings under the Senior Credit Facility.
Effective December 1, 1997, the Company entered into an agreement to
purchase substantially all of the net assets of the inmate pay phone
division of North American InTeleCom, Inc. from TSC Communications for a
cash purchase price of $6.5 million in cash, a deferred payment of $1.7
million, and the assumption of certain liabilities approximating $0.7
million. The Company funded the acquisition with borrowings under the Senior
Credit Facility.
Effective December 19, 1997, the Company entered into an agreement to
purchase substantially all of the net assets of the inmate pay phone
division of Peoples Telephone Company, Inc. for $10.6 million with the
assumption of certain liabilities. The acquisition agreement also provides
for additional contingent payments if certain financial results are obtained
in the future. The additional payments will be accounted for as an
adjustment to the purchase price when the contingency is resolved. The
Company funded the acquisition with borrowings under the Senior Credit
Facility.
Effective January 1, 1998, the Company entered into an agreement to purchase
substantially all of the net assets of the inmate pay phone division of ILD
Teleservices, Inc. for a cash purchase price of $2.6 million. The
acquisition was funded with borrowings under the Senior Credit Facility.
Effective February 1, 1998, the Company entered into an agreement to
purchase MOG Communications, Inc. for a cash purchase price of $1.9 million
and assumption of a note payable of $950,000. The acquisition was funded
with borrowings under the Senior Credit Facility.
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 Facility.
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.
38
<PAGE>
The above 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 consolidated financial
statements of the Company. At the acquisition date, the purchase price was
allocated to assets acquired, including identifiable intangibles and
liabilities assumed based on their fair values. The excess of the total
purchase prices over the fair value of the net assets acquired represents
goodwill.
In connection with the acquisitions, assets were acquired and liabilities
were assumed as follows:
<TABLE>
<CAPTION>
Purchase Prices: 1998 1999
- ---------------- ----------------- ------------------
<S> <C> <C>
Net cash paid $ 7,021,727 $ 10
Amounts payable for acquisition costs 1,262,986
Subordinated notes and common stock issued
to sellers, net of expenses 950,000 150,000
----------------- ------------------
Total net purchase prices, including professional fees 7,971,727 1,412,996
Fair values of net assets acquired:
Fair values of assets acquired 3,828,315 1,687,996
Liabilities assumed (416,780) (275,000)
----------------- ------------------
Total net assets acquired 3,411,535 1,412,996
----------------- ------------------
Goodwill $ 4,560,192 $ --
================= ==================
</TABLE>
39
<PAGE>
The following table presents unaudited pro forma results of operations of
the Company for the years ended December 31, 1998 and 1999 respectively, as
if the acquisitions had occurred at the beginning of each respective period:
Years Ended December 31,
------------------------------------
1998 1999
------------ ------------
Operating revenues $232,779,019 $239,300,742
Net loss 27,172,457 10,885,383
The unaudited pro forma results of operations are not necessarily indicative
of what the actual results of operations of the Company would have been had
the acquisitions occurred at the beginning of the periods presented, nor do
they purport to be indicative of the future results of operations of the
Company.
3. ACCOUNTS RECEIVABLE
Accounts receivable consist of the following:
<TABLE>
<CAPTION>
December 31,
---------------------------------------
1998 1999
----------------- -----------------
<S> <C> <C>
Trade accounts receivable, net of advance payments
received of $141,460 and $0 at
December 31, 1998 and 1999, respectively $42,308,582 $38,384,376
Advance commissions receivable 2,020,020 1,870,475
Receivables related to acquisitions 141,044 226,015
Recoverable Universal Service Fund Fees - current portion 1,089,800 1,123,165
Receivables from joint venture partner 419,643
Employees and other 329,749 251,419
----------------- -----------------
46,308,838 41,855,450
Less allowance for unbillable and
uncollectible chargebacks (7,237,879) (3,592,618)
----------------- -----------------
$39,070,959 $38,262,832
================= =================
</TABLE>
At December 31, 1998 and 1999, the Company had advanced commissions to
certain facilities of $2,495,558 and $2,100,149, respectively, 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.
The Company bills the majority of its collect call revenue through direct
billing arrangements with local exchange carriers. The local exchange
carriers establish reserves for future uncollectibles by withholding funds
from the Company as part of the recurring receivables settlement process.
The allowance for unbillable and uncollectible chargebacks reflected in the
financial statements of the Company is dependent upon a number of factors,
including i) the amount of reserves already established by the LECs or third
party billing services and ii) the Company's historical unbillable and
uncollectible experience.
40
<PAGE>
4. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
December 31,
--------------------------------
1998 1999
----------- ------------
Leasehold improvements $ 834,051 $ 913,420
Telephone system equipment 33,776,168 39,666,667
Vehicles 431,807 429,460
Office equipment 2,419,992 2,540,215
----------- ------------
37,462,018 43,549,762
Less accumulated depreciation (7,976,074) (15,174,405)
----------- ------------
$29,485,944 $ 28,375,357
=========== ============
DEPRECIATION AND IMPAIRMENT - Depreciation and impairment in 1997, 1998 and
1999 includes depreciation expense of $2,218,694, $5,996,816 and $7,199,737,
respectively. Also included in depreciation and impairment in 1998 is an
impairment loss of $695,138, representing the net book value of telephone
system equipment that was removed from service.
