<PAGE>
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For Quarter Ended: September 30, 1997 Commission File Number: 0-22610
DAVEL COMMUNICATIONS GROUP, INC.
--------------------------------
(Exact name of registrant as specified in its charter)
ILLINOIS 37-1064777
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) I.D. No.)
1429 MASSARO BOULEVARD, TAMPA, FLORIDA 33619
--------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant`s telephone number: (813) 623-3545
________________________
Indicate by check mark whether the Registrant has (1) 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. X Yes No
----- -----
As of November 13, 1997, the number of shares outstanding of the Registrant`s
Common Stock was 4,623,073.
<PAGE>
Davel Communications Group, Inc. and Subsidiaries
Consolidated Balance Sheets
(Unaudited)
<TABLE>
<CAPTION>
ASSETS September 30, December 31,
1997 1996
------------- ------------
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents $ 2,111,187 $ 4,629,936
Accounts receivable, at net 8,411,695 6,079,421
Accounts receivable - officers and employees 117,336 59,418
Note receivable 2,301,000 2,301,000
Inventories 51,053 50,856
Prepaid income taxes 195,169 804,945
Other current assets 684,568 230,269
Net assets of discontinued operations - 599,237
----------- -----------
Total current assets 13,872,008 14,755,082
PROPERTY AND EQUIPMENT - AT COST
less accumulated depreciation 36,479,871 28,417,615
OTHER ASSETS
Goodwill, less accumulated amortization 293,777 274,586
Other assets 479,346 414,844
----------- -----------
Total other assets 773,123 689,430
----------- -----------
Total assets $51,125,002 $43,862,127
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Current maturities of long-term debt $ 1,125,000 $ 69,207
Accounts payable 1,360,619 1,044,179
Accrued expenses 1,568,780 1,511,803
Deferred gain sale/leaseback 138,822 -
----------- -----------
Total current liabilities 4,193,221 2,625,189
LONG-TERM DEBT, less current maturities 7,179,961 5,726,019
DEFERRED INCOME TAXES 3,154,781 2,575,626
SHAREHOLDERS' EQUITY
Preferred stock - authorized but unissued,
1,000,000 shares $.01 par value - -
Common stock - authorized 10,000,000 shares
without par value - 4,623,073 shares
issued and outstanding 46,231 45,813
Additional paid-in capital 20,593,000 19,912,080
Retained earnings 15,957,808 12,977,400
----------- -----------
Total shareholders' equity 36,597,039 32,935,293
----------- -----------
Total liabilities and shareholders' equity $51,125,002 $43,862,127
=========== ===========
</TABLE>
The accompanying notes are an integral part of these statements
2
<PAGE>
Davel Communications Group, Inc. and Subsidiaries
Consolidated Statements of Earnings
(Unaudited)
<TABLE>
<CAPTION>
For the Three For the Three
Months Ended Months Ended
September 30, September 30,
1997 1996
------------- -------------
<S> <C> <C>
Revenues
Coin calls $ 6,760,526 $ 5,221,293
Non-coin calls 6,190,889 4,087,663
Long distance income 101,670 677,110
------------- -------------
Total revenues 13,053,085 9,986,066
Costs and expenses
Telephone charges - payphones 2,618,304 1,981,482
Commissions - payphones 1,639,011 1,285,888
Cost of long distance income 73,304 466,619
Service, maintenance and network costs 3,194,407 2,386,127
Selling, general and administrative 2,914,353 1,770,866
Provision for dial-around compensation 1,157,201 -
Depreciation and amortization 1,148,179 710,085
------------- -------------
Total operating costs and expenses 12,744,759 8,601,067
------------- -------------
Operating profit 308,326 1,384,999
Other income (expense)
Interest and other income 226,665 24,627
Interest expense (158,243) (131,251)
------------- -------------
Total other income (expense) 68,422 (106,624)
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Earnings from continuing operations before income taxes 376,748 1,278,375
Income taxes 132,230 299,355
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Earnings from continuing operations 244,518 979,020
Discontinued operations
Gain from operations of hospitality division, net of income taxes - 52,460
------------- -------------
Net earnings $ 244,518 $ 1,031,480
============= =============
Earnings per common share
Continuing operations $ 0.05 $ 0.22
Discontinued operations - 0.01
------------- -------------
Total $ 0.05 $ 0.23
============= =============
Average shares outstanding 4,612,260 4,554,247
============= =============
</TABLE>
The accompanying notes are an integral part of these statements
3
<PAGE>
Davel Communications Group, Inc. and Subsidiaries
Consolidated Statements of Earnings
(Unaudited)
<TABLE>
<CAPTION>
For the Nine For the Nine
Months Ended Months Ended
September 30, 1997 September 30, 1996
------------------- ------------------
<S> <C> <C>
Revenues
Coin calls $ 18,217,665 $ 13,302,134
Non-coin calls 16,996,610 11,669,196
Long distance income 399,550 1,810,244
------------ ------------
Total revenues 35,613,825 26,781,574
Costs and expenses
Telephone charges - payphones 7,187,397 5,316,321
Commissions - payphones 4,393,709 3,358,057
Cost of long distance income 246,550 1,306,413
Service maintenance and network costs 7,792,327 6,183,004
Selling, general and administrative 7,082,315 4,354,792
Provision for dial-around compensation 1,157,201 -
Depreciation and amortization 3,044,043 2,091,977
------------ ------------
Total operating costs and expenses 30,903,542 22,610,564
------------ ------------
Operating profit 4,710,283 4,171,010
Other income (expense)
Interest and other income 395,238 74,204
Interest expense (318,937) (161,668)
------------ ------------
Total other income (expense) 76,301 (87,464)
------------ ------------
Earnings from continuing operations before income taxes 4,786,584 4,083,546
Income taxes 1,806,176 1,365,320
------------ ------------
Earnings from continuing operations 2,980,408 2,718,226
Discontinued operations
Gain from operations of hospitality division, net of income taxes - 128,834
------------ ------------
Net earnings $ 2,980,408 2,847,060
============ ============
Earnings per common share
Continuing operations $ 0.65 $ 0.60
Discontinued operations - 0.63
------------ ------------
Total $ 0.65 $ 0.63
============ ============
Average shares outstanding 4,591,713 4,495,672
============ ============
</TABLE>
The accompanying notes are an integral part of these statements
4
<PAGE>
Davel Communications Group, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
For the Nine For the Nine
Months Ended Months Ended
September 30, September 30,
1997 1996
------------------ ------------------
<S> <C> <C>
Increase (decrease) in cash and cash equivalents
Cash flows from operating activities
Net earnings $ 2,980,408 $ 2,847,060
Adjustments to reconcile net earnings to net cash
provided by continuing operations
Discontinued operations - (128,834)
Gain on sale of property and equipment (137,921) (1,432)
Depreciation and amortization 3,044,044 2,280,165
Deferred income taxes 579,155 208,839
Deferred gain on sale of assets 138,822 -
Changes in assets and liabilities
Increase in accounts receivable (2,390,192) (1,106,420)
Increase in inventories (197) (58,485)
Increase in other assets (454,299) (75,364)
(Increase) decrease in prepaid income taxes 609,776 (952,731)
Increase in accounts payable 316,440 173,871
Increase in accrued expenses 56,977 233,697
Decrease in income taxes payable - (23,377)
------------------ ------------------
Net cash provided by operating activities 4,743,013 3,396,989
Cash flows from investing activities
Capital expenditures (4,375,016) (4,153,359)
Proceeds from sale of property and equipment 18,800 7,000
Decrease in net assets of discontinued operations 599,237 585,801
Increase in cash value of life insurance (6,451) (7,377)
Purchase of pay telephones (6,673,979) (4,377,350)
Increase in other investing assets (164,028) -
------------------ -----------------
Net cash used in investing activities (10,601,437) (7,945,285)
Cash flows from financing activities
Payments on long-term debt (3,501,959) (570,393)
Increase in other financing assets 681,338 815,332
Long-term debt financing 6,160,296 4,900,000
------------------ -----------------
Net cash provided by
financing activities 3,339,675 5,144,939
------------------ -----------------
Net increase (decrease) in cash
and cash equivalents (2,518,749) 596,643
Cash and cash equivalents at beginning of year 4,629,936 2,433,143
------------------ -----------------
Cash and cash equivalents at end of year $ 2,111,187 $ 3,029,786
================== =================
</TABLE>
The accompanying notes are an integral part of these statements
5
<PAGE>
Davel Communications Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
September 30, 1997
(Unaudited)
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying unaudited consolidated financial statements have been prepared
by the Company and include the accounts of its subsidiaries. These statements
reflect all adjustments, consisting of only normal recurring adjustments which
are, in the opinion of management, necessary for a fair presentation of
financial results for the nine month periods ended September 30, 1997 and 1996,
in accordance with generally accepted accounting principles for interim
financial reporting. Certain information and footnote disclosures normally
included in audited financial statements have been omitted pursuant to such
rules and regulations. These interim consolidated financial statements should
be read in conjunction with the Company's audited consolidated financial
statements and the notes thereto for the years ended December 31, 1996 and 1995
and Management's Discussion and Analysis of Financial Condition and Results of
Operations appearing elsewhere in this Form 10-Q and in the Company's Form 10-K
for the year ended December 31, 1996. The results of operations for the nine
month periods ended September 30, 1997 and 1996 are not necessarily indicative
of the results for the full year.
