, 1999
To Lynch Stockholders:
I am writing to advise you about a spin off of the stock of Lynch Interactive
Corporation, which you will receive shortly through a dividend on your Lynch
common stock.
Lynch Interactive will consist primarily of the multimedia and services
businesses of Lynch Corporation. Upon the spin off, Lynch Corporation will
continue to own the manufacturing businesses of Lynch Corporation.
Lynch Interactive had revenues of $205.1 million for the year ended December 31,
1998 compared to revenues of $309.5 million for Lynch's manufacturing
businesses. At December 31, 1998, the total assets of Lynch Interactive were
$229.5 million compared to assets of $250.5 million for Lynch's manufacturing
businesses.
I believe that the division of Lynch Corporation's businesses into a multimedia
and services company and a manufacturing company is in the best interests of
Lynch Corporation and its shareholders. It is intended to improve management
focus, facilitate and enhance financings and set the stage for future growth. It
could also help surface the underlying values of Lynch Corporation as the
different business segments appeal to differing "value" and "growth" cultures in
the investment community.
For each share of Lynch Common Stock owned by you on , 1999, you will receive
one share of Common Stock of Lynch Interactive. The distribution is expected to
be made on or about , 1999. Shareholders do not have to take any action to
receive their Interactive shares.
For further information about Lynch Interactive and the spin off, please read
the enclosed Information Statement. As described more fully in the Information
Statement, Lynch has received a private letter ruling from the Internal Revenue
Service that the spin off will not be taxable to the shareholders of Lynch and
Lynch itself.
Mario J. Gabelli
Chairman of the Board and
Chief Executive Officer
1
LYNCH INTERACTIVE CORPORATION
Information Statement Dated , 1999
Re: Proposed Spin Off of Lynch Interactive Corporation
This Information Statement is being furnished in connection with the
spin off (the "Spin Off") by Lynch Corporation ("Lynch") to holders of its
common stock, no par value per share ("Lynch Common Stock"), of all the
outstanding shares of common stock, par value $.0001 per share ("Interactive
Common Stock"), of Lynch Interactive Corporation, ("Interactive"). Lynch has
transferred or will transfer to Interactive all of the multimedia and services
businesses formerly conducted by Lynch, plus certain other assets. See "Business
of Interactive."
Shares of Interactive Common Stock will be distributed to holders of
Lynch Common Stock of record as of the close of business on , 1999 (the "Record
Date"). Each such holder will receive one share of Interactive Common Stock for
each one share of Lynch Common Stock held on the Record Date. The Spin Off will
be effective at 12:01 a.m. on , 1999. No consideration will be paid by Lynch's
shareholders for shares of Interactive Common Stock. There is no current trading
market for Interactive Common Stock. The Company has applied to list Interactive
Common Stock on the American Stock Exchange.
In reviewing this Information Statement, you should carefully consider
the matters described under the caption "Risk Factors" on pages 7 - 10.
NO SHAREHOLDER APPROVAL OF THE DISTRIBUTION IS REQUIRED OR
SOUGHT. WE ARE NOT ASKING YOU FOR A PROXY AND YOU
ARE REQUESTED NOT TO SEND US A PROXY.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS
THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF
THIS INFORMATION STATEMENT. ANY REPRESENTATION
TO THE CONTRARY IS A CRIMINAL OFFENSE.
This Information Statement is being furnished by Lynch solely to
provide information to shareholders of Lynch who will receive Interactive shares
in the Spin Off. It is not, and is not to be construed as, an inducement or
encouragement to buy or sell any securities of Lynch or Interactive. The
information contained in this Information Statement is believed by Lynch and
Interactive to be accurate as of the date set forth on its cover. It is not
accurate in various respects, which may be material, as of the date the
Information Statement is filed in preliminary form with the Security and
Exchange Commission. Changes may occur after that date, and neither Lynch nor
Interactive will update the information except in the normal course of their
respective public disclosure practices.
The information contained in this preliminary form of Information
Statement filed with the Securities and Exchange Commission is intended to be as
of the date to be set forth on the cover, is not necessarily accurate as of the
date of filing of the preliminary form of Information Statement and is subject
to change and correction.
2
INDEX
Item Page
Summary 4
Forward Looking Information 5
Interactive 5
Listing and Trading of Interactive Common Stock 6
Risk Factors 7
Capitalization of Interactive 10
Selected Financial Data 11
Management Discussion and Analysis of
Financial Condition and Results of Operations 12
Business of Interactive 19
I Multi1media 19
II Services 28
III Spinnaker Stock 31
IV Other Information 32
Relationship Between Lynch and Interactive After the Spin Off 32
Executive Officers and Directors of Interactive 34
Corporate Expense 37
Transactions with Certain Affiliated Persons 38
Principal Stockholders of Interactive 39
Description of Capital Stock of Interactive 40
Federal Income Tax Consequences of Spin Off 41
Available Information 42
Index to Combined Financial Statements F-1
Combined Financial Statements F-2
3
Summary
1. Split Up of Lynch Corporation. Lynch Corporation ("Lynch") intends to split
the Corporation into two parts:
(i) Lynch Interactive Corporation ("Interactive" or the "Company"), which
would own Lynch's multimedia and services businesses. In addition,
Interactive would own 1 million shares of Common Stock of Spinnaker
Industries, Inc. (representing approximately 13.6% of the equity and
approximately 2.5% of the vote)(AMEX:SKK) ("Spinnaker"), Lynch's
approximately 61% owned manufacturing subsidiary. These shares could
be sold as needed to fund, in part, Lynch Interactive's proposed
growth plans. Interactive had revenues of $205.1 million for the year
ended December 31, 1998 and total assets of $229.5 million at December
31, 1998; and
(ii) Lynch Corporation, which would continue to own Lynch's manufacturing
businesses. Lynch had revenues of $309.5 million for the year ended
December 31, 1998 and total assets of $250.5 million at December 31,
1998.
2. How Effected. The split would be effected by Lynch distributing to its
shareholders, in the form of a stock dividend, one share of Interactive
Common Stock for each outstanding share of Lynch Common Stock. Lynch
shareholders do not have to take any action to receive their Interactive
shares.
3. Purpose. The purpose of the Spin Off is to improve management focus,
facilitate and enhance financings and position the two companies for future
growth. The Spin Off could also help surface the underlying values of Lynch
as the different business segments appeal to differing "value" and "growth"
cultures in the investment community. By simplifying Lynch, it is expected
that each company would be more easily understood by investors.
4. Timing. Lynch expects to distribute the stock dividend on or about _______,
1999,to shareholders of record as of the close of business on _________,
1999.
5. Non-Taxable. Lynch has obtained a private letter ruling from the Internal
Revenue Service which holds that the value of the stock distributed as a
dividend in the Spin Off is not taxable to the recipient. See "Federal
Income Tax Consequences."
6. Stock Exchange Listing. It is expected that Lynch common stock will remain
listed on the American Stock Exchange ("AMEX"). Interactive has applied for
the listing of its common stock on the AMEX.
7. Dividend Policy. Lynch has not paid any cash dividends on its Common Stock
since 1989. Interactive does not expect to pay cash dividends on its Common
Stock in the foreseeable future. Interactive currently intends to retain
its earnings, if any, for use in its business. Future financings may limit
or prohibit the payment of dividends.
8. Relationship with Lynch. Following the Spin Off, Interactive will be an
independent public company, and Lynch will have no continuing stock
ownership interest in Interactive. Six current directors of Lynch will
become the initial directors of Interactive. It is expected that for a
period of no more than three years following the Spin Off, the executive
officers of current Lynch will also be executive officers of Interactive.
At the Spin Off, the employees of the corporate office of Lynch will become
employees of Interactive, and Lynch will be charged a management fee for
corporate services provided by the Interactive corporate office to Lynch.
Lynch will initially have no corporate office employees of its own. Lynch
and Interactive will enter into a Separation Agreement governing their
relationship subsequent to the Spin Off, including the provision of
management services and the allocation of tax and certain other liabilities
and obligations.
4
FORWARD LOOKING INFORMATION
This Information Statement contains certain forward looking
information, including without limitation "Listing and Trading of Interactive
Common Stock," "Risk Factors," "Business of Interactive - harvesting of assets"
initiative, "Business of Interactive-I. Multimedia" - "Regulatory Environment"
and possible changes thereto, "Business of Interactive- I. Multimedia
- -Competition ," "Business of Interactive- Multimedia- Personal Communications
Services ("PCS")," "Business of Interactive-Morgan's Growth Strategy,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations of Interactive" including financing requirement and alternatives, a
cost cutting initiative, quantitative and qualitative disclosure about market
risk, and Year 2000 matters, and "Notes to Financial Statements of Interactive."
It should be recognized that such information are estimates or forecasts based
upon various assumptions, including the matters referred to therein, as well as
meeting Interactive's internal performance assumptions regarding expected
operating performance and the expected performance of the economy and financial
markets as it impacts the Company's businesses. As a result, such information is
subject to uncertainties, risks and inaccuracies.
Interactive
At the time of the Spin Off, Interactive will hold the multimedia and
services businesses of Lynch.
The multimedia business currently consists of the
(i) ownership of ten rural telephone companies (with minority interests of
0% to 20%) in seven states serving approximately 37,600 access lines
as of December 31, 1998, and companies offering related
telecommunications services;
(ii) a 20% interest and a 50% interest (after conversion of preferred
stock), respectively, in two network televison stations, one serving
the Rock Island and Moline, Illinois and Davenport and Bettendorf,
Iowa markets and the other serving the Ames/Des Moines, Iowa market
(these interest are accounted for under the equity basis); and
(iii)minority investments in entities holding personal communications
services ("PCS") licenses.
Interactive's strategy is to grow its telecommunications businesses
through an active acquisition program, providing services to new customers, or
additional services to existing customers, upgrading existing customers to
higher levels of service and by offering related services in its existing
service areas and areas adjacent to existing service areas. In late May 1999,
Interactive subsidiaries entered into an agreement to acquire Central Scott
Telephone Company for approximately $28 million.
The services businesses are conducted through Lynch's 55% (as of March
31, 1999) owned subsidiary, The Morgan Group, Inc. (AMEX:MG)("Morgan"). Morgan
is the nations's largest publicly owned service company in managing the delivery
of manufactured homes, commercial vehicles and specialized equipment in the
United States. Morgan provides outsourcing transportation services through a
national network of approximately 1,530 independent owner operators and
approximately 1,420 other drivers. Morgan dispatches its drivers from 105
locations in 32 states. Morgan's largest customers include Oakwood Homes
Corporation, Fleetwood Enterprises, Inc., Champion Enterprises, Inc., Winnebago
Industries, Inc., Clayton Homes, Inc., Cavalier Homes, Inc., Palm Harbor Homes,
Inc. Four Seasons Housing, Inc., Ryder Systems, Inc. and Fairmont Homes, Inc.
Morgan's services also include providing certain insurance and financing
services to its owner operators.
Morgan's strategy is to grow through expansion in the niche businesses
already being serviced with particular emphasis on outsourcing, along with
pursuing acquisitions of niche transportation carriers who are
5
servicing their customer base with unique service and/or equipment. In addition,
Morgan will look to expand insurance product offerings to drivers through its
subsidiary Interstate Indemnity Company and to broaden its financing activities
through Morgan Finance, Inc.
Interactive will also own 1,000,000 shares of Common Stock of Spinnaker
(13.6% of the total common equity and 2.5% of the total voting power). Spinnaker
is a leading manufacturer of adhesive backed paper label stock and industrial
tape for the packaging industry as well as being a major supplier of stock for
pressure sensitive U.S. postage stamps. In April 1999, Spinnaker announced that
it had entered into contracts to sell its industrial tape businesses. See
"Business of Interactive - Spinnaker Stock."
Listing and Trading of Interactive Common Stock
There is not currently a public market for Interactive Common Stock.
Interactive has applied for the listing of Interactive Common Stock on the
American Stock Exchange ("AMEX"). Assuming such listing is approved, it is
possible that trading may commence on a "when-issued" basis prior to the Spin
Off. On the first AMEX trading day following the Spin Off, "when-issued" trading
in respect of Interactive Common Stock will end and "regular-way" trading will
begin. The AMEX will not approve any trading in respect of Interactive Common
Stock until the Securities and Exchange Commission (the "SEC") has declared
effective Interactive's Registration Statement on Form 10 (the "Registration
Statement") in respect of the Interactive Common Stock.
There can be no assurance as to the price at which Interactive Common
Stock will trade before, on or after the Spin Off. Until Interactive Common
Stock is fully distributed and an orderly market develops in Interactive Common
Stock, the price at which such stock trades may fluctuate significantly and may
be lower than the price that would be expected for a fully distributed issue.
The price of Interactive Common Stock will be determined in the marketplace and
may be influenced by many factors, including without limitation (i) the depth
and liquidity of the market for Interactive Common Stock, (ii) developments
affecting its businesses generally, (iii) investor perception of Interactive and
the businesses in which Interactive participates and (iv) general economic and
market conditions. In addition, the combined trading prices of Interactive
Common Stock and Lynch Common Stock held by stockholders after the Distribution
may be less than, equal to or greater than the trading price of Lynch Common
Stock prior to the Distribution.
Interactive initially will have approximately 916 stockholders of
record based upon the number of stockholders of record of Lynch as of June 1,
1999.
The shares distributed to Lynch shareholders will be freely
transferable, except for shares received by persons who may be deemed to be
"affiliates" of Interactive under the Securities Act of 1933, as amended (the
"Securities Act"). Persons who may be deemed affiliates of Interactive after the
Spin Off generally include individuals or entities that control, are controlled
by or are under common control with Interactive. Persons who are affiliates of
Interactive will be permitted to sell their Shares only pursuant to an effective
registration statement under the Securities Act or an exemption from the
registration requirements of the Securities Act of 1933, as amended (the
"Securities Act"), such as exemptions afforded by Section 4(2) of the Securities
Act or Rule 144 thereunder.
