<PAGE> 1
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
[ ] 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 0-16715
PHONETEL TECHNOLOGIES, INC.
---------------------------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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OHIO 34-1462198
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<S> <C>
(STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION) (I.R.S. EMPLOYER IDENTIFICATION NO.)
NORTH POINT TOWER, 7TH FLOOR, 1001 LAKESIDE AVENUE, CLEVELAND, OHIO 44114-1195
------------------------------------------------------------------- ----------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
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(216) 241-2555
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(ISSUER'S TELEPHONE NUMBER, INCLUDING AREA CODE)
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 __
----
Applicable only to Corporate Issuers
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date: AS OF NOVEMBER 13,
1998, 18,754,133 SHARES OF THE REGISTRANT'S COMMON STOCK, $.01 PAR VALUE, WERE
OUTSTANDING.
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PHONETEL TECHNOLOGIES, INC. AND SUBSIDIARIES
FORM 10-Q
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1998
INDEX
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Page No.
PART I. FINANCIAL INFORMATION
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Item 1. Financial Statements
Consolidated Balance Sheets as of December 31, 1997
and September 30, 1998...........................................................3
Consolidated Statements of Operations for the Three and
Nine Months Ended September 30, 1997 and 1998....................................4
Statements of Changes in Mandatorily Redeemable Preferred Stock
for the Year Ended December 31, 1997
and the Nine Months Ended September 30, 1998.....................................5
Statements of Changes in Non-mandatorily Redeemable Preferred Stock,
Common Stock and Other Shareholders' Equity (Deficit)
for the Year Ended December 31, 1997
and the Nine Months Ended September 30, 1998.....................................6
Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 1997 and 1998.................................................7
Notes to Consolidated Financial Statements
for the Three and Nine Months Ended September 30, 1998............................8
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations....................................17
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K....................................................23
Signatures.......................................................................................................24
</TABLE>
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PHONETEL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
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- ---------------------------------------------------------------------------------------
(UNAUDITED)
DECEMBER 31 SEPTEMBER 30
1997 1998
--------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash $ 6,519 $ 7,343
Accounts receivable, net of allowance for doubtful
accounts of $507 and $760, respectively 16,278 20,113
Other current assets 972 1,183
--------- ---------
Total current assets 23,769 28,639
Property and equipment, net 30,109 29,430
Intangible assets, net 115,607 105,085
Other assets 341 574
--------- ---------
$ 169,826 $ 163,728
========= =========
LIABILITIES AND EQUITY
Current liabilities:
Current portion:
Long-term debt $ 544 $ 40,296
Obligation under capital leases 92 27
Accounts payable 8,768 11,051
Accrued expenses:
Location commissions 3,142 2,422
Personal property and sales tax 1,927 2,893
Interest 991 4,937
Salaries, wages and benefits 466 485
Other -- 473
--------- ---------
Total current liabilities 15,930 62,584
Long-term debt 150,203 125,008
Obligations under capital leases 19 5
Commitments and contingencies -- --
14% cumulative preferred stock mandatorily redeemable
(redemption amount $9,190 due June 30, 2000) 7,716 8,741
Non-mandatorily redeemable preferred stock,
common stock and other shareholders' equity (deficit) (4,042) (32,610)
--------- ---------
$ 169,826 $ 163,728
========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
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PHONETEL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT FOR SHARE AND PER SHARE AMOUNTS)
- -----------------------------------------------------------------------------
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(UNAUDITED) (UNAUDITED)
NINE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
----------------------------- -----------------------------
1997 1998 1997 1998
------------ ------------ ------------ ------------
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REVENUES:
Coin calls $ 43,884 $ 40,513 $ 15,742 $ 13,578
Non-coin telecommunication services 38,678 34,777 11,780 12,300
Other 468 105 129 66
------------ ------------ ------------ ------------
83,030 75,395 27,651 25,944
------------ ------------ ------------ ------------
OPERATING EXPENSES:
Line and transmission charges 17,734 22,163 5,901 7,531
Telecommunication and validation fees 9,400 8,816 3,464 2,960
Location commissions 10,577 10,726 4,076 4,167
Field operations 16,493 16,591 5,665 6,057
Selling, general and administrative 8,049 9,610 3,192 3,177
Depreciation and amortization 16,621 19,126 6,068 6,464
Other unusual charges and contractual settlements 8,257 2,386 8,257 1,392
------------ ------------ ------------ ------------
87,131 89,418 36,623 31,748
------------ ------------ ------------ ------------
Loss from operations (4,101) (14,023) (8,972) (5,804)
OTHER INCOME (EXPENSE):
Interest expense - related parties (791) (1,036) (639) --
Interest expense - others (11,493) (13,009) (3,865) (4,906)
Interest income 468 125 21 51
Other 15 291 5 55
------------ ------------ ------------ ------------
(11,801) (13,629) (4,478) (4,800)
------------ ------------ ------------ ------------
NET LOSS ($ 15,902) ($ 27,652) ($ 13,450) ($ 10,604)
============ ============ ============ ============
Earnings per share calculation:
Net loss ($ 15,902) ($ 27,652) ($ 13,450) ($ 10,604)
Preferred dividend payable in kind (400) (261) (121) (48)
Accretion of 14% Preferred to its redemption value (294) (764) (180) (308)
------------ ------------ ------------ ------------
Net loss applicable to common shareholders ($ 16,596) ($ 28,677) ($ 13,751) ($ 10,960)
============ ============ ============ ============
Net loss per common share ($ 1.04) ($ 1.72) ($ 0.85) ($ 0.65)
============ ============ ============ ============
Weighted average number of shares 15,937,973 16,624,356 16,176,477 16,736,633
============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
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PHONETEL TECHNOLOGIES, INC. AND SUBSIDIARIES
STATEMENTS OF CHANGES IN MANDATORILY REDEEMABLE PREFERRED STOCK
(IN THOUSANDS EXCEPT FOR SHARE AMOUNTS)
- -------------------------------------------------------------------------------
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(Unaudited)
Year Ended Nine Months Ended
December 31, 1997 September 30, 1998
----------------------------------- -----------------------------------
Shares Amount Shares Amount
---------------- ---------------- ---------------- ----------------
<S> <C> <C> <C> <C>
14% CUMULATIVE REDEEMABLE
CONVERTIBLE PREFERRED STOCK
Balance at beginning of year 120,387 $6,708 138,147 $7,716
Dividends payable-in-kind 17,760 514 15,019 261
Accretion of carrying value to amount
payable at redemption on June 30, 2000 - 494 - 764
Total Mandatorily Redeemable ================ ================ ================ ================
Preferred Stock 138,147 $7,716 153,166 $8,741
================ ================ ================ ================
</TABLE>
The accompanying notes are an integral part of these financial statements.
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PHONETEL TECHNOLOGIES, INC. AND SUBSIDIARIES
STATEMENTS OF CHANGES IN NON-MANDATORILY REDEEMABLE PREFERRED STOCK,
COMMON STOCK AND OTHER SHAREHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS EXCEPT FOR SHARE AMOUNTS)
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
(UNAUDITED)
YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, 1997 SEPTEMBER 30, 1998
---------------------------- ---------------------------------
SHARES AMOUNT SHARES AMOUNT
--------------- ----------- ---------------- -------------
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SERIES A SPECIAL CONVERTIBLE
PREFERRED STOCK
Balance at beginning of year - - - -
Exercise of warrants 12,500 $3 - -
Conversion to common stock (12,500) (3) - -
-------------- ----------- ---------------- -------------
Balance at end of period - - - -
============== ----------- ================ -------------
COMMON STOCK
Balance at beginning of year 14,488,828 145 16,360,829 $164
Company Equity Offering 1,012,500 10 - -
Exercise of warrants and options 409,754 4 375,804 4
Conversion of Series A Preferred 250,000 3 - -
Other issuances of stock 199,747 2 - -
============== ----------- ================ -------------
Balance at end of period 16,360,829 164 16,736,633 168
============== ----------- ================ -------------
ADDITIONAL PAID-IN CAPITAL
Balance at beginning of year 59,104 62,600
Company Equity Offering 2,815 -
Exercise of warrants and options 101 25
Warrants issued to Directors - 80
Other issuances of stock 580 -
----------- -------------
Balance at end of period 62,600 62,705
----------- -------------
ACCUMULATED DEFICIT
Balance at beginning of year (42,544) (66,806)
Net loss for the period (23,254) (27,652)
14% Preferred dividends payable-in-kind
and accretion (1,008) (1,025)
----------- -------------
Balance at end of period (66,806) (95,483)
----------- -------------
Total Non-mandatorily Redeemable
Preferred Stock, Common Stock and
Other Shareholders' Equity (Deficit) ($4,042) ($32,610)
=========== =============
</TABLE>
The accompanying notes are an integral part of these financial statements.