1. The Company
Davel Communications Group, Inc. and its Subsidiaries taken as a whole ("the
Company") operates, services and maintains a system of over 18,700 pay
telephones in 27 states and the District of Columbia, and provides operator
services to these pay telephones. Until December 31, 1996, the Company also
provided operator services to approximately 74,000 motel and hotel telephones in
47 states ("the Hospitality Division"). The Company also manufactured,
remanufactured and repaired pay telephones and other telecommunications
equipment for its own use and for sale to others through the fourth quarter of
1996 ("the Remanufacturing Division"). The Hospitality Division was sold and
the Remanufacturing Division was discontinued late in 1996 (See Note B
Discontinued Operations).
2. Principles of Consolidation
The accompanying financial statements include the accounts of the Company and
its wholly-owned subsidiaries. Intercompany transactions and balances have been
eliminated in consolidation.
3. Inventories
Inventories, which consist mainly of repair and manufacturing parts and
supplies, are carried at the lower of cost or market. Cost is determined by the
first-in, first-out method.
6
<PAGE>
4. Concentrations of Credit Risk
Receivables have a significant concentration of credit risk in the
telecommunications industry. In addition, a significant amount of receivables
are generated by approximately 23% of the Company's pay telephones located in
the State of Florida.
The Company and its Subsidiaries maintain cash balances at several financial
institutions located throughout the United States. Accounts at each institution
are insured by the Federal Deposit Insurance Corporation up to $100,000. The
Company has not experienced any losses in such accounts and believes it is not
exposed to any significant credit risk on cash and cash equivalents.
5. Property and Equipment
Property and equipment are stated at cost less accumulated depreciation.
Depreciation is provided for in amounts sufficient to relate the cost of
depreciable assets to operations over their estimated service lives using
straight-line and accelerated methods.
6. Intangible Assets
Intangible assets represent the unamortized excess of cost over fair market
value of net assets of businesses acquired by purchase in business combinations.
Goodwill is being amortized on a straight-line basis primarily over ten years.
Accumulated amortization of goodwill as of September 30, 1997 and 1996, was
$105,296 and $78,837, respectively.
The Company periodically evaluates the carrying amount of intangible assets,
considering whether the undiscounted cash flows from related operations will be
sufficient to recover recorded asset amounts. As of September 30, 1997,
management of the Company believes no impairment exists, and therefore no write-
downs of intangibles have been made.
7. Recognition of Revenue
Revenues from coin calls and non coin calls are recognized as calls are made.
When revenue on a telephone call is recorded, an expense is also recorded for
costs associated with the call.
8. Income Taxes
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Such temporary
differences include a deferred gain on an involuntary conversion, accumulated
depreciation and amortization of property and equipment and intangibles,
allowance for doubtful accounts and accrued liabilities.
7
<PAGE>
9. Earnings Per Share
Earnings per common share is computed on the basis of the average number of
shares outstanding during each period.
10. Cash Equivalents
For purposes of determining cash flows, the Company defines cash and cash
equivalents as highly-liquid investments purchased with an original maturity of
three months or less.
11. Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Although these estimates are based on management's knowledge of current events
and actions it may undertake in the future, they may ultimately differ from
actual results.
12. Reclassification
Certain reclassifications have been made to conform 1996 amounts to the 1997
presentation.
NOTE B - DISCONTINUED OPERATIONS
On December 31, 1996, the Company sold the Hospitality Division (Comtel Computer
Corp.) in a stock sale agreement for approximately $ 5 million (cash proceeds of
$ 2.7 million and a note receivable of $ 2.3 million). The note receivable has a
maturity date of December 31, 1997, with a stated interest rate of 9.75% per
annum, compounded daily. The Company holds a first security interest in the
assets and common stock of Comtel. This division is being accounted for as a
discontinued operation and its operating results are segregated and reported as
discontinued operations in the accompanying consolidated statements of earnings
and cash flows for the periods ended September 30, 1996.
During the fourth quarter of 1996, the Company also discontinued its
Remanufacturing Division. This division is being accounted for as a discontinued
operation and its operating results are segregated and reported as discontinued
operations in the accompanying consolidated statements of earnings and cash
flows for the periods ended September 30, 1996. The net assets of the
Remanufacturing Division to be disposed of have been separately classified in
the accompanying balance sheet at December 31, 1996. The Company disposed of
the assets of the Remanufacturing Division in the first quarter of 1997 through
the sale of the remaining inventory and equipment at its book value, resulting
in no gain or loss on the sale.
8
<PAGE>
Information relating to discontinued operations for the nine months ended
September 30, 1996, is as follows:
<TABLE>
<S> <C>
Revenues $8,179,552
Costs and expenses 8,019,606
----------
Operating profit 159,946
Other income 26,130
----------
Earnings before income taxes 186,076
Income taxes 57,242
----------
Net earnings $ 128,834
==========
</TABLE>
NOTE C - FAIR VALUES OF FINANCIAL INSTRUMENTS
For certain of the Company's financial instruments, including cash and cash
equivalents, accounts receivable, accounts payable and accrued liabilities, and
notes payable, the carrying amounts approximate fair value due to their short
maturities. Due to floating interest rates and values determined using
borrowing rates currently available to the Company, long-term debt is also
carried at amounts that approximate fair value.
NOTE D - LINE-OF-CREDIT
The Company has a $25 million revolving line of credit with NationsBank, with
provisions to convert up to $17.5 million of the line of credit to term loans.
The terms of the agreement call for the Company to pay interest on a graduated
scale based on NationsBank's Corporate Base Rate ("CBR"), which was 8.50% on
September 30, 1997. The interest rate is indexed based on the Company's ratio
of funded debt to EBITDA as defined in the credit facility and is adjusted based
on market interest rates for CBR and LIBOR. The maturity date of the revolving
portion of the credit facility is September 30, 2001. Principal outstanding on
each term loan under the convertible portion of the credit facility shall be
payable in 12 to 20 quarterly installments with the last installment due no
later than September 30, 2003. As of November 13, 1997, the Company had
approximately $1.2 million borrowed under the revolving portion and $7.1 million
borrowed under the term portion of the credit facility.