6
RISK FACTORS
A. Relating to Interactive's Businesses
Interactive Intends to Grow by Acquisitions/High Leverage
As it has in the past, Interactive intends to grow its
telecommunications and services businesses through acquisitions. Future
acquisitions may be substantially larger than in the past. Accordingly,
Interactive would be subject to all of the risks of an acquisition program,
including being able to find and complete acquisitions at an attractive price
and being able to integrate and operate successfully any acquisitions made.
As a result of acquisitions, Interactive has a relatively high total
debt to equity ratio of 7.0 to 1 at March 31, 1999. In addition, certain
subsidiaries also have high debt to equity ratios. Interactive also expects to
fund the acquisition of Central Scott Telephone Company (an acquisition
agreement which was signed in late May 1999) principally through borrowings,
which would increase Interactive's debt to equity ratio. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
"Business of Interactive - I. Multimedia, A. Telecommunications - Telephone
Acquisitions" below.
Interactive Will Need Funds
An acquisition program would require substantial additional debt and
equity funds. In accordance with its representations to the Internal Revenue
Service in connection with obtaining its tax ruling, Interactive intends to make
at least an approximately $15 million public equity offering of its stock within
a year of the Spin Off. There is no assurance that financial market conditions
will be favorable or that Interactive can raise additional debt and equity funds
or on terms attractive to Interactive. If Interactive cannot raise sufficient
equity funds, its leverage may increase, increasing financial risk. If a major
acquisition were to perform substantially below projections, that could also
increase financial risks. See "Business - Multimedia" and "Management's
Discussion of Financial Condition and Results of Operations."
Interactive Intends to Enter New Related Businesses
Interactive intends to enter into or expand related telecommunications
businesses such as internet service provider, long distance resale and
competitive local exchange carrier ("CLEC") services. Morgan may also initiate
new services or products. There is no assurance that Interactive can
successfully develop these businesses or that these new or expanded businesses
can be made profitable within a reasonable period of time. Such businesses, in
particular any CLEC businesses, would not be expected to be profitable initially
or for a period of time.
It is also possible that Interactive could determine to acquire
businesses unrelated to its current businesses.
See "Business of Interactive - Multimedia - Related Businesses."
Telecommunications Regulations/Competitive Environment is Changing
Interactive's local exchange carrier ("LEC") telephone operations do
not have significant wireline competition at the present time. Because of the
rural nature of their operations and related low population density, they are
high cost operations which receive substantial Federal and state subsidies.
The regulatory environment for LEC operations has begun to change. A
principal purpose of the
7
Federal Telecommunications Act of 1996 (the "1996 Act") was to encourage
competition in local telephone services. Though the 1996 Act reaffirmed Federal
policy of universal telephony service at fair and reasonable rates, the 1996 Act
and related proceedings will also change the method of subsidizing high cost
rural LECs such as Interactive's and the new methods have not yet been
determined. Similar regulatory changes have also been initiated in many of the
states in which Interactive operates. Because of its low population density and
high cost operations, Interactive believes that competition will be slower in
coming to its service areas than to larger urban areas. Interactive also
believes that a satisfactory subsidization mechanism will be developed to
compensate Interactive's LEC's for their high cost service areas; however, these
are very significant issues to Interactive and there can be no assurance as to
how such issues will ultimately be determined. See "Business - Multimedia -
Competition and Regulation."
Interactive Has PCS Investments
Interactive has substantial investments in two PCS licensees - Fortunet
Communications, L.P., a C- Block licensee ($18.8 million at December 31, 1998),
and East/West Communications, Inc., an F-Block licensee ($4.8 million at
December 31, 1998). Certain C-Block licensees, including Fortunet, have
experienced financial problems, and the three largest original C-Block licensees
have filed for protection under the Bankruptcy Act. Neither Fortunet nor
East/West has determined what they intend to do with their licenses. PCS is
subject to many risks, and there is no assurance that Interactive will receive
back its investments in PCS. On April 15, 1999, the Federal Communications
Commission completed a reauction of all the "C Block" licenses that were
returned to it subsequent to the original auction, including the 15MHz licenses
that Fortunet returned on June 8, 1998, in the basic trading areas of
Tallahassee, Panama City, and Ocala, Florida. In that reauction, the successful
bidders paid a total of $2.7 million for the three licenses as compared to the
$18.8 million carrying amount of Interactive's investment in Fortunet.
Accordingly, for the quarter ended March 31, 1999, Interactive has provided a
reserve of $15.4 million to write down its investment in Fortunet to reflect the
amount bid for similar licenses in the reauction, plus an additional $0.7
million of capitalized expenses and interest, to leave a net carrying value of
$3.4 million. See "Business - Multimedia - PCS."
Harvesting Initiative Risk
Interactive has indicated that it may attempt to sell all or portions
of certain operating entities, including its television station investments and
certain Interactive telephone operations where competitive local exchange
carrier opportunities are not readily apparent. There can be no assurance that
any such transaction can be consummated on terms favorable or acceptable to
Interactive.
Morgan Depends on Manufactured Housing Industry
Morgan's business is dependent, to a significant extent, on the
manufactured housing industry which is subject to broad production cycles. In
addition to general economic conditions, the manufactured housing industry is
affected by fluctuations in interest rates and the availability of credit to
purchasers of manufactured homes. Interactive believes that demand for
manufactured housing will continue to grow but there can be no assurance.
Shipments by the manufactured housing industry could decline relative to
historical levels. See "Business - Services."
Morgan Claims Costs May Affect Profitability
A principal factor in the profitability of Morgan's business has been
the cost of claims, both for personal injuries resulting from vehicle accidents
and damage to homes and vehicles being transported, and related insurance costs.
While Morgan's management has devoted substantial attention to controlling claim
costs, there is no assurance that claims and insurance costs will not in the
future substantially affect
8
profitability. See "Business - Services - Risk Management, Safety and
Insurance." Morgan Has Limited Number of Major Customers
Historically, a majority of Morgan's operating revenues have been
derived under contracts with customers. Such contracts generally have one, two,
or three year terms. There is no assurance that customers will agree to renew
their contracts on acceptable terms or on terms as favorable as those currently
in force. Morgan's top ten customers have historically accounted for a majority
of the Company's operating revenues. The loss of one or more of these
significant customers could adversely affect Morgan's results of operations.
See "Business - Services - Customers and Marketing."
Morgan Has to Compete For Qualified Drivers
Recruitment and retention of qualified drivers and independent
owner-operators is highly competitive. Morgan's contracts with independent
owner-operators are terminable by either party on ten days' notice. There is no
assurance that Morgan's drivers will continue to maintain their contracts in
force or that Morgan will be able to recruit a sufficient number of new drivers
on terms similar to those presently in force. Morgan may not be able to engage a
sufficient number of new drivers to meet customer shipment demands from time to
time resulting in loss of operating revenues that might otherwise be available
to Morgan.
Morgan Use of Independent Contractors
From time to time, tax authorities have sought to assert that
independent contractors in the transportation service industry are employees,
rather than independent contractors. Under existing interpretations of federal
and state tax laws, Morgan maintains that its independent contractors are not
employees. There can be no assurance that tax authorities will not challenge
this position, or that such tax laws or interpretations thereof will not change.
If the independent contractors were determined to be employees, such
determination could materially increase Morgan's payroll tax and workers'
compensation insurance costs. See "Business - Services - Regulation."
Interactive May Have Difficulty Selling Spinnaker Stock
Interactive owns 1,000,000 shares of Spinnaker Common Stock which
constitutes 26.5% of the class and 13.6% of the total outstanding common stock
of Spinnaker. In addition to the risks of Spinnaker's business, because of
Interactive's large position and the limited trading in Spinnaker Common Stock,
it may be difficult for Interactive to sell such stock and realize its value if
and when it wants to. In April 1999, Spinnaker announced that it had entered
into contracts to sell its industrial tape units. See "Business of Interactive -
Spinnaker Stock."
Year 2000 Matters
Reference is made to Management's Discussion of Financial Condition and
Results of Operations for a discussion of "Year 2000" matters.
B. Control/Management and Transaction Risks
Interactive Depends on Controlling Shareholder
Because of his approximate 22.8% ownership interests in Interactive and
Lynch and his positions as Chairman and Chief Executive Officer of both
Interactive and Lynch, Mario J. Gabelli may be deemed to
9
control both Interactive and Lynch. As a result, transactions subsequent to the
Spin Off between Interactive and Lynch may not be at arms length. There can also
be no assurance that his interest in Interactive will coincide with the
interests of other shareholders. In addition, since Mr. Gabelli is also Chairman
and Chief Executive Officer of Gabelli Funds, Inc. and Gabelli Asset Management
Inc., major investment and securities companies, and of Lynch, Mr. Gabelli does
not work for Interactive on a full-time basis. If Mr. Gabelli were to cease to
provide executive services to Interactive, it could have a material adverse
effect on Interactive. See "Necessity to Split Interactive/Lynch Management"
below and "Principal Stockholders."
Necessity to Split Interactive/Lynch Management
After a transition period of up to three years, the principal executive
officers of Interactive, including Mr. Gabelli, can no longer be the principal
executive officers of both Interactive and Lynch, although Mr. Gabelli can
remain Chairman of the Board of the company of which he is not the chief
executive officer. No determination has been made at this time as to which
company the executive officers will continue to serve.
Tax Free Spin Off Ruling
In connection with obtaining the rulings from the Internal Revenue
Service ("IRS") as to the tax-free nature of the Spin Off, Lynch made certain
representations to the IRS, which include, among other things, certain
representations as to how Lynch and Interactive intend to conduct their
businesses in the future. Among other representations, Lynch represented that a
principal purpose of the Spin Off was to facilitate a public offering of
Interactive stock to finance Interactive's acquisition program and that
Interactive would make at least an approximately $15 million public offering
within one year of the Spin Off. In addition, Lynch represented that the
principal executive officers of Interactive would remain the principal executive
officers of both Interactive and Lynch only for a transition period of up to
three years from the date of the Spin Off. If Lynch or Interactive should
violate such representations, the IRS could take the position that its rulings
are not binding and that Interactive and/or its shareholders are subject to tax.
CAPITALIZATION OF INTERACTIVE
The following table sets forth the capitalization of Interactive and
its subsidiaries at March 31, 1999. This table should be read in conjunction
with the Combined Financial Statements and Notes thereto appearing elsewhere in
this Information Statement.
Short-Term Debt $ 11,605,000
Long-Term Debt $125,672,000
Equity, Investments By and Advances From Lynch Corporation $ 19,513,000
As part of its request for the tax ruling, Lynch has represented to the
IRS that a principal purpose of the Spin Off was to facilitate an equity
offering of Interactive stock to finance Interactive's acquisition program and
that Interactive would make at least an approximately $15 million public
offering within one year from the date of the Spin Off. There is no assurance
that the financial market conditions will be favorable or that Interactive can
raise additional funds on terms attractive to it.
10
SELECTED FINANCIAL DATA
Selected Financial Data(e)
(In Thousands)
3 Months Ended
March 31,
------------------------ Year Ended December 31,
------------------------------------------------------------
1999 1998 1998 1997 1996 1995 1994
----------- ----------- ----------- ----------- ----------- ----------- -----------
Sales and revenues (a) $ 48,712 $ 46,903 $ 205,076 $ 194,062 $ 160,816 $ 145,900 $ 122,024
Costs and expenses 45,145 44,580 188,419 182,774 158,876 139,801 114,638
Operating profit (b) 3,567 2,323 16,657 11,288 1,940 6,099 7,386
Net financing activities (c) (2,126) (2,206) (9,147) (8,187) (4,452) (2,484) (3,457)
Reserve for impairment of investment
in PCS license holders (15,406) - (7,024) - - -
Gain on sales of subsidiary and
affiliate stock and other
operating assets - - 3,198 263 1,072 59 190
Income (loss) before income taxes,
minority interests and
extraordinary item (13,965) 117 10,708 (3,660) (1,440) 3,674 4,119
(Provision) benefit for income taxes 4,650 (37) (4,857) 830 251 (1,730) (1,534)
Minority interest (199) 20 (1,224) (631) 747 (1,409) (1,147)
Income (loss) before extraordinary item (9,514) 100 4,627 (3,461) (442) 535 1,438
Cash, marketable securities and
short- term investments $ 17,417 $ 19,503 $ 27,988 $ 28,043 $ 25,541 $ 21,148 $ 29,870
Total assets 206,582 234,584 229,479 234,376 213,771 141,088 125,961
Long-term debt 125,672 132,441 127,663 134,200 123,002 75,472 67,094
Equity, investments by and advances
from Lynch Corporation (d) $ 19,513 $ 21,446 $ 29,544 $ 21,987 $ 24,382 $ 19,815 $ 16,782
<FN>
(a) Includes results of Station WOI-TV (9,674) from March 1, 1994, Haviland
Telephone Company from September 26, 1994, Dunkirk and Fredonia Telephone
Company from November 26, 1996, Transit Homes of America from December 30,
1996, and Upper Peninsula Telephone Company from March 18, 1997.
(b) Operating Profit is sales and revenues less operating expenses, which
excludes investment income, interest expense, share of operations of
affiliated companies, minority interests and taxes.
(c) Consists of investment income, interest expense and equity in earnings of
affiliated companies.
(d) No cash dividends have been declared over the period. In 1997, for each
share of Lynch Common Stock, shareholders received one share of East/West
Communications, Inc., an F-Block PCS licensee with licenses covering a
population of 20 million. These shares had a net book value of $0.12 per
share.
(e) The data should be read in conjunction with the combined financial
statements, related notes and other financial information included herein.
</FN>
11
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This discussion should be read together with Combined Financial
Statements of Interactive and the notes thereto included herein and the Risk
Factors set forth above.