5. INTANGIBLE AND OTHER ASSETS
Intangible and other assets consist of the following:
<TABLE>
<CAPTION>
December 31,
-----------------------------------------
1998 1999
------------------ ------------------
<S> <C> <C>
Intangible and other assets:
Acquired telephone contracts $ 63,835,844 $ 67,761,060
Noncompete agreements 568,611 568,611
Deferred loan costs 8,299,067 8,636,059
Goodwill 84,530,834 84,530,834
Other intangibles 694,493 766,502
------------------ ------------------
157,928,849 162,263,066
Less accumulated amortization (42,640,007) (65,195,703)
------------------ ------------------
115,288,842 97,067,363
Deposits 400,540 431,996
Recoverable Universal Service Fund Fees - noncurrent portion 421,888
Other assets - noncurrent portion
of commission advances to facilities 475,538 229,674
------------------ ------------------
$116,586,808 $ 97,729,033
================== ==================
</TABLE>
41
<PAGE>
6. ACCRUED EXPENSES
Accrued expenses consist of the following:
<TABLE>
<CAPTION>
December 31
--------------------------------------
1998 1999
----------------- ---------------
<S> <C> <C>
Facility commissions $ 8,007,248 $ 7,303,783
Billing and collection fees 1,804,790 1,411,127
Uncollectible call chargebacks 5,267,345 4,554,260
Accrued acquisition and financing
costs 3,941,666 1,493,164
Accrued interest 218,646 64,782
Accrued excise taxes payable 2,072,856 1,847,889
Accrued dividends on preferred stock 474,000 1,268,432
Accrued restructure costs 654,245 17,796
Accrued payroll and bonuses 778,633 1,689,438
Other 578,626 1,550,792
----------------- -----------------
$23,798,055 $21,201,463
================= =================
</TABLE>
The accrual for uncollectible call chargebacks represents a reserve for
amounts collected from LECs that are expected to be charged back to the
Company in future periods.
42
<PAGE>
7. LONG-TERM DEBT
The following is a summary of long-term debt:
DECEMBER 31,
--------------------------------------------
1998 1999
-------------------- ------------------
Senior Notes $115,000,000 $115,000,000
Senior Credit Facility:
Revolving loan facility 14,500,000 11,500,000
Term loan facility 49,500,000 39,875,000
Additional term loan facility 5,500,000
Note payable (see Note 2),
with interest of 8.0%, due at
maturity on February 19, 1999,
and subordinate to borrowings
of the Senior Notes and Senior
Credit Facility 950,000
Other 32,729 86,234
------------------ ------------------
179,982,729 171,961,234
Less current portion of long-term
debt (10,607,729) (12,434,468)
------------------ ------------------
$169,375,000 $159,526,766
================== ==================
SENIOR NOTES - On June 27, 1997, the Company issued $115.0 million of 11%
Senior Notes due 2007 (the "Senior Notes"). A portion of the proceeds of the
issuance was used to repay substantially all of the Company's previous debt
outstanding and to fund the purchase of Security Telecom Corporation. As a
result of the repayment of the outstanding debt, and amendment of the
Company's Senior Credit Facility, the Company incurred an extraordinary loss
of $4.7 million resulting from the write-off of the unamortized deferred
loan costs and the unamortized discount of the original senior subordinated
notes.
Interest on the Senior Notes is payable semiannually. All of the Company's
subsidiaries (the "Subsidiary Guarantors") are fully, unconditionally, and
jointly and severally liable for the Senior Notes. The Subsidiary Guarantors
are wholly-owned and constitute all of the Company's direct and indirect
subsidiaries. The Company has not included separate financial statements of
its subsidiaries because (a) the aggregate assets, liabilities, earnings and
equity of such subsidiaries are substantially equivalent to the assets,
liabilities, earnings and equity of the Company on a consolidated basis and
(b) the Company believes that separate financial statements and other
disclosures concerning subsidiaries are not material to investors.
The Senior Notes are redeemable at the Company's option on or after June 30,
2002. The Senior Notes are redeemable at the redemption prices (expressed as
percentages of principal amount) set forth below plus accrued and unpaid
interest:
YEAR PERCENTAGE
2002 105.500%
2003 103.667%
2004 101.833%
2005 and thereafter 100.000%
43
<PAGE>
At any time on or prior to June 30, 2000, the Company may redeem up to 30%
of the Senior Notes originally issued at a redemption price of 111% of the
principal amount, plus accrued and unpaid interest, with the proceeds of one
or more Equity Offerings (as defined in the Senior Credit Facility).
SENIOR CREDIT FACILITY - The Company amended and restated its Senior Credit
Facility with a group of lenders in March 1999 in conjunction with the
issuance of First Preferred Series A stock and warrants. The amendment
provides for an additional $5.5 million term loan facility that will bear
interest at similar rates to borrowings under the Senior Credit Facility.
The Senior Credit Facility includes a $55 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 million letter of credit
facility). Scheduled principal payments under the term loan facilities
cannot be reborrowed.
Amounts outstanding under the Senior Credit Facility bear interest at a rate
per annum equal to one of the following rates, at the Company's option: (i)
a base rate equal to the higher of the Federal Funds rate plus 50 basis
points or the lead bank's reference rate plus a margin that varies from 75
to 225 basis points, depending on the Company's Total Debt to Earnings
Before Interest, Taxes, Depreciation and Amortization ("EBITDA") Ratio (as
defined in the Senior Credit Facility) or (ii) the London Interbank Offering
Rate ("LIBOR") plus a margin that varies from 200 to 350 basis points, based
on the Company's Total Debt to EBITDA Ratio. The Company pays a commitment
fee on unused amounts of the Senior Credit Facility at the rate of 50 basis
points. The blended interest rate in effect at December 31, 1999, on the
Senior Credit Facility was 9.38%.
Interest is payable quarterly, and scheduled principal installments on the
term loan acquisition facility are due in quarterly installments of
$3,093,750 beginning on March 31, 2000, increasing to $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. Both the
revolving and the term loan facilities are collateralized by substantially
all of the assets of the Company.
INTEREST RATE CAP AGREEMENT - 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 Senior Credit
Facility. At December 31, 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 at 7.5%, plus the applicable
LIBOR margin.
COVENANTS AND OTHER - The Senior Notes and the Senior Credit Facility
contain financial and operating covenants requiring, among other items, the
maintenance of certain financial ratios, including total debt to free cash
flow (as defined in the Senior Credit Facility), senior secured debt to free
cash flow and various other ratios of free cash flow to specified minimums.