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PHONETEL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
- ------------------------------------------------------------------------------
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(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30
1997 1998
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<S> <C> <C>
CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES:
Net loss ($15,902) ($27,652)
Adjustments to reconcile net loss to net cash flows
from operating activities:
Depreciation and amortization 16,621 19,126
Amortization of deferred revenues (300) 0
Gain on disposal of assets - (292)
Increase in allowance for doubtful accounts 693 715
Other noncash charges (10) 3
Change in current assets, net of assets acquired (2,368) (4,760)
Change in current liabilities, net of liabilities assumed and
reclassification of long-term debt 2,051 7,047
-------- --------
785 (5,813)
-------- --------
CASH FLOWS USED IN INVESTING ACTIVITIES:
Acquisitions (48,005) (2,466)
Purchases of property and equipment (4,979) (3,202)
Purchases of intangible assets (1,051) (737)
Change in other assets (71) (233)
Proceeds from sale of assets 734 413
-------- --------
(53,372) (6,225)
-------- --------
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES:
Proceeds from debt issuance 110 12,002
Proceeds from related party debt 21,700 3,090
Principal payments on borrowings (1,441) (617)
Proceeds from issuance of stock 2,825 -
Debt issuance costs (4,265) (1,642)
Proceeds from warrant and option exercises 108 29
-------- --------
19,037 12,862
-------- --------
Increase (decrease) in cash (33,550) 824
Cash at beginning of period 46,438 6,519
-------- --------
Cash at end of period $ 12,888 $ 7,343
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
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PHONETEL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1998
(IN THOUSANDS EXCEPT FOR INSTALLED PUBLIC PAY TELEPHONE,
SHARE AND PER SHARE AMOUNTS)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary for a fair presentation
have been included. Operating results for the three and nine months ended
September 30, 1998 are not necessarily indicative of the results that may be
expected for the year ended December 31, 1998. For further information, refer to
the consolidated financial statements and footnotes thereto included in the
Company's Annual Report on Form 10-K for the year ended December 31, 1997.
Certain amounts relating to 1997 have been reclassified to conform to
the current quarter presentation. The reclassifications have had no impact on
total assets, shareholders' equity (deficit) or net loss as previously reported.
2. TERMINATION OF MERGER WITH DAVEL COMMUNICATIONS GROUP, INC.
On June 11, 1998, PhoneTel Technologies, Inc. ("PhoneTel") entered into
an Agreement and Plan of Merger and Reorganization (the "Davel Merger
Agreement") with Davel Communications Group, Inc., a publicly held, independent
pay telephone provider ("Davel"). Under the terms of the Davel Merger Agreement,
which had been unanimously approved by the Boards of Directors of both
companies, holders of outstanding common stock of PhoneTel ("PhoneTel Common
Stock") were to receive shares of common stock of a newly formed holding company
("New Davel Common Stock"), based upon a maximum value of $3.08 per share of
PhoneTel Common Stock. The number of shares of New Davel Common Stock to be
issued was to be determined based on the average closing price of Davel's common
stock for the 30 consecutive trading days ending on the second day prior to the
shareholders' approval of the Davel Merger Agreement, subject to a cap of
0.13765 shares of New Davel Common Stock for each share of PhoneTel Common
Stock.
The transaction was subject to approval by the Common Stockholders of
PhoneTel and Davel, and certain other conditions, including the redemption of
PhoneTel's 14% Cumulative Redeemable Convertible Preferred Stock and completion
of a cash tender offer for PhoneTel's $125,000 12% Senior Notes due 2006. Under
the Davel Merger Agreement, Davel was required to pay PhoneTel a termination fee
of $1,000 and expenses not to exceed $500 if the merger was terminated as a
result of Davel's failure to obtain the requisite financing to complete these
transactions.
On July 5, 1998, Peoples Telephone Company, Inc., a publicly held,
independent pay telephone provider ("Peoples"), also entered into a merger
agreement (the "Peoples Merger Agreement") with Davel. The Peoples Merger
Agreement is subject to the approval of the holders of Common Stock of both
Davel and Peoples and is conditioned on its eligibility for pooling of interests
accounting treatment. The Peoples Merger is also conditioned upon conversion of
Peoples convertible preferred stock into common stock and receipt by Davel of
financing for, and successful consummation of, a cash tender offer for $100,000
of Peoples' 12-1/4% Senior Notes.
On September 29, 1998, PhoneTel received a letter from Davel purporting
to terminate the Davel Merger Agreement. Thereafter, a complaint against
PhoneTel was filed in the Court of Chancery of New Castle County, Delaware by
Davel, which was subsequently amended, alleging, among other things, equitable
fraud and breach of contract relating to the Davel Merger Agreement. On October
27, 1998, PhoneTel filed its answer to the amended complaint denying the
substantive allegations contained therein and filed a counterclaim against Davel
for breach of
8
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contract. At the same time, PhoneTel filed a third party claim
against Peoples for tortuous interference with contract alleging that Peoples
induced Davel to not comply with the terms of the Davel Merger Agreement.
PhoneTel is seeking specific performance from Davel, which would
require Davel to comply with the terms of the Davel Merger Agreement or,
alternatively, for compensatory damages and costs of an unspecified amount.
PhoneTel is also seeking injunctive relief enjoining Peoples from further
tortuous interference with contract and for compensatory damages and costs of an
unspecified amount. Management believes the claims against PhoneTel are without
merit and is vigorously pursuing its claims against Davel and Peoples.
As of September 30, 1998, the Company has incurred $1,141 of costs
relating to the Davel Merger Agreement, of which $1,106 was incurred in the
third quarter of 1998. Such costs are included in other unusual charges and
contractual settlements in the accompanying consolidated statements of
operations.
3. PHONETEL ACQUISITIONS
TERMINATION OF PROPOSED ACQUISITION
On March 14, 1997, PhoneTel entered into an Agreement and Plan of
Merger (the "CCI Merger") to acquire Communications Central Inc. ("CCI"),
pursuant to which a wholly-owned subsidiary of PhoneTel commenced a tender offer
(the "Offer") for all of the outstanding shares of common stock of CCI ("CCI
Shares") at $12.85 per share in cash. The Offer expired on August 20, 1997. No
CCI Shares were purchased and all CCI Shares tendered and not properly withdrawn
at the time of expiration were returned by the depositary. On August 21, 1997,
PhoneTel announced that the CCI Merger had been terminated and in connection
therewith forfeited a $6,000 deposit. The Company recorded a charge of $7,818
relating to the transaction, including the forfeited deposit and $1,818 in
professional fees and related expenses in the third quarter of 1997.
ACQUISITIONS COMPLETED DURING THE NINE MONTHS ENDED SEPTEMBER 30, 1998:
TDS TELECOMMUNICATIONS CORPORATION - MAY 18, 1998 ("TDS")
The Company entered into an asset purchase agreement to acquire
approximately 3,450 installed pay telephones from TDS's network of Local
Exchange Carriers ("LECs") for a purchase price of $851. The majority of the pay
telephones acquired must be upgraded with the necessary microprocessor
technology needed to operate the pay telephones under the Company's operating
and management information systems. The estimated aggregate cost to upgrade
these pay telephones is approximately $2,000, of which $1,513 has been incurred
as of September 30, 1998. The Company began installing the upgrade equipment and
operating these pay telephones during the third quarter of 1998 and expects to
have all pay telephones operating by the end of 1998.
ACQUISITIONS COMPLETED DURING THE YEAR ENDED DECEMBER 31, 1997:
LONDON COMMUNICATIONS, INC. - JUNE 10, 1997 ("LONDON")
The Company acquired 2,519 installed public pay telephones for
$9,514 and incurred related acquisition expenses of $204.