Overview
After the Spin Off, Interactive will own the multimedia and services
businesses previously owned by Lynch. In addition, Interactive will own 1
million shares of Spinnaker. The Spin Off marks the beginning of Interactive's
operations as an independent, publicly-traded company. As such, the combined
Interactive financial statements may not be indicative of Interactive's future
performance, nor do they necessarily reflect what the financial position and
results of operations of Interactive would have been if it had operated as a
separate stand-alone entity during the periods covered.
FIRST QUARTER OF 1999 COMPARED TO 1998
Revenues for the first quarter of 1999 increased by $1.8 million, or
4%, to $48.7 million from the first quarter of 1998. Within the operating
segments: multimedia, whose revenues increased 3.6%, contributed $0.5 million to
the increase and services, whose revenues increased 4%, contributed $1.3 million
to the increase.
Multimedia revenues grew primarily due to growth in both
telecommunications services as well as the provision of non-traditional
telephone services such as Internet. Morgan's revenues grew due to growth in
Specialized Outsourcing Services whose revenues increased by 14%.
Operating profit for the first quarter of 1999 increased by $1.2
million to $3.6 million from the first quarter of 1998 due to increase in
services. Operating profit in the multimedia segment was flat as a $0.1 million
increase in operating profit from operations was offset by additional allocation
of corporate overhead. Morgan's operating results swung from a loss of $0.3
million in the first quarter of 1998 to a profit of $0.3 million in the first
quarter of 1999 due to better pricing and a reduction of Morgan's operation cost
structure. Net corporate expense was $0.3 million in the first quarter of 1999
compared to $0.9 million in the first quarter of 1998. Effective September 30,
1998, Lynch amended its SAR (stock appreciation rights) Program so that the SARs
become exercisable only in the event the price for Lynch's shares double from
the SAR grant price within five years from the original issuance. This amendment
eliminated the recording of the profit and loss effect from changes in the
market price in Lynch's common stock until it is probable that the SARs will
become exercisable. During the first quarter of 1998, Lynch allocated $0.8
million SAR expense to Interactive as compared to no income or expense in 1999.
It is expected that Interactive will adopt a SAR program similar to Lynch's.
Investment income in the first quarter of 1999 of $0.8 million
increased by $0.2 million from the first quarter of 1998 due to change in
unrealized gain (loss) of marketable securities.
Interest expense decreased by $0.1 million to $2.7 million in the first
quarter of 1999 from $2.8 million in the first quarter of 1998, as reduced
borrowings were offset by the lower capitalized interest on the Company's
investment in PCS licenses.
A Lynch subsidiary has loans to and a 49.9% limited partnership
interest in Fortunet Communications, L.P. ("Fortunet"). Fortunet's only assets
consist of three 15MHz personal communications licenses that were acquired in
the C-Block auction held by the Federal Communications Commission ("FCC"). In
that auction, Fortunet acquired 30MHz licenses in these markets, but on June 8,
1998, under FCC restructuring options,
12
it returned 15MHz of the original 30MHz acquired. On April 15, 1999, the FCC
completed the reauction of all the C-Block licenses that were returned to it
since the original C-Block auction, including the three 15MHz licenses that
Fortunet returned. In that reauction, the successful bidders paid a total $2.7
million for the three licenses as compared to $18.7 million carrying amount of
Lynch's investment in Fortunet. Accordingly, for the quarter ended March 31,
1999, Lynch has recorded a write-down of $15.4 million in its investment in
Fortunet to reflect the amount bid for similar licenses in the reauction, plus
an additional $0.7 million of capitalized expenses and interest to leave a net
carrying value of $3.4 million.
The income tax provision (benefit) includes federal, as well as state
and local taxes. The tax provision (benefit) for the three months ended March
31, 1999 and 1998, represent effective tax rates of (33%) and 21%, respectively.
The differences from the federal statutory rate are principally due to the
effect of state income taxes and amortization of non-deductible goodwill. Of
note, no state tax benefit has been provided for the reserve for the impairment
of $15.4 million in the investment in PCS license holders.
Minority interest decreased profitability by $0.2 million in 1999
versus a $20 thousand contribution of income in 1998. Of note, the reserve for
impairment of PCS operations had no effect on minority interest.
Net loss for the three months ended March 31, 1999 was ($9.7) million
as compared to a net income of $0.1 million in the previous year's quarter. The
reserve for the impairment of the investment in PCS license holders ($10.2
million net of income tax benefit) was the primary cause for the swing.
RESULTS OF OPERATIONS
YEAR 1998 COMPARED TO 1997
Revenues increased to $205.1 million in 1998 from $194.1 million in
1997, a 6% increase. In the multimedia segment, revenues increased by $6.7
million, or 14% from the previous year, partially due to the acquisition of
Upper Peninsula Telephone Company in which control was acquired on March 18,
1997, the remainder primarily coming from growth in regulated and deregulated
revenues. In addition, 1998 results include management service income of $1.0
million related to compensation for bidding and administrative services provided
in certain PCS auctions. For telecommunications businesses owned for comparable
periods in both years, revenues increased by 9%. At The Morgan Group, Inc.,
revenues increased by $4.3 million, or 3% due to gains in Specialized Transport.
Earnings before interest, taxes, depreciation and amortization (EBITDA)
increased to $30.9 million in 1998 from $24.6 million in 1997, a $6.3 million,
or 26% increase. EBITDA is presented because it is a widely accepted financial
indicator of value and ability to incur and service debt. EBITDA is not a
substitute for operating income or cash flows from operating activities in
accordance with generally accepted accounting principles. EBITDA for the
telecommunications segment, which for 1998 represented 93% of combined EBITDA,
increased by $4.7 million, or 20%, from 1997 to 1998. $1.4 million of this
increase was due to the acquisition of Upper Peninsula Telephone Company. The
remaining increase was due to growth in regulated and deregulated operations.
For telecommunications businesses owned for comparable periods in both years,
EBITDA increased by 13%. EBITDA at The Morgan Group, Inc. which represents 10%
of combined EBITDA increased by $1.1 million, or 52% from 1997's EBITDA
primarily due to the absence of special charges in 1998, special charges were
$0.6 million in 1997.
Operating profits for 1998 were $16.7 million, up from $11.3 million in
1997. The telecommunications segment's operating profits grew $3.9 million due
to the inclusion of Upper Peninsula Telephone Company for the full year and
revenue growth. Operating profits in the services segment increased by $1.0
million, or 98%, due to the absence of special charges.
13
Effective September 30, 1998, Lynch amended its SAR program so that the
SARs become exercisable only in the event the price for Lynch's shares double
from the SAR grant price within five years from the original issuance. This
amendment eliminated the recording of the profit and loss effect from changes in
the market price in Lynch's common stock until it is probable that the SARs will
become exercisable. During 1997, Lynch allocated $0.4 million SAR expense to
Interactive and in 1998, prior to the amendment of the program, $0.2 million in
SAR income.
Investment income was approximately $1.9 million in 1998 compared to
$1.7 million in 1997.
Interest expense increased by $0.6 million in 1998 when compared to
1997. The increase is due primarily to the debt related to the purchase of Upper
Peninsula Telephone Company for the full year in 1998.
As of December 9, 1998, WNM Communications, Inc. a Lynch Telephone
Corporation subsidiary, sold the assets of its direct broadcast satellite
business serving portions of New Mexico for approximately $3.1 million. As a
result of the transaction, a pre-tax gain on the sale of the assets of
approximately $2.7 million was recognized and classified as gain on sales of
subsidiary stock and other operating assets in the combined statements of
operations.
In 1997, Lynch Interactive recorded 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 ("PCS") acquired in the FCC's C-Block PCS
auction. Such write-off amounted to $7.0 million, or $4.6 million after tax
benefit (see discussion below). No such write-off occurred in 1998. On April 15,
1999, the Federal Communications Commission completed a reauction of all the
C-Block PCS licenses that were returned to it subsequent to the original
auction, including the 15 MHZ licenses that Fortunet returned in June 1998 in
the basic trading areas of Tallahassee, Panama City, and Ocala, Florida. The
final net cost of these licenses in the reauction was substantially below
Fortunet's cost of the licenses it retained in these markets. During the first
quarter of 1999, Lynch Interactive recorded an additional write down of $15.4
million. See "First Quarter 1999 compared to 1998."
The 1998 tax provision of $4.9 million, includes federal, state and
local taxes and represents an effective rate of 45% versus 23% effective tax
benefit rate in 1997. The difference in the effective rates is primarily due to
the effects of the amortization of goodwill, state taxes, and losses of
subsidiaries.
During 1998, minority interest was $1.2 million compared with $0.6
million in 1997.
YEAR 1997 COMPARED TO 1996
Revenues increased to $194.1 million in 1997 from $160.8 million in
1996, a 21% increase. Acquisitions made during late 1996 and early 1997 in the
multimedia and service segments were the most significant contributors to this
increase. In the multimedia segment, revenues increased by $19.3 million to
$47.9 million from $28.6 million in the previous year. Dunkirk and Fredonia
Telephone Company, which was acquired on November 26, 1996, contributed $10.3
million compared to $0.9 million in 1996. Upper Peninsula Telephone Company,
control of which was acquired on March 18, 1997, contributed $7.2 million to
this segment's revenue increase. For telecommunications businesses owned for
comparable periods in both years, revenues increased by 10%. In the services
segment, revenues of $21.2 million resulting from the acquisition of Transit
Homes of America, Inc. on December 31, 1996, offset by lower "Truckaway"
revenues, was the primary contributor to the revenue increase at The Morgan
Group, Inc.
EBITDA increased to $24.6 million in 1997 from $12.1 million in 1996, a
$12.5 million, or 103%
14
increase. EBITDA for the multimedia segment, which for 1997 represented 99% of
combined EBITDA, increased $8.8 million in 1997, to $24.7 million from $15.9
million in 1996. The increase is primarily attributable to the acquisition of
Dunkirk & Fredonia Telephone Company in November 1996 and Upper Peninsula
Telephone Company in March 1997. For telecommunications businesses owned for
comparable periods in both year, EBITDA increased by 14%. The services segment
had EBITDA of $2.2 million versus negative EBITDA of ($1.7) million in 1996
predominately due to special charges recorded at Morgan of $3.5 million in 1996
and $0.6 million in 1997.
Operating profits for 1997 were $11.3 million, an increase of $9.4
million compared to 1996. Operating profits in the multimedia and services
segments increased by $5.2 million and $4.3 million, respectively, due to the
same factors impacting EBITDA.
Investment income decreased by $0.5 million to $1.7 million in 1997
versus 1996. The decrease was related to lower dollar investments generating
current income.
Interest expense increased by $3.4 million in 1997 when compared to
1996. The increase is due primarily to the full year effect of financing the
acquisitions of Dunkirk & Fredonia Telephone Company and Upper Peninsula
Telephone Company.
In 1997, Lynch Interactive provided a reserve 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 ("PCS") acquired in the FCC's C-Block PCS auction. Such
write-off amounted to $7.0 million, or $4.6 million after tax benefit.
In May 1996, the FCC concluded the C-Block Auction for 30 MHZ of
broadband spectrum across the United States to be used for 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 a substantial portion of 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 POP, after the 25% bidding credit. The U.S.
Government lent licensees 90% of the net cost of the licenses. Events during and
subsequent to the auction, as well as other externally driven technologies and
market forces, have made financing of the Government installment debt and the
development 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,
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, and modified on March 26,1998, afforded license
holders a choice of four options, one of which was the resumption of current
debt payments which had been suspended earlier in 1997. 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.
On July 8, 1998, Fortunet returned 28 of the 31 licenses it was awarded
and returned half of the spectrum of the remaining three licenses. Fortunet
currently is the licensee for 15 MHZ of spectrum in three
15
Florida markets: Tallahassee, Panama City, and Ocala covering approximately
785,000 POPs at a cost of $20.09 per 15 MHZ POP (equal to $40.18 per 30 MHZ
POP). It used the down payment from the licenses returned, after deducting the
30% forfeited, to repay all remaining Government debt.
The 1997 tax benefit of $0.8 million, includes federal, state and local
taxes and represents an effective rate of 23% versus the 17% effective tax rate
in 1996. The difference in the effective rates is primarily due to the effects
of state income taxes, amortization of goodwill and losses of subsidiaries.
FINANCIAL CONDITION
As of December 31, 1998, the Company had current assets of $58.0
million and current liabilities of $52.4 million. Working capital was therefore
$5.6 million as compared to a negative $0.4 million at December 31, 1997.
As of March 31, 1999, the Company had current assets of $49.2 million
and current liabilities of $46.6 million. Working capital was therefore $2.6
million as compared to $5.6 million at December 31, 1998. The primary reason for
the decrease was a $3.0 million loan to an entity that was bidding in a Federal
Communications Commission Auction for personal communications spectrum. The loan
was repaid in the second quarter of 1999.
Capital expenditures were $11.6 million in 1998 and $11.8 million in
1997. Overall 1999 capital expenditures are expected to be approximately $6.0
million above the 1998 level due to additional expenditures for the Company's
Kansas telephone operations. Capital expenditures were $2.3 million and $2.2
million for the three months ended March 31, 1999 and 1998, respectively.
At March 31, 1999, total debt was $137.3 million, which was $7.6 less
than the $144.9 million at the end of 1998. At March 31, 1999, there was $110.7
million of fixed interest rate debt averaging 6.9% and $26.5 million of variable
interest rate debt averaging 7.2%. Debt at year end 1998 included $110.8 million
of fixed interest rate debt, at an average interest rate of 7.1% and $34.1
million of variable interest rate debt at an average interest rate of 7.6%.
Additionally, the Company had $16.6 million in unused lines of credit at
December 31, 1998, of which $8.7 million was attributable to Morgan. At March
31, 1999, there was $15.8 million in unused lines of credit of which Morgan had
$3.3 million available. As of March 31, 1999 and December 31, 1998, Interactive
borrowed $8.6 million and $15.2 million from Lynch under two short-term line of
credit facilities with maximum availability totaling $20.0 million. These
short-term lines of credit expire on June 30, 1999 ($10.0 million) and December
29, 1999 ($10.0 million). These facilities mirror facilities between Lynch and
third party lenders. It is expected that these facilities will be transferred to
Interactive. Management anticipates that these lines will be renewed when they
expire but there is no assurance that they will be.