In addition, the Senior Credit Facility contains various covenants, which,
among other things, limit the Company's ability to incur additional
indebtedness, restrict the Company's ability to invest in and divest of
assets, and restrict the Company's ability to pay dividends. As of December
31, 1999, the Company is in compliance with its financial and operating
covenants under the Senior Credit Facility. In the event the Company fails
to comply with the covenants and other restrictions, as specified, it could
be in default under the Senior Notes and the Senior Credit Facility and
substantially all of the Company's long-term maturities could be
accelerated.
44
<PAGE>
As a result of the issuance of the First Preferred Series A Stock and
warrants discussed in Note 9, the Company was required to obtain a waiver
from its Senior Credit Facility group of lenders that waives the lenders'
rights to the proceeds raised by the Company from the equity offering.
At December 31, 1999, the scheduled maturities of long-term debt were as
follows:
2000 $ 12,434,468
2001 13,776,766
2002 30,750,000
2003 0
2004 0
Thereafter 115,000,000
------------
$171,961,234
============
8. INCOME TAXES
A summary of the income tax expense (benefit) is as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------------------------------------------
1997 1998 1999
----------------------- ----------------------- -------------------
<S> <C> <C> <C>
Current income tax provision:
Federal $ 228,461 $ (135,134) $ 200,000
State 425,377 611,605 250,000
Deferred income taxes (1,295,508)
----------------------- ---------------------- -------------------
$ (641,670) $ 476,471 $ 450,000
======================= ======================= ==================
</TABLE>
The following is a reconciliation of the income tax benefit reported in the
statement of operations:
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------------------------------------
1997 1998 1999
-------------------- ---------------------- ------------------
<S> <C> <C> <C>
Tax benefit at statutory rates $ (5,973,339) $ (8,639,386) $ (3,633,030)
Effect of state income taxes (301,595) (521,679) (287,250)
Effect of nondeductible goodwill amortization 675,910 759,953 759,953
Nondeductible write-off of debt discount 332,163
Valuation allowance on deferred tax assets 4,674,920 8,588,395 3,740,708
Other (49,729) 289,188 (130,381)
-------------------- ---------------------- ------------------
$ (641,670) $ 476,471 $ 450,000
==================== ====================== ==================
</TABLE>
45
<PAGE>
The tax effects of temporary differences giving rise to deferred income tax
assets and liabilities were:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------------------------------------
1998 1999
---------------------------- ----------------------------
<S> <C> <C>
Reserves for unbillable and uncollectible chargebacks $ 3,214,286 $ 2,339,632
Other reserves 689,786 234,625
Amortization of intangibles 8,191,148 12,925,463
Net operating loss carryforward 2,610,217 3,000,831
Valuation allowance (13,263,315) (17,004,023)
---------------------------- -----------------------------
1,442,122 1,496,528
Deferred income tax liability:
Depreciation and amortization (1,442,122) (1,496,528)
---------------------------- -----------------------------
Net deferred income tax asset (liability) $ - $ -
============================ =============================
</TABLE>
This net deferred income tax liability is classified in the consolidated
balance sheet as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------------------------------
1998 1999
--------------------------- ------------------------------
<S> <C> <C>
Current asset $ 1,442,122 $ 1,496,528
Noncurrent liability (1,442,122) (1,496,528)
--------------------------- ------------------------------
$ - $ -
=========================== =============================
</TABLE>
The Company has established a valuation allowance for deferred tax assets
primarily as a result of operating and extraordinary losses. The Company was
unable to determine that it is more likely than not that the deferred tax
assets will be realized. The Company has accumulated a federal income tax
net operating loss carryforward of approximately $8.9 million through
December 31, 1999 of which $0.3 million, $4.2 million and $4.4 million will
expire in 2017, 2018 and 2019, respectively.
9. STOCKHOLDERS' EQUITY
COMMON STOCK - The authorized common stock of the Company includes 49,600
shares of Class A common stock and 400 shares of Class B common stock.
Holders of the shares of the Company's Class A and the Company's Class B
common stock have identical rights and privileges except that holders of the
Company's Class B common stock are entitled to four votes a share as
compared to one vote per share for holders of the Company's Class A common
stock.
In September 1998, an employee exercised his option, received in connection
with a previous acquisition, to purchase 100 shares of the Company's Class A
common stock for $2,000 per share. Additionally, in November 1998, a former
employee exercised options to purchase 33 shares of the Company's Class A
common stock for $2,000 per share. In June 1999 the Company issued 100
shares of Class A common stock in conjunction with the Alliance Acquisition
(see Note 2).
Issued and outstanding shares of Class A common stock as of December 31,
1998 and 1999, were 15,933 shares and 16,033 shares, respectively. Issued
and outstanding shares of Class B common
46
<PAGE>
stock as of December 31, 1998 and 1999, were 400 shares. The Class B common
stock is convertible into four shares of Class A common stock upon the
occurrence of a major event, as defined below.
SENIOR PREFERRED STOCK - In connection with the acquisitions of Talton
Telecommunications Corporation and AmeriTel Pay Phones, Inc. as discussed in
Note 2, the Company issued 5,925 shares of senior preferred stock to former
stockholders of the acquired companies. The preferred stockholders have no
voting rights and are entitled to receive cumulative dividends at the rate
of $80 per share per annum, payable quarterly, when declared by the Board of
Directors. In the event of any liquidation, dissolution or winding up of the
Company (voluntary or involuntary), the holders of the preferred stock shall
be entitled to receive a preference over common stockholders in any
distribution of assets of the Company, equal to $1,000 per share plus
cumulative unpaid dividends. Upon the occurrence of a major event, which
includes (i) a sale of all or substantially all the assets of the Company or
(ii) a registered public offering of equity interests with gross proceeds of
at least $20.0 million under the Securities Act of 1933, as amended, the
Company is required to redeem the outstanding shares of preferred stock at a
price equal to $1,000 a share plus cumulative unpaid dividends. Each holder
of preferred stock is entitled to convert each preferred share into 0.08505
shares of Class A common stock, at the option of the holder, at any time
after the date of issuance and on or prior to the occurrence of a major
event, as defined.