ADVANCE PAY SYSTEMS, INC. - MAY 30, 1997 ("ADVANCE")
The Company acquired 800 installed public pay telephones for
$2,709 and incurred related acquisition expenses of $62.
AMERICAN PUBLIC TELECOM, INC. - MAY 30, 1997 ("AMERICAN")
The Company acquired 859 installed public pay telephones for $3,312
and incurred related acquisition expenses of $69.
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COINLINK, LLC - FEBRUARY 14, 1997 ("COINLINK")
The Company acquired 300 installed public pay telephones for $938 and
approximately $4 in related acquisition expenses.
RSM COMMUNICATIONS, INC.- JANUARY 31, 1997 ("RSM")
The Company acquired 292 installed public pay telephones for $1,054 and
incurred acquisition expenses of approximately $7.
AMERICOM, INC. - JANUARY 17, 1997 ("AMERICOM")
The Company acquired 99 installed public pay telephones for $264 and
incurred acquisition costs of $10.
TEXAS COINPHONE - JANUARY 14, 1997 ("TEXAS COINPHONE")
The Company acquired 1,250 installed public pay telephones, parts and
supplies inventories, and certain other assets for $3,660 and incurred related
acquisition expenses of approximately $50.
CHEROKEE COMMUNICATIONS, INC. - JANUARY 1, 1997 ("CHEROKEE")
The Company acquired 13,131 public pay telephones for a purchase price
consisting of: $53,953; $1,250 for non-competition agreements; $4,174 for
acquired outstanding accounts receivable, prepaid expenses, deposits and coin in
the installed pay telephones; and the assumption of $5,443 in liabilities.
Additionally, the Company incurred approximately $1,656 in acquisition related
expenses.
PURCHASE PRICE ACCOUNTING
The above transactions have been accounted for as purchases and have
been included in the results of operations from the respective dates of each
acquisition. The difference between the total purchase price and the current
assets and liabilities assumed has been allocated to property and equipment,
location contracts and non-competition agreements based on the relative fair
values. Fair values of location contracts are determined using discounted cash
flows over the remaining estimated economic lives of the acquired location
contracts. The amount of the location contracts and non-competition agreements
recorded for each acquisition and the estimated economic life of the acquired
location contracts are as follows: London $8,608, 102 months; Advance $2,313,
120 months; American $2,763, 103 months; Coinlink $838, 103 months; RSM $956,
100 months; Americom $243, 120 months; Texas Coinphone $3,097, 101 months;
Cherokee $53,103, 113 months. Acquired property and equipment is depreciated
over three to five years.
PRO FORMA FINANCIAL DATA (UNAUDITED)
Set forth below is the Company's unaudited pro forma condensed
statement of operations data as though the London, Advance, and American
acquisitions had occurred at the beginning of 1997.
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Pro Forma Condensed Statement of Operations Data
Nine Months Three Months
Ended September 30 Ended September 30
1997 1997
---- ----
<S> <C> <C>
Total revenues $ 88,025 $ 27,651
Net loss (16,757) (13,450)
Net loss applicable to
common shareholders (17,450) (13,751)
Net loss per common share (1.10) (0.85)
</TABLE>
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The unaudited pro forma results above are not necessarily indicative of
either actual results of operations that would have occurred had the
acquisitions been made at the beginning of 1997 or of future results. The pro
forma condensed statement of operations data includes adjustments related to the
depreciation and amortization of tangible and intangible assets, interest
expense on borrowings used to finance the acquisitions, the weighted average
number of common shares outstanding after giving effect to the acquisitions, and
excludes the assets and results of operations not acquired.
4. ACCOUNTS RECEIVABLE AND DIAL-AROUND COMPENSATION
At December 31, 1997 and September 30, 1998, accounts receivable
included $12,938 and $18,238, respectively relating to dial-around compensation.
A dial-around call occurs when a non-coin call is placed from the Company's
public pay telephone which utilizes a carrier other than the Company's dedicated
provider of long distance and operator assisted service. Payments relating to
such receivables are normally received quarterly in arrears. For the nine months
ended September 30, 1997 and 1998, revenues from non-coin telecommunication
services included $14,366 and $14,474, respectively, relating to dial-around
compensation.
Effective November 6, 1996, pursuant to the rules and regulations
promulgated by the FCC under Section 276 of the Telecommunications Act (the
"1996 Payphone Order"), the Company was to receive dial-around compensation of
$45.85 per installed pay telephone per month from November 6, 1996 through
October 6, 1997 (as compared with the flat fee of $6.00 per installed pay
telephone per month in periods prior to November 6, 1996), and per-call
compensation from October 7, 1997 to October 6, 1998 at $0.35 per call (as
compared with the flat fee of $45.85 per installed pay telephone per month) and
thereafter, at a per-call rate equal to the local coin rate for each dial-around
call.
Several parties, including interexchange carriers ("IXCs"), filed
petitions with the U. S. Court of Appeals for the District of Columbia Circuit
(the "Court") for review of certain of the FCC regulations, including the
dial-around compensation rate. In 1997, the Court vacated certain portions of
the 1996 Payphone Order, including the dial-around compensation rate, and
remanded the issue to the FCC for further consideration.
On October 9, 1997, the FCC issued its Second Report and Order (the
"1997 Payphone Order") which established a new dial-around compensation rate,
effective October 7, 1997, of $0.284 per call (the market based local coin rate
estimated at a default rate of $0.35 less certain costs defined by the FCC as
$0.066 per call) multiplied by the actual number of dial-around calls placed
from a pay telephone. Furthermore, the 1997 Payphone Order tentatively concluded
that the dial-around compensation rate of $0.284 per call would be used to
calculate dial-around compensation for the period November 6, 1996 to October 7,
1997. Evidence initially presented by a pay telephone industry trade association
as part of the Court of Appeals proceeding indicated that the average number of
dial-around calls placed from independent pay telephones equaled 131 calls per
month.
Based on the FCC's tentative conclusions in the 1997 Payphone Order, in
the third quarter of 1997 the Company adjusted the amount of dial-around
compensation recorded in prior quarters from the initial $45.85 rate to $37.20
(131 calls per installed pay telephone per month multiplied by $0.284). Included
in this adjustment was a net charge of $965 for dial-around compensation
relating to the first quarter of 1997 and $1,001 relating to the second quarter
of 1997. These adjustment amounts are included in revenues from non-coin
telecommunication services in the third quarter of 1997. In addition, other
unusual charges and contractual settlements in the third quarter of 1997
includes an adjustment of $395 relating to the reduction in dial-around
compensation for the November 6 to December 31, 1996 period.
On March 9, 1998, the Common Carrier Bureau of the FCC issued a
Memorandum Opinion and Order (the "Memorandum") which, among other things,
granted a waiver of the time frame previously scheduled and established a new
timetable for LEC's to implement a system for identifying dial-around calls
placed from pay telephones ("ANI Identification"). The Memorandum reiterated the
obligation of the IXCs to pay, by April 1, 1998, $0.284 per call based on the
actual number of dial-around calls per pay telephone if such call data is
available. In its
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Memorandum, the FCC recognized, given its waiver and extension of the time frame
set for certain IXCs for the implementation of ANI Identification, that certain
disputes between carriers and pay telephone providers were likely to arise
regarding the true number of compensable calls. Therefore, the FCC identified
the potential need for it to address true-up requirements for dial-around
compensation in a subsequent order and clarified that the timing of the
subsequent order in no way relieved or delayed the obligations of IXCs to pay
compensation on April 1, 1998. In the first nine months of 1998, the Company has
recorded revenues of $14,474 for dial-around compensation based upon a rate of
$37.20 per installed pay telephone per month.