9
<PAGE>
NOTE E - SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest and income taxes for the nine month periods ended
September 30, 1997 and 1996 was as follows:
<TABLE>
<CAPTION>
1997 1996
--------- -----------
<S> <C> <C>
Interest $318,937 $ 224,452
Income taxes $286,172 $1,606,698
</TABLE>
The Company entered into a financing and investing non-cash transaction in
September 1997 in which the Company sold certain fixed assets and a life
insurance policy to a related party in exchange for long distance switching
equipment which had previously been leased to the Company and the assumption of
two loans totaling $148,602. The transaction is being treated as a
sale/leaseback transaction and the Company will recognize a gain of $ 377,877
over the term of the leases.
NOTE F - CAPITAL STOCK TRANSACTIONS
1. Preferred Stock
The Company's articles of incorporation authorize 1,000,000 shares of preferred
stock, par value $.01 per share. The Company does not have any current plans to
issue any shares of preferred stock.
2. Stock Options and Warrants
The Company maintains an Employee Stock Option Plan and a Directors' Stock
Option Plan, accounted for under APB Opinion 25 and related Interpretations.
The plans provide for the grant of nonqualified options to purchase shares of
common stock and outright grants of common stock. Generally, key employee
options vest in three equal installments and outright stock grants vest in two
installments. Nonemployee Director options become fully vested upon receipt.
The exercise price of each option generally equals the market price of the
common stock on the date of the grant. The maximum number of shares of common
stock reserved for issuance under the Employee Stock Option Plan and the
Directors' Stock Option Plan are 1,000,000 and 150,000 shares, respectively.
NOTE G - 401(K) PROFIT SHARING PLAN
The Company maintains a 401(k) profit sharing plan which covers all full-time
employees who meet the eligibility requirements as to age and length of service.
A participant may elect to have his or her compensation reduced by an amount not
to exceed 15% of compensation actually paid. The Company will match 50% of the
participants' elective deferrals not exceeding 3% of the participants'
compensation.
10
<PAGE>
NOTE H - PROVISION FOR DIAL-AROUND COMPENSATION
On September 20, 1996, the Federal Communications Commission ("FCC") adopted
rules in a docket entitled In the Matter of Implementation of the Pay Telephone
Reclassification and Compensation Provisions of the Telecommunications Act of
1996, FCC 96-388 (the "1996 Payphone Order"), implementing the payphone
provisions of Section 276 of the Telecommunications Act of 1996 (the "Telcom
Act"). The 1996 Payphone Order, which became effective November 7, 1996,
initially mandated dial-around compensation for both access code calls and 800
subscriber calls at a flat rate of $45.85 per payphone per month (131 calls
multiplied by $0.35 per call). Commencing October 7, 1997 and ending October 6,
1998 the $45.85 per payphone per month rate was to transition to a per-call
system at the rate of $0.35 per call. Several parties filed petitions for
judicial review of certain of the FCC regulations including the dial-around
compensation rate. On July 1, 1997, the U.S. Court of Appeals for the District
of Columbia Circuit (the "Court") responded to appeals related to the 1996
Payphone Order by remanding certain issues to the FCC for reconsideration.
These issues included, among other things, the manner in which the FCC
established the dial-around compensation for 800 subscriber and access code
calls, the manner in which the FCC established the interim dial-around
compensation plan and the basis upon which interexchange carriers ("IXCs") would
be required to compensate payphone service providers ("PSPs"). The Court
remanded the issue to the FCC for further consideration, and clarified on
September 16, 1997 that it had vacated certain portions of the FCC's 1996
Payphone Order, including the dial-around compensation rate. Specifically, the
Court determined that the FCC did not adequately justify (i) the per-call
compensation rate for 800 subscriber and access code calls at the deregulated
local coin rate of $0.35, because it did not sufficiently justify its conclusion
that the costs of local coin calls are similar to those of 800 subscriber and
access code calls; and (ii) the allocation of the payment obligation among the
IXCs for the period from November 7, 1996 through October 6, 1997.
In accordance with the Court's mandate, on October 9, 1997, the FCC adopted and
released its Second Report and Order in the same docket, FCC 97-371 (the "1997
Payphone Order"). This order addressed the per-call compensation rate for 800
subscriber and access code calls that originate from payphones in light of the
decision of the Court which vacated and remanded certain portions of the FCC's
1996 Payphone Order. The FCC concluded that the rate for per-call compensation
for 800 subscriber and access code calls from payphones is the deregulated local
coin rate adjusted for certain cost differences. Accordingly, the FCC
established a rate of $0.284 ($0.35 - $0.066) per call for the first two years
of per-call compensation (October 7, 1997 through October 6, 1999). The IXCs
are required to pay this per-call amount to PSPs, including the Company,
beginning October 7, 1997. After the first two years of per-call compensation,
the market-based local coin rate, adjusted for certain costs defined by the FCC
as $0.066 per call, is the surrogate for the per-call rate for 800 subscriber
and access code calls. These new rule provisions were made effective as of
October 7, 1997.
11
<PAGE>
In addition, the 1997 Payphone Order tentatively concluded that the same $0.284
per-call rate adopted on a going-forward basis should also govern compensation
obligations during the period from November 7, 1996 through October 6, 1997, and
that PSPs are entitled to compensation for all access code and 800 subscriber
calls during this period. The FCC stated that the manner in which the payment
obligation of the IXCs for the period from November 7, 1996 through October 6,
1997 will be allocated among the IXCs will be addressed in a subsequent order.
Based on the FCC's tentative conclusion in the 1997 Payphone Order, the Company
has adjusted the amounts of dial-around compensation previously recorded related
to the period from November 7, 1996 through June 30, 1997 from the initial
$45.85 rate to $37.20 ($0.284 per call multiplied by 131 calls). As a result of
this adjustment, the provision recorded in the three month period ended
September 30, 1997 for reduced dial-around compensation is approximately $1.2
million ($0.7 million net of applicable commissions and income taxes) or $0.16
per share. For the period from July 1, 1997 through October 6, 1997, the Company
has recorded (and will record) dial-around compensation at the rate of $37.20
per payphone per month. The amount of dial-around revenue recognized in the
period from July 1, 1997 through October 6, 1997 is approximately $2.2 million
and such amount will be billed after final resolution of the allocation
obligations of the IXCs as determined by the FCC.
The Company's counsel, Rammelkamp, Bradney, Kuster, Fritsche & Lindsay, P.C., is
of the opinion that the Company is legally entitled to fair compensation under
the Telcom Act for dial-around calls the Company delivered to any carrier during
the period from November 7, 1996 through October 6, 1997. Based on the
information available, the Company believes that the minimum amount it is
entitled to as fair compensation under the Telcom Act for the period from
November 7, 1996 through October 6, 1997 is $37.20 per payphone per month and
the Company, based on the information available to it, does not believe that it
is reasonably possible that the amount will be materially less than $37.20 per
payphone per month. While the amount of $0.284 per call constitutes the
Company's position of the appropriate level of fair compensation, certain IXCs
have asserted in the past, are asserting and are expected to assert in the
future that the appropriate level of fair compensation should be lower than
$0.284 per call. In a letter to the FCC dated August 15, 1997, AT&T stated its
intention to make dial-around payments to PSPs based on its imputed rate of
$0.12 per call until the FCC issues a new order setting the level of fair
compensation.
12
<PAGE>
MANAGEMENT`S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with
the consolidated financial statements and notes thereto appearing elsewhere in
this Form 10-Q and in conjunction with the consolidated financial statements and
notes thereto and Management's Discussion and Analysis of Financial Condition
and Results of Operations appearing in the Company's Form 10-K for the year
ended December 31, 1996.
