SECURITIES & EXCHANGE COMMISSION WASHINGTON, D.C. 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, 1997 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OF 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File No. 1-106 LYNCH CORPORATION (Exact name of Registrant as specified in its charter) Indiana 38-1799862 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 8 Sound Shore, Drive, Suite 290, Greenwich, Connecticut 06830 (Address of principal executive offices) (Zip Code) (203) 629-3333 Registrant'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 (20 has been subject to such filing requirements for the past 90 days. Yes X No Indicate the number of shares outstanding of each of the Registrant's classes of Common Stock, as of the latest practical date. Class Outstanding at November 1, 1997 Common Stock, no par value 1,416,834 INDEX LYNCH CORPORATION AND SUBSIDIARIES PART I. FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) Condensed Consolidated Balance Sheet: - September 30, 1997 - December 31, 1996 (Audited) Condensed Consolidated Statements of Operations: - Three and nine months ended September 30, 1997 and 1996 Condensed Consolidated Statements of Cash Flows: - Nine months ended September 30, 1997 and 1996 Notes to Consolidated Financial Statements: Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations PART II. OTHER INFORMATION Item 2. Changes in Securities Item 5. Other Information Item 6. Exhibits and Reports on Form 8-K SIGNATURES Part 1 - FINANCIAL INFORMATION Item 1 - Financial Statements LYNCH CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEET (In thousands) September 30 December 31 1997 1996 (Unaudited) (A) ASSETS CURRENT ASSETS: Cash and Cash Equivalents $ 25,556 $ 33,946 Marketable Securities and Short-Term Investments 2,919 2,156 Receivables, Less Allowances of $1,624 and $1,525 57,572 52,963 Inventories 36,643 36,859 Deferred Income Tax Benefits 5,571 5,571 Other Current Assets 11,230 8,598 Total Current Assets 139,491 140,093 PROPERTY, PLANT AND EQUIPMENT: Land 1,473 1,367 Buildings and Improvements 23,847 21,334 Machinery and Equipment 188,350 157,025 213,670 179,726 Less Accumulated Depreciation (58,012) (46,707) Net Property, Plant and Equipment 155,658 133,019 INVESTMENTS IN AND ADVANCES TO PCS ENTITIES 24,947 34,116 INVESTMENTS IN AND ADVANCES TO AFFILIATED COMPANIES 1,273 2,529 EXCESS OF COSTS OVER FAIR VALUE OF NET ASSETS ACQUIRED 74,133 69,206 OTHER ASSETS 13,486 13,657 Total Assets $408,988 $392,620 LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Notes Payable to Banks $ 22,334 $ 17,419 Trade Accounts Payable 21,033 20,998 Accrued Liabilities 39,174 36,275 Current Maturities of Long-Term Debt 8,776 23,769 Total Current Liabilities 91,317 98,461 LONG-TERM DEBT 244,952 219,579 DEFERRED INCOME TAXES 22,557 22,389 MINORITY INTERESTS 14,201 13,268 SHAREHOLDERS' EQUITY COMMON STOCK, NO PAR VALUE-10,000,000 SHARES AUTHORIZED; 1,471,191 shares issued (at stated value) 5,139 5,139 ADDITIONAL PAID - IN CAPITAL 8,635 8,417 RETAINED EARNINGS 22,936 26,472 TREASURY STOCK OF 54,357 AND 80,157 SHARES AT COST (749) (1,105) Total Shareholders' Equity 35,961 38,923 Total Liabilities and Shareholders' Equity $408,988 $392,620 (A)The Balance Sheet at December 31, 1996 has been derived from the Audited Financial Statements at that date, but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. See Notes to Condensed Consolidated Financial Statements LYNCH CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS (UNAUDITED) (In thousands, except share amounts) Three Months Nine Months Ended September 30 Ended September 30 SALES AND REVENUES 1997 1996 1997 1996 Multimedia $ 12,739 $ 7,397 $ 34,901 $ 20,753 Services 38,293 35,306 111,137 102,510 Manufacturing 67,685 74,618 202,884 217,026 118,717 117,321 348,922 340,289 Costs and expenses: Multimedia 9,396 5,223 26,188 14,824 Services 34,821 32,417 101,674 94,922 Manufacturing 57,164 63,063 170,369 180,670 Selling and administrative 11,049 9,904 32,052 31,839 OPERATING PROFIT 6,287 6,714 18,639 18,034 Other income (expense): Investment Income 554 519 1,411 1,667 Interest expense (5,901) (4,254) (17,178) (12,439) Share of operations of affiliated companies 20 8 91 74 Impairment of PCS licenses (7,024) 0 (7,024) 0 Gain (Loss) on Sale of Subsidiary Stock (91) 0 169 4,178 (12,442) (3,727) (22,531) (6,520) INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES AND MINORITY INTERESTS (6,155) 2,987 (3,892) 11,514 Provision for income taxes 2,041 (1,240) 1,139 (4,666) Minority interests (160) (498) (783) (1,160) INCOME (LOSS) FROM CONTINUING OPERATIONS $ (4,274) $ 1,249 $ (3,536) $ 5,688 DISCONTINUED OPERATIONS: LOSS FROM OPERATIONS OF DIS- CONTINUED LYNCH TRI-CAN INTER- NATIONAL (LESS APPLICABLE INCOME TAXES OF $90) 0 0 0 (148) LOSS ON DISPOSAL OF LYNCH TRI-CAN INTER-NATIONAL(LESS APPLICABLE INCOME TAXES OF $305) 0 0 0 (595) NET INCOME (LOSS) $ (4,274) $ 1,249 $ (3,536) $ 4,945 Weighted average shares outstanding 1,417,000 