In March 1999, the Company raised $5 million of equity from its existing
shareholders 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. 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 will be entitled to receive dividends at
the applicable First Preferred Series A Rate, payable quarterly commencing
on April 1, 1999. Such dividends will be payable out of funds legally
available therefor, will be payable only when, as, and if declared by the
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 will be 8% per annum through March 31,
2001, will be 10% 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 of the Company with respect to dividend rights upon
liquidation. The warrants have a strike price of $1,000 per share and will
expire if not sooner exercised on December 31, 2007.
In conjunction with the March 1999 equity offering, the preferred dividend
rates on the original Senior Preferred Stock were modified to mirror the
preferred dividend rates on the First Preferred Series A Stock.
Also in March 1999, in conjunction with the issuance of the First Preferred
Series A Stock and warrants, the Company amended and restated its Senior
Credit Facility, as discussed further in Note 7. The amendment increased
the Company's borrowing capacity under the term loan facility of the Senior
Credit Facility by $5.5 million.
JUNIOR PREFERRED STOCK - In addition to the senior preferred stock discussed
above, the Company is authorized to issue up to 39,000 shares of junior
preferred stock, of which no shares had been issued as of December 31, 1999.
WARRANTS - At the Company's inception, the Company entered into a warrant
agreement with certain of its senior subordinated note holders, which
granted the note holders the right to purchase 1,085 shares of Class A
common stock at an exercise price of $.01 a share, which was below the
market value of the underlying shares at that date. Accordingly, as of
December 31, 1996, approximately $1,085,500 of the proceeds of the senior
subordinated note borrowings were allocated to these warrants and were
47
<PAGE>
recorded as additional paid-in capital. The $1,085,500, net of accumulated
amortization, was written off in 1997 as part of the extraordinary loss on
debt extinguishment upon the issuance of the Senior Notes and the related
repayment of the outstanding balances under the previous Senior Credit
Facility.
At the Company's inception, the Company also entered into various warrant
agreements with its other subordinated lenders along with its Class B common
stockholders that granted such holders the right to purchase 6,230 shares of
Class A common stock of the Company upon terms established by the Board of
Directors. In conjunction with the issuance of the Senior Notes, 1,059 of
these warrants were terminated. The remaining 5,171 warrants are exercisable
in whole or part, at various dates through December 27, 2006, at warrant
prices ranging from $1,000 to $3,000 a share.
In March 1999, the Company issued 5,000 warrants giving the holders of each
warrant the right to acquire one share of the Company's Class A Common Stock
for $1,000 per share.
OPTIONS - In connection with certain employment agreements in 1997, 1998,
and 1999 the Company granted 691, 896, and 160, respectively, options to
acquire common stock at an exercise price equal to or in excess of the fair
value of such shares at the date of grant. The options vest ratably over
the term of the employment agreements and expire ten years from the date of
grant.
On May 26, 1998, the Company's Board of Directors approved the Evercom, Inc.
1998 Stock Option Plan (the "Plan"). The Plan provides for the grant of
options to purchase shares of Class A common stock to certain officers and
employees.
The following information summarize the shares subject to options:
<TABLE>
<CAPTION>
Number of Shares Weighted Average Exercise Price
Per Share
1997 1998 1999 1997 1998 1999
-------------------------------------- -----------------------------------
<S> <C> <C> <C> <C> <C> <C>
Options outstanding, beginning of year 691 1,555 $2,000 $2,000
Granted 691 952 420 $2,000 2,000 2,000
Exercised (33) 2,000
Cancelled (55) (120) 2,000 2,000
--------------------------------------
Options outstanding, end of year 691 1,555 1,855 2,000 2,000 2,000
======================================
Options exercisable, end of year 106 291 819
======================================
</TABLE>
The following table summarizes information about options outstanding at
December 31, 1999:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE REMAINING WEIGHTED AVERAGE EXERCISE
EXERCISE PRICE NUMBER OUTSTANDING CONTRACTUAL LIFE PRICE
<S> <C> <C> <C>
$2,000 1,855 8.81 $2,000
</TABLE>
48
<PAGE>
The Company applies the provisions of Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees," and related
interpretations in accounting for its options. Accordingly, no compensation
cost has been recognized for such option grants. Had compensation cost for
the Company's options been determined based upon the fair value at the grant
dates for awards consistent with the method prescribed by the SFAS No. 123,
"Accounting for Stock-Based Compensation," the Company's pro forma net loss
would have been as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------------------------
1997 1998 1999
<S> <C> <C> <C>
COMPENSATION COST DISCLOSURE
Compensation Cost $ 207,000 $ 344,000 $ 438,000
Net Loss:
As reported (16,926,974) (25,886,429) (11,135,383)
Pro forma (17,133,974) (26,230,429) (11,573,383)
Stock option share data:
Stock options granted during the period 691 952 420
Weighted average option fair value (a) $ 900 $ 720 $ 669
</TABLE>
________________
(a) Calculated in accordance with the Black-Scholes option pricing model, using
the following assumptions: expected volatility of 0%; expected dividend
yield of 0%; expected option term of seven to ten years and risk-free rate
of return of 6.1%, 4.5%, and 5.9% for the options granted in 1997, 1998,
and 1999, respectively.
49
<PAGE>
10. RELATED-PARTY TRANSACTIONS
One of the Company's subsidiaries leased office space from a stockholder
under a month-to-month lease with monthly payments in 1998 and 1999 of
$9,812 and $9,618, respectively. The lease term extends through December 31,
2001, at which time the Company has an option to extend the lease for an
additional five years.
A stockholder of the Company earns a commission based on the net operating
income, as defined by the commission agreement, generated from one of the
Company's contracts. The Company paid $300,000 and $180,000 to this
stockholder in accordance with this commission agreement during the year
ended December 31, 1998 and 1999, respectively.