On February 22, 1999, The Morgan Group, Inc. filed a Schedule 13E4,
that invited its shareholders to tender up to 100,000 shares of Class A common
stock, to Morgan at prices not less than $8.50 nor greater than $10.00 per
share. The tender offer expired March 19, 1999, whereby Morgan purchased 103,000
shares at $9 per share. Lynch Interactive did not tender any shares in response
to this offer.
Lynch has not paid any cash dividends on its Common Stock since 1989.
Interactive does not expect to pay cash dividends on its Common Stock in the
foreseeable future. Interactive currently intends to retain its earnings, if
any, for use in its business. Future financings may limit or prohibit the
payment of dividends.
Interactive has a high degree of financial leverage. As of March 31,
1999, the ratio of total debt to equity was 7.0 to 1. Certain subsidiaries also
have high debt to equity ratios. In addition, the debt at
16
subsidiary companies contains restrictions on the amount of readily available
funds that can be transferred to the respective parent of the subsidiaries.
On May 26, 1999, Interactive subsidiaries entered into an agreement to
acquire, by merger, Central Scott Telephone Company ("Scott") for approximately
$28.1 million in cash. Scott has approximately 6,000 access lines in Scott
County, Iowa. Interactive expects to fund the acquisition principally through
borrowings. Consummation of the transactions is subject to certain conditions,
including approval by the holders of a majority of the common stock of Scott.
Scott had revenues of $4.4 million in 1998. While Scott was profitable in 1998,
Scott is not expected to contribute to Interactive's earnings in 1999 due to
interest expense on the expected financing debt.
The Company has a significant need for resources to fund future growth
as well as the ongoing operations of the parent company. Interactive is
currently considering various alternative long and short-term financing
arrangements. Certain alternatives could include an equity offering of
Interactive stock, a sale of shares of Spinnaker stock or a sale of a portion or
all of certain investments in operating entities either directly or through an
exchangeable debt instrument. As part of the representations made to the
Internal Revenue Service in connection with the private letter ruling,
Interactive has a commitment to enter into a minimum $15 million equity stock
offering within one year of the Spin Off. While management expects to obtain
adequate financing resources to enable the Company to meet its obligations,
there is no assurance that such can be readily obtained or at reasonable costs.
The Company has recently initiated two programs which may effect future
operations and cash flow.
(a) Cost Cutting - The Company is taking a three step approach to
cutting costs. First is a review to eliminate certain
centralized overhead costs. Second, a review of the Company's
overall financial costs is being undertaken with an objective
of achieving savings from refinancing and restructuring
certain debt instruments. Third, the Company's operating
entities will take advantage of cost savings opportunities
without sacrificing quality of service.
(b) Harvesting - The second program is a concentrated effort to
monetize the Company's assets, including selling a portion or
all of certain investments in Company's operating entities.
These may include the Company's minority interest in network
affiliated television stations and certain telephone
operations where competitive local exchange carrier
opportunities are not readily apparent. The Company's
approximately 14% ownership interest in Spinnaker may also be
sold in order to fund future growth initiatives. There is no
assurance that all or any part of this program can be effected
on acceptable terms.
YEAR 2000
The Company has initiated a comprehensive review of its computer
systems to identify the systems that could be affected by the "Year 2000" issue
and is developing and conducting an implementation plan to resolve the issue.
The Year 2000 problem is the result of computer programs being written using two
digits (rather than four) to define the applicable year. Any of the Company's
programs or programs utilized by vendors to the Company that have time-sensitive
software may recognize a date using "00" as the year 1900 rather than the year
2000. This could result in a major system failure or miscalculation. The
Company's Year 2000 review is being performed primarily by internal staff, and
in certain operations is supplemented by outside consultants. The principal
Information Technology ("IT") systems that may be impacted by the Year 2000 for
the Company's telecommunications operations are central office switching,
billing and accounting. The principal IT systems for the Morgan Group are order
entry dispatch and accounting. The Year 2000 may also impact various non-IT
systems, including among other things security systems, HVAC, elevator systems,
and
17
communications systems. In addition, each of the Company's businesses may be
impacted by the Year 2000 readiness of third party vendors/suppliers.
Due to the integral nature of switching equipment and billing software
to their operations, the telecommunications businesses are most effected by the
Year 2000 issue. The majority of the telephone companies' switching and billing
software is Year 2000 compliant, with the remaining expected to be compliant by
the third quarter of 1999. The telecommunications businesses rely on switching
equipment and software provided by third party vendors. It is the Company's
understanding that the vendors have completed testing of the software and that
no additional action by the Company will be required after installation. The
telecommunications businesses periodically upgrade switching software in order
to remain current with respect to service features. The upgrades provided other
enhanced service features as well as included Year 2000 readiness and have been
capitalized. Other remediation costs, including internal costs have been charged
to expense as incurred. The total cost of Year 2000 remediation for the
telecommunications businesses is estimated to be approximately $0.9 million, of
which approximately $0.4 million has been spent to date. The telecommunications
businesses have not developed a contingency plan and are in the process of
determining the needs for such a plan.
The Morgan Group, Inc. is in the process of remediating the Year 2000
issue, primarily through the replacement of a significant portion of its
operating software. Implementation is expected to be completed by July 1999,
with final testing completed by September 1999. The total cost of Year 2000
remediation is estimated to be approximately $0.4 million, of which
approximately $0.1 million has been spent to date. Costs specifically associated
with modifying internal use software are charged to expense as incurred. At this
time, The Morgan Group has not developed a comprehensive contingency plan.
The estimated costs and projected dates of completion for the Company's
Year 2000 program are based on management's estimates and were developed using
numerous assumptions of future events, some of which are beyond the Company's
control. The Company presently believes that with modifications to existing
software and converting to new software, the Year 2000 issue will not pose
significant operational problems for the Company as a whole. However, if such
modifications and conversions are not completed timely or are ineffective, the
Year 2000 issue may materially and adversely impact the Company's financial
condition, results of operations and cash flows.
MARKET RISK
The Company is exposed to market risk relating to changes in the
general level of U.S. interest rates. Changes in interest rates affect the
amounts of interest earned on the Company's cash equivalents and short-term
investments (approximately $17.4 million at March 31, 1999 and $28.0 million at
December 31, 1998). The Company generally finances the debt portion of the
acquisition of long-term assets with fixed rate, long-term debt. The Company
generally maintains the majority of its debt as fixed rate in nature either by
borrowing on a fixed long-term basis or, on a limited basis, entering into
interest rate swap agreements. The Company does not use derivative financial
instruments for trading or speculative purposes. Management does not foresee any
significant changes in the strategies used to manage interest rate risk in the
near future, although the strategies may be reevaluated as market conditions
dictate.
At March 31, 1999, approximately $26.5 million, or 19% of the Company's
long-term debt and notes payable bears interest at variable rates. Accordingly,
the Company's earnings and cash flows are affected by changes in interest rates.
Assuming the current level of borrowings for variable rate debt and assuming a
one percentage point change in the 1998 average interest rate under these
borrowings, it is estimated that the Company's 1998 interest expense would have
changed by $0.3 million. In the event of an adverse change in interest rates,
management would likely take actions to further mitigate its exposure. However,
due to the
18
uncertainty of the actions that would be taken and their possible effects, the
analysis assumes no such actions. Further, the analysis does not consider the
effects of the change in the level of overall economic activity that could exist
in such an environment.
BUSINESS OF INTERACTIVE
Interactive was incorporated in 1996 under the laws of the State of
Delaware. Prior to the Spin Off, Interactive has no significant assets,
liabilities or operations. As a successor to certain businesses of Lynch,
Interactive will become a diversified holding company with subsidiaries
primarily engaged in multimedia and transportation services (see Interactive on
p.5). Interactive's executive offices are located at 401 Theodore Fremd Avenue,
Rye, New York 10580-1430. Its telephone number is 914/921-7601.
Interactive's business development strategy is to expand its existing
operations through internal growth and acquisitions. It may also, from time to
time, consider the acquisition of other assets or businesses that are not
related to its present businesses. For the year ended December 31, 1998,
multimedia operations provided 27% of the Company's combined revenues, and
services operations provided 73% of the Company's combined revenues. As used
herein, Interactive includes subsidiary corporations.
In November 1998, Lynch announced a "harvesting" initiative, i.e., an
effort to monetize certain assets, including considering selling all or portions
of certain operating entities. These may include Interactive's minority
interests in network affiliated television stations, and certain Interactive
telephone operations where competitive local exchange carrier opportunities are
not readily apparent. As part of this initiative, Interactive sold in December
1998 its DirectTV franchise serving certain counties in New Mexico for
approximately $3.1 million. Interactive intends to continue this initiative.
There is no assurance that any transaction can be consummated on terms favorable
or acceptable to Interactive.
I. MULTIMEDIA
A. Telecommunications
Operations. Interactive is intended to conduct its telecommunications
operations through subsidiary corporations. The telecommunications segment has
been expanded through the selective acquisition of local exchange telephone
companies serving rural areas and by offering additional services such as
Internet service and long distance service. From 1989 through 1998, Interactive
has acquired ten telephone companies, five of which have indirect minority
ownership of 2% to 20%, whose operations range in size from approximately 500 to
over 10,000 access lines. The Company's telephone operations are located in
Kansas, Michigan, New Hampshire, New Mexico, New York, North Dakota and
Wisconsin. As of December 31, 1998, total access lines were approximately
37,600, 100% of which are served by digital switches.
These subsidiaries' principal business is providing telecommunications
services. These services fall into four major categories: local network, network
access, long distance and other non-regulated telecommunications services. Toll
service to areas outside franchised telephone service territory is furnished
through switched and special access connections with intrastate and interstate
long distance networks.
Interactive holds franchises, licenses, and permits adequate for the
conduct of its business in the territories which it serves.
19
Future growth in telephone operations is expected to be derived from
the acquisition of additional telephone companies, from providing service to new
customers or additional services to existing customers, from upgrading existing
customers to higher grades of service, and from additional service offerings.
The following table summarizes certain information regarding
Interactive's multimedia operations.
Year Ended December 31,
1998 1997 1996
--------- ---------- ---------
Telecommunications Operations
Access lines* 37,604 36,525 28,630
% Residential 75% 75% 74%
% Business 25% 25% 26%
Internet Subscribers 7,977 3,506 971
Cable Subscribers 4,709 4,660 4,454
Total Multimedia Revenues
Telecommunications Operations
Local Service 13% 13% 13%
Network Access & Long Distance 67% 69% 72%
Non-Regulated & Other** 17% 15% 10%
Total Telecommunications Operations 97% 97% 95%
Cable Operations 3% 3% 5%
Total Multimedia Revenues 100% 100% 100%
($ in 000)
Total Revenues $ 54,622 $ 47,908 $ 28,608
EBITDA+ 29,389 24,666 15,863
Depreciation & Amortization 12,995 12,175 8,653
Capital Expenditures 11,028 10,914 11,056
Total Assets $195,010 $146,285 $178,415
<FN>
* An "access line" is a telecommunications circuit between the customer's
establishment and the central switching office. ** Non-regulated and other
revenues include Internet, PCS, Direct Broadcast Satellite and other
non-regulated revenues. + EBITDA is earnings before interest, taxes,
depreciation and amortization, and corporate overhead allocation.
</FN>
Telephone Acquisitions. Interactive pursues an active program of
acquiring operating telephone companies. From January 1, 1988 through December
31, 1998, Lynch has acquired ten telephone companies serving a total of
approximately 30,950 access lines at the time of these acquisitions for an
aggregate consideration totaling approximately $138 million. Such acquisitions
are summarized in the following table:
ACQUISITION HISTORY
Number of Number of Annual
Year of Cost of Access Lines Access Lines Revenues Ownership
Company Acquisition Acquisition Yr. of Acq. 12/31/98 12/31/98 Percentage
------------------------------------------------------------------------------------------------------------------
($ in 000) ($ in 000)
Western New Telephone Co. 1989 $44,300 4,200 6,189 $16,587 83.1
Inter-Community Telephone Co. (a) 1991 10,405 2,550 2,609 3,663 100.0
Cuba City Telephone Co. &
Belmont Telephone Co. 1991 7,200 2,200 2,647 1,927 81.0
Bretton Woods Telephone Co. 1993 1,700 250 515 688 100.0
JBN Telephone Co. (b) 1993 7,200 2,300 2,740 4,278 98.0
Haviland Telephone Co. 1994 13,400 3,800 4,140 4,078 100.0
Dunkirk&Fredonia Telephone Co.
& Cassadaga Telephone Co. 1996 27,700 11,100 11,968 11,292 100.0
Upper Peninsula Telephone Co. 1997 26,500 6,200 6,796 9,240 100.0
<FN>
(a) Includes 1,350 access lines acquired in 1996 for approximately $4.7 million.
(b) Includes 354 access lines acquired in 1996 for approximately $.9 million.
</FN>
20
On May 26, 1999, an Interactive subsidiary entered into an agreement to
acquire by merger Central Scott Telephone Company ("Scott") for approximately
$28.1 million in cash. Scott has approximately 6,000 access lines in Scott
County, Iowa. Interactive expects to fund the acquisition principally through
borrowings. Consummation of the transaction is subject to certain conditions,
including approval by the holders of a majority of the common stock of Scott.
Scott had revenues of $4.4 million in 1998. While Scott was profitable in 1998,
Scott is not expected to contribute to Interactive's earnings in1999 due to
interest expense on the expected financing debt.