1,408,000 1,414,000 1,404,000 INCOME (LOSS) PER COMMON SHARE: INCOME (LOSS) FROM CONTINUING OPERATIONS $ (3.02) $ 0.89 $ (2.50) $ 4.05 LOSS FROM DISCONTINUED OPERATIONS 0.00 0.00 0.00 (0.53) NET INCOME (LOSS) $ (3.02) $ 0.89 $ (2.50) $ 3.52 See Notes to Condensed Consolidated Financial Statements LYNCH CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED) (In thousands) Nine Months Ended September 30 1997 1996 OPERATING ACTIVITIES Net Income (Loss) $(3,536) $ 4,945 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 15,984 12,514 Net effect of purchases and sales of trading securities (763) 9,461 Deferred taxes (2,388) 1,707 Share of operations of affiliated companies (91) (74) Minority interests 783 1,160 Gain on sale of stock by subsidiaries (169) (4,187) Impairment of PCS Licenses 7,024 0 Changes in operating assets and liabilities: Receivables (4,449) (2,741) Inventories 216 (5,953) Accounts payable and accrued liabilities 1,259 1,268 Other (635) (3,255) NET CASH FROM OPERATING ACTIVITIES 13,235 14,854 INVESTING ACTIVITIES Capital Expenditures (13,700) (17,435) Acquisition of lines from U.S. West 0 (5,680) Investment in Coronet Communications Company 2,995 0 Investment in Upper Peninsula Telephone Company (25,721) 0 Sale of Investments-Cellular Partnership 8,576 0 Investment in Personal Communications Services Partnerships 2,145 (14,306) Other (82) (363) NET CASH USED IN INVESTING ACTIVITIES (25,787) (37,784) FINANCING ACTIVITIES Issuance of long-term debt, net 3,219 22,410 Treasury stock transactions 657 730 Minority interest transactions 286 637 NET CASH FROM FINANCING ACTIVITIES 4,162 23,777 Net increase (decrease) in cash and cash equivalents (8,390) 847 Cash and cash equivalents at beginning of period 33,946 15,921 CASH AND CASH EQUIVALENTS AT END OF PERIOD 25,556 16,768 See Notes to Condensed Consolidated Financial Statements. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS A. Subsidiaries of the Registrant Owned by Subsidiary Lynch Brighton Communications Corporation 100.0% Lynch Telephone Corporation IV 100.0% Bretton Woods Telephone Company, Inc. 100.0% World Surfer, Inc. 100.0% Lynch Kansas Telephone Corporation 100.0% Lynch Telephone Corporation VI 98.0% J.B.N. Telephone Company, Inc. 98.0% J.B.N. Finance Corporation 98.0% Giant Communications, Inc. 100.0% Lynch Telephone Corporation VII 100.0% USTC Kansas, Inc. 100.0% Haviland Telephone Company, Inc. 100.0% Haviland Finance Corporation 100.0% DFT Communications Corporation 100.0% Dunkirk & Fredonia Telephone Company 100.0% Cassadaga Telephone Company 100.0% Macom, Inc. 100.0% Comantel, Inc. 100.0% D&F Cellular Telephone, Inc. 100.0% Erie Shore Communications, Inc. 100.0% DFT Long Distance Corporation 100.0% LMT Holding Corporation 100.0% Lynch Michigan Telephone Holding Corporation 100.0% Upper Peninsula Telephone Company 100.0% Alpha Enterprises Limited 100.0% Upper Peninsula Cellular North, Inc. 100.0% Upper Peninsula Cellular South, Inc. 100.0% Global Television, Inc. 100.0% Inter-Community Acquisition Corporation 83.0% Home Transport Services, Inc. 100.0% Lynch Capital Corporation 100.0% Lynch Entertainment Corporation 100.0% Lynch Entertainment Corporation II 100.0% Lynch International Exports, Inc. 100.0% Lynch Manufacturing Corporation 100.0% Lynch Display Technologies, Inc. 100.0% Lynch Machinery, Inc. 90.0% M-tron Industries, Inc. 94.0% M-tron Industries, Ltd. 94.0% Spinnaker Industries, Inc 67.3% Entoleter, Inc. 67.3% Brown-Bridge Industries, Inc. 67.3% Central Products Company 67.3% Lynch Multimedia Corporation 100.0% CLR Video, L.L.C. 60.0% The Morgan Group, Inc. 66.24%(V)/50.95%(O) Morgan Drive Away, Inc. 66.24%(V)/50.95%(O) Transport Services Unlimited, Inc. 66.24%(V)/50.95%(O) Interstate Indemnity Company 66.24%(V)/50.95%(O) Morgan Finance, Inc. 66.24%(V)/50.95%(O) TDI, Inc. 66.24%(V)/50.95%(O) Home Transport Corporation 66.24%(V)/50.95%(O) MDA Corporation 66.24%(V)/50.95%(0) Lynch PCS Communications Corporation 100.0% Lynch PCS Corporation A 100.0% Lynch PCS Corporation F 100.0% Lynch PCS Corporation G 100.0% Lynch Interactive Corporation 100.0% Lynch Telecommunications Corporation 100.0% Lynch Telephone Corporation 80.1% Western New Mexico Telephone Co., Inc. 80.1% WNM Communications Corporation 80.1% Wescel Cellular, Inc. 80.1% Wescel Cellular of New Mexico Limited Partnership 40.9% Wescel Cellular, Inc. II 80.1% Northwest New Mexico Cellular, Inc. 40.1% Northwest New Mexico Cellular of New Mexico Limited Partnership 20.5% Enchantment Cable Corporation 80.1% Lynch Telephone Corporation II 83.0% Inter-community Telephone Company 83.0% Inter-community Telephone Company II 83.0% Lynch Telephone Corporation III 81.0% Cuba City Telephone Exchange Company 81.0% Belmont Telephone Company 81.0% Notes: (V)=Percentage voting control; (O)=Percentage of equity ownership B. Basis of Presentation The accompanying unaudited condensed 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 of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of