The Company entered into a management services and consulting agreement with
a company affiliated with certain stockholders, along with separate
consulting agreements with four stockholders who are former employees of the
acquired companies. These agreements required the payment of aggregate
minimum consulting fees over the agreement life and also provided for the
reimbursement of direct expenses along with future payments for transaction
consulting services. In connection with these agreements, the Company paid
$478,000, $300,000, and $200,000 during the years ended December 31, 1997,
1998 and 1999, respectively. Each of these agreements were terminated in
1999.
One of the agreements entitled an affiliate of certain stockholders to a 1%
fee based on the gross acquisition price for any asset or stock acquisitions
by the Company. This agreement, which was cancelled in 1999, limited the
cumulative acquisition fees paid to this consultant to an amount not to
exceed $1,250,000 over the life of the agreement. In 1997, 1998 and 1999,
the Company paid $187,000, $666,000, and $210,000, respectively, under the
terms of this agreement.
11. BENEFIT PLAN
The Company's subsidiaries sponsor 401(k) savings plans for the benefit of
eligible full-time employees, which are qualified benefit plans in
accordance with the Employee Retirement Income Security Act ("ERISA").
Employees participating in the plan can generally make contributions to the
plan of up to 15% of their compensation. The plans provide for discretionary
matching contributions by the Company of up to 50% of an eligible employee's
contribution. Total plan expenses were $5,115, $5,490 and $9,217 for the
years ended December 31, 1997, 1998 and 1999, respectively.
12. COMMITMENTS AND CONTINGENCIES
OPERATING LEASES - The Company leases office furniture, office space,
vehicles and other equipment under various operating lease
50
<PAGE>
agreements. Rent expense under these operating lease agreements was
$496,967, $919,085 and $905,169 during the year ended December 31, 1997,
1998 and 1999, respectively. Minimum future rental payments under
noncancelable operating leases for each of the next five years ending
December 31 and thereafter and in the aggregate are:
2000 $ 714,440
2001 629,611
2002 518,711
2003 430,225
2004 435,015
Thereafter 1,370,585
----------
$4,098,587
==========
EMPLOYMENT AGREEMENTS - As of December 31, 1999, the Company had entered
into employment agreements with certain key management personnel, which
provided for minimum compensation levels and incentive bonuses along with
provisions for termination of benefits in certain circumstances and for
certain severance payments in the event of a change in control (as defined).
LITIGATION - The Company is subject to various legal proceedings and claims
that arise in the ordinary course of business operations. In the opinion of
management, the amount of liability, if any, with respect to these actions
would not materially affect the financial statements of the Company.
13. FAIR VALUE OF FINANCIAL INSTRUMENTS
Pursuant to SFAS No. 107, "Disclosure About Fair Value of Financial
Instruments," the Company is required to disclose an estimate of the fair
value of the Company's financial instruments. The Company believes that the
carrying amounts of cash and cash equivalents, accounts receivable and
accounts payable are a reasonable estimate of their fair value because of
the short- term maturities of such instruments. In addition, because the
interest rates on the amounts borrowed under the Senior Credit Facility are
variable, their fair values approximate their carrying values.
The fair value of the Senior Notes is based on their quoted market value.
The following is a summary of the carrying value of the Company's debt
instruments:
<TABLE>
<CAPTION>
DECEMBER 31, 1998 DECEMBER 31, 1999
--------------------------------------------------- ----------------------------------------------------
HISTORICAL HISTORICAL
CARRYING VALUE FAIR VALUE CARRYING VALUE FAIR VALUE
<S> <C> <C> <C> <C>
Senior Notes $115,000,000 $109,434,000 $115,000,000 $109,250,000
Senior Credit Agreement 64,000,000 64,000,000 $ 56,875,000 $ 56,875,000
Interest Rate Cap -- $ (43,000)
</TABLE>
14. RESTRUCTURING AND OTHER COSTS
RESTRUCTURING COSTS - During 1998, management authorized and committed to a
plan of restructure. The plan provided 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. Based on the finalization of estimates included within the plan
and the actual 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 relate to 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. Although certain specific actions
51
<PAGE>
of the plan were modified, the overall plan for restructuring the Company
has been substantially completed at a total cost of approximately $200,000
less than the original provision.
Major categories of the restructuring reserve and the amounts incurred are
summarized below:
<TABLE>
<CAPTION>
Balance Balance
12/31/98 (Reductions) Payments 12/31/99
-------- ------------ -------- --------
<S> <C> <C> <C> <C>
Severance and related costs 361,792 (361,792) --
Leased facilities 149,453 (56,269) (93,184) --
Legal and other costs 143,000 (12,346) (112,858) 17,796
------- --------- -------- -------
654,245 (68,615) (567,834) 17,796
Balance Balance
12/31/97 (Additions) Payments 12/31/98
-------- ------------ -------- --------
<S> <C> <C> <C> <C>
Severance and related costs -- 614,678 (252,886) 361,792
Leased facilities -- 217,902 (68,449) 149,453
Legal and other costs -- 379,685 (236,685) 143,000
------- --------- -------- -------
-- 1,212,265 (558,020) 654,245
</TABLE>
Management considers the 1998 plan to be substantially completed as of
December 31, 1999. The accrued expense balance of $17,796 will be paid in
accordance with the terms of the remaining agreements. Therefore, $68,615 of
the reserve was reduced in the fourth quarter of 1999.
OFFERING COSTS - During 1998, the Company incurred $531,025 of external
costs associated with a potential offering of equity securities. Due to the
postponement of the equity offering, these costs were expensed in 1998.
FEDERAL BID COSTS - During 1997, the Company incurred $399,817 of external
costs associated with a bid for the Federal Bureau of Prisons contract. The
Company was unsuccessful in obtaining the contract. The Company expensed all
costs associated with the bid.
EXTRAORDINARY LOSS- During 1997, as a result of the repayment of outstanding
indebtedness and amendments of the Senior Credit Facility, the Company
expensed approximately $4.7 million of debt issuance, legal and other costs
associated with the extinguishment of the prior credit facilities. These
amounts have been classified as an extraordinary loss in accordance with the
provisions of SFAS No. 4, "Reporting Gains and Losses From the
Extinguishment of Debt."