Certain IXCs have asserted in the past, are now asserting and are
expected to assert in the future that the appropriate level of fair compensation
should be lower than the $0.284 per call. A number of parties filed a Motion to
Stay the 1997 Payphone Order pending judicial review and filed a motion
requesting expedited consideration and briefing schedule with the Court. The
Court denied the Motion to Stay and granted the Motion for Expedited
Consideration and Briefing Schedule. On May 7, 1998, the Court heard arguments
regarding the pending appeals relating to the FCC's 1997 Payphone Order. On May
15, 1998, the Court of Appeals issued an opinion which remanded the 1997
Payphone Order to the FCC for further consideration in order to justify that the
dial-around compensation rate should be based on the deregulated local coin
rate. The Court of Appeals elected not to vacate the $0.284 per call rate on the
understanding that if and when on remand the FCC established some different rate
of fair compensation for dial-around calls, the FCC may adjust the dial-around
compensation rate retroactively, should the equities so dictate. Further, the
Court stated that if, within 6 months from the date of issuance of their order,
the FCC fails to adequately respond to the Court's remand, any adversely
affected party may request effective relief from the Court. On June 19, 1998,
the FCC solicited comments from interested parties on the issues remanded. The
Company expects that the FCC will issue its ruling in the current proceeding in
early 1999.
Based on the information available, the Company believes that the
minimum amount it is entitled to as fair compensation under the
Telecommunications Act for the period from November 7, 1996 through September
30, 1998 is $37.20 per pay telephone per month based on $0.284 per call and 131
calls per pay telephone per month. Further, the Company does not believe that it
is reasonably possible that the amount will be materially less than $37.20 per
pay telephone per month.
5. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
<TABLE>
<CAPTION>
Estimated
Useful Lives December 31 September 30
(in years) 1997 1998
---------- ---- ----
<S> <C> <C> <C>
Telephones, boards, enclosures and cases 3-10 $ 41,653 $ 46,963
Furniture, fixtures and other equipment 3-5 3,063 3,190
Leasehold improvements 2-5 424 471
---------- ----------
45,140 50,624
Less: accumulated depreciation (15,031) (21,194)
---------- ----------
$ 30,109 $ 29,430
========== ==========
</TABLE>
12
<PAGE> 13
6. INTANGIBLE ASSETS
Intangible assets consisted of the following:
<TABLE>
<CAPTION>
Amortization Period December 31 September 30
(in months) 1997 1998
----------- ---- ----
<S> <C> <C> <C>
Location contracts 60-120 $ 126,775 $ 127,424
Deferred financing costs 36-120 10,254 11,895
Non-competition agreements 24-60 3,731 3,733
State operating certifications 60 567 590
--------- ----------
141,327 143,642
Less: accumulated amortization (25,720) (38,557)
--------- ----------
$ 115,607 $ 105,085
========= ==========
</TABLE>
7. AMENDMENTS TO CREDIT AGREEMENT
On May 30, 1997, the Company entered into an agreement (the "Credit
Agreement") with various lenders (collectively referred to as the "Lenders"). On
such date, ING (U.S.) Capital Corporation ("ING") was Agent for the Lenders and
Transamerica Business Credit Corporation and Finova Capital Corporation were
Co-Agents for the Lenders. ING is a significant shareholder of the Company's
common equity. The Credit Agreement provided a $75,000 commitment of which
$60,000 was to be utilized for future acquisitions ("Expansion Loan
Commitment"), and $15,000 was to be utilized for general working capital
requirements. Borrowings accrued interest at the ING Alternate Base Rate (as
defined in the Credit Agreement) plus 1.50%. The Credit Agreement was originally
scheduled to mature on May 20, 2000 and all the Company's installed public pay
telephones are pledged as collateral. The Company borrowed $17,700 under the
Expansion Loan Commitment to complete the acquisitions of Advance, American, and
London and to pay related acquisition and credit facility fees. The Company also
borrowed $7,300 of the Revolving Credit Commitment for interest payments due
under the Notes and for general working capital purposes. Subsequent to the
September 16, 1997 Court ruling which vacated dial-around compensation (see Note
4), and pursuant to certain terms of the Credit Agreement, the Agent gave notice
to the Company that it was prohibited from making additional borrowings under
the Credit Agreement without prior approval from the Lenders.
The Credit Agreement includes covenants which, among other things,
require the Company to maintain ratios as to fixed charges, debt to earnings,
current ratio and interest coverage (all as defined in the Credit Agreement).
Other covenants limit incurrence of additional long-term debt, the level of
capital expenditures, the incurrence of lease obligations and permitted
investments.
On February 24, 1998, the Credit Agreement was amended to increase the
Revolving Credit Commitment to $20,000 and to decrease the Expansion Loan
Commitment to $55,000 (the "First Amendment"). The amount available for letters
of credit under the working capital commitment was reduced from $5,000 to $3,000
and certain covenants therein were modified. On the same date, the Company was
permitted to borrow an additional $3,000 for working capital purposes under the
Revolving Credit Commitment. On March 31, 1998, the Credit Agreement was further
amended (the "Second Amendment") to modify certain financial covenants.
On May 8, 1998, the Company amended the Credit Agreement (the "Third
Amendment") and Foothill Capital Corporation, as replacement Agent and Lender,
assumed all of the rights and obligations of the former Lenders. Under the Third
Amendment, the Revolving Credit Commitment remained at $20,000 and the Expansion
Loan Commitment was reduced to $20,000. Interest is payable monthly in arrears
at 2% above the Lender's reference rate (as defined in the Third Amendment) and
the maturity date of the Credit Agreement was extended to May 8, 2001. Certain
financial covenants under the Credit Agreement were also modified. The Company
incurred $990 in fees and expenses in connection with the Third Amendment.
13
<PAGE> 14
During the second quarter of 1998, the Company borrowed $10,547 under
the Revolving Credit Commitment for interest payments due under the Company's
$125,000 12% Senior Notes, to fund acquisition and financing costs and for
working capital. On July 3, 1998, the Company borrowed an additional $1,453, the
remaining amount available under the Credit Agreement, to finance the cost of
equipment upgrades relating to the pay telephones acquired as result of the TDS
acquisition (See Note 3).
At September 30, 1998, the Company was not in compliance with certain
financial covenants and was in default under its Credit Agreement. Under certain
circumstance, such obligations could become immediately due and payable.
Accordingly, the Company has classified the amounts due under the Credit
Agreement as a current liability in the accompanying consolidated balance sheet
at September 30, 1998. The Company has requested and expects to receive from the
Agent and Lenders a waiver through December 31, 1998 of the financial covenants
in the Credit Agreement with which the Company was not in compliance.
8. PREFERRED STOCK MANDATORILY REDEEMABLE
Mandatorily redeemable preferred stock consisted of the following:
<TABLE>
<CAPTION>
December 31 September 30
1997 1998
---- ----
<S> <C> <C>
14% Cumulative Redeemable Convertible Preferred Stock ($60 stated value
- 200,000 shares authorized; 107,918 shares issued and outstanding,
cumulative dividends issuable of 30,229 shares at December 31, 1997
(valued at $851) and 45,248 shares at September 30, 1998 (valued at
$1,112); mandatory redemption amount of $9,190 due September 30, 2000) $ 7,716 $ 8,741
</TABLE>
The Company records dividends, declared and undeclared, at their fair
market value and recognizes the difference between the carrying value of the 14%
Preferred and the mandatory redemption amount, through monthly accretions, using
the interest method. For the nine months ended September 30, 1998, the carrying
value of the 14% Preferred was increased by $764 through accretions. Each share
of 14% Preferred is entitled to receive a quarterly dividend of 0.035 shares of
14% Preferred. Each share of 14% Preferred is convertible into 10 shares of
Common Stock.
9. NON-MANDATORILY REDEEMABLE PREFERRED STOCK, COMMON STOCK AND OTHER
SHAREHOLDERS' EQUITY (DEFICIT)
Non-mandatorily redeemable preferred stock, common stock, and other
shareholders' equity (deficit) consisted of the following:
<TABLE>
<CAPTION>
December 31 September 30
1997 1998
---- ----
<S> <C> <C>
Series A Special Convertible Preferred Stock ($0.20 par value, $0.20
stated value - 250,000 shares authorized; no shares issued) - -
Common Stock
($0.01 par value - 50,000,000 shares authorized; 16,360,829 and
16,736,633 shares issued and outstanding at December 31, 1997 and
September 30, 1998, respectively) $ 164 $ 168
Additional paid-in capital 62,600 62,705
Accumulated deficit (66,806) (95,483)
----------- -----------
($ 4,042) ($ 32,610)
=========== ===========
</TABLE>
14
<PAGE> 15
In January 1998, warrants for 190,678 shares of Common Stock, including
warrants to purchase 179,996 shares of common stock with an exercise price of
$0.01 per share ("Nominal Value Warrants") were exercised by their holders. The
Company received proceeds of $27 as a result of the exercise of these warrants.