the management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine month periods ended September 30, 1997 are not necessarily indicative of the results that may be expected for the year ended December 31, 1997. For further information, refer to the consolidated financial statements and footnotes thereto included in the Registrant's Annual Report on Form 10-K for the year ended December 31, 1996. C. Acquisitions On March 18, 1997, Lynch Michigan Telephone Holding Company, a wholly-owned subsidiary of the Registrant, acquired approximately 60% of the outstanding shares of Upper Peninsula Telephone Company for $15.2 million. The Registrant completed the acquisition of the remaining 40% on May 23, 1997. The total cost of the acquisition was $26.5 million. As a result of this transaction, the Registrant recorded approximately $7.4 million in goodwill which is being amortized over 25 years. On December 31, 1996, The Morgan Group, Inc., an approximately 51% owned subsidiary of the Registrant, acquired the operating assets of Transit Homes of America, Inc., a provider of transportation services to a number of producers in the manufactured housing industry. The purchase price was approximately $4.4 million, including assumed obligations. On November 25, 1996, DFT Communications Corporation, a wholly-owned subsidiary of the Registrant, acquired all of the outstanding shares of Dunkirk & Fredonia Telephone Company, a local exchange company serving portions of Western New York. The total cost of this transaction was $27.7 million. As a result of this transaction, the Registrant recorded $13.8 million in goodwill which is being amortized over 25 years. All of these acquisitions were accounted for as purchases, and, accordingly, the assets and liabilities were recorded at their estimated fair market value. The operating results of the acquired companies are included in the Consolidated Statement of Income from their respective acquisition dates. The following unaudited proforma information shows the results of the Registrant's operations as though the purchase of Upper Peninsula Telephone Company, Transit Homes and Dunkirk & Fredonia were made at the beginning of 1996. Three Months Ended Nine Months Ended September 30 September 30 1997 1996 1997 1996 (In thousands, except per share data) Sales and Revenues $118,717 $130,981 $351,178 $378,198 Operating Profit 6,287 7,952 19,549 26,388 Income (Loss) from Continuing Operations Before Income Taxes and Minority Interest (6,155) 3,101 (3,664) 16,454 Net Income (Loss) (4,274) 1,220 (3,440) 7,946 Net Income (Loss) Per Share ($3.02) $0.87 ($2.43) $5.66 The proforma results for the nine months ending September 30, 1996, reflect the sale of Dunkirk & Fredonia's cellular telephone interests which resulted in a pre-tax gain of $5.1 million, or $3.65 per share, included in operating profit. The after-tax gain on the sale of the cellular interests was $3.4 million, or $2.43 per share. D. Discontinued Operations During the second quarter of 1996, the Registrant decided to discontinue the operations of Tri-Can International, Ltd. ("Tri-Can") and sell the assets of that operation. The sale was completed in August 1996. Tri-Can, a manufacturer of packaging machinery, recorded sales of $2.8 million for the nine months ended September 30, 1996. The assets sold primarily consisted of inventory, fixed assets and intangibles. Accordingly, during the nine months ended September 30, 1996, results of Tri-Can are presented as "discontinued operations." E. Inventories Inventories are stated at the lower of cost or market value. At September 30, 1997, inventories were valued by three methods: last-in, first-out (LIFO) - - 56%, specific identification - 40%, and first-in, first-out (FIFO) - 4%. At December 31, 1996, the respective percentages were 53%, 42%, and 5%. In Thousands 9-30-97 12-31-96 Raw material and supplies $ 9,634 $10,987 Work in process 5,104 3,950 Finished goods 21,905 21,922 Total Inventories $36,643 $36,859 F. Indebtedness On a consolidated basis, at September 30, 1997, the Registrant maintains short-term and long-term lines of credit facilities totaling $81.2 million, of which $52.1 million was available. The Registrant (Parent Company) maintains an $18.0 million short-term line of credit facility, of which $3.5 million was available at September 30, 1997. This facility decreases by $1.0 million per month starting on November 30, 1997 and will expire on February 16, 1998. Spinnaker Industries, Inc. maintains lines of credit at its subsidiaries which total $40.0 million, of which $39.7 million was available at September 30, 1997. The Morgan Group maintains lines of credit totaling $10.4 million, $1.6 million was available at September 30, 1997. These facilities, as well as facilities at other subsidiaries of the Registrant, generally limit the credit available under the lines of credit to certain variables, such as inventories and receivables, and are secured by