Statements in Management's Discussion and Analysis relating to matters that
are not historical facts are forward-looking statements. Such forward-looking
statements involve known and unknown risks, uncertainties and other factors,
which may cause the actual results, performance or achievements of Davel
Communications Group, Inc. to be materially different from any future results,
performance or achievements expressed or implied by such forward-looking
statements. Such known and unknown risks, uncertainties and other factors
include, but are not limited to, the following: the impact of competition and
the possibility of increasing competitive pressures in a deregulated
environment, continuing increases in "dial-around" call traffic originating from
the Company's pay telephones, uncertainties with respect to the implementation
and effects of the Telecommunications Act of 1996, including the possibility of
litigation seeking to modify or overturn the 1997 Payphone Order or portions
thereof and the ongoing ability of the Company to deploy its pay telephones in
favorable locations. Such factors and others are set forth more fully in the
Company's Annual Report on Form 10-K for the year ended December 31, 1996,
Quarterly Reports on Form 10-Q and the consolidated financial statements and
notes thereto appearing elsewhere in this Form 10-Q.
The financial results discussed below relate to continuing operations which
primarily consist of the Company's pay telephone operations.
General
Davel Communications Group, Inc. (the "Company") is one of the largest
independent providers of pay telephone services in the United States. The
Company owns and operates a network of over 18,700 pay telephones in 27 states
and the District of Columbia, and provides operator services to these pay
telephones through its long distance switching equipment and through contractual
relationships with various long distance companies. The Company's pay
telephones accept coins as payment for local and long distance calls and can
also be used to make "non-coin" or "cashless" calls, including calling card
calls, credit card calls, collect calls and third-party billed calls. The
Company's pay telephones are located at convenience stores, truck stops, service
stations, grocery stores and other locations with a high demand for pay
telephone service.
On December 31, 1996, the Company sold its Hospitality Division ("Comtel")
in a stock sale agreement for approximately $ 5 million (cash proceeds of $ 2.7
million and a note receivable of $ 2.3 million). The note receivable has a
maturity date of December 31, 1997,
13
<PAGE>
with a stated interest rate of 9.75% per annum, compounded daily. The Company
holds a first security interest in the assets and common stock of Comtel. This
division is being accounted for as a discontinued operation and its operating
results are segregated and reported as discontinued operations in the
accompanying consolidated statements of earnings and cash flows for the periods
ended September 30, 1996.
During the fourth quarter of 1996, the Company also discontinued its
Remanufacturing Division. This division is being accounted for as a discontinued
operation and its operating results are segregated and reported as discontinued
operations in the accompanying consolidated statements of earnings and cash
flows for the periods ended September 30, 1996.
The Company derives virtually all its revenues from calls placed from its
pay telephones which include coin calls, non-coin calls and "dial-around" calls.
The Company's pay telephones generate coin revenues primarily from local
calls. The maximum rate LECs and independent pay telephone companies may charge
for local calls was generally set by state regulatory authorities and in most
cases was $0.25 or $0.35 through October 6, 1997. Among other provisions, the
1996 Payphone Order required that local coin call rates must generally be
deregulated no later than October 7, 1997. See "Safe Harbor Statement Local
Coin Rates."
The Company also receives revenues from cashless calls made from its pay
telephones. Cashless calls include credit card calls, calling card calls,
collect calls and third-party billed calls. Cashless calls from the Company`s
pay telephones are generally handled by the Company's switching equipment which
is located in Tampa, Florida. Through the use of its switching equipment, the
Company performs certain of the operator services necessary to complete cashless
calls.
Non-coin or cashless calls made from the Company's pay telephones and other
telephones to which the Company provides operator services generate revenues in
an amount that depends upon whether the Company or a long distance company
handles the call. If the cashless call is handled by the Company through its
switch or an "unbundled" services arrangement, the Company recognizes non-coin
revenues equal to the total amount charged for the call. If the cashless call
is handled by a long distance company, the Company generally recognizes revenues
in an amount equal to the commission on that call paid to the Company by the
long distance company. Under an unbundled services arrangement, the Company
performs certain functions necessary to service cashless calls, uses the long
distance company's switching equipment and its other services on an as-needed
basis, and pays the long distance company on an unbundled basis for the operator
services actually used to complete these calls.
The Company realizes additional revenues from certain long distance
companies pursuant to FCC regulation as compensation for "dial-around" cashless
calls made from its pay telephones. A dial-around call is made by dialing an
access code for the purpose of
14
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reaching a long distance company other than the one designated by the pay
telephone provider, generally by dialing a 1-800 number or a five-digit "10XXX"
code. On September 20, 1996, the Federal Communications Commission ("FCC")
adopted rules in a docket entitled In the Matter of Implementation of the Pay
Telephone Reclassification and Compensation Provisions of the Telecommunications
Act of 1996, FCC 96-388 (the "1996 Payphone Order"), implementing the payphone
provisions of Section 276 of the Telecommunications Act of 1996 (the "Telcom
Act"). The 1996 Payphone Order, which became effective November 7, 1996,
initially mandated dial-around compensation for both access code calls and 800
subscriber calls at a flat rate of $45.85 per payphone per month (131 calls
multiplied by $0.35 per call). Commencing October 7, 1997 and ending October 6,
1998 the $45.85 per payphone per month rate was to transition to a per-call
system at the rate of $0.35 per call. Several parties filed petitions for
judicial review of certain of the FCC regulations including the dial-around
compensation rate. On July 1, 1997, the U.S. Court of Appeals for the District
of Columbia Circuit (the "Court") responded to appeals related to the 1996
Payphone Order by remanding certain issues to the FCC for reconsideration.
These issues included, among other things, the manner in which the FCC
established the dial-around compensation for 800 subscriber and access code
calls, the manner in which the FCC established the interim dial-around
compensation plan and the basis upon which interexchange carriers ("IXCs") would
be required to compensate payphone service providers ("PSPs"). The Court
remanded the issue to the FCC for further consideration, and clarified on
September 16, 1997 that it had vacated certain portions of the FCC's 1996
Payphone Order, including the dial-around compensation rate. Specifically, the
Court determined that the FCC did not adequately justify (i) the per-call
compensation rate for 800 subscriber and access code calls at the deregulated
local coin rate of $0.35, because it did not sufficiently justify its conclusion
that the costs of local coin calls are similar to those of 800 subscriber and
access code calls; and (ii) the allocation of the payment obligation among the
IXCs for the period from November 7, 1996 through October 6, 1997.
In accordance with the Court's mandate, on October 9, 1997, the FCC adopted
and released its Second Report and Order in the same docket, FCC 97-371 (the
"1997 Payphone Order"). This order addressed the per-call compensation rate for
800 subscriber and access code calls that originate from payphones in light of
the decision of the Court which vacated and remanded certain portions of the
FCC's 1996 Payphone Order. The FCC concluded that the rate for per-call
compensation for 800 subscriber and access code calls from payphones is the
deregulated local coin rate adjusted for certain cost differences. Accordingly,
the FCC established a rate of $0.284 ($0.35 - $0.066) per call for the first two
years of per-call compensation (October 7, 1997 through October 6, 1999). The
IXCs are required to pay this per-call amount to PSPs, including the Company,
beginning October 7, 1997. After the first two years of per-call compensation,
the market-based local coin rate, adjusted for certain costs defined by the FCC
as $0.066 per call, is the surrogate for the per-call rate for 800 subscriber
and access code calls. These new rule provisions were made effective as of
October 7, 1997.
15
<PAGE>
In addition, the 1997 Payphone Order tentatively concluded that the same
$0.284 per-call rate adopted on a going-forward basis should also govern
compensation obligations during the period from November 7, 1996 through October
6, 1997, and that PSPs are entitled to compensation for all access code and 800
subscriber calls during this period. The FCC stated that the manner in which
the payment obligation of the IXCs for the period from November 7, 1996 through
October 6, 1997 will be allocated among the IXCs will be addressed in a
subsequent order.