52
<PAGE>
EVERCOM, INC.
SCHEDULE II
CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS
Years Ended December 31, 1997, 1998 and 1999
(In thousands)
<TABLE>
<CAPTION>
Additions
Charged to
Beginning Costs and Ending
Description Balance Expense Deductions Balance
----------- --------- ---------- ---------- -------
<S> <C> <C> <C> <C> <C>
1997 Allowance for doubtful accounts 1,125 17,257 (13,065) 5,317
1998 Allowance for doubtful accounts 5,317 35,670 (33,749) 7,238
1999 Allowance for doubtful accounts 7,238 43,757 (47,402) 3,593
</TABLE>
53
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
54
<PAGE>
PART III
--------
ITEMS 10. THROUGH 13.
- ---------------------
The Company intends to file a Form 10K/A with the Securities and
Exchange Commission not later than 120 days after the end of its fiscal year
ended December 31, 1999. Accordingly, the information required by Part III
(Items 10, concerning the Company's directors and disclosure pursuant to Item
405 of Regulation S-K, and items 11, 12 and 13) is incorporated herein by
reference to such Form 10K/A in accordance with General Instruction G(3) to Form
10-K.
55
<PAGE>
PART IV
- -------
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) and (2) The response to this portion of Item 14 is submitted as
a separate section of this report commencing on page 29.
(a) (3) Exhibits.
Exhibit
No. Description of Exhibit
- ----------- ----------------------
1.1 Asset Purchase Agreement, dated as of August 21, 1997, among the Company,
InVision Telecom, Inc., and Communications Central, Inc. (filed as
Exhibit 2.1 to the Company's Registration Statement No. 333-33639 and
incorporated herein by reference).
1.2 Contribution Agreement, dated as of December 20, 1996, among the Company,
Richard C. Green, Jr., Robert K. Green, T.R. Thompson, Roger K. Sallee,
and certain other stockholders, and AmeriTel Pay Phones, Inc. (filed as
Exhibit 2.2 to the Company's Registration Statement No. 333-33639 and
incorporated herein by reference).
1.3 Contribution Agreement, dated as of December 20, 1996, among the Company,
Julius E. Talton, Julius E. Talton, Jr., and James E. Lumpkin (filed as
Exhibit 2.3 to the Company's Registration Statement No. 333-33639 and
incorporated herein by reference).
1.4 Stock Acquisition Agreement, dated as of December 20, 1996, among the
Company, Richard C. Green, Jr., Robert K. Green, T. R. Thompson, Roger K.
Sallee, and certain other stockholders, and AmeriTel Pay Phones, Inc.
(filed as Exhibit 2.4 to the Company's Registration Statement No. 333-
33639 and incorporated herein by reference).
1.5 Stock Acquisition Agreement, dated as of December 20, 1996, among the
Company, Julius E. Talton, Julius E. Talton, Jr., James E. Lumpkin,
Carrie T. Glover, Talton Telecommunications Corporation, and Talton
Telecommunications of Carolina, Inc. (filed as Exhibit 2.5 to the
Company's Registration Statement No. 333-33639 and incorporated herein by
reference). 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 of February 11, 1999 (filed as Exhibit 3.4 to the
Company's Quarterly Report on Form 10-Q, dated as of May 12, 1999 and
incorporated herein by reference).
4.1 Indenture, dated as of June 27, 1997, between the Company and U.S. Trust
Company of Texas, N.A. (filed as Exhibit 4.1 to the Company's
Registration Statement No. 333-33639 and incorporated herein by
reference).
4.2 Form of Note (contained in Indenture filed as Exhibit 4.2 to the
Company's Registration Statement No. 333-33639 and incorporated herein by
reference).
4.3 Form of Subsidiary Guaranty (contained in Indenture filed as Exhibit 4.3
to the Company's Registration Statement No. 333-33639 and incorporated
herein by reference).
56
<PAGE>
4.4 Registration Rights Agreement, dated as of June 27, 1997, between the
Company and the Initial Purchaser (filed as Exhibit 4.4 to the Company's
Registration Statement No. 333-33639 and incorporated herein by
reference).
4.5 Registration Rights Agreement, dated as of December 27, 1996, by and
among the Company and certain Holders named therein (filed as Exhibit 4.5
to the Company's Registration Statement No. 333-33639 and incorporated
herein by reference).
4.6 Shareholders Agreement, dated as of December 27, 1996, by and among the
Company and certain Persons named therein (filed as Exhibit 4.6 to the
Company's Registration Statement No. 333-33639 and incorporated herein by
reference).
4.7 Warrant Agreement, dated as of December 27, 1996, between the Company and
CIBC Wood Gundy Ventures, Inc. (filed as Exhibit 4.7 to the Company's
Registration Statement No. 333-33639 and incorporated herein by
reference).
4.8 Warrant Agreement, dated as of December 27, 1996, between the Company and
Gregg L. Engles (filed as Exhibit 4.8 to the Company's Registration
Statement No. 333-33639 and incorporated herein by reference).
4.9 Warrant Agreement, dated as of December 27, 1996, between the Company and
Gregg L. Engles (filed as Exhibit 4.9 to the Company's Registration
Statement No. 333-33639 and incorporated herein by reference).
4.10 Warrant Agreement, dated as of December 27, 1996, between the Company and
Gregg L. Engles (filed as Exhibit 4.10 to the Company's Registration
Statement No. 333-33639 and incorporated herein by reference).
4.11 Warrant Agreement, dated as of December 27, 1996, between the Company and
Onyx Talton Partners, L.P. (filed as Exhibit 4.11 to the Company's
Registration Statement No. 333-33639 and incorporated herein by
reference).
4.12 Warrant Agreement, dated as of December 27, 1996, between the Company and
Onyx Talton Partners, L.P. (filed as Exhibit 4.12 to the Company's
Registration Statement No. 333-33639 and incorporated herein by
reference).