the operating assets of the subsidiary, and include various financial covenants. At September 30, 1997, $30.1 million of these total facilities expire within one year. In general, the long-term debt credit facilities are secured by property, plant and equipment, inventory, receivables and common stock of certain subsidiaries and contain certain covenants restricting distributions to the Registrant. On October 23, 1996, Spinnaker Industries completed the issuance of $115 million of 10-3/4% senior secured debt due 2006. The debt proceeds were used to extinguish substantially all existing bank debt, bridge loans, and lines of Credit at Spinnaker and its two major operating subsidiaries, Central Products and Brown-Bridge. In addition, Spinnaker established a $40.0 million asset-backed senior-secured revolving credit facility. Long term debt consists of: 9-30-97 12-31-96 Spinnaker Industries, Inc. 10.75% Senior Secured Note due 2006 $115,000 $115,000 Rural Electrification Administration and Rural Telephone Bank notes payable in equal quarterly installments through 2027 at fixed interest rates ranging from 2% to 7.5% (4.7% weighted average) 47,549 34,734 Bank credit facilities utilized by certain telephone and telephone holding companies through 2009, $36.4 million at a fixed interest rate averaging 8.9% and $19.3 million at variable interest rates averaging 9.0% 55,742 41,513 Unsecured notes issued in connection with telephone company acquisitions at fixed interest rates averaging 9% with maturities through 2006. 27,945 28,044 Gabelli Funds, Inc. and affiliates loans at fixed rates of 10% due on August 12, 1997 0 11,800 Other 7,492 12,257 253,728 243,348 Current Maturities (8,776) (23,769) $244,952 $219,579 H. Gain (Loss) on Sale of Subsidiary Stock As a result of the conversion of the $6.0 million Convertible Subordinated Alco Note of Spinnaker into their Common Stock on May 5, 1996 and other transactions, the Registrant, in accordance with its accounting policy, recognized a gain of $4.1 million, ($2.4 million, or $1.74 per share after taxes) in the second quarter of 1996. During the third quarter of 1997, as a result of the exercise of a portion of the stock warrants held by the management of Spinnaker, the Registrant recorded a loss of $91 thousand, or $53 thousand after tax (or $0.04 per share). I. Earnings Per Share Earnings per common and common equivalent share amounts are based on the average number of common shares outstanding during each period, assuming the exercise of all stock options having an exercise price less than the average market price of the common stock using the treasury stock method. Fully diluted earnings per share reflect the effect, where dilutive, of the exercise of all stock options having an exercise price less than the greater of the average or closing market price at the end of the period of the Common Stock of the Registrant using the treasury stock method. In February 1997, the Financial Accounting Standards Board issued, Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share," which changes the methodology of calculating earnings per share. SFAS No.128 requires a disclosure of diluted earnings per share regardless of its difference from basic earnings per share. The Registrant plans to adopt SFAS No. 128 in December 1997. Early adoption is not permitted. The Registrant does not expect the adoption of SFAS No. 128 to have a material effect on the financial statements. Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Sales and Revenues Revenues for the third quarter of 1997 increased by $1.4 million, or 1%, from the third quarter of 1996. Within the operating segments, multimedia, whose revenues increased by 72%, contributed $5.3 million to the increase and services, whose revenues increased by 8%, contributed $3.0 million to the overall increase. Revenues of the manufacturing segment dropped 9% and were $6.9 million less than the third quarter of 1996. The acquisitions of Dunkirk & Fredonia Telephone Company ($2.6 million contribution), which occurred on November 26, 1996, and Upper Peninsula Telephone Company ($2.2 million contribution), which a majority interest was obtained on March 18, 1997, were the primary contributors to the increase in multimedia's operating revenues. Revenues of $4.8 million as a result of the acquisition of Transit Homes of America, Inc., which occurred on December 30, 1996, offset by lower "Truckaway" revenues, an operation which was sold in the second quarter of 1997, was the primary contributor to the increased revenues at The Morgan Group, Inc. Within the manufacturing group, revenues for Spinnaker were lower by $6.8 million or 11% from the third quarter of 1996: at Central Products Company, competitive pricing pressure offset somewhat higher unit demand and resulted in lower revenues by $2.1 million, timing of shipments decreased Brown-Bridge revenues by $3.1 million and Entoleter revenues of industrial equipment were lower by $1.6 million. Timing