Interactive continually evaluates acquisition opportunities targeting
domestic rural telephone companies with a strong market position, good growth
potential and predictable cash flow. In addition, Interactive generally sought
companies with excellent local management already in place who will remain
active with their company. Recently, certain large telephone companies have
offered certain of their rural telephone exchanges for sale, often on a
state-wide or larger area basis. Interactive has and in the future may, bid on
such groups of exchanges. Telephone holding companies and others actively
compete for the acquisition of telephone companies and such acquisitions are
subject to the consent or approval of regulatory agencies in most states. While
management believes that it will be successful in making additional
acquisitions, there can be no assurance that Interactive will be able to
negotiate additional acquisitions on terms acceptable to it or that regulatory
approvals, where required, will be received.
Related Services and Investments. Interactive also provides
non-regulated telephone related services, including internet access service and
long distance resale service, in certain of its telephone service (and adjacent)
areas. Interactive also intends to provide local telephone and other
telecommunications service outside certain of its franchise areas by
establishing competitive local exchange carrier (CLEC) operations in certain
adjacent areas. Affiliates of seven of Interactive's telephone companies now
offer internet access service. At December 31, 1998, internet access customers
totaled approximately 8,000 compared to approximately 3,500 at December 31,
1997.
In late 1998, an affiliate of Dunkirk & Fredonia Telephone Company
began providing long distance resale service, and affiliates of certain of
Interactive's other telephone companies are considering becoming long distance
resellers.
An affiliate of Dunkirk & Fredonia Telephone Company began providing
(CLEC) service on a resale basis in neighboring Dunkirk, NY in the second
quarter of 1999. Affiliates of Inter-Community Telephone Company in North
Dakota, and Western New Mexico Telephone Company in New Mexico have filed with
the state regulatory commissions to provide CLEC services in those states. Final
plans to offer CLEC service in areas adjacent to Interactive's telephone
operations in those states have not been completed. In December 1998,
Interactive also acquired a 10 MHZ personal communications service (PCS) license
for the Basic Trading Area covering the Las Cruces, New Mexico market and is
considering how to utilize that license.
At December 31, 1998, Interactive owned minority interests in certain
entities that provide wireless cellular telephone service in several Rural
Service Areas ("RSA's") in New Mexico and North Dakota, covering areas with a
total population of approximately 305,000, of which Interactive's proportionate
interest is approximately 10,000.
The operating results of these services and investments have not been
material to date, although Interactive expects its CLEC services to operate at
losses initially.
21
Regulatory Environment. Operating telephone companies are regulated by
state regulatory agencies with respect to its intrastate telephone services and
the Federal Communications Commission ("FCC") with respect to its interstate
telephone service and, with the enactment of the Telecommunications Act of 1996
(the "1996 Act"), certain other matters relating principally to fostering local
and intrastate competition.
Interactive's telephone subsidiaries participate in the National
Exchange Carrier Association ("NECA") common line and traffic sensitive tariffs
and participate in the access revenue pools administered by NECA for interstate
services. Where applicable, Interactive's subsidiaries also participate in
similar pooling arrangements approved by state regulatory authorities for
intrastate services. Such interstate and intrastate arrangements are intended to
compensate local exchange carriers ("LEC's"), such as Interactive's operating
telephone companies, for the costs, including a fair rate of return, of
facilities furnished in originating and terminating interstate and intrastate
long distance services.
In addition to access pool participation, certain of Interactive's
subsidiaries are compensated for their intrastate costs through billing and
keeping access charge revenues (without participating in an access pool). The
intrastate access charge revenues are developed based on intrastate access rates
filed with the state regulatory agency.
In addition, a 1989 FCC decision provided for price cap regulation for
certain interstate services. The price cap approach differs from traditional
rate-of-return regulation by focusing primarily on the prices of communications
services. The intention of price cap regulation is to focus on productivity and
the approved plan for telephone operating companies. This allows for the sharing
with its customers of profits achieved by increasing productivity. Alternatives
to rate-of-return regulation have also been adopted or proposed in some states
as well. Inter-Community Telephone Company is an example of one such subsidiary
which has elected a price cap limitation on intrastate access charges. However,
management does not believe that this agreement will have a material effect on
the Company's results. In certain states, regulators have ordered the
restructuring of local service areas to eliminate nearby long distance calls and
substitute extended calling areas.
Various aspects of federal and state telephone regulation have in
recent years been subject to re-examination and on-going modification. In
February 1996, the Telecommunications Act of 1996 (the "1996 Act"), which is the
most substantial revision of communication law since the 1930's, became law. The
1996 Act is intended generally to allow telephone, cable, broadcast and other
telecommunications providers to compete in each other's businesses, while
loosening regulation of those businesses. Among other things, the Act (i) would
allow major long distance telephone companies and cable television companies to
provide local exchange telephone service; (ii) would allow new local telephone
service providers to connect into existing local telephone exchange networks and
purchase services at wholesale rates for resale; (iii) would provide for a
commitment to universal service for high-cost, rural areas and authorizes state
regulatory commissions to consider their status on certain competition issues;
(iv) would allow the Regional Bell Operating Companies to offer long distance
telephone service and enter the alarm services and electronic publishing
businesses; (v) would remove rate regulation over non-basic cable service in
three years; and (vi) would increase the number of television stations that can
be owned by one party.
Although the FCC has completed numerous regulatory proceedings required
to implement the 1996 Act, the FCC is still in the process of promulgating new
regulations covering these and related matters. For certain issues, the FCC
bifurcated the proceedings between price cap and rate-of-return companies or in
the case of the Universal Service Fund (USF) between rural and non-rural
companies. In several cases, the regulations for the price-cap (or non-rural)
local exchange carriers (LECs) have been or are being determined first, followed
by separate proceedings for rate-of-return (or rural) companies. Since all of
Interactive's
22
telephone subsidiaries are rural, rate-of-return companies for the interstate
jurisdiction, many of the issues are yet to be resolved by the FCC for
Interactive's subsidiaries. Current or anticipated proceedings, which could have
significant revenue impacts for rural, rate-of-return companies, include changes
in access charge regulations, jurisdictional separations rules (which allocate
costs between interstate and intrastate services), reevaluation of the
interstate rate-of-return and permanent USF procedures.
The USF is intended, among other things, to provide special support
funds to high cost rural LECs so that they can provide affordable services to
their customers notwithstanding their high cost due to low population density.
In May 1997, the FCC adopted interim USF procedures effective January 1, 1998
which continue to use actual embedded costs for rural companies. The interim
procedures transferred the Weighted DEM (which is a subsidy related to central
office switching equipment) and Long-Term Support (LTS) to the USF and required
all telecommunications companies (including Interactive's telephone
subsidiaries) to contribute to the fund. In addition, a cap was implemented on
the amount of corporate expense allowable for the computation of USF. The
interim rules are expected to be in effect until January 1, 2001. This is the
earliest date that a transition to a new universal service support mechanism may
begin. On July 1, 1998, the Federal-State Joint Board on Universal Service
(Joint Board) appointed a Rural Task Force ("RTF") to address changes to the
universal service support mechanisms for rural carriers. All of Interactive's
telephone companies are designated as rural carriers for universal service
support. Nine months after the implementation of a new universal service plan
for non-rural carriers, the RTF is scheduled to make recommendations to the
Joint Board regarding any changes required to the current universal service
support mechanism for rural carriers. This includes, but is not limited to,
reviewing a proxy model built on Forward-Looking Economic Costs (FLEC).
The FCC is currently in the process of determining permanent USF
procedures for non-rural carriers. In October 1998, the FCC adopted a proxy
model platform based on FLEC. The FCC is still in the process of developing
inputs for the FLEC proxy model for non-rural carriers. The new universal
service support mechanism for non-rural carriers based on the FLEC proxy model
is scheduled to be in effect January 1, 2000.
In addition to the changes to universal service, the FCC also has open
dockets related to access charges, jurisdictional separations and rate-of-return
reevaluation. The FCC made several changes to access charges for price cap
companies in May 1997. The FCC issued a proposal for similar changes to access
charges for rate-of-return carriers in June 1998. In October 1997, the FCC
initiated a proceeding where companies provided comments to the FCC regarding
how costs should be allocated between the intrastate and interstate
jurisdictions. In October 1998, the FCC requested comments regarding whether the
interstate rate-of- return was at the appropriate rate. No final decision
regarding proposed changes for rate-of-return carriers related to access
charges, jurisdictional separations or rate-of-return reevaluation has been
issued by the FCC. Since interstate revenues constituted approximately 50% of
the regulated revenues of the Registrant's telephone companies in 1998,
modifications to access charges, separations, rate-of-returns, and/or USF could
have a material effect. It is impossible to determine the impact of these
proposed changes on the Registrant's telephone companies at this time.
Interactive cannot predict the effect of the 1996 Act, state
initiatives and new proposed Federal and state regulations, but because its
telecommunications and multimedia properties (other than its television stations
interests) are primarily in high-cost, rural areas, Interactive expects
competitive changes to be slower in coming than in non-rural areas.
Competition. All of Interactive's current telephone companies are
currently monopoly wireline providers in their respective area of local
telephone exchange service; although there can be no assurance that this will
continue. However, as a result of the 1996 Act, FCC and state regulatory
authority initiatives and
23
judicial decisions, competition has been introduced into certain areas of the
toll network wherein certain providers are attempting to bypass local exchange
facilities to connect directly with high-volume toll customers. For example, in
the last few years the States of New York, Michigan, Wisconsin and Kansas passed
or amended telecommunications bills intended to introduce more competition among
providers of local services and reduce regulation. Regulatory authorities in
certain states, including New York, have taken steps to promote competition in
local telephone exchange service, by requiring certain companies to offer
wholesale rates to resellers. A substantial impact is yet to be seen on
Interactive's telephone companies. Interactive's subsidiaries do not expect
bypass to pose a significant near-term competitive threat due to a limited
number of high-volume customers they serve. In addition, cellular radio or
similar radio-based wireless services, including personal communication services
("PCS"), and cable television and internet based services could provide an
alternative local telephone exchange service as well as possible competition
from electric companies.
Interactive's telephone companies, in the aggregate, own approximately
10,000 miles of cable and 1,000 miles of fiber optic cable. Substantially all of
the telephone companies' properties are encumbered under mortgages and security
interests, principally to the Rural Utilities Services.
B. Broadcasting
See the "Harvesting" initiative at page 17 above concerning the television
operations.
STATION WHBF-TV - Lynch Entertainment Corporation ("Lynch Entertainment I"), a
wholly-owned subsidiary of Interactive, and Lombardo Communications, Inc.,
wholly-owned by Philip J. Lombardo, are the general partners of Coronet
Communications Company ("Coronet"). Lynch Entertainment I has a 20% interest in
Coronet and Lombardo Communications, Inc. has an 80% interest. Coronet owns a
CBS-affiliated television station WHBF-TV serving Rock Island and Moline,
Illinois and Davenport and Bettendorf, Iowa.
STATION WOI-TV - Lynch Entertainment Corporation II ("LEC-II"), a wholly-owned
subsidiary of Interactive, owns 49% of the outstanding common shares of Capital
Communications Corporation ("Capital") and convertible preferred stock, which
when converted, would bring LEC-II's common share ownership to 50%. On March 1,
1994, Capital acquired the assets of WOI-TV for $12.7 million. WOI-TV is an ABC
affiliate and serves the Ames/Des Moines, Iowa market. Lombardo Communications,
Inc. II, controlled by Philip J.
Lombardo, has the remaining share interest in Capital.
Operations. Revenues of a local television station depend to some
extent upon its relationship with an affiliated television network. In general,
the affiliation contracts of WHBF-TV and WOI-TV with CBS and ABC, respectively,
provide that the network will offer to the affiliated station the programs it
generates, and the affiliated station will transmit a number of hours of network
programming each month. The programs transmitted by the affiliated station
generally include advertising originated by the network, for which the network
is compensated by its advertisers.
The affiliation contract provides that the network will pay to the
affiliated station an amount which is determined by negotiation, based upon the
market size and rating of the affiliated station. Typically, the affiliated
station also makes available a certain number of hours each month for network
transmission without compensation to the local station, and the network makes
available to the affiliated station certain programs which will be broadcast
without advertising, usually public information programs. Some network programs
also include "slots" of time in which the local station is permitted to sell
spot advertising for its own account. The affiliate is permitted to sell
advertising spots preceding, following, and sometimes during network programs.
24
A network affiliation is important to a local station because network
programs, in general, have higher viewer ratings than non-network programs and
help to establish a solid audience base and acceptance within the market for the
local station. Because network programming often enhances a station's audience
ratings, a network-affiliated station is often able to charge higher prices for
its own advertising time. In addition to revenues derived from broadcasting
network programs, local television stations derive revenues from the sale of
advertising time for spot advertisements, which vary from 10 seconds to 120
seconds in length, and from the sale of program sponsorship to national and
local advertisers. Advertising contracts are generally short in duration and may
be canceled upon two-weeks notice. WHBF-TV and WOI-TV are represented by a
national firm for the sale of spot advertising to national customers, but have
local sales personnel covering the service area in which each is located.
National representatives are compensated by a commission based on net
advertising revenues from national customers.
Competition. WHBF-TV and WOI-TV compete for revenues with local
television and radio stations, cable television, and other advertising media,
such as newspapers, magazines, billboards and direct mail. Generally, television
stations such as WHBF-TV and WOI-TV do not compete with stations in other
markets.
Other sources of competition include community antenna television
("CATV") systems, which carry television broadcast signals by wire or cable to
subscribers who pay a fee for this service. CATV systems retransmit programming
originated by broadcasters, as well as providing additional programming that is
not originated on, or transmitted from, conventional broadcasting stations. In
addition, some alternative media operators, such as multipoint distribution
service owners, provide for a fee and on a subscription basis, programming that
is not a part of regular television service. Additional program services are
provided by low-power television stations and direct broadcast satellites
provide video services as well.