4.13 Warrant Agreement, dated as of December 27, 1996, between the Company and
Onyx Talton Partners, L.P. (filed as Exhibit 4.13 to the Company's
Registration Statement No. 333-33639 and incorporated herein by
reference).
4.14 Warrant Agreement, dated as of December 27, 1996, between the Company and
Joseph P. Urso (filed as Exhibit 4.14 to the Company's Registration
Statement No. 333-33639 and incorporated herein by reference).
4.15 Warrant Agreement, dated as of December 27, 1996, between the Company and
Joseph P. Urso (filed as Exhibit 4.15 to the Company's Registration
Statement No. 333-33639 and incorporated herein by reference).
4.16 Warrant Agreement, dated as of December 27, 1996, between the Company and
Joseph P. Urso (filed as Exhibit 4.16 to the Company's Registration
Statement No. 333-33639 and incorporated herein by reference).
4.17 Warrant Agreement, dated as of December 27, 1996, between the Company and
Todd W. Follmer (filed as Exhibit 4.17 to the Company's Registration
Statement No. 333-33639 and incorporated herein by reference).
57
<PAGE>
4.18 Warrant Agreement, dated as of December 27, 1996, between the Company and
Todd W. Follmer (filed as Exhibit 4.18 to the Company's Registration
Statement No. 333-33639 and incorporated herein by reference).
4.19 Warrant Agreement, dated as of December 27, 1996, between the Company and
Todd W. Follmer (filed as Exhibit 4.19 to the Company's Registration
Statement No. 333-33639 and incorporated herein by reference).
4.20 Form of Warrant Agreement, dated as of March 12, 1999 (filed as Exhibit
4.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended
March 31, 1999 and incorporated herein by reference).
10.1 Purchase Agreement dated as of June 27, 1997, between the Company and
CIBC Wood Gundy Securities Corp. (filed as Exhibit 10.1 to the Company's
Registration Statement No. 333-33639 and incorporated herein by
reference).
10.2 Amended and Restated Credit Agreement, dated as of July 30, 1997, among
the Company, Canadian Imperial Bank of Commerce, CIBC Inc., and First
Source Financial LLP (filed as Exhibit 10.2 to the Company's Registration
Statement No. 333-33639 and incorporated herein by reference).
10.3 Asset Purchase Agreement, dated as of May 9, 1997, among the Company,
Security Telecom Corporation, and William H. Ohland (filed as Exhibit
10.3 to the Company's Registration Statement No. 333-33639 and
incorporated herein by reference) .
10.4 First Amendment to Asset Purchase Agreement, dated as of June 21, 1997,
among the Company, Security Telecom Corporation, and William H. Ohland
(filed as Exhibit 10.4 to the Company's Registration Statement No. 333-
33639 and incorporated herein by reference).
10.5 Consulting Agreement, dated as of December 27, 1966, between the Company
and James E. Lumpkin (filed as Exhibit 10.6 to the Company's Registration
Statement No. 333-33639 and incorporated herein by reference).
10.6 Consulting Agreement, dated as of December 27, 1996, between the Company
and Julius E. Talton (filed as Exhibit 10.7 to the Company's Registration
Statement No. 333-33639 and incorporated herein by reference).
10.7 Consulting and Strategic Services Agreement, dated as of December 27,
1996, between the Company and EUF Talton, L.P. (filed as Exhibit 10.8 to
the Company's Registration Statement No. 333-33639 and incorporated
herein by reference).
10.8 Employment Agreement, dated as of December 27, 1996, between the Company
and Julius E. Talton, Jr. (filed as Exhibit 10.9 to the Company's
Registration Statement No. 333-33639 and incorporated herein by
reference).
10.9 Employment Agreement, dated as of November 17, 1997, between the Company
and Jeffrey D. Cushman (filed as Exhibit 10.12 to the Company's
Registration Statement No. 333-33639 and incorporated herein by
reference).
10.10 Employment Agreement, dated as of June 26, 1998, between the Company and
Donald B. Vaello (filed as Exhibit 10.10 to the Company's Annual Report
on Form 10-K for the year ended December 31, 1998 and incorporated herein
by reference).
10.11 Letter Agreement, dated as of April 17, 1998, between the Company and
Keith S. Kelson (filed as Exhibit 10.1 to the Company's Quarterly Report
on Form 10-Q for the quarter ended September 30, 1998 and incorporated
herein by reference).
10.12 Employment Agreement, dated as of September 7, 1998, between the Company
and Dennis L. Whipple (filed as Exhibit 10.12 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1998 and incorporated
herein by reference).
58
<PAGE>
10.13 First Amendment to Employment Agreement, dated as of October 21, 1998,
between the Company and Jeffrey D. Cushman (filed as Exhibit 10.13 to the
Company's Annual Report on Form 10-K for the year ended December 31, 1998
and incorporated herein by reference).
10.14 Talton Agreement, dated as of July 1, 1998, among the Company, Talton
Network Services, Inc., Julius E. Talton Sr., Julius E. Talton Jr., and
James E. Lumpkin (filed as Exhibit 10.2 to the Company's Quarterly Report
on Form 10-Q/A for the quarter ended September 30, 1998 and incorporated
herein by reference).
10.15 Agreement, dated as of April 15, 1998, between the Company (doing
business as Correctional Billing Services) and [Confidential information
set forth here has been filed separately with the Securities and Exchange
Commission under Rule 24b-2 under the Securities Exchange Act of 1934]
(filed as Exhibit 10.15 to the Company's Annual Report on Form 10-K for
the year ended December 31, 1998 and incorporated herein by reference.)
10.16 Amendment No.2 to Second Amended and Restated Credit Agreement, dated as
of March 3, 1999, among the Company, Canadian Imperial Bank of Commerce,
and Lenders named therein (filed as Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q for the quarter ended March 31, 1999 and
incorporated herein by reference).
10.17 Amendment to Employment Agreement, dated as of June 1, 1999, between the
Company and Dennis L. Whipple (filed as Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1999 and
incorporated herein by reference).