delays in the manufacturing of extra-large glass presses resulted in a $2.8 million period to period short-fall in revenues at Lynch Machinery, Inc. and improved demand for electronic components, predominantly by telecommunications capital equipment manufacturers, resulted in higher revenues of $2.6 million at M- tron. For the nine months ended September 30, 1997, revenues increased by $8.6 million, or 3% better than the nine months ended September 30, 1996. Multimedia revenues increased by $14.1 million reflecting the acquisitions of Dunkirk & Fredonia and Upper Peninsula of $7.6 million and $4.4 million, respectively. Morgan's revenues increased by $8.6 million reflecting revenues of Transit Homes of America of $13.9 million, offset by lower driver outsourcing Truckaway revenues. Manufacturing revenues decreased by $14.1 million reflecting (1) order short-fall at Lynch Machinery, $5.8 lower (2) revenue shortfalls at all three units of Spinnaker, $11.6 million decrease and (3) offset by improved demand at M-tron, $3.3 million increase. Operating Profit Operating profit for the third quarter of 1997 decreased by $.4 million from the third quarter of 1996. Operating profit in the multimedia and services segments increased by $1.2 million and $0.5 million, respectively, while manufacturing operating profits decreased by $2.0 million. Corporate expenses increased by $0.1 million. In the multimedia segment, higher revenues resulted in increased EBITDA (earnings before interest, taxes, depreciation and amortization) of $2.3 million, offset by increased depreciation and amortization expense of $1.1 million, both primarily associated with the acquisitions of Dunkirk & Fredonia Telephone Company and Upper Peninsula Telephone Company. Increased revenues and absence of the unprofitable Truckaway operation, increased operating profit at Morgan by $0.5 million or 59%. The decrease in the operating profit at the manufacturing group related to the reduced revenues at all the operating units except for M-tron whose revenues and profit increased significantly. For the nine months ended September 30, 1997, operating profit increased by $0.6 million, or 3%. Multimedia operating profit increased by $2.7 million reflecting the acquisition of Dunkirk & Fredonia and Upper Peninsula of $0.7 million and $1.9 million, respectively. Morgan's operating profit increased by $1.6 million reflecting higher revenues and improved product mix. Manufacturing operating profit fell by $3.9 million. Spinnaker's operating profit fell by $0.9 million due to reduced revenues at all units. Lynch Machinery's operating profit fell by $2.8 million reflecting reduced revenues. M-tron's operation profit increased by $0.2 million. Other Income (Expense), Net Investment income in the third quarter of 1997 was $0.6 million which was an increase of $0.1 million from the third quarter of 1996. Interest expense increased by $1.6 million to $5.9 million in the third quarter of 1997 from $4.3 in the third quarter of 1996. The increase was a result of an increase in interest expense and amortization of deferred financing costs of $1.0 million at Spinnaker Industries, Inc., as a result of the issuance of $115 million of senior secured notes on October 23, 1996, and interest expenses of $0.5 million associated with the acquisition of Dunkirk & Fredonia Telephone Company and $0.6 million with the acquisition of Upper Peninsula Telephone Company. These amounts did not include $0.7 million of capitalized interest associated with the development of the personal communications services ("PCS") licenses. On a year to date basis, the acquisition of Dunkirk & Fredonia contributed $1.5 million of interest expense, Upper Peninsula contributed $1.1 million of additional interest expense and Spinnaker's high yield results in $2.6 million of incremental interest expense. This amount did not include $1.7 million of capitalized interest for PCS licenses. As part of Spinnaker's acquisition of Central Products, Spinnaker issued to Alco a $6 million Convertible Subordinated Note that converted into Spinnaker Common Stock on May 5, 1996. As it is the accounting policy of the Registrant to recognize gains and losses on the sale of stock by a subsidiary, the conversion of this Note resulted in a pre-tax gain of $4.1 million to the Registrant in the second quarter of 1996. During the third quarter of 1997, the Registrant took a write off of 30% of the investment in, loans to, and deferred costs associated with its subsidiary's 49.9% equity ownership in Fortunet Communications, L.P. ("Fortunet"), a partnership formed to acquire, construct and operate licenses for the provision of personal communications services in the so called C- Block auction. Such write-off amounted to $7.0 million, or $4.6 million after tax benefit. In May 1996, the FCC concluded the so-called "C-Block" auction for 30- megahertz of broadband spectrum across the United States to be used for personal communications