In April 1998, the Company granted warrants to purchase 100,000 shares of Common
Stock to its four non-employee Directors with an aggregate value of $80 and an
exercise price of $1.875 per share, as compensation for services during the
1997-98 service year. During the second quarter of 1998, Nominal Value Warrants
for 185,126 shares of Common Stock were exercised by their holders, including
Nominal Value Warrants for 89,998 shares of Common Stock held by a Director of
the Company. The Company received proceeds of $2 as a result of the exercise of
these Nominal Value Warrants.
As of September 30, 1998, two of the Company's former lenders held
warrants which were exercisable into 192,324 shares of Series A Special
Convertible Preferred Stock (the "Series A Warrants") at an exercise price of
$0.20 per share. Each share of Series A Preferred is convertible into 20 shares
of Common Stock. On October 13, 1998, the Company received notice from one of
the former lenders which purported to exercise its put right as defined in the
agreement for the Series A Warrants (the "Warrant Agreement"), with respect to
89,912 Series A Warrants and 124,300 Common Shares. The Warrant Agreement
specifies that the Company is to redeem Series A Warrants that are convertible
into shares of Common Stock. The Company does not intend to make payment
pursuant to this purported exercise of a put right. Further, to make such a
payment would constitute a breach of the 12% Senior Notes indenture. The Company
intends to engage in further discussions with said former lender regarding such
notice.
On November 13, 1998 the other former lender exercised Series A
Warrants to purchase and immediately converted their Series A Convertible
Preferred Stock to Common Stock. This exercise resulted in the issuance of
2,017,500 shares of Common Stock, net of Common Stock not issued in lieu of cash
payment.
10. CONTINGENCIES
The Company, in the course of its normal operations, is subject to
regulatory matters, disputes, claims and lawsuits. In management's opinion, all
such outstanding matters of which the Company has knowledge have been reflected
in the financial statements or will not have a material adverse effect on the
Company's financial position, results of operations or cash flows.
11. CONDENSED CONSOLIDATING FINANCIAL STATEMENT DATA
The Company's wholly-owned subsidiary, Cherokee Communications, Inc.
("Cherokee") which was acquired January 1, 1997, is a guarantor of the $125,000
12% Senior Notes due 2006. The following are the condensed consolidating
financial statements of PhoneTel and Cherokee as of September 30, 1998, and for
the nine months ended September 30, 1998.
15
<PAGE> 16
Condensed Consolidating Financial Statements
Balance Sheet, at September 30, 1998
<TABLE>
<CAPTION>
PhoneTel Cherokee(a) Eliminations Consolidated
-------- ----------- ------------ ------------
<S> <C> <C> <C> <C>
Current assets $ 19,808 $ 8,831 - $ 28,639
Property and equipment, net 24,466 4,964 - 29,430
Intangible assets, net 66,754 38,331 - 105,085
Other non-current assets 59,103 6,700 ($65,229) 574
----------- ------------ -------- --------------
Total $ 170,131 $ 58,826 ($65,229) $ 163,728
=========== ============= ======== ==============
Current liabilities $ 47,166 $ 15,418 $ 62,584
Inter-company debt 65,229 (65,229) -
Long-term debt and capital leases 124,199 814 - 125,013
14% Preferred stock 8,741 - - 8,741
Other equity (deficit) (9,975) (22,635) - (32,610)
----------- ------------ -------- --------------
Total $ 170,131 $ 58,826 ($65,229) $ 163,728
=========== ============= ======== ==============
Statement of Operations, for the nine months ended September 30, 1998
Total revenues $ 46,187 $ 29,208 - $ 75,395
Operating expenses 56,493 32,925 - 89,418
----------- ------------ -------- --------------
Loss from operation (10,306) (3,717) - (14,023)
Other income (expense), net (5,606) (8,023) - (13,629)
----------- ------------ -------- --------------
Net loss ($ 15,912) ($ 11,740) - ($ 27,652)
=========== ============= ======== ==============
</TABLE>
(a) The Cherokee separate financial statement data reflects the push
down of the Company's debt, related interest expense and allocable debt
issue costs associated with the Company's acquisition of Cherokee.
12. FINANCIAL CONDITION
The Company's working capital (excluding long-term debt reclassified as
currently payable) declined from $7,839 at December 31, 1997 to $6,069 at
September 30, 1998, a decrease of $1,770. Cash flows provided by (used in)
operating activities declined from $785 for the nine months ended September 30,
1997 to ($5,813) for the nine months ended September 30, 1998, a decrease of
$6,598, primarily due to the increase in the Company's net loss. The Company's
net loss increased from $15,902 to $27,652 for the nine months ended September
30, 1997 and 1998, respectively. At September 30, 1998, the Company had a
deficit of $32,610 in stockholders equity (excluding mandatorily redeemable
preferred stock) as a result of the current and prior year losses. The Company
was not in compliance with certain financial covenants at September 30, 1998
resulting in a default under its Credit Agreement. The Company has requested and
expects to receive from the Agent and the Lenders a waiver through the December
31, 1998 reporting date of its non-compliance with certain financial covenants
contained in the Credit Agreement.
The Company's working capital, liquidity and capital resources may be
limited by its ability to generate sufficient cash flows from its operations or
its investment or financing activities. Cash flow from operations depends on
revenues from coin and non-coin sources. There can be no assurance that coin or
non-coin revenues will increase, that revenues from dial-around compensation
will continue at rates anticipated and be received by the Company in the amounts
recorded as receivables, or that operating expenses can be maintained at present
or reduced levels. To the extent that cash flows from operating activities are
insufficient to meet the Company's cash
16
<PAGE> 17
needs, there can be no assurance that the Company can obtain additional
financing to meet its debt service and other cash requirements.
As discussed in Note 2, the Davel Merger Agreement has been terminated
along with the planned cash tender offer by Davel of PhoneTel's 12% Senior Notes
due 2006 ("Note"). The Company is currently negotiating with representatives of
the note holders to restructure this debt to reduce the Company's debt service
requirements. Although Management believes they will be able to restructure the
Company's obligations under the 12% Senior Notes, there can be no assurance that
such restructuring will be completed. In the event the Company is unable to
restructure this debt or obtain additional financing, it is unlikely that cash
flow from operations will be sufficient to make the required interest payment
thereunder. If the Company fails to meet its debt service, such debt could
become immediately due and payable. These uncertainties raise substantial doubt
about the Company's ability to continue as a going concern. The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (IN THOUSANDS EXCEPT FOR PUBLIC PAY TELEPHONES,
PER CALL, SHARE AND PER SHARE AMOUNTS)
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Statements, other than historical facts, contained in this Form 10-Q
are "forward looking statements" within the meaning of Section 27A of the
Securities Act of 1933, as amended, and section 21E of the Securities Exchange
Act of 1934, as amended. Although the Company believes that its forward looking
statements are based on reasonable assumptions, it cautions that such statements
are subject to a wide range of risks and uncertainties with respect to the
Company's operations in fiscal 1998 as well as over the long-term such as,
without limitation: (i) a downturn in the public pay telephone industry which is
dependent on consumer spending and subject to the impact of domestic economic
conditions, changes in technology, and regulations and policies regarding the
telecommunications industry; (ii) the ability of the Company to accomplish its
strategic objectives with respect to external expansion through selective
acquisitions and internal expansion; and (iii) increases in the dial-around
compensation rate and the coin drop rate. Any or all of these risks and
uncertainties could cause actual results to differ materially from those
reflected in the forward-looking statements. These forward-looking statements
are based on certain assumptions and analyses made by the Company in light of
its experience and its perception of historical trends, current conditions,
expected future developments and other factors it believes are appropriate in
the circumstances. In addition, such statements are subject to a number of
assumptions, risks and uncertainties, including, without limitation, the risks
and uncertainties identified in this report, general economics and business
conditions, the business opportunities (or lack thereof) that may be presented
to and pursued by the Company, changes in laws or regulations and other factors,
many of which are beyond the control of the Company. Investors and prospective
investors are cautioned that any such statements are not guarantees of future
performance and that actual results or developments may differ materially from
those projected in the forward-looking statements.