Based on the FCC's tentative conclusion in the 1997 Payphone Order, the
Company has adjusted the amounts of dial-around compensation previously recorded
related to the period from November 7, 1996 through June 30, 1997 from the
initial $45.85 rate to $37.20 ($0.284 per call multiplied by 131 calls). As a
result of this adjustment, the provision recorded in the three month period
ended September 30, 1997 for reduced dial-around compensation is approximately
$1.2 million ($0.7 million net of applicable commissions and income taxes) or
$0.16 per share. For the period from July 1, 1997 through October 6, 1997, the
Company has recorded (and will record) dial-around compensation at the rate of
$37.20 per payphone per month. The amount of dial-around revenue recognized in
the period from July 1, 1997 through October 6, 1997 is approximately $2.2
million and such amount will be billed after final resolution of the allocation
obligations of the IXCs as determined by the FCC.
The Company's counsel, Rammelkamp, Bradney, Kuster, Fritsche & Lindsay,
P.C., is of the opinion that the Company is legally entitled to fair
compensation under the Telcom Act for dial-around calls the Company delivered to
any carrier during the period from November 7, 1996 through October 6, 1997.
Based on the information available, the Company believes that the minimum amount
it is entitled to as fair compensation under the Telcom Act for the period from
November 7, 1996 through October 6, 1997 is $37.20 per payphone per month and
the Company, based on the information available to it, does not believe that it
is reasonably possible that the amount will be materially less than $37.20 per
payphone per month. The foregoing sentence constitutes a forward-looking
statement within the meaning of Section 21E of the Securities and Exchange Act
of 1934, as amended.
While the amount of $0.284 per call constitutes the Company's position of
the appropriate level of fair compensation, certain IXCs have asserted in the
past, are asserting and are expected to assert in the future that the
appropriate level of fair compensation should be lower than $0.284 per call. In
a letter to the FCC dated August 15, 1997, AT&T stated its intention to make
dial-around payments to PSPs based on its imputed rate of $0.12 per call until
the FCC issues a new order setting the level of fair compensation.
The flat-rate payment level prescribed in the 1997 Payphone Order
significantly increases dial-around compensation revenues to the Company over
levels received prior to implementation of the Telcom Act. However, market
forces and factors outside the Company's control could significantly effect the
resulting revenue impact. These factors
16
<PAGE>
include the possibility of litigation seeking to modify or overturn the 1997
Payphone Order or portions thereof (See "Safe Harbor Statement Dial-Around
Compensation"), as well as the FCC's recognition that existing regulations do
not prohibit an IXC from blocking 800 subscriber numbers from pay telephones if
the IXC wants to avoid paying per-call compensation on these calls.
The principal costs related to the ongoing operation of the Company`s pay
telephones include telephone charges, commissions, and service, maintenance and
network costs. Telephone charges consist of payments made by the Company to
LECs for access charges and use of their networks. Commission expense represents
payments to property owners for allowing the Company to place its pay telephones
on the owner's property. Service, maintenance and network costs represent the
cost of servicing and maintaining the pay telephones on an ongoing basis, costs
related to operation of the Company`s switch and, in connection with unbundled
services arrangements, the fees paid for those services.
Three Months Ended September 30, 1997 Compared to Three Months Ended
September 30, 1996
For the three months ended September 30, 1997, total revenues from
continuing operations increased approximately $3.1 million or 30.7%, compared to
the three months ended September 30, 1996. This growth was primarily
attributable to an increase from 14,044 pay telephones on September 30, 1996 to
18,772 pay telephones on September 30, 1997. Coin call revenues increased
approximately $1.5 million or 29.5% driven primarily by the growth in the number
of installed pay telephones, the acquisition and installation of pay telephones
at locations with favorable coin call traffic, and the impact of the removal
during the third and fourth quarter of 1996 of approximately 600 under-
performing pay telephones and their replacement at better locations. Non-coin
call revenues increased approximately $2.1 million or 51.5%. In addition to
growth in the number of installed pay telephones, the increase in non-coin call
revenues was attributable to additional dial-around compensation resulting from
implementation of the Telecommunications Act of 1996 which became effective in
November 1996. While non-coin call revenues increased in the period over the
prior year, the Company continued to experience lower volumes of calls per phone
routed through its long distance network due to increases in the number of dial-
around calls. See "Safe Harbor Statement Dial-Around Compensation".
Long distance income consists primarily of operator services provided
through the Company's long distance switching equipment under a contractual
relationship with Comtel. Long distance income decreased approximately $575,000
or 85.0% in the three months ended September 30, 1997 over the three months
ended September 30, 1996. The decrease was primarily the result of the terms of
a Telecommunication Services Agreement connected with the sale of Comtel which
calls for the provision of certain long distance services to Comtel for a period
of one year after the effective date of the sale. The Agreement provides that,
effective January 1, 1997, gross revenues on calls carried over the Company's
long distance network will be recorded by Comtel rather than by the
17
<PAGE>
Company as was the case in previous periods. Amounts recorded by the Company as
long distance income in the period ended September 30, 1997 consist of payments
to the Company for use of its long distance network rather than the gross call
revenue.
Telephone charge expenses decreased to 20.2% of pay telephone revenues
compared to 21.3% in the prior year. The decrease in telephone charges as a
percentage of pay telephone revenues was primarily attributable to higher pay
telephone revenues.
Commission expenses decreased to 12.7% of pay telephone revenues compared
to 13.8% in the prior year. The decrease in commissions as a percentage of pay
telephone revenues was primarily attributable to higher pay telephone revenues.
Service, maintenance and network costs decreased to 24.6% of pay telephone
revenues compared to 25.6% in the prior-year period. The decrease in service,
maintenance and network costs as a percentage of pay telephone revenues was
primarily attributable to higher pay telephone revenues and increasing operating
efficiencies achieved through increasing density in the Company's pay telephone
routes resulting from expansion of its installed base of phones.
Cost of long distance income consists primarily of costs associated with
the provision of operator services to Comtel. Cost of long distance income
decreased approximately $393,000 or 84.3% in the three months ended September
30, 1997 over the three months ended September 30, 1996. Cost of long distance
income in the period ended September 30, 1996 included not only costs associated
with providing network services to Comtel, but also costs associated with
billing and collection of calls and bad debt, for which the Company is no longer
responsible. Cost of long distance income in the three months ended September
30, 1997 includes only costs associated with providing network services to
Comtel.
Depreciation and amortization expense on continuing operations increased
approximately $438,000 or 61.7%, from the prior year, reflecting a 33.7%
increase in the number of installed pay telephones. Selling, general and
administrative expenses on continuing operations increased approximately
$1.1 million, or 64.6%, from the prior year. The increase was primarily
attributable to the establishment of an allowance for doubtful accounts relating
to dial-around compensation of approximately $600,000, costs associated with
the opening and operation of four new divisional sales and service offices and
the hiring of additional support personnel needed to service the Company's
increasing pay telephone base.
The Company has adjusted the amounts of dial-around compensation previously
recorded related to the period from November 7, 1996 through June 30, 1997 from
the initial $45.85 rate to $37.20 ($0.284 per call multiplied by 131 calls). As
a result of this adjustment, the provision recorded in the three month period
ended September 30, 1997 for reduced dial-around compensation is approximately
$1.2 million. For the period from July 1, 1997 through October 6, 1997, the
Company has recorded (and will record) dial-around compensation at the rate of
$37.20 per payphone per month.
18
<PAGE>
Interest and other income in the three months ended September 30, 1997
increased approximately $202,000, or 820.4%, compared to the prior year period.
This increase resulted primarily from a currently recognizable gain of $131,548
on the sale of certain assets to the Company's majority shareholder. The assets
consisted of a life insurance policy, and a three bedroom home and airplane
which were subsequently leased back to the Company on terms approved by the
Company's disinterested directors. The sale of the house and airplane are being
treated as a sale/leaseback and the Company will recognize a deferred gain over
the term of the leases of the house and airplane of $246,329. In the period
September 30, 1997, the Company also recognized interest income of approximately
$57,000 on the note receivable related to the sale of Comtel on December 31,
1996. (See Note B of Notes to Consolidated Financial Statements).