services ("PCS"). PCS is the second generation of low-cost digital wireless service utilized for voice, video and data devices. In the C-Block auction, certain qualified small businesses were afforded bidding credits as well as access to long-term government financing for the cost of the licenses acquired. As a result of this auction, Fortunet acquired 31 licenses in 17 states covering a population ("POP") of 7.0 million. The total cost of these licenses was $216 million, or $30.76 per 30-megahertz POP, after the 25% bidding credit. Events during and subsequent to the auction, as well as other externally driven technological and market forces, have made financing of the build-out of these licenses through the capital markets much more difficult than previously anticipated. Fortunet, as well as many of the license holders from this auction, has petitioned the FCC for relief in terms of (1) resetting the interest rate to the appropriate rate at the time; (2) further reducing or delaying the required debt payments in order to afford better access to capital markets; and (3) relaxing the restrictions with regard to ownership structure and alternative arrangements in order to afford these small businesses the opportunity to more realistically restructure and build-out their systems. The response from the FCC, which was announced on September 26, 1997, afforded license holders a choice of four options, one of which was the resumption of current debt payments; which had been suspended earlier this year. The ramifications of choosing the other three courses of action could result in Fortunet ultimately forfeiting either 30%, 50%, or 100% of its current investment in these licenses. While Fortunet is still examining what action, if any, it will take with these options and will continue to look for ways to finance and build out this spectrum, the management of the Registrant provided for a 30% reserve of its investment at this time, as this represents management's estimate of the impairment of this investment given the current available alternatives. Tax Provision The income tax provision (benefit) includes federal, as well as state and local taxes. The tax provision (benefit) for the three months ended September 30, 1997 and 1996, represent effective tax rates of (33%) and 42%, respectively. The 1997 rate is effected due to the anticipated inability to currently provide for a state income tax benefit for the impairment of the PCS investment. The remaining differences from the federal statutory rate are principally due to the effect of state income taxes and amortization of non-deductible goodwill. Minority Interest Minority interest was $0.3 million lower in the third quarter of 1997 versus the third quarter of 1996, predominantly due to decreased net profits at Spinnaker Industries, Inc. a 67.3% owned subsidiary. Income From Continuing Operations During the third quarter of 1997, the Registrant recorded losses from continuing operations of ($4.3) million, or ($3.02) per share, as compared to income from continuing operations of $1.2 million, or $.89 per share, in the third quarter of 1996. The gain on the sale of Lafayette County Satellite TV in 1997 had a net profit effect of $158 thousand, or $0.11 per share, and the gain on the conversion of the Alco note in the third quarter of 1996, had a net profit effect of $2.4 million, or $1.74 per share in 1996. Discontinued Operations The Registrant had decided to discontinue the operations at Tri-Can International, Ltd. in the second quarter of 1996 (see Note D). Accordingly, its operating results in the nine months ended September 30, 1996 are treated as discontinued operations. Net Income/Loss Net loss for the three months ended September 30, 1997 was ($4.3) million, or ($3.02) per share, as compared to a net income of $1.2 million, or $0.89 per share in the previous year's quarter. Net loss for the nine months ended September 30, 1997 was ($3.5) million, or ($2.50) per share, as compared to $4.9 million, or $3.52 per share, for the comparable period in 1996. Backlog/New Orders Total backlog of manufactured products at September 30, 1997 was $44.4 million, which represents an increase of $23.5 million from the backlog of $20.9 million at December 31, 1996. A $16.0 million extra-large glass press order at Lynch Machinery helped increase their backlog to $26.7 million. Liquidity/Capital Resources At September 30, 1997, the Registrant has $28.5 million in cash and short- term investments, $1.2 million of which was at the Parent Company, which was $7.6 million less than the amount reported at December 31, 1996. Working capital at September 30, 1997, was $48.2 million compared to $41.6 million at December 31, 1996. The decrease in cash and short-term investments was primarily the result of funding the acquisition of Upper Peninsula and the increase in working capital was primarily the result of the reduction in the current portion of long-term debt. Total debt was $276.1 