Acquisitions and Mergers
As described in Note 3 to the consolidated financial statements, the
Company completed various acquisitions during the first and second quarters of
1997 and the second quarter of 1998. In the third quarter of 1997, the Company
also terminated its merger agreement to acquire Communications Central Inc. The
completed acquisitions were accounted for as purchases and have been included in
the results of operations from their respective acquisition dates.
RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
1997
17
<PAGE> 18
REVENUES Revenues decreased by $7,635 or 9.2%, from $83,030 for the
first nine months of 1997 to $75,395 for the first nine months of 1998. This
decrease is primarily due to a decline in call volume, offset in part by the
increase in the local coin call rate from $0.25 to $0.35, and the decrease in
revenues from non-coin telecommunication services as discussed below. The
average number of installed pay telephones increased from 42,073 for the nine
months ended September 30, 1997 to 43,223 for the nine months ended September
30, 1998, an increase of 1,150 or 2.7%. This increase was principally due to
acquisitions in the second quarter of 1997 and 1998.
Revenues from coin calls decreased by $3,371 or 7.7%, from $43,884 for
the nine months ended September 30, 1997 to $40,513 for the nine months ended
September 30, 1998. The decrease is primarily due to a decline in the number of
local coin calls which represents approximately 70% of total coin revenue.
During the fourth quarter of 1997, the Company increased its local coin call
rate from $0.25 to $0.35 and, as initially expected, experienced a reduction in
call volume. There can be no assurance that coin call volumes will return to
historical levels or that coin revenue per phone will increase in excess of
historical levels. To a lesser extent, coin revenues have been adversely
affected by changes in customer and geographic mix and adverse weather
conditions in the first quarter of 1998.
Revenues from non-coin telecommunication services decreased by $3,901
or 10.1%, from $38,678 for the nine months ended September 30, 1997 to $34,777
for the nine months ended September 30, 1998. Of this decrease, long distance
revenues from operator service providers decreased by $4,009 principally due to
a reduction in the number of operator service calls as a result of continuing
aggressive dial-around advertising by long distance carriers such as AT&T and
MCI Communications Corporation. In addition, revenues from dial-around
compensation increased by $108 compared to the nine months ended September 30,
1997, due to the increase in the average number of installed pay telephones. In
the third quarter of 1997, the Company recorded an adjustment of $2,361 to
reduce dial-around compensation previously recognized as a result of regulatory
changes discussed below. Of this amount, $1,966 relating to the six months ended
June 30, 1997 has been classified herein as a reduction in revenues from
non-coin telecommunication services and $395 relating to the fourth quarter of
1996 has been classified as other unusual charges and contractual settlements.
Effective November 6, 1996, pursuant to the rules and regulations
promulgated by the FCC under Section 276 of the Telecommunications Act (the
"1996 Payphone Order"), the Company was to receive dial-around compensation of
$45.85 per installed pay telephone per month from November 6, 1996 through
October 6, 1997 (as compared with the flat fee of $6.00 per installed pay
telephone per month in periods prior to November 6, 1996), and per-call
compensation from October 7, 1997 to October 6, 1998 at $0.35 per call (as
compared with the flat fee of $45.85 per installed pay telephone per month) and
thereafter, at a per-call rate equal to the local coin rate for each dial-around
call.
Several parties, including interexchange carriers ("IXCs"), filed
petitions with the U. S. Court of Appeals for the District of Columbia Circuit
(the "Court") for review of certain of the FCC regulations, including the
dial-around compensation rate. In 1997, the Court vacated certain portions of
the 1996 Payphone Order, including the dial-around compensation rate, and
remanded the issue to the FCC for further consideration.
On October 9, 1997, the FCC issued its Second Report and Order (the
"1997 Payphone Order") which established a new dial-around compensation rate,
effective October 7, 1997, of $0.284 per call (the market based local coin rate
estimated at a default rate of $0.35 less certain costs defined by the FCC as
$0.066 per call) multiplied by the actual number of dial-around calls placed
from a pay telephone. Furthermore, the 1997 Payphone Order tentatively concluded
that the dial-around compensation rate of $0.284 per call would be used to
calculate dial-around compensation for the period November 6, 1996 to October 7,
1997. Evidence initially presented by a pay telephone industry trade association
as part of the Court of Appeals proceeding indicated that the average number of
dial-around calls placed from independent pay telephones equaled 131 calls per
month.
Based on the FCC's tentative conclusions in the 1997 Payphone Order, in
the third quarter of 1997 the Company adjusted the amount of dial-around
compensation recorded in prior quarters from the initial $45.85 rate to $37.20
(131 calls per installed pay telephone per month multiplied by $0.284). Included
in this adjustment was a net charge of $965 for dial-around compensation
relating to the first quarter of 1997 and $1,001 relating to the second quarter
of 1997. These adjustment amounts were included in revenues from non-coin
telecommunication services
18
<PAGE> 19
in the third quarter of 1997. In addition, other unusual charges and contractual
settlements in the third quarter of 1997 includes an adjustment of $395 relating
to the reduction in dial-around compensation for the November 6 to December 31,
1996 period.
On March 9, 1998, the Common Carrier Bureau of the FCC issued a
Memorandum Opinion and Order (the "Memorandum") which, among other things,
granted a waiver of the time frame previously scheduled and established a new
timetable for LEC's to implement a system for identifying dial-around calls
placed from pay telephones ("ANI Identification"). The Memorandum reiterated the
obligation of the IXCs to pay, by April 1, 1998, $0.284 per call based on the
actual number of dial-around calls per pay telephone if such call data is
available. In its Memorandum, the FCC recognized, given its waiver and extension
of the time frame set for certain IXCs for the implementation of ANI
Identification, that certain disputes between carriers and pay telephone
providers were likely to arise regarding the true number of compensable calls.
Therefore, the FCC identified the potential need for it to address true-up
requirements for dial-around compensation in a subsequent order and clarified
that the timing of the subsequent order in no way relieved or delayed the
obligations of IXCs to pay compensation on April 1, 1998. In the first nine
months of 1998, the Company has recorded revenues of $14,474 for dial-around
compensation based upon a rate of $37.20 per installed pay telephone per month.
Certain IXCs have asserted in the past, are now asserting and are
expected to assert in the future that the appropriate level of fair compensation
should be lower than the $0.284 per call. A number of parties filed a Motion to
Stay the 1997 Payphone Order pending judicial review and filed a motion
requesting expedited consideration and briefing schedule with the Court. The
Court denied the Motion to Stay and granted the Motion for Expedited
Consideration and Briefing Schedule. On May 7, 1998, the Court heard arguments
regarding the pending appeals relating to the FCC's 1997 Payphone Order. On May
15, 1998, the Court of Appeals issued an opinion which remanded the 1997
Payphone Order to the FCC for further consideration in order to justify that the
dial-around compensation rate should be based on the deregulated local coin
rate. The Court of Appeals elected not to vacate the $0.284 per call rate on the
understanding that if and when on remand the FCC established some different rate
of fair compensation for dial-around calls, the FCC may adjust the dial-around
compensation rate retroactively, should the equities so dictate. Further, the
Court stated that if, within six months from the date of issuance of their
order, the FCC fails to adequately respond to the Court's remand, any adversely
affected party may request effective relief from the Court. On June 19, 1998,
the FCC solicited comments from interested parties on the issues remanded. The
Company expects that the FCC will issue its ruling in the current proceeding in
early 1999.
Based on the information available, the Company believes that the
minimum amount it is entitled to as fair compensation under the
Telecommunications Act for the period from November 7, 1996 through September
30, 1998 is $37.20 per pay telephone per month based on $0.284 per call and 131
calls per pay telephone per month. Further, the Company does not believe that
it is reasonably possible that the amount will be materially less than $37.20
per pay telephone per month.
Other revenues decreased $363 from $468 for the nine months ended
September 30, 1997 to $105 for the nine months ended September 30, 1998. This
decrease was primarily the result of the amortization of a deferred operator
services bonus received in 1996.