Interest expense in the three months ended September 30, 1997 increased
approximately $27,000, or 20.6%, compared to the prior year period. This
increase resulted from an increase in long-term debt, including current
maturities, from approximately $4.6 million on September 30, 1996, to
approximately $8.3 million on September 30, 1997.
Earnings from continuing operations for the three months ended September
30, 1997 decreased approximately $735,000 or 75.0% from the prior year period.
Without giving effect to the provision for dial-around compensation of
approximately $1.2 million recorded in the quarter which related to prior
periods, the Company would have reported an increase in earnings from continuing
operations of approximately $18,000 or 1.8%.
The Company experienced earnings from discontinued operations, net of
income taxes, for the three months ended September 30, 1996 of $52,460.
Net earnings for the three months ended September 30, 1997 decreased
approximately $787,000 or 76.3% from the prior year period. Without giving
effect to the provision for dial-around compensation of approximately $1.2
million recorded in the quarter which related to prior periods, the Company
would have reported a decrease in net earnings of approximately $34,000 or 3.3%.
Earnings before interest, taxes, depreciation and amortization ("EBITDA")
on continuing operations decreased approximately $639,000 or 30.5%. Without
giving effect to the provision for dial-around compensation of approximately
$1.2 million recorded in the quarter which related to prior periods, the Company
would have reported an increase in EBITDA of approximately $0.5 million or
24.8%. EBITDA is not determined in accordance with Generally Accepted Accounting
Principles ("GAAP"), nor, as a result, is it included as a line item in the
Company's consolidated financial statements. EBITDA is not being presented as an
alternative to GAAP operating income or cash flows from operations being shown
on the Company's statements of cash flows. However, it is a commonly accepted
measure of performance in the telecommunications industry.
19
<PAGE>
Nine Months Ended September 30, 1997 Compared to Nine Months Ended
September 30, 1996
For the nine months ended September 30, 1997, total revenues from
continuing operations increased approximately $8.8 million or 33.0%, compared to
the nine months ended September 30, 1996. This growth was primarily
attributable to an increase from 14,044 pay telephones on September 30, 1996 to
18,772 pay telephones on September 30, 1997. Coin call revenues increased
approximately $4.9 million or 37.0% driven primarily by the growth in the number
of installed pay telephones, the acquisition and installation of pay telephones
at locations with favorable coin call traffic, and the impact of the removal
during the third and fourth quarter of 1996 of approximately 600 under-
performing pay telephones and their replacement at better locations. Non-coin
call revenues increased approximately $5.3 million or 45.7%. In addition to
growth in the number of installed pay telephones, the increase in non-coin call
revenues was attributable to additional dial-around compensation resulting from
implementation of the Telecommunications Act of 1996 which became effective in
November 1996. While non-coin call revenues increased in the period over the
prior year, the Company continued to experience lower volumes of calls per phone
routed through its long distance network due to increases in the number of dial-
around calls. See "Safe Harbor Statement Dial-Around Compensation".
Long distance income consists primarily of operator services provided
through the Company's long distance switching equipment under a contractual
relationship with Comtel. Long distance income decreased approximately $1.4
million or 77.9% in the nine months ended September 30, 1997 over the nine
months ended September 30, 1996. The decrease was primarily the result of the
terms of a Telecommunication Services Agreement connected with the sale of
Comtel which calls for the provision of certain long distance services to Comtel
for a period of one year after the effective date of the sale. The Agreement
provides that, effective January 1, 1997, gross revenues on calls carried over
the Company's long distance network will be recorded by Comtel rather than by
the Company as was the case in previous periods. Amounts recorded by the
Company as long distance income in the period ended September 30, 1997 consist
of payments to the Company for use of its long distance network rather than the
gross call revenue.
Telephone charge expenses decreased to 20.4% of pay telephone revenues
compared to 21.3% in the prior year. The decrease in telephone charges as a
percentage of pay telephone revenues was primarily attributable to higher pay
telephone revenues.
Commission expenses decreased to 12.5% of pay telephone revenues compared
to 13.4% in the prior year. The decrease in commissions as a percentage of pay
telephone revenues was primarily attributable to higher pay telephone revenues.
Service, maintenance and network costs decreased to 22.1% of pay telephone
revenues compared to 24.8% in the prior-year period. The decrease in service,
maintenance and network costs as a percentage of pay telephone revenues was
primarily attributable to higher pay telephone revenues and increasing operating
efficiencies
20
<PAGE>
achieved through increasing density in the Company's pay telephone routes
resulting from expansion of its installed base of phones.
Cost of long distance income consists primarily of costs associated with
the provision of operator services to Comtel. Cost of long distance income
decreased approximately $1.1 million or 81.1% in the nine months ended September
30, 1997 over the nine months ended September 30, 1996. Cost of long distance
income in the period ended September 30, 1996 included not only costs associated
with providing network services to Comtel, but also costs associated with
billing and collection of calls and bad debt, for which the Company is no longer
responsible. Cost of long distance income in the nine months ended September
30, 1997 includes only costs associated with providing network services to
Comtel.
Depreciation and amortization expense on continuing operations increased
approximately $952,000 or 45.5%, from the prior year, reflecting a 33.7%
increase in the number of installed pay telephones. Selling, general and
administrative expenses on continuing operations increased approximately $2.7
million, or 62.6%, from the prior year. The increase was primarily attributable
to costs associated with the opening and operation of four new divisional sales
and service offices, the establishment of an allowance for doubtful accounts
relating to dial around compensation of approximately $600,000 and the hiring of
additional support personnel needed to service the Company's increasing pay
telephone base.
The Company has adjusted the amounts of dial-around compensation previously
recorded related to the period from November 7, 1996 through June 30, 1997 from
the initial $45.85 rate to $37.20 ($0.284 per call multiplied by 131 calls). As
a result of this adjustment, the provision recorded in the nine month period
ended September 30, 1997 for reduced dial-around compensation is approximately
$1.2 million. For the period from July 1, 1997 through October 6, 1997, the
Company has recorded (and will record) dial-around compensation at the rate of
$37.20 per payphone per month.
Interest and other income in the nine months ended September 30, 1997
increased approximately $321,000, or 432.6%, compared to the prior year period.
This increase resulted primarily from a currently recognizable gain of $131,548
on the sale of certain assets to the Company's majority shareholder. The assets
consisted of a life insurance policy, and a three bedroom home and airplane
which were subsequently leased back to the Company on terms approved by the
Company's disinterested directors. The sale of the house and airplane are being
treated as a sale/leaseback and the Company will recognize a deferred gain over
the term of the leases of the house and airplane of $246,329. In the period
September 30, 1997, the Company also recognized interest income of approximately
$171,000 on the note receivable related to the sale of Comtel on December 31,
1996. (See Note B of Notes to Consolidated Financial Statements).
Interest expense in the nine months ended September 30, 1997 increased
approximately $157,000, or 97.3%, compared to the prior year period. This
increase resulted from an increase in long-term debt, including current
maturities, from
21
<PAGE>
approximately $4.6 million on September 30, 1996, to approximately $8.3 million
on September 30, 1997.
Earnings from continuing operations for the nine months ended September 30,
1997 increased approximately $262,000 or 9.65% from the prior year period.
Earnings from discontinued operations, net of income taxes, for the nine
months ended September 30, 1996 was $128,834 (See Note B of Notes to
Consolidated Financial Statements).
Net earnings for the nine months ended September 30, 1997 increased
approximately $133,000 or 4.68% from the prior year period.
Earnings before interest, taxes, depreciation and amortization ("EBITDA")
on continuing operations increased approximately $1.5 million or 23.8%, rising
from approximately $6.3 million in the nine months ended September 30, 1996, to
approximately $7.8 million in the nine months ended September 30, 1997. EBITDA
is not determined in accordance with Generally Accepted Accounting Principles
("GAAP"), nor, as a result, is it included as a line item in the Company's
consolidated financial statements. EBITDA is not being presented as an
alternative to GAAP operating income or cash flows from operations being shown
on the Company's statements of cash flows. However, it is a commonly accepted
measure of performance in the telecommunications industry.