Federal Regulation. Television broadcasting is subject to the
jurisdiction of the FCC under the Communications Act of 1934, as amended (the
"Communications Act"). The Communications Act, and/or the FCC's rules, among
other things, (i) prohibit the assignment of a broadcast license or the transfer
of control of a corporation holding a license without the prior approval of the
FCC; (ii) prohibit the common ownership of a television station and an AM or FM
radio station or daily newspaper in the same market, although AM-FM station
combinations by itself are permitted; (iii) prohibit ownership of a CATV system
and television station in the same market; (iv) restrict the total number of
broadcast licenses which can be held by a single entity or individual or entity
with attributable interests in the stations and prohibits such individuals and
entities from operating or having attributable interests in most types of
stations in the same service area (loosened in the 1996 Act); and (v) limit
foreign ownership of FCC licenses under certain circumstances. See Regulatory
Environment under A. above for a description of certain provisions of the 1996
Act including in particular those which would remove the regulations over
non-basic cable service in three years and permit telephone service providers to
provide cable service. In calculating media ownership interests, The Company's
interests may be aggregated under certain circumstances with certain other
interests of Mr. Mario J. Gabelli, Chairman and Chief Executive Officer of the
Company, and certain of his affiliates.
Television licenses are issued for terms of eight years and are
renewable for terms of eight years. The current licenses for WHBF-TV and WOI-TV
expire on December 1, 2005 and February 1, 2006, respectively.
Other
On December 1, 1995, CLR Video LLC, a 60% owned subsidiary of
Interactive acquired 23 cable television systems in northeast Kansas serving
approximately 4,500 subscribers for $5.2 million. Certain of the systems cluster
with local telephone exchanges owned by J.B.N. Telephone. Interactive also owns
a small cable system in Haviland, Kansas. Results of operations have not been
significant to date.
25
See the "harvesting" initiative at page 17 as to sale of Interactive's
DirectTV franchise in certain parts of New Mexico. In December 1999, Interactive
sold for approximately $3.1 million its right to market direct broadcasting TV
services via satellite in New Mexico. Financial results for the operation had
not been material.
C. Personal Communications Services ("PCS").
A subsidiary of Interactive is a 49.9% limited partner in Fortunet
Communications, L.P. ("Fortunet"). Fortunet is the successor to five
partnerships that won 30 megahertz personal communications services licenses in
the FCC's C-Block auction (restricted to small businesses and certain other
qualifying bidders), which concluded in 1996. Fortunet won 31 licenses in 17
states covering a population of approximately 7 million people. The licenses had
an aggregate purchase price of $216 million after a 25% bidding credit.
Under FCC rules, Fortunet made a down payment equal to 10% of the cost
(net of bidding credits) of the licenses ($21.6 million). The Government
provided 10 year installment financing, interest only for the first six years at
an interest rate of 7% per annum. Interactive's subsidiary has loaned Fortunet
an aggregate of approximately $24.0 million to fund the down payments and the
first interest payment on the licenses. The 50.1% general partner has no
obligation to provide loans or additional funds to Fortunet.
Certain C-Block licensees, including Fortunet, experienced substantial
financial problems in connection with servicing the FCC installment debt and/or
building out the licenses. The three largest C-Block licensees filed for
protection under the Federal Bankruptcy Act. As a result, the FCC in March 1997,
suspended interest payments on the FCC installment debt while it examined the
situation. In September 1997 the FCC gave C- Block licensees four choices (one
of which was the resumption of principal and interest payments) with respect to
their licenses. The three other options, as modified in March 1998, were (i)
giving up all C-Block licenses in any Metropolitan Trading Areas ("MTA"); for
licenses returned, the licensee may either opt (a) to rebid on those licenses in
the reauction and forfeit 100% of the down payment or (b) to forego the
opportunity to rebid on those licenses and receive a credit of 70% of the down
payment to be used to prepay any licenses retained, (ii) using 70% of the down
payments (100% in the case of licenses to be paid up) to prepay licenses in any
MTA while giving up the licenses not prepaid, and (iii) giving up 15 MHZ of the
30 MHZ licenses in any MTAs for forgiveness of 50% of the debt; a licensee who
elects to resume installment payments on the remaining portion would be entitled
to a credit towards debt service equal to 40% of the down payments on the
spectrum given up while a licensee who elects to prepay the retained licenses
would receive a credit towards prepayment equal to 70% of the down payments on
the spectrum given up. In the third quarter of 1997, Interactive provided a
reserve of 30% of its subsidiary's investment in Fortunet ($4.6 million
after-tax).
In June 1998, Fortunet, pursuant to the FCC restructuring program,
elected to give up all of its PCS licenses, except for 15 MHZ licenses in
Tallahassee, Panama City and Ocala, Florida. It used the FCC credits from the
returned licenses to pay the remaining purchase prices for the retained Florida
licenses. Fortunet also received back $3.9 million from the FCC, which was used
to pay down a portion of Fortunet's loan from Interactive's subsidiary. This
reduced the loan to Fortunet to approximately $20 million. On April 15, 1999,
the FCC completed a reauction of all the "C Block" licenses that were returned
to it subsequent to the original auction, including the 15 MHZ licenses that
Fortunet returned on June 8, 1998, in the basic trading areas of Tallahassee,
Panama City, and Ocala, Florida. In that reauction, the successful bidders paid
a total of $2.7 million for the three licenses as compared to the $18.7 million
carrying amount of Interactive's investment in Fortunet. Accordingly, for the
quarter ended March 31, 1999, Interactive has provided a reserve of $15.4
million to write down its investment in Fortunet to reflect the amount bid for
similar licenses in the reauction, plus an additional $0.7 million of
capitalized expenses, to leave a net carrying value of $3.4 million.
26
Another subsidiary of Interactive, Lynch PCS Corporation F ("LPCSF"),
was a 49.9% limited partner in Aer Force Communications B, L.P. ("Aer Force").In
the FCC's F-Block Auction (restricted to small businesses and certain other
qualifying bidders) of 10 megahertz PCS licenses, Aer Force won five licenses in
four states covering a population of approximately 20 million people. The
licenses have an aggregate purchase price of $19 million after a 25% bidding
credit. In December 1997, East/West Communications, Inc. ("East/West") succeeded
to the assets and liabilities of Aer Force with LPCSF receiving 49.9% of the
common stock. Immediately thereafter, Lynch spun off 39.9% of the common stock
of East/West to Lynch's shareholders and transferred 10% of East/West stock to
Gabelli Funds, Inc. ("GFI") in satisfaction of an obligation to pay it 10% of
the net profits of Aer Force (after an assumed cost of capital). Interactive
currently owns 7,800 shares ($7,800,000 par and liquidation value) of 5%
payment-in-kind preferred stock of East/West with a carrying value of $4.5
million at March 31, 1999, redeemable in 2009 subject to earlier payment in
certain circumstances. East/West has certain financial and operating hurdles to
overcome in the near term, including the need for sufficient liquidity.
Another subsidiary of Interactive, Lynch PCS Corporation G ("LPCSG")
had an agreement with Rivgam Communications L.L.C. ("Rivgam"), a subsidiary of
GFI, which won licenses in the FCC's D and E Block PCS Auctions for 10 megahertz
PCS licenses, to receive a fee equal to 10% of the realized net profits of
Rivgam (after an assumed cost of capital) in return for providing bidding and
certain other services. Rivgam won 12 licenses in seven states covering a
population of 33 million, with an aggregate cost of $85.1 million. In December
1998, Rivgam settled its obligation under said agreement by transferring to
LPCSG its 10 MHZ PCS license for the Las Cruces, New Mexico, market.
LPCSG also has an agreement with Bal/Rivgam LLC (in which GFI has a
49.9% equity interest), which won licenses in FCC's Wireless Communications
Services ("WCS") Auction in 1997, to receive a fee equal to 5% of the realized
net profits of Bal/Rivgam (after an assumed cost of capital), in return for
providing bidding and certain other services to Bal/Rivgam. Bal/Rivgam won 5 WCS
licenses covering a population of approximately 42 million with an aggregate
cost of $0.7 million. LPCSG also has an agreement to provide BCK\Rivgam L.L.C.,
in which GFI has a 49.9% equity interest, with similar services in connection
with the FCC's Local Multipoint Distribution Services ("LMDS") Auction ended on
March 25, 1998. Subject to final grant, BCK/Rivgam won three licenses covering a
population of 1.3 million with an aggregate cost of $6.1 million. LPCSG has an
agreement to receive 5% of the net profits of BCK\Rivgam (after an assumed cost
of capital).
FCC rules impose build-out requirements that require PCS licensees to
provide adequate service to at least one-third of the population in the licensed
area within five years from the date of grant and to at least two-thirds within
ten years, as well as build out requirements for WCS and LMDS licenses. Neither
Fortunet nor East/West has begun any build out of their licenses. There are also
substantial restrictions on the transfer of control of C and F Block PCS
licenses, WCS licenses and LMDS licenses.
There are many risks relating to PCS communications including without
limitation, the high cost of PCS licenses, the fact that it involves start-up
businesses, raising the substantial funds required to pay for the licenses and
the build out, determining the best way to develop the licenses and which
technology to utilize, the small size and limited resources of Fortunet and
East/West compared to other potential competitors, existing and changing
regulatory requirements, additional auctions of wireless telecommunications
spectrum and actually building out and operating new businesses profitably in a
highly competitive environment (including already established cellular telephone
operators and other new PCS licensees). There are also similar risks as to WCS
and LMDS licenses. There can be no assurance that any licenses granted to
Fortunet or East/West can be successfully sold or financed or developed, with
The Company's subsidiaries recovering their debt and equity investments.
27
II. SERVICES
The Morgan Group, Inc.
The Morgan Group Inc. ("Morgan") is Interactive's only service
subsidiary. On July 22, 1993, Morgan completed an initial public offering
("IPO") of 1,100,000 shares of its Class A common stock, $.015 par value, at
$9.00 per share. As a result of this offering, Interactive's equity ownership in
Morgan was reduced from 90% to 47%, represented by its ownership of 1,200,000
shares of Class B common stock. In December 1995, Interactive acquired from
Morgan 150,000 shares of Class A common stock (plus $1.3 million in cash plus
accrued dividends) in exchange for its 1,493,942 shares of Series A Preferred
Stock of Morgan. As of March 19, 1999, Morgan purchased approximately 102,528
shares of its Class A common stock at $9.00 per share pursuant to a "Dutch
Auction." At March 25, 1999, Interactive's equity ownership in Morgan was
approximately 55%. Because the Class B common stock is entitled to two votes per
share, its voting interest in Morgan at March 25, 1999 was approximately 70%
and, therefore, Interactive continues to consolidate Morgan's results in its
financial statements. Morgan Class A common stock is listed on the American
Stock Exchange under the symbol "MG."
Morgan is the nation's largest publicly owned service company in
managing the delivery of manufactured housing, specialized equipment and
commercial vehicles in the United States, and through its wholly owned
subsidiary, Morgan Drive Away, Inc. has been operating since 1936. Morgan
provides outsourcing transportation services through a national network of
approximately 1,530 independent owner- operators and 1,420 other drivers. Morgan
dispatches its drivers from 105 locations in 31 states. Morgan's largest
customers include Fleetwood Enterprises, Inc., Oakwood Homes Corporation,
Winnebago Industries, Inc., Champion Enterprises, Inc., Cavalier Homes, Inc.,
Clayton Homes, Palm Harbor Homes, Inc., Four Seasons Housing, Inc., Fairmont
Homes, Inc. and Ryder Systems, Inc.
In 1996, Morgan acquired the assets of Transit Homes of America, a
national outsourcing company located in Boise, Idaho. In 1995, Morgan acquired
the assets of Transfer Drivers, Inc. ("TDI"), a northern Indiana-based
outsourcing company. TDI is a market leader in the fragmented truck delivery
business focusing on relocation of consumer and commercial vehicles for
customers, including Budget One-Way Rental, Ryder System, Inc. and Ford Motor
Company.
Morgan also provides certain insurance and financing services to its
owner-operators through its subsidiaries, Interstate Indemnity Company
("Interstate") and Morgan Finance, Inc. ("Finance").
In the first half of 1997, Morgan discontinued the "Truckaway"
operation of the Specialized Transport Division taking a special charge to
income in the fourth quarter of 1996. Truckaway was a line of business which
focused on the transportation of van conversions, tent campers, and automotive
products utilizing Company-owned equipment. The truckaway operation had revenues
of $12,900,000 and an estimated operating loss of $1,800,000 for the year ended
December 31, 1996.
Industry Information. Morgan's business is substantially dependent upon
the manufactured housing industry. Morgan's operations are affected by, among
other things, fluctuations in interest rates and availability of credit to
purchasers of manufactured homes and motor homes and the availability and price
of motor fuels. This industry is subject to production cycles. The manufactured
housing industry growth was approximately 2.3% in 1998.
Growth Strategy. Morgan's strategy is to grow through expansion in the
niche businesses already being served with heavy emphasis on outsourcing, along
with pursuing acquisitions of niche transportation
28
carriers who are servicing their customer base with unique service and/or
equipment. In addition, the Company looks to expand insurance product offerings
to drivers through its subsidiary Interstate.
Morgan's initiatives for improved margins are to exit lines of business
which are unrewarding, reducing corporate overhead, and improving the Company's
safety record. There is no assurance that such strategy and initiatives will be
successful in light of changing economic markets and competitive conditions.
Morgan is continuously reviewing and negotiating potential
acquisitions. There can be no assurance that any future acquisitions will be
effected or, if effected, that they can be successfully integrated with Morgan's
business.
Competition. All of Morgan's activities are highly competitive. In
addition to fleets operated by manufacturers, Morgan competes with several large
national interstate carriers and numerous small regional or local interstate and
intrastate carriers. Morgan's principal competitors in the manufactured housing
marketplace are privately owned. In the commercial transport market, Morgan
competes with large national interstate carriers, many of whom have
substantially greater resources than Morgan. No assurance can be given that
Morgan will be able to maintain its competitive position in the future.
Competition among carriers is based on the rate charged for services,
quality of service, financial strength, insurance coverage and the geographic
scope of the carrier's authority and operational structure. The availability of
tractor equipment and the possession of appropriate registration approvals
permitting shipments between points required by the customer may also be
influential.