10.18 Amendment No. 3 to Second Amended and Restated Credit Agreement, dated as
of September 13, 1999, among the Company, certain lenders named therein,
and Canadian Imperial Bank of Commerce (filed as Exhibit 10.1 to the
Company's Quarterly Report on Form 10-Q for the quarter ended September
30, 1999 and incorporated herein by reference).
12.1* Computation of Ratio of Earnings to Fixed Charges.
21.1* Subsidiaries of the Company.
27.1* Financial Data Schedule
__________________
* Filed herewith.
(b) Reports on Form 8-K.
None.
(c) Exhibits -- The response to this portion of Item 14 is submitted as a
separate section of this report commencing on page 56.
(d) Financial Statement Schedules -- The response to this portion of Item 14 is
submitted as a separate section of this report on page 53.
The agreements set forth above described the contents of certain exhibits
thereunto that are not included. Such exhibits will be furnished to the
Commission upon request.
59
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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/ Donald B. Vaello
-------------------------
Donald B. Vaello
Chief Operating Officer
Date: March 30, 2000
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the Registrant and
in the capacities indicated.
<TABLE>
<CAPTION>
Signature Title Date
<S> <C> <C>
/s/ Richard H. Hochman Director March 30, 2000
Richard H. Hochman
/s/ Nina E. McLemore Director March 30, 2000
Nina E. McLemore
/s/ Julius E. Talton, Sr. Director March 30, 2000
Julius E. Talton, Sr.
/s/ David A. Sachs Director March 30, 2000
David A. Sachs
/s/ Todd W. Follmer Director March 30, 2000
Todd W. Follmer
/s/ Bruce I. Raben Director March 30, 2000
Bruce I. Raben
/s/ Roger K. Sallee Director March 30, 2000
Roger K. Sallee
/s/ Joseph P. Urso Director March 30, 2000
Joseph P. Urso
/s/ Jay R. Levine Director March 30, 2000
Jay R. Levine
/s/ Gregg L. Engles Director March 30, 2000
Gregg L. Engles
/s/ Keith S. Kelson Chief Financial Officer, Vice March 30, 2000
Keith S. Kelson President, Assistant Secretary
and Assistant Treasurer
</TABLE>
60
<PAGE>
Exhibit 12.1
Evercom, Inc.
Statement Regarding Computation of Ratios
Ratio of Earnings to Fixed Charges
(in thousands)
<TABLE>
<CAPTION>
Combined Predecessors The Company
--------------------------- -----------------------------------------------
Eleven Months One Month
Year ended Ended Ended Years Ended December 31
December 31, November 30, December 31, ------------------------------
1995 1996 1996 1997 1998 1999
--------------------------- -----------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Earnings:
Income from continuing operations before
income taxes and extraordinary loss $ 2,230 $ 5,183 $ (283) $ (12,829) $(25,410) (10,685)
Interest expense 1,360 1,469 612 11,138 19,638 19,458
Interest portion of rent expense 87 56 0 129 306 302
--------------------------- -----------------------------------------------
Earnings available for fixed charges $ 3,677 $ 6,708 $ 329 $ (1,562) $ (5,466) $ 9,075
--------------------------- -----------------------------------------------
Fixed Charges:
Interest expense $ 1,360 $ 1,469 $ 612 $ 11,138 $ 19,638 $19,458
Interest portion of rent expense 87 56 0 129 306 302
--------------------------- -----------------------------------------------
Total fixed charges $ 1,447 $ 1,525 $ 612 $ 11,267 $ 19,944 $19,760
--------------------------- -----------------------------------------------
Ratio of earnings to fixed charges 2.5 4.4 - - - -
Deficiency of earnings to fixed charges $ 283 $ 12,829 $ 25,410 $10,685
</TABLE>
<PAGE>
EXHIBIT NO. 21.1
CONSOLIDATED SUBSIDIARIES
Evercom, Inc. and Subsidiaries
The following list includes certain companies that are owned directly by
Evercom, Inc., a Delaware corporation, Irving, Texas, as of December 31, 1999.
This list includes all significant subsidiaries. The place of
incorporation or organization is shown parenthetically. The location of each
subsidiary is the same as Evercom, Inc.
Consolidated Subsidiaries
Evercom Systems, Inc. (Delaware)
One Source Telecommunications, Inc. (Delaware)
Saratoga Telephone Company, Inc. (New York)
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1999
<PERIOD-START> JAN-01-1998 JAN-01-1999
<PERIOD-END> DEC-31-1998 DEC-31-1999
<CASH> 1,691,762 1,987,732
<SECURITIES> 0 0
<RECEIVABLES> 46,308,838 41,855,450
<ALLOWANCES> (7,237,879) (3,592,618)
<INVENTORY> 2,360,280 3,512,073
<CURRENT-ASSETS> 45,393,164 46,004,166
<PP&E> 37,462,018 43,549,762
<DEPRECIATION> (7,976,074) (15,174,405)
<TOTAL-ASSETS> 191,465,916 172,108,556
<CURRENT-LIABILITIES> 56,262,268 53,378,214
<BONDS> 169,875,000 160,231,766
0 0
59 109
<COMMON> 163 164
<OTHER-SE> (36,113,696) (42,997,952)
<TOTAL-LIABILITY-AND-EQUITY> 191,465,916 172,108,556
<SALES> 225,292,986 236,800,742
<TOTAL-REVENUES> 225,292,986 236,800,742
<CGS> 231,301,060 228,035,123
<TOTAL-COSTS> 231,301,060 228,035,123
<OTHER-EXPENSES> (235,623) (6,640)
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 19,637,507 19,457,642
<INCOME-PRETAX> (25,409,958) (10,685,383)
<INCOME-TAX> 476,471 450,000
<INCOME-CONTINUING> (25,886,429) (11,135,383)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (25,886,429) (11,135,383)
<EPS-BASIC> 0 0
<EPS-DILUTED> 0 0
</TABLE>