OPERATING EXPENSES. Total operating expenses increased $2,287, or 2.6%,
from $87,131 for the nine months ended September 30, 1997 to $89,418 for the
nine months ended September 30, 1998. The increase was due to increases in line
and transmission charges, selling, general and administrative expenses ("SG&A
expense"), and depreciation and amortization. Such increases were due in part to
increases in amounts charged by LEC's for the provision of local telephone
service, the increase in the average number of installed pay telephones, and the
increase in the number of sales and administrative personnel added as a result
of acquisitions in the first and second quarters of 1997. These increases were
offset in part by the decrease in other unusual charges and contractual
settlements as explained below.
19
<PAGE> 20
Line and transmission charges increased $4,429, or 25.0%, from $17,734
for the nine months ended September 30, 1997 to $22,163 for the nine months
ended September 30, 1998. Line and transmission charges represented 21.4% of
total revenues for the nine months ended September 30, 1997 and 29.4% of total
revenues for the nine months ended September 30, 1998, an increase of 8.0%. The
dollar increase was due to the increase in the average number of installed pay
telephones and the increase in the average line and transmission charge per
phone. The average line and transmission charge per phone increased as a result
of the increased charges by LECs for end user common line charges, Preferred
Interexchange Carrier charges ("PICC"), "flex ANI" charges for implementation of
ANI Identification, and to a more limited extent, state Universal Service Fund
fees ("USF") passed through to users such as independent public pay telephone
providers. The increase as a percentage of revenues also reflects the effect of
the decrease in revenues discussed above.
Telecommunication and validation fees which consist primarily of
processing costs relating to operator services decreased by $584, or 6.2%, from
$9,400 for the nine months ended September 30, 1997 to $8,816 for the nine
months ended September 30, 1998. Telecommunication and validation fees
represented 11.3% of total revenues for the nine months ended September 30, 1997
and 11.7% for the nine months ended September 30, 1998, an increase of 0.4%. The
dollar decrease was primarily the result of the decrease in operator service
calls compared to the first nine months of 1997. The percentage increase was
mostly the result of changes in the call volumes processed by various operator
service providers pursuant to contracts with different rates for providing such
services.
Location commissions increased $149, or 1.4%, from $10,577 for the nine
months ended September 30, 1997 to $10,726 for the nine months ended September
30, 1998. Location commissions represented 12.7% of total revenues for the nine
months ended September 30, 1997 and 14.2% for the nine months ended September
30, 1998, an increase of 1.5%. The dollar and percentage increases are due to
the increase in commission rates in response to competitive demands for new
location providers as well as renewal of location contracts with existing
location providers. Higher commission rates on location contracts relating to
acquisitions completed at the end of the second quarter of 1997 also
contributed to these increases.
Field operations which consists principally of field operations
personnel costs, rents and utilities of the local service facilities, and repair
and maintenance of the Company's installed pay telephone base, increased $98, or
0.6%, from $16,493 for the nine months ended September 30, 1997 to $16,591 for
the nine months ended September 30, 1998. Field operations represented 19.9% of
total revenues for the nine months ended September 30, 1997 and 22.0% of total
revenues for the nine months ended September 30, 1998. The dollar increase in
1998 compared to 1997 was primarily due to the increase in service vehicle
costs and Universal Service Fees, offset in part by efficiencies achieved in
integrating the operations of companies previously acquired. The percentage
increase was a result of the lower revenues during the first nine months of
1998.
SG&A expenses increased $1,561, or 19.4%, from $8,049 for the nine
months ended September 30, 1997 to $9,610 for the nine months ended September
30, 1998. SG&A expenses represented 9.7% of total revenues for the nine months
ended September 30, 1997 and 12.7% of total revenues for the nine months ended
September 30, 1998, an increase of 3.0%. The dollar and percentage increases
were primarily due to an expansion of the sales force, the transfer of technical
support and other personnel from the Company's Jacksonville, Texas (former
Cherokee headquarters) local service facility to the Company's headquarters in
the second quarter of 1997, and an increase in telephone expense.
Depreciation and amortization increased $2,505, or 15.1%, from $16,621
for the nine months ended September 30, 1997 to $19,126 for the nine months
ended September 30, 1998. Depreciation and amortization represented 20.0% of
total revenues for the nine months ended September 30, 1997 and 25.4% of total
revenues for the nine months ended September 30, 1998, an increase of 5.4%. The
dollar and percentage increases were primarily due to the acquisitions
previously completed and expansion of the Company's public pay telephone base.
The percentage increase was also due to the reduction in total revenues.
Other unusual charges and contractual settlements decreased $5,871, or
71.9% from $8,257 for the nine months ended September 30, 1997 to $2,386 for
the nine months ended September 30, 1998. For the nine months ended September
30, 1998, other unusual charges and contractual settlements consisted of: (i)
costs incurred in connection with the Davel Merger Agreement which has been
terminated, $1,141; (ii) certain fees relating to amendments to the Company's
Credit Agreement, $314; and (iii) legal and professional fees relating to
non-recurring litigation and contractual matters, $931. For the nine months
ended September 30, 1997, other unusual charges and contractual settlements
consisted of: (i) a forfeited deposit, professional fee and related expense
applicable to the termination of the proposed acquisition of CCI, $7,818; (ii) a
retroactive adjustment to dial-around compensation relating to the fourth
quarter of 1996 resulting from regulatory changes in 1997, $395; and (iii)
other non-recurring items, $44.
20
<PAGE> 21
OTHER INCOME (EXPENSE). Other income (expense) is comprised principally
of interest expense incurred on debt and interest income. Total interest expense
increased $1,761, or 14.3%, from $12,284 for the nine months ended September 30,
1997 to $14,045 for the nine months ended September 30, 1998. Interest expense
represented 14.8% of total revenues for the nine months ended September 30, 1997
and 18.6% of total revenues for the nine months ended September 30, 1998, an
increase of 3.8%. The dollar and percentage increases were a result of the
additional borrowings under the Company's Credit Agreement in 1997 and 1998 and
the increase in the interest rate under the Third Amendment in the second
quarter of 1998. Interest income for the first nine months of 1998 decreased
$343 due to the utilization of acquisition deposits in 1997 and the reduction
in cash invested compared to the first nine months of 1997. Other income
increased $276 primarily due to the sale of the Company's Jacksonville, Texas
land and building during the second quarter of 1998.
EBITDA. EBITDA (income before interest income, interest expense, taxes,
depreciation and amortization, and other unusual charges and contractual
settlements) decreased $13,288, or 64.0%, from $20,777 for the nine months ended
September 30, 1997 to $7,489 for the nine months ended September 30, 1998.
EBITDA represented 25.0% of total revenues for the nine months ended September
30, 1997 and 9.9% of total revenues for the nine months ended September 30,
1998, a decrease of 15.1%. The dollar and percentage decreases are primarily due
to the decreases in coin and non-coin telecommunication revenues (including
dial-around compensation), and the increases in line and transmission charges
and SG&A expenses. EBITDA is not intended to represent an alternative to
operating income (as defined in accordance with generally accepted accounting
principles) as an indicator of the Company's operating performance, or as an
alternative to cash flows from operating activities (as determined in accordance
with generally accepted accounting principles) as a measure of liquidity. The
Company believes that EBITDA is a meaningful measure of performance because it
is commonly used in the public pay telephone industry to analyze comparable
public pay telephone companies on the basis of operating performance, leverage
and liquidity.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOWS. The Company had working capital, excluding long-term debt
reclassified as current, of $6,069 at September 30, 1998, compared to $7,839 at
December 31, 1997, a decrease of $1,770, resulting primarily from an increase in
accounts receivable relating to dial-around compensation offset by the increase
in accrued interest and accounts payable. Net cash provided by (used in)
operating activities during the nine months ended September 30, 1997 and 1998
were $785 and $(5,813), respectively. Net cash used in operations resulted
mainly from the increase in the net loss for the nine months ended September 30,
1998, offset in part by higher non-cash charges for depreciation and
amortization and an increase in cash flow provided by current assets and
liabilities, net of assets acquired and reclassification of long-term debt.
Cash used in investing activities during the nine months ended
September 30, 1997 and 1998 was $53,372 and $6,225, respectively. Cash used in
investing activities in the first nine months of 1997 consisted primarily of
payments and deposits to acquire companies and purchases of property and
equipment, offset by the release of the escrowed cash equivalents for the
closing of the Cherokee acquisition. In the first nine months of 1998, cash used
in investing activities consisted mainly of purchases of telephones and other
property and equipment and the pay telephones acquired as part of the TDS
acquisition.