Lines of Business. Morgan has three lines of business: manufactured
housing, specialized outsourcing services and insurance and finance. The
Company's manufactured housing line provides outsourced transportation and
logistical services to manufacturers of manufactured housing through a network
of terminals located in 31 states. The Company's specialized outsourcing
services provides outsourced transportation services primarily to manufacturers
of recreational vehicles, commercial trucks and trailers through a network of
service centers in eight states. The third line, insurance and finance, provides
insurance and financing to the Company's drivers and independent
owner-operators.
Selected Operating and Industry Participation Information. The
following table sets forth certain operating and industry participation
information for each of the five years ended December 31, 1998.
Manufactured Housing 1994 1995 1996 1997 1998
- -------------------------------------------------------------------------------------------------------------------------
Operating Information:
New Home Shipments......................... 98,181 114,890 121,136 154,389 161,543
Other Shipments............................ 23,423 29,860 23,465 24,144 17,330
------ ------ ------ ------ ------
Total Shipments............................ 121,604 144,750 144,601 178,533 178,873
Linehaul Revenues (000s) (1)............... $53,520 $63,353 $72,616 $93,092 $94,158
Manufactured Housing
Industry Participation: 1994 1995 1996 1997 1998
------------------------------------------------------------------------------------------------------------------------
Industry Production (2).................... 451,646 505,819 553,133 558,435 601,678
New Home Shipments......................... 98,181 114,890 121,136 154,389 161,543
Share of Unites Shipped.................... 21.7% 22.7% 21.9% 27.6% 26.8%
Specialized Outsourcing 1994 1995 1996 1997 1998
- --------------------------------------------------------------------------------------------------------------------------
Services Operating Information:
Shipments.................................. 73,994 94,291 99,623 80,314 82,344
Linehaul Revenues (000s)(1)................ $43,443 $49,336 $49,259 $39,336 $42,994
<FN>
(1) Linehaul revenue is derived by multiplying the miles of a given shipment by
the stated mileage rate.
(2) Based on reports of Manufactured Housing Institute. To calculate share of
homes shipped, Morgan assumes two units shipped for each multi-section
home.
</FN>
29
Customers and Marketing. A substantial portion of Morgan's operating
revenues are generated under one, two, or three year contracts with producers of
manufactured homes, recreational vehicles, and the other products. In these
contracts, the manufacturers agree that a specific percentage (up to 100%) of
their transportation service requirements from a particular location will be
performed by Morgan on the basis of a prescribed rate schedule, subject to
certain adjustments to accommodate increases in the Company's transportation
costs. Operating results generated under customer contracts in 1996, 1997, and
1998 were 62%, 68% and 64% of total operating revenues, respectively. Morgan's
ten largest customers have been served for at least three years and accounted
for approximately 59%, 66%, and 69% of its operating revenues in 1996, 1997, and
1998, respectively.
Independent Owner-Operators. The shipment of product by Manufactured
Housing and certain Specialized Outsourcing Services such as towaway and pickup
is conducted by contracting for the use of the equipment of independent
owner-operators.
Owner-operators are independent contractors who own toters, tractors or
pickup trucks which they contract to, and operate for, Morgan on a long-term
basis. Independent owner-operators are not generally approved to transport
commodities on their own in interstate or intrastate commerce. Morgan, however,
possesses such approvals and/or authorities (see "Regulation"), and provides
marketing, insurance, communications, administrative, and other support required
for such transportation.
Risk Management, Safety and Insurance. The risk of substantial losses
arising from traffic accidents is inherent in any transportation business.
Morgan carries insurance to cover such losses up to $25 million per occurrence
with a deductible of up to $250,000 per occurrence for personal injury and
property damage. The frequency and severity of claims under the Company's
liability insurance affect the cost, and potentially the availability, of such
insurance. If Morgan is required to pay substantially greater insurance
premiums, or incurs substantial losses above $25 million or substantial losses
below its $150,000 deductible, its results of operations can be materially
adversely affected. There can be no assurance that Morgan can continue to
maintain its present insurance coverage on acceptable terms.
Interstate makes available physical damage insurance coverage for the
Company's owner-operators. Interstate also writes performance surety bonds for
Morgan Drive Away, Inc.
Regulation. Morgan's interstate operations are subject to regulation by
the Federal Highway Administration, which is an agency of the United States
Department of Transportation ("D.O.T."). Effective August 26, 1994, essentially
all motor common carriers were no longer required to file individually
determined rates, classifications, rules or practices with the Interstate
Commerce Commission ("I.C.C.") Effective January 1, 1995, the economic
regulation of certain intrastate operations by various state agencies was
preempted by federal law. The states will continue to have jurisdiction
primarily to insure that carriers providing intrastate transportation services
maintain required insurance coverage, comply with all applicable safety
regulations, and conform to regulations governing size and weight of shipments
on state highways. Most states have adopted D.O.T. safety regulations and
conform to regulations governing size and weight of shipments on state highway,
and actively enforce them in conjunction with D.O.T. personnel.
Carriers normally are required to obtain authority from the I.C.C. or
its successor as well as various state agencies. Morgan is approved to provide
transportation from, to, and between all points in the continental United
States.
Federal regulations govern not only operating authority and
registration, but also such matters as the content of agreements with
owner-operators, required procedures for processing of cargo loss and damage
30
claims, and financial reporting. Morgan believes that it is in substantial
compliance with all material regulations applicable to its operations.
The D.O.T. regulates safety matters with respect to the interstate
operations of Morgan. Among other things, the D.O.T. regulates commercial driver
qualifications and licensing; sets minimum levels of carrier liability
insurance; requires carriers to enforce limitations on drivers' hours of
service; prescribes parts, accessories and maintenance procedures for safe
operation of freight vehicles; establishes noise emission and employee health
and safety standards for commercial motor vehicle operators; and utilizes
audits, roadside inspections and other enforcement procedures to monitor
compliance with all such regulations. In 1997, the D.O.T. has established
regulations which mandate random, periodic, pre-employment, post-accident and
reasonable cause drug testing for commercial drivers. The D.O.T. has also
established similar regulations for alcohol testing. Morgan believes that it is
in substantial compliance with all material D.O.T. requirements applicable to
its operations.
From time to time, tax authorities have sought to assert that owner
operators in the trucking industry are employees, rather than independent
contractors. No such tax claim has been successfully made with respect to
Morgan. Under existing industry practice and interpretations of federal and
state tax laws, as well as Morgan's current method of operation, Morgan, based
on the advice of counsel, maintains that its owner operators are not employees.
Whether an owner operator is an independent contractor or employee is, however,
generally a fact-sensitive determination and the laws and their interpretations
can vary from state to state. There can be no assurance that tax authorities
will not successfully challenge this position, or that such tax laws or
interpretations thereof will not change. If the owner operators were determined
to be employees, such determination could materially increase Morgan's payroll
tax and workers' compensation insurance costs.
Interstate, Morgan's insurance subsidiary, is a captive insurance
company incorporated under Vermont law. It is required to report annually to the
Vermont Department of Banking, Insurance & Securities and must submit to an
examination by this Department on a triennial basis. Vermont regulations require
Interstate to be audited annually and to have its loss reserves certified by an
approved actuary. Morgan believes Interstate is in substantial compliance with
Vermont insurance regulations.
III. SPINNAKER STOCK
Interactive will own 1,000,000 shares of Common Stock of Spinnaker, of
which all are pledged by Lynch to two banks to secure two lines of credit to
Lynch aggregating $20.0 million. Interactive intends to sell such shares from
time to time to fund its acquisition program. On May 28, 1999, the closing price
in limited trading of Spinnaker Common Stock on the AMEX was $13.75 per share.
See "Risk Factors - Interactive May Have Difficulty Selling Spinnaker Stock."
Spinnaker is a leading manufacturer of adhesive backed paper label
stock and industrial tape for the packaging industry as well as being a major
supplier of stock for pressure sensitive U.S. postage stamps. On April 12, 1999,
Spinnaker announced that it has agreed to sell its two industrial tape business
units to Intertape Polymer Group, Inc. (AMEX"ITP; Toronto), Montreal, Quebec,
Canada, for approximately U.S. $105 million and 300,000 seven-year warrants to
purchase Intertape common shares at a price of U.S. $35 each. The two
subsidiaries are Central Products Company, acquired from Alco Standard in 1995,
and Spinnaker Electrical, a pressure sensitive electrical tape business acquired
from tesa tape, inc., in 1998. The transactions are subject to certain
conditions including U.S. Government approval, which will govern the closing
dates. The sales are part of a plan to seek strategic alternatives which
Spinnaker announced in November 1998.
31
IV. OTHER INFORMATION
While Interactive holds licenses of various types, Interactive does not
believe they are critical to its overall operations, except for (1) the
television-broadcasting licenses of WHBF-TV and WOI-TV; (2) Interactive's
telephone subsidiaries' franchise certificates to provide local-exchange
telephone service within its service areas; (3) Western New Mexico Telephone
Company's FCC licenses to operate point-to-point microwave systems; (4) licenses
held by partnerships and corporations in which Western New Mexico Telephone
Company and Inter-Community Telephone Company own minority interests to operate
cellular telephone systems covering areas in New Mexico and North Dakota, (5)
CLR Video's franchises to provide cable television service within its service
areas and (6) personal communications services licenses held by companies in
which Interactive's subsidiaries have investments, as well as the Las Cruces,
New Mexico PCS License held by Interactive.
The capital expenditures, earnings and competitive position of
Interactive have not been materially affected by compliance with current
federal, state, and local laws and regulations relating to the protection of the
environment; however, Interactive cannot predict the effect of future laws and
regulations. Interactive has not experienced difficulties relative to fuel or
energy shortages but substantial increases in fuel costs or fuel shortages could
adversely affect the operations of Morgan.
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations" for a discussion of Year 2000 matters.
Interactive is a party to certain lawsuits in the ordinary course of
business, primarily at Morgan. See "Risk Factors - Morgan Claims Costs May
Affect Profitability" and "Business of Interactive - II. Services The Morgan
Group, Inc. - Risk Management, Safety and Insurance" for information on claims,
lawsuits and insurance relating to Morgan.
No portion of the business of Interactive is regarded as seasonal,
except that, in the case of Morgan, fewer shipments are scheduled during the
winter months in those parts of the country where weather conditions limit
highway use.
There were no customers in 1998 or 1997 that represents 10% or more of
combined revenues, except for Oakwood Homes Corporation (15.5% in 1998 and 11.1%
in 1997) and Fleetwood Enterprises, Inc. (12.7% in 1998 and 14.5% in 1997).
Interactive does not believe that its multimedia business is dependent on any
single customer.
Excluding the following for Morgan: approximately 1,530 independent
owner-operators and 1,420 other drivers, Interactive had a total of
approximately 630 employees at December 31, 1998, compared to approximately 633
employees at December 31, 1997.
Additional information with respect to each of Interactive's segments
is included in Note 13, Segment information to the Combined Financial Statements
included herein.
RELATIONSHIP BETWEEN LYNCH AND INTERACTIVE
AFTER THE SPIN OFF
Interactive was organized by Lynch as a wholly owned subsidiary. After
the Spin Off, Lynch will not have any ownership interest in Interactive, and
Interactive will be an independent public company.
32
Six current directors of Lynch will become directors of Interactive. It
is currently expected that for a period of up to three years following the Spin
Off, the current executive officers of Lynch will also be the executive officers
of Interactive. The employees of the corporate office of Lynch will become
employees of Interactive, and Lynch will be charged a management fee for
corporate services provided by the Interactive corporate office to Lynch. Lynch
will have no corporate office of its own.
Prior to the Spin Off, Interactive and Lynch will enter into a
Separation Agreement, described below, for the purpose of governing their
relationship subsequent to the Spin Off, including the provision of management
services and the allocation of tax and certain other liabilities and
obligations. Following the Spin Off, additional or modified agreements,
arrangements and transactions may be entered into by Interactive, Lynch and
their respective subsidiaries. The Separation Agreement was not and any
additional or modified agreements arrangements and transaction may not be the
result of arm's-length negotiations between independent parties, and as a result
the terms may be more or less favorable to one of the companies than if made on
an arms length basis.
The Separation Agreement will be filed as an exhibit to Interactive's
Registration Statement filed with the SEC registering Interactive's Common Stock
under the Exchange Act. The following description summarizes the material terms
of the Agreement, but the following descriptions do not purport to be complete
and are qualified in their entirety by reference to the exhibit.
The Separation Agreement provides that the transfer by Lynch to
Interactive of the assets and business entities constituting Interactive are on
an "as is, where is" basis, and no representations or warranties are being made
by Lynch with respect thereto.
The Separation Agreement provides that each of Lynch and Interactive
will be granted access to certain records and information in the possession of
the other and requires each of Lynch and Interactive to provide to the other
copies of all documents filed with the SEC pursuant to the periodic and interim
reporting requirements of the Exchange Act.
The Separation Agreement provides that, in general, except as otherwise
set forth therein or in any related agreement, all costs and expenses incurred
in connection with the Spin Off will be paid 50% by each Company.
The Separation Agreement generally provides for the assumption of
liabilities and cross indemnities designed to place with Interactive
responsibility for liabilities of its Interactive Businesses and with Lynch
responsibility for liabilities of its retained businesses. The Separation
Agreement generally provides that Interactive will be responsible for any tax
liabilities relating to its businesses, whether before or after the Spin Off,
and Lynch will be responsible for any tax liabilities relating to its retained
businesses, whether before or after the Spin Off, and for cross
indemnifications.
The Separation Agreement provides that Interactive may use the names
Lynch Interactive, Lynch Telephone, Lynch Telecommunications, Lynch Multimedia
and derivatives. While it is currently expected that Interactive will not seek
manufacturing acquisitions similar to Lynch's current manufacturing operations
and Lynch will not seek multimedia and transportation services acquisitions
similar to Interactive's current multimedia and services operations, the
Separation Agreement does not restrict either Interactive or Lynch.