million at September 30, 1997 compared to $260.8 million at December 31, 1996. The increase was due primarily to debt incurred to fund the Registrant's acquisition of Upper Peninsula Telephone Company. As reported in the Registrant's Consolidated Statement of Cash Flow, during the nine months ended September 30, 1997, operating activities generated $13.2 million in cash, investing activities used $25.8 million, and financing activities provided $4.2 million. Respective amounts for nine months ended September 30, 1996, were $14.9 million, ($37.8) million, and $23.8 million. The net loss, lower net sales of trading securities, and an increase in accounts receivable at The Morgan Group, Inc. resulted in decreased cash generated from operating activities for the nine months ended September 30, 1997 versus the nine months ending September 30, 1996. With regard to investment activities, the acquisition of Upper Peninsula Telephone Company, offset by repayment of a note by Coronet Communications Corporation, sale of cellular partnership interests previously held by Upper Peninsula Telephone Company and return of bidding deposits from the FCC with respect to activities by Aer Force Communications B, L.P., resulted in a $12.0 million decrease in cash used in investing activities as compared to the prior year period. The $4.0 million generated from financing activities resulted when the Registrant repaid a $10 million affiliate loan with funds received from the return of the F-Block bidding deposit, borrowed $10 million from an affiliate to finance the acquisition of 60% of the shares of Upper Peninsula Telephone Company and the payment of the first interest installment on the C-Block debt (see below). The Registrant borrowed an additional $10 million in July to pay for the 40% of Upper Peninsula. This compared to net borrowings of $22.4 million in the first three quarters of 1996, due to capital expenditures and acquisition of telephone access lines by the Registrant's telephone companies. Registrant maintains an active acquisition program and generally finances each acquisition with a significant component of debt. This acquisition debt contains restrictions on the amount of readily available funds that can be transferred to the Parent Company from its subsidiaries. At September 30, 1997, the Registrant has $52.1 million of unused short-term and long-term lines of credit facilities, $3.5 million of which applied to the Parent Company. Subsidiaries of the Registrant hold limited partnership interests in and have loan commitments to two partnerships which were the winning bidders in the Federal Communications Commission's ("FCC") C-Block and F-Block Auctions for 30 megahertz and 10 megahertz, respectively, of broadband spectrum to be used for PCS. In the C-Block Auction, Fortunet, 49.9% owned by a subsidiary of the Registrant, acquired 31 licenses to provide PCS to geographic areas of the United States with a population of 7.0 million. The cost of these licenses was $216.2 million. $194.6 million of the cost of these licenses was funded via a loan from the United States Government. The loan requires quarterly interest payments of 7% (The Registrant argues strenuously that the interest rate should have been 6.51%, the applicable treasury rate at the time the licenses were awarded), and with quarterly principal amortization in years 7, 8, 9, and 10. In the F-Block Auction, East/West Communications, Inc. ("East/West"), incorporated in August 1997 as a successor to Aer Force Communications B, L.P. minority owned by a subsidiary of the Registrant, acquired five licenses to provide personal communications services in geographic areas of the United States with a total population of 20 million. The cost of these licenses was $19.0 million. $15.2 million of the cost of the licenses is financed with a loan from the United States Government. The interest rate on the loan is 6.25% with quarterly principal amortization in years 3 to 10. On May 12, 1997, the Registrant's subsidiary loaned East/West $1.0 million to make its final down payment on four of the five licenses (which were awarded). On July 14, 1997, the Registrant loaned East/West $0.9 million to make the final down payment on the fifth license which was awarded at that time. As of September 30, 1997, Registrant's subsidiary has invested $99 thousand in partnership equity and provided East/West with a loan of $2.5 million funded by a short-term secured borrowing by the Registrant and has a funding commitment of $8.9 million to East/West. The Registrant has borrowed the $3.5 million on a short-term basis to fund its F-Block loan commitment. In addition, the Registrant intends to dividend to its shareholders its 40% net interest of East/West on or about December 5, 1997, subject to necessary approvals. The Registrant's subsidiaries are currently seeking alternatives to minimize or raise funds for their funding commitments to the entities. There are many risks associated with