Liquidity and Capital Resources
As of September 30, 1997, the Company had a current ratio of 3.31 to 1, as
compared to a current ratio of 5.62 to 1 on December 31, 1996. The decrease was
primarily attributable to a decrease in working capital from approximately $12.1
million as of December 31, 1996, to approximately $9.7 million as of September
30, 1997. This decrease in working capital resulted primarily from a decrease
in cash and cash equivalents related to the application of approximately $3.5
million in cash to payments on long-term debt during the period and an increase
of approximately $1.1 million in current maturities of long-term debt related to
borrowings on the Company's credit line in the month of June 1997 for
acquisitions. The Company also experienced an increase of approximately $2.4
million in accounts receivable during the period related primarily to an
increase in dial-around call compensation receivable. See "Safe Harbor Statement
Dial-Around Compensation".
The Company's capital expenditures for the nine month periods ended
September 30, 1997 and 1996 were approximately $4.4 million and $4.2 million,
respectively. The Company's capital expenditures primarily consisted of the
installation of additional pay telephones. The Company also made acquisitions of
payphones totaling approximately $6.7 million and $4.4 million in the periods
ended September 30, 1997 and 1996, respectively. In the nine months ended
September 30, 1997, the Company financed its capital expenditures and
acquisitions primarily with approximately $4.7 million in cash
22
<PAGE>
provided by continuing operations, approximately $6.2 million in long-term debt
financing and available cash reserves. In the nine months ended September 30,
1996, the Company financed its capital expenditures and acquisitions primarily
with approximately $3.4 million in cash provided by continuing operations, $4.9
million in long-term debt financing and available cash reserves.
The Company has a $25 million revolving line of credit with the
NationsBank, with provisions to convert up to $17.5 million of the line of
credit to term loans. The terms of the agreement call for the Company to pay
interest on a graduated scale based on NationsBank's Corporate Base Rate
("CBR"), which was 8.50% on September 30, 1997. The interest rate is indexed
based on the Company's ratio of funded debt to EBITDA as defined in the credit
facility and is adjusted based on market interest rates for CBR and LIBOR. The
maturity date of the revolving portion of the credit facility is September 30,
2001. Principal outstanding on each term loan under the convertible portion of
the credit facility shall be payable in 12 to 20 quarterly installments with the
last installment due no later than September 30, 2003. As of November 13, 1997,
the Company had approximately $1.2 million borrowed under the revolving portion
and $7.1 million borrowed under the term portion of the credit facility.
The Company believes that cash generated from operations and available
borrowings under the credit facility will be sufficient to fund the Company's
cash requirements, including capital expenditures, for the next three years.
The Company also believes that it will be able to fund any acquisitions through
a combination of cash generated from operations, additional borrowing and the
issuance of shares of its Common Stock. There can be no assurance, however,
that the Company will continue to expand at its current rate or that additional
financing will be available when needed or, if available, will be available on
terms acceptable to the Company.
Impact of Inflation
Inflation is not a material factor affecting the Company's business. Long
distance network and local access costs have not increased and in some cases,
have decreased in recent years. General operating expenses such as salaries,
employee benefits and occupancy costs are, however, subject to normal
inflationary pressures.
Seasonality
The Company's revenues from its pay telephone operating regions are
affected by seasonal variations to different degrees. For example, many of the
Company's pay telephones in Florida produce substantially higher call volume in
the first and second quarters than at other times during the year, while the
Company's pay telephones throughout the midwestern and eastern United States
produce their highest call volumes during the second and third quarters. While
the aggregate effect of the variations in different geographical regions tend to
counteract the effect of one another, the Company has historically experienced
higher revenue and income in the second and third quarters
23
<PAGE>
than in the first and fourth quarters, Changes in the geographical distribution
of its pay telephones may in the future result in different seasonal variations
in the Company's results.
Safe Harbor Statement
The following "Safe Harbor Statement" is made pursuant to the Private
Securities Litigation Reform Act of 1995. Certain of the statements contained
in the body of this Report are forward-looking statements (rather than
historical facts) that are subject to risks and uncertainties that could cause
actual results to differ materially from those described in the forward-looking
statements. With respect to such forward-looking statements, the Company seeks
the protections afforded by the Private Securities Litigation Reform Act of
1995. The list set forth below is intended to identify certain of the principal
factors that could cause actual results to differ materially from those
described in the forward-looking statements included elsewhere herein. These
factors are not intended to represent a complete list of all risks and
uncertainties inherent in the Company's business. This Safe Harbor Statement
should be read in conjunction with the Company's Annual Report on Form 10-K for
the year ended December 31, 1996, Quarterly Reports on Form 10-Q and the
consolidated financial statements and notes thereto appearing elsewhere in this
Form 10-Q.
Dial-Around Compensation
One of the key mandates of the Telecommunications Act was the requirement
that pay telephone providers be paid fair compensation for each and every call
made from their pay telephones, including dial-around access code and 800
subscriber calls. On September 20, 1996, the Federal Communications Commission
("FCC") adopted rules in a docket entitled In the Matter of Implementation of
the Pay Telephone Reclassification and Compensation Provisions of the
Telecommunications Act of 1996, FCC 96-388 (the "1996 Payphone Order"),
implementing the payphone provisions of Section 276 of the Telecommunications
Act of 1996 (the "Telcom Act"). The 1996 Payphone Order, which became effective
November 7, 1996, initially mandated dial-around compensation for both access
code calls and 800 subscriber calls at a flat rate of $45.85 per payphone per
month (131 calls multiplied by $0.35 per call). Commencing October 7, 1997 and
ending October 6, 1998 the $45.85 per payphone per month rate was to transition
to a per-call system at the rate of $0.35 per call. Several parties filed
petitions for judicial review of certain of the FCC regulations including the
dial-around compensation rate. On July 1, 1997, the U.S. Court of Appeals for
the District of Columbia Circuit (the "Court") responded to appeals related to
the 1996 Payphone Order by remanding certain issues to the FCC for
reconsideration. These issues included, among other things, the manner in which
the FCC established the dial-around compensation for 800 subscriber and access
code calls, the manner in which the FCC established the interim dial-around
compensation plan and the basis upon which interexchange carriers ("IXCs") would
be required to compensate payphone service providers ("PSPs"). The Court
remanded the issue to the FCC for further consideration, and clarified on
September 16, 1997 that it had vacated
24
<PAGE>
certain portions of the FCC's 1996 Payphone Order, including the dial-around
compensation rate. Specifically, the Court determined that the FCC did not
adequately justify (i) the per-call compensation rate for 800 subscriber and
access code calls at the deregulated local coin rate of $0.35, because it did
not sufficiently justify its conclusion that the costs of local coin calls are
similar to those of 800 subscriber and access code calls; and (ii) the
allocation of the payment obligation among the IXCs for the period from November
7, 1996 through October 6, 1997.
In accordance with the Court's mandate, on October 9, 1997, the FCC adopted
and released its Second Report and Order in the same docket, FCC 97-371 (the
"1997 Payphone Order"). This order addressed the per-call compensation rate for
800 subscriber and access code calls that originate from payphones in light of
the decision of the Court which vacated and remanded certain portions of the
FCC's 1996 Payphone Order. The FCC concluded that the rate for per-call
compensation for 800 subscriber and access code calls from payphones is the
deregulated local coin rate adjusted for certain cost differences. Accordingly,
the FCC established a rate of $0.284 ($0.35 - $0.066) per call for the first two
years of per-call compensation (October 7, 1997 through October 6, 1999). The
IXCs are required to pay this per-call amount to PSPs, including the Company,
beginning October 7, 1997. After the first two years of per-call compensation,
the market-based local coin rate, adjusted for certain costs defined by the FCC
as $0.066 per call, is the surrogate for the per-call rate for 800 subscriber
and access code calls. These new rule provisions were made effective as of
October 7, 1997.