Cash flows provided by financing activities during the first nine
months ended September 30, 1997 and 1998 were $19,037 and $12,862, respectively,
which in 1997 consisted primarily of the net proceeds from the exercise of the
underwriters' overallotment pursuant to the Company equity offering completed on
December 18, 1996, offset by additional debt offering expenses and additional
borrowings under the Credit Agreement to fund acquisitions. Cash flows provided
by financing activities during the nine months ended September 30, 1998
consisted primarily of borrowings under the Company's Credit Agreement for
acquisitions, capital expenditures, interest on the Company's 12% Senior Notes,
and working capital purposes, offset by additional debt financing costs.
On May 8, 1998, the Company amended the Credit Agreement and Foothill
Capital Corporation, as replacement Agent and Lender, assumed all of the rights
and obligations of the former Lenders. Under the Third Amendment, the Revolving
Credit Commitment remained at $20,000 and the Expansion Loan Commitment was
reduced to $20,000. Interest is payable monthly in arrears at 2% above the
Lender's reference rate (as defined in
21
<PAGE> 22
the Third Amendment) and the maturity date of the Credit Agreement was extended
to May 8, 2001. Certain financial covenants under the Credit agreement were also
modified. The Company incurred $990 in fees and expenses in connection with the
Third Amendment.
At September 30, 1998, the Company was not in compliance with certain
financial covenants resulting in a default under the Credit Agreement. Such
financial covenant noncompliance could, at the discretion of the Lenders, cause
such obligation to become immediately due and payable. Accordingly, the Company
has classified the amounts due under the Credit Agreement as a current liability
in the accompanying consolidated balance sheet at September 30, 1998. The
Company has requested and expects to receive from the Agent and the Lenders a
waiver through December 31, 1998 of the financial covenants in the Credit
Agreement with which the Company was not in compliance.
The Company's working capital (excluding long-term debt reclassified as
currently payable) declined from $7,839 at December 31, 1997 to $6,069 at
September 30, 1998, a decrease of $1,770. Cash flows provided by (used in)
operating activities declined from $785 for the nine months ended September 30,
1997 to ($5,813) for the nine months ended September 30, 1998, a decrease of
$6,598, primarily due to the increase in the Company's net loss. The Company's
net loss increased from $15,902 to $27,652 for the nine months ended September
30, 1997 and 1998, respectively. At September 30, 1998, the Company had a
deficit of $32,610 in stockholders equity (excluding mandatorily redeemable
preferred stock) as a result of the current and prior year losses.
The Company's working capital, liquidity and capital resources may be
limited by its ability to generate sufficient cash flows from its operations or
its investment or financing activities. Cash flow from operations depends on
revenues from coin and non-coin sources. There can be no assurance that coin or
non-coin revenues will increase, that revenues from dial-around compensation
will continue at rates anticipated and be received by the Company in the amounts
recorded as receivables, or that operating expenses can be maintained at present
or reduced levels. To the extent that cash flows from operating activities are
insufficient to meet the Company's cash needs, there can be no assurance that
the Company can obtain additional financing to meet its debt service and other
cash requirements.
As discussed in Note 2, the Davel Merger Agreement has been terminated
along with the planned cash tender offer by Davel of PhoneTel's 12% Senior Notes
due 2006. The Company is currently negotiating with representatives of the note
holders to restructure this debt. Although management believes it will be able
to obtain the agreement of such representatives to restructure the Company's
obligations under the 12% Senior Notes, there can be no assurance that such
restructuring will be completed. In the event the Company is unable to
restructure this debt or obtain additional financing, it is unlikely that cash
flow from operations will be sufficient to meet the debt service required
thereunder. If the Company fails to meet its debt service, such debt could
become immediately due and payable. These uncertainties raise substantial doubt
about the Company's ability to continue as a going concern. The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
CAPITAL EXPENDITURES
For the nine months ended September 30, 1998, the Company had capital
expenditures (exclusive of acquisitions) of $3,202, which were financed by cash
flows from operations and proceeds from the Company's Credit Agreement. Capital
expenditures are principally for replacement and expansion of the Company's
installed public pay telephone base and include purchases of telephones, related
equipment, site contracts, operating equipment and computer hardware.
22
<PAGE> 23
SEASONALITY
The seasonality of the Company's historical operating results has been
affected by shifts in the geographic concentrations of its public pay telephones
resulting from acquisitions and other changes to the Company's customer mix.
Historically, revenues and related expenses during the first three months of the
year have been lower than the remainder of the year due to weather conditions
that affect pay telephone usage.
IMPACT OF THE YEAR 2000 ISSUE
The Year 2000 Issue is the result of computer programs being written
using two digits rather than four to define the applicable year. Any of the
Company's computer programs that have date-sensitive software may recognize a
date using "00" as the year 1900 rather that the year 2000. This could result in
a system failure or miscalculations causing disruptions of operations,
including, among other things, a temporary inability to process transactions,
send commissions, or engage in similar normal business activities.
The Company has completed a detailed assessment of the Year 2000 Issue
and has developed a plan for compliance. In the fourth quarter of 1998, the
Company began to implement its plan relating to its accounting, business
operations and corporate telephone systems. Complete implementation of the
Company's plan is dependent, among other things, upon receiving updated versions
of proprietary software from pay telephone manufacturers and replacement of the
Company's central office telephone switch. The cost to achieve full compliance
is currently estimated to be approximately $500.
Management believes the Company will be able to implement its plan and
achieve full Year 2000 compliance before the end of 1999. Management does not
believe the Year 2000 issue will have a material effect on future financial
results or cause reported financial information not to be necessarily indicative
of future operating results or future financial condition.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On September 29, 1998, PhoneTel received a letter from Davel purporting
to terminate the Davel Merger Agreement (see Notes 2). On October 1, 1998, a
complaint against PhoneTel under Civil Action No. 16675 was filed in the Court
of Chancery of New Castle County, Delaware by Davel, which was subsequently
amended on October 9, 1998, alleging, among other things, equitable fraud and
breach of contract relating to the Davel Merger Agreement. Davel is seeking a
declaratory judgement terminating the Davel Merger Agreement or, alternatively,
an order to rescind the merger agreement, and compensatory damages and costs of
an amount in excess of $1,000.
On October 27, 1998, PhoneTel filed its answer to the amended complaint
denying the substantive allegations contained therein and filed a counterclaim
against Davel for breach of contract. On the same date, PhoneTel filed a third
party claim against Peoples for tortuous interference with contract alleging
that Peoples induced Davel to not comply with the terms of the Davel Merger
Agreement.
PhoneTel is seeking specific performance from Davel, which would
require Davel to comply with the terms of the Davel Merger Agreement, or
alternatively for compensatory damages and costs of an unspecified amount.
PhoneTel is also seeking injunctive relief enjoining Peoples from further
tortuous interference with contract and for compensatory damages and costs of an
unspecified amount. Management believes the claims against PhoneTel are without
merit and is vigorously pursuing its claims against Davel and Peoples.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS:
(27) Financial Data Schedule
(b) REPORTS ON FORM 8-K
The Company filed a report on Form 8-K dated September 28, 1998
reporting a transaction under Item 1, change in control of registrant, reporting
the receipt of a letter from Davel Communication purporting to terminate the
Agreement and Plan of Merger and Item 5, other events, reporting that the
American Stock Exchange had notified the Company that the Company does not meet
the criteria for continued listing.
The Company filed a report on Form 8-K, dated November 9, 1998 under
Item 4 reporting that the Company's independent accountants,
PricewaterhouseCoopers LLP, had resigned.
23
<PAGE> 24
In accordance with Section 13 or 15(d) of the Securities Exchange Act
of 1934, the Registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
PHONETEL TECHNOLOGIES, INC.
November 16, 1998 By: /s/ Peter G. Graf
---------------------------------
Peter G. Graf
Chairman of the Board and
Chief Executive Officer
November 16, 1998 By: /s/ Richard P. Kebert
---------------------------------
Richard P. Kebert
Chief Financial Officer and
Treasurer
(Principal Financial Officer and
Accounting Officer)
24
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