PCS. Interest payments on the Government debt which were suspended in March-April, 1997 by the FCC will resume beginning March 31, 1998. In addition, funding aspects of acquisition of licenses and the subsequent mandatory build out requirements plus the amortization of the license, could significantly and materially impact the Registrant's reported net income over the next several years. Of note, under the current structure, the ramifications of this should not impact reported revenues and EBITDA in the future. For further information on PCS, including various risks, see Item 1 -I(c) of Form 10-K for the year ended December 31, 1996. In December, 1996, the Registrants' Board of Directors announced that it is examining the possibility of splitting, through a "Spin-off," of either its communications operations or its manufacturing operations. A spin-off could improve management focus, facilitate and enhance financings and set the stage for future growth, including acquisitions. A split could also help surface the underlying values of the company as the different business segments appeal to differing "value" and "growth" cultures in the investment community. There are a number of matters to be examined in connection with a possible spin-off, including tax consequences, and there is no assurance that such a spin-off will be effected. In order to fund future growth of the Registrant's manufacturing subsidiaries, each of these subsidiaries, Spinnaker Industries, Inc., Lynch Display Technologies, Inc. (parent of Lynch Machinery, Inc.) and M-tron Industries, Inc. is in the process of undertaking refinancing/strategic initiative program, that is, to either raise financing for future acquisitions or form a joint venture strategic partnership. There is no assurance that any or all of these companies can accomplish these programs. In February 1997, the Financial Accounting Standards Board issued, Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share," which changes the methodology of calculating earnings per share. SFAS No.128 requires a disclosure of diluted earnings per share regardless of its difference from basic earnings per share. The Registrant plans to adopt SFAS No. 128 in December 1997. Early adoption is not permitted. The Registrant does not expect the adoption of SFAS No. 128 to have a material effect on the financial statements. Included in this Management Discussion and Analysis of Financial Condition and Results of Operations are certain forward looking financial and other information, including without limitation matters relating to PCS, possible spin-offs and a refinancing/strategic initiative program. It should be recognized that such information are projections, estimates or forecasts based on various assumptions, including without limitation, meeting its assumptions regarding expected operating performance and other matters specifically set forth, as well as the expected performance of the economy as it impacts the Registrant's businesses, tax consequences and what actions the FCC may take with respect to PCS. As a result, such information is subject to uncertainties, risks and inaccuracies. PART II OTHER INFORMATION Item 2. Changes in Security and Use of Proceeds (c) On August 11, 1997, Registrant granted 214 shares of its common stock pursuant to Registrant's Directors Stock Plan to a person who became a director of Registrant in 1997, at a price of $70.10 per share (equal to the average stock price for the 30 trading days ended December 31, 1996). The issuance was exempt from registration under the Securities Act of 1993 (the "Securities Act") under Section 4(2) thereof and/or the "no sale" theory. Item 5. Other Information Reference is made to Item 2. Management's Discussions and Analysis of Financial Condition and Results of Operations for information on personal communications services. See also Item 1-I(c) Personal Communications Services ("PCS") in Registrant's Form 10-K for the year ended December 31, 1996. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 10(u)(i)(a) - Correction to Loan Agreement dated as of August 12, 1996 between Registrant and Gabelli Funds, Inc. 10(x) - Letter Agreement dated March 25, 1997 between Bal/Rivgam L.L.C. and Lynch PCS Corporation G. 10(y)(i) - Promissory Notes of Registrant, dated March 17, 1997, in the aggregate amount of $10 million payable to Gabelli Funds, Inc. and Gabelli Securities, Inc. (which Notes have been paid off). 10(y)(ii) - Pledge and Security Interest Agreement, dated as of March 17, 1997 relating to the Promissory Notes. *10(z) - Principal Executive Bonus Plan 27 - Financial Data Schedule (b) Reports on Form 8-K Registrant filed a Form 8-K, dated October 14, 1997 (Item 5. Other Information) with respect to a letter from Lynch Interactive Corporation to Hector Communications Corporation. SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. LYNCH CORPORATION (Registrant) By: s/Robert E. Dolan Robert E. Dolan Chief Financial Officer