In addition, the 1997 Payphone Order tentatively concluded that the same
$0.284 per-call rate adopted on a going-forward basis should also govern
compensation obligations during the period from November 7, 1996 through October
6, 1997, and that PSPs are entitled to compensation for all access code and 800
subscriber calls during this period. The FCC stated that the manner in which
the payment obligation of the IXCs for the period from November 7, 1996 through
October 6, 1997 will be allocated among the IXCs will be addressed in a
subsequent order.
Based on the FCC's tentative conclusion in the 1997 Payphone Order, the
Company has adjusted the amounts of dial-around compensation previously recorded
related to the period from November 7, 1996 through June 30, 1997 from the
initial $45.85 rate to $37.20 ($0.284 per call multiplied by 131 calls). As a
result of this adjustment, the provision recorded in the three month period
ended September 30, 1997 for reduced dial-around compensation is approximately
$1.2 million ($0.7 million net of applicable commissions and income taxes) or
$0.16 per share. For the period from July 1, 1997 through October 6, 1997, the
Company has recorded (and will record) dial-around compensation at the rate of
$37.20 per payphone per month. The amount of dial-around revenue recognized in
the period from July 1, 1997 through October 6, 1997 is approximately $2.2
million and such amount will be billed after final resolution of the allocation
obligations of the IXCs as determined by the FCC.
25
<PAGE>
The Company's counsel, Rammelkamp, Bradney, Kuster, Fritsche & Lindsay,
P.C., is of the opinion that the Company is legally entitled to fair
compensation under the Telcom Act for dial-around calls the Company delivered to
any carrier during the period from November 7, 1996 through October 6, 1997.
Based on the information available, the Company believes that the minimum amount
it is entitled to as fair compensation under the Telcom Act for the period from
November 7, 1996 through October 6, 1997 is $37.20 per payphone per month and
the Company, based on the information available to it, does not believe that it
is reasonably possible that the amount will be materially less than $37.20 per
payphone per month. The foregoing sentence constitutes a forward-looking
statement within the meaning of Section 21E of the Securities and Exchange Act
of 1934, as amended.
While the amount of $0.284 per call constitutes the Company's position of
the appropriate level of fair compensation, certain IXCs have asserted in the
past, are asserting and are expected to assert in the future that the
appropriate level of fair compensation should be lower than $0.284 per call. In
a letter to the FCC dated August 15, 1997, AT&T stated its intention to make
dial-around payments to PSPs based on its imputed rate of $0.12 per call until
the FCC issues a new order setting the level of fair compensation.
The flat-rate payment level prescribed in the 1997 Payphone Order
significantly increases dial-around compensation revenues to the Company over
levels received prior to implementation of the Telcom Act. However, market
forces and factors outside the Company's control could significantly effect the
resulting revenue impact. These factors include the possibility of litigation
seeking to modify or overturn the 1997 Payphone Order or portions thereof, as
well as the FCC's recognition that existing regulations do not prohibit an IXC
from blocking 800 subscriber numbers from pay telephones if the IXC wants to
avoid paying per-call compensation on these calls.
Local Coin Rates
In ensuring "fair compensation" for all calls, the FCC further determined
that local coin rates from pay telephones should be generally deregulated by
October 7, 1997, but provided for possible modifications or exemptions from
deregulation upon a detailed showing by an individual state that there are
market failures within the state that would not allow market-based rates to
develop. On July 1, 1997, the U.S. Court of Appeals for the District of Columbia
Circuit issued an order which upheld the FCC's authority to deregulate local
coin call rates. Certain LECs and independent payphone service providers,
including the Company, have announced their intention to increase rates charged
for local calls placed from their payphones in certain markets. The Company
believes that deregulation, where implemented, will likely result in higher
rates charged for local coin calls and increase the Company's revenues from such
calls. However, given the lack of direction on the part of the FCC on specific
requirements for obtaining a state exemption, the Company's inability to predict
the responses of individual states or the market, the Company's inability to
provide assurance that deregulation, if and where
26
<PAGE>
implemented, will lead to higher local coin call rates, the Company is unable to
predict the ultimate impact on its operations of local coin rate deregulation.
Other Provisions of the Telecommunications Act and FCC Rules
There are several other provisions of the Telecommunications Act and FCC
Rules that may have substantial positive and negative impacts on the Company.
As a whole, the Telecommunications Act and FCC Rules should significantly alter
the competitive framework of the pay telephone industry. The Company believes
that implementation of the Telecommunications Act and FCC Rules will address
certain historical inequities in the pay telephone marketplace and lead to a
more equitable competitive environment for all pay telephone providers.
However, due to the possibility of litigation seeking to modify or overturn the
1997 Payphone Order or portions thereof and uncertainties related to the impact
and/or timing of implementation, the Company can provide no assurance that the
Telecommunications Act and/or FCC Rules will result in a long-term positive
impact on the Company.
Billed Party Preference
The FCC has issued a Second Notice of Proposed Rulemaking regarding Billed
Party Preference ("BPP") and associated call rating issues, including potential
rate benchmarks and caller notification requirements for 0+ and 0- interstate
long distance calls. If BPP is implemented, cashless calls would be directed
automatically to the long distance company of the billed party`s previously
expressed preference. The Company believes that the significant expense and
technical modifications necessary to implement a system of BPP as evidenced by
the record in the FCC proceeding make its adoption in the proposed form
unlikely. However, rate benchmarks or caller notification of charges could be
implemented by the FCC for interstate operator-assisted calls. Such a ruling
could impact the financial performance of the Company, depending on the specific
level of the benchmark or the particular notification requirements. There is no
currently mandated schedule for a decision on the BPP docket. Without further
guidance from the FCC, the Company is unable to assess the likelihood of
adoption of BPP, rate benchmarks or caller notification, nor the impact, if any,
that such adoption might have on the Company's operations or results.
27
<PAGE>
PART II - OTHER INFORMATION
- ---------------------------
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Reports on Form 8-K. No reports on Form 8-K were filed by the Company
during the quarter ended September 30, 1997.
28
<PAGE>
SIGNATURE
- ---------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DAVEL COMMUNICATIONS GROUP, INC.
Date: November 13, 1997 /s/ Michael E. Hayes
-------------------------------------
Michael E. Hayes
Senior Vice President and
Chief Financial Officer
29
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<PAGE>
<ARTICLE> 5
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1996 DEC-31-1996
<PERIOD-START> JUL-01-1997 JAN-01-1997
<PERIOD-END> SEP-30-1997 SEP-30-1997
<CASH> 2,111,187 2,111,187
<SECURITIES> 0 0
<RECEIVABLES> 9,313,369 9,313,369
<ALLOWANCES> 901,674 901,674
<INVENTORY> 51,053 51,053
<CURRENT-ASSETS> 13,872,008 13,872,008
<PP&E> 48,404,843 48,404,843
<DEPRECIATION> 11,924,972 11,924,972
<TOTAL-ASSETS> 51,125,002 51,125,002
<CURRENT-LIABILITIES> 4,193,221 4,193,221
<BONDS> 0 0
0 0
0 0
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<OTHER-SE> 36,550,808 36,550,808
<TOTAL-LIABILITY-AND-EQUITY> 51,125,002 51,125,002
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<TOTAL-REVENUES> 13,053,085 35,613,825
<CGS> 7,525,026 19,619,983
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<OTHER-EXPENSES> 4,576,205 10,640,031
<LOSS-PROVISION> 643,528 643,528
<INTEREST-EXPENSE> 158,243 318,937
<INCOME-PRETAX> 376,748 4,786,584
<INCOME-TAX> 132,230 1,806,176
<INCOME-CONTINUING> 244,518 2,980,408
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