The Separation Agreement provides that employees of the corporate
office of Lynch will become employees of Interactive following the Spin Off and
that Interactive will provide corporate management services to Lynch for a
transition period of up to three years, with Lynch paying a proportion of
Interactive's corporate office expense as described below under "Corporate
Expense." Subject to the direction of Lynch's
33
Board of Directors, such corporate management services may include supervision
of operating subsidiaries, strategic planning, acquisition analysis, investment
banking and financial advisory services, supervision of the preparation of the
corporate tax returns, and supervision of financial reporting and other
regulatory matters applicable to Lynch as a public company. In providing these
services, Interactive may employ consultants and other advisers in addition to
utilizing its own employees. The Separation Agreement provides that Interactive
shall not be liable to Lynch in connection with the provision of such services
except for its wilful misconduct and that Lynch will indemnify Interactive to
the maximum extent permitted by law for any claims against it except where it
has been found liable for its willful misconduct.
EXECUTIVE OFFICERS AND DIRECTORS OF INTERACTIVE
The executive officers and directors of Interactive, and their ages as
of April 1, 1999 are as follows:
Name
Age
Position
Mario J. Gabelli
56
Director, Chairman of the Board and
Chief Executive Officer
Robert E. Dolan
47
Chief Financial Officer
Robert A. Hurwich
57
Vice President-Administration,
General Counsel and Secretary
Paul J. Evanson
57
Director
John C. Ferrara 47
Director
David C. Mitchell
57
Director
Salvatore Muoio
39
Director
Ralph R. Papitto
72
Director
Mario J. Gabelli, Chairman and Chief Executive Officer of the Corporation
(since 1986); Chairman and Chief Executive Officer of Gabelli Funds, Inc.,
(since 1980), a private company which makes investments for its own account;
Chairman and Chief Executive Officer of Gabelli Asset Management Inc. (since
1999), a NYSE listed holding company for subsidiaries engaged in various aspects
of the securities business (including GAMCO Investors, Inc. of which he is
Chairman and Chief Executive Officer); Director/Trustee and/or President of
thirteen registered investment companies managed by Gabelli Funds, LLC (since
1986); Director of East/West Communications, Inc.; Governor of the American
Stock Exchange.
Robert E. Dolan, Chief Financial Officer of Lynch (since February 1992) and
Controller (since May 1990).
Robert A. Hurwich, Vice President-Administration, General Counsel and
Secretary of Lynch Corporation since February 1994.
Paul J. Evanson, President (since 1995) of Florida Power & Light Co.; Vice
President, Finance and Chief Financial Officer of FPL Group, Inc. (1992-1995),
parent company of Florida Power & Light; President and Chief Operating Officer
of Lynch (1988 - 1992); Chairman (1990 - 1992) and President (1988 - 1992)
34
of Spinnaker Industries, Inc., a subsidiary of Lynch engaged in the
manufacturing of adhesive backed materials; Director of FPL Group, Inc., Florida
Power & Light Company and Southern Energy Homes, Inc.
John C. Ferrara, Executive Vice President and Chief Financial Officer
(1998-January 1999) of Golden Books Family Entertainment, Inc., a NASDAQ company
which published, licensed and marketed entertainment products and subsequently
filed for protection under the Bankruptcy Act in late February 1999; Vice
President and Chief Financial Officer (1989-1997) of Renaissance Communications
Corp., a NYSE company which owned and operated television broadcast stations;
from 1973-1989, various financial positions at The American Express Company,
National Broadcasting Company (NBC) and Deloitte & Touche; Director of Gabelli
Funds, Inc. (since 1999).
David C. Mitchell, President of the Telephone Group and member of the Board
of Directors of Rochester Telephone (now Frontier Corp.) until 1992; President
and Chief Executive Officer of Personal Sound Technologies, Inc., a development
stage new venture company bringing a technology hearing aid to market (1992-3);
Advisor to C-Tec Corporation from 1993 to its corporate reorganization in 1997;
Director of Commonwealth Telephone Enterprises, Inc. (where he has also serves
as an adviser), USN Communications, Inc., Marine Midland Bank (Rochester, NY
Board), Finger Lakes Long Term Care Insurance Co. and IBS International Corp.
Salvatore Muoio, Principal and Chief Investment Officer of S. Muoio & Co.
LLC, a securities advisory firm (since 1996); Security Analyst and Vice
President of Lazard Freres & Co., L.L.C., an investment banking firm
(1995-1996); Securities Analyst at Gabelli & Company, Inc. (1985-1995).
Ralph R. Papitto, Chairman and Chief Executive Officer of AFC Cable
Systems, Inc. a manufacturer and supplier of electrical distribution products
(since 1993); Founder, Chairman and a Director of Nortek, Inc., a manufacturer
of construction products (1967-1993); Director of AFC Cable Systems, Inc.;
Chairman of the Board of Trustees of Roger Williams University.
The Board of Directors of Interactive has established three standing
committees, the principal duties of which are described below:
Audit Committee: Will recommend to the Board of Directors the
appointment of independent auditors; will review annual financial reports to
shareholders prior to their publications; will review the report by the
independent auditors concerning management procedures and policies; and will
determine whether the independent auditors have received satisfactory access to
Interactive's financial records and full cooperation of corporate personnel in
connection with their audit of Interactive's records. The present members are
Messrs. Ferrara (Chairman), Mitchell and Muoio.
Executive Compensation and Benefits Committee: Will develop and make
recommendations to the Board of Directors with respect to Interactive's
executive compensation policies; will recommend to the Board of Directors the
compensation to be paid to executive officers; will administer Interactive's
executive benefit plans; and will perform such other duties as may be assigned
to it by the Board of Directors. The initial members will be Messrs. Papitto
(Chairman), and Evanson.
Executive Committee: Will exercise all power and authority of the Board
of Directors, except as otherwise provided by Delaware law or by the By-laws of
Interactive, in the management affairs of Interactive during intervals between
meetings of the Board of Directors. The present members are Messrs Gabelli
(Chairman), Evanson and Papitto.
35
Interactive does not have a nominating committee. Nominations for
directors and officers of Interactive are matters considered by the entire Board
of Directors.
Compensation of Directors. Directors, who are not otherwise employees,
receive a monthly cash retainer of $1,500 and a fee of $2,000 for each in person
Board of Directors meeting and a fee of $1,000 for each telephonic Board of
Directors meeting (which lasts more than one hour) and each Committee meeting
the Director attends. In addition, a non-employee director serving as a
committee chairman receives an addition $2,000 annual cash retainer. A Director
who is an employee of Interactive is not compensated for services as a member of
the Board of Directors or any committee thereof. In addition, Interactive
purchases accident and dismemberment insurance coverage of $100,000 for each
member of the Board of Directors and maintains a liability insurance policy
which provides for indemnification of each Director (and officer) against
certain liabilities which each may incur in his capacity as such.
Indemnification of Directors and Officers. Under Section 145 of the
Delaware General Corporation Law ("Delaware Law"), the Company has broad powers
to indemnify its directors and officers against liabilities they may incur in
such capacities, including liabilities under the Securities Act. The Company's
Certificate of Incorporation provides that directors and officers of the Company
shall be indemnified to the fullest extent of Delaware law.
The Delaware Law provides that a corporation may limit the liability of
each director to the corporation or its stockholders for monetary damages except
for liability (i) for any breach of the director's duty of loyalty to the
corporation or its stockholders, (ii) for acts or omissions not in good faith or
that involve intentional misconduct or a knowing violation of law, (iii) in
respect of certain unlawful dividend payments or stock redemptions or
repurchases and (iv) for any transaction which the director derives an improper
personal benefit. The Certificate of Incorporation provides for the elimination
and limitation of the personal liability of directors of the Company for
monetary damages to the fullest extent permitted by Delaware Law. In addition,
the Certificate of Incorporation provides that if Delaware Law is amended to
authorize the further elimination or limitation of the liability of a director,
then the liability of the directors shall be eliminated or limited to the
fullest extent permitted by Delaware Law, as so amended. The effect of this
provision is to eliminate the rights of the Company and its stockholders
(through stockholders' derivative suits on behalf of the Company) to recover
monetary damages against a director for breach of the fiduciary duty of care as
a director (including breaches resulting from negligent or grossly negligent
behavior) except in the situations described in clauses (i) through (iv) above.
This provision does not limit or eliminate the rights of the Company or any
stockholder to seek non-monetary relief such as an injunction or recission in
the event of a breach of a director's duty of care. The Company's Certificate of
Incorporation also provides that the Company shall, to the full extent permitted
by Delaware Law, as amended from time to time, indemnify and advance expenses to
each of its currently acting and former directors, officers, employees and
agents.
At present, there is no pending litigation or proceeding involving any
director, officer, employee or agent of Interactive where indemnification will
be required or permitted.
Executive Officers. The principal executive officers of Interactive
will initially be the same as the principal executive officers of Lynch. After a
transition period of up to three years, the chief executive officer and the
other principal officers can only be executive officers of either Interactive or
Lynch, although Mr. Gabelli may remain the Chairman of the Board of the company
of which he is no longer chief executive officer.
No determination has been made at this time as to which company the executive
officers will continue to serve.
Executive Officers Compensation. Messrs. Gabelli, Dolan and Hurwich have
been executive officers at Lynch for at least the last five years and are
expected to be executive officers of both Manufacturing and
36
Interactive for a transition period of up to three years from the date of the
Spin Off. As employees of Lynch, they received the following compensation:
SUMMARY COMPENSATION TABLE
Annual Compensation
Long Term
Name and Compensation All Other
Principal Awards Compensation
Position Year Salary($) Bonus($)1 Stock Underlying Option2 ($)3
- -------- ---- --------- --------- ------------------------ ----
Mario J. Gabelli 1998 500,000 0 - 200
Chief Executive Officer, 1997 500,000 0 25,000 200
Chairman of the Board 1996 500,000 0 - 200
Chairman of the Executive
Committee
Robert E. Dolan 1998 240,000 50,000 2,000 200
Chief Financial Officer 1997 201,000 0 4,000 200
1996 172,500 200,000 4,000 200
Robert A. Hurwich 1998 164,000 20,000 1,000 200
Vice President-Admin.- 1997 156,000 0 1,500 200
istration, Secretary, 1996 147,500 50,000 2,500 200
General Counsel
Corporate Expense
The employees of Lynch's corporate office will become employees of
Interactive at the time of the Spin Off and Interactive will become a lessee
with Lynch of the corporate office lease in Rye. After the Spin Off, Interactive
will provide corporate management services to Lynch for a period of up to three
years, and either Interactive or Lynch may amend or terminate the arrangements
at any time on 90 days notice to the other.
Pursuant to the management arrangement, expenses specifically related
to Interactive or Lynch will be charged to the company for which they were
incurred. Other corporate office expenses such as employee expense, rent, and
other non-specifically allocated corporate office expenses ("Corporate Overhead
Expense"), will be allocated between Interactive and Lynch. Based principally on
an informal estimate of time spent by the corporate office in the past on
Interactive and Lynch matters, the initial allocation of Corporate Overhead
Expense after the Spin Off will be 75% to Interactive and 25% to Lynch. However,
Interactive or Lynch may change that allocation from time to time to reflect
changing time estimates or other factors determined to be relevant at the time.
The employees have not and will not keep time sheets, and the allocation was not
and in the future may not be the result of arms-length negotiations and as a
result may be more or less favorable to one company or the other than might
otherwise result. Total corporate expense for pre-Spin Off Lynch for the year
ended December 31, 1998, was approximately $2.4 million. Interactive may hire an
executive substantially all of whose time would be spent on Interactive,
particularly its multimedia businesses, and
<FN>
- --------
1 Bonuses earned during any fiscal year are generally paid during the
following fiscal year.
2 Shares of Common Stock underlying Phantom Stock Plan awards.
3 The compensation reported represents contributions made by Lynch to the
Lynch 401(k) Savings Plan. The amount of perquisites, as determined in
accordance with the rules of the Securities and Exchange Commission
relating to Executive Compensation did not exceed the lesser of $50,000 or
10% of salary and bonus for 1998.
</FN>
37
whose cost would be billed accordingly. Total corporate expense for Interactive
and Lynch after the Spin Off may be greater than for Lynch before the Spin Off.
This may result, in part, from the fact that there will be two public companies,
each with its own shareholders, transfer agent and registrar, directors,
directors and officers insurance, stock exchange listing, SEC filing, auditing
and other public company expenses.
Bonuses for corporate headquarters employees in 1999 are expected to be
determined under Lynch's bonus plans as if the Spin Off had not occurred, and
Interactive is expected to bear its proportionate share. Beginning in 2000, each
of Interactive and Lynch will determine their own bonuses for corporate office
staff and bear the cost thereof.
With respect to the 43,000 units under Lynch's Phantom Stock Plan, each
representing one share of Lynch stock outstanding at the time of the Spin Off,
the units will be divided into two units, one representing one share of
Interactive stock and one representing one share of Lynch stock. The original
unit grant price will be divided between the two new units based upon the
average relative market price of Interactive stock versus Lynch stock for the
five trading days beginning on the eleventh trading day after the effective date
of the Spin Off. Because the grant price has to double within the five grant
periods for the units to be exercisable, it is not currently probable that any
units will be exercised. However, each of Interactive and Lynch will bear its
own cost of the divided units. Interactive intends to adopt a new Phantom Stock
Plan similar to existing Lynch Phantom Stock Plan.
The foregoing arrangements, including the allocation of Corporate
Overhead Expense, may be changed in the future by either Interactive or Lynch.
TRANSACTIONS WITH CERTAIN AFFILIATED PERSONS
Mr. Gabelli is affiliated with various entities which he directly or
indirectly controls and which are engaged in various aspects of the securities
business, such as an investment advisor to various institutional and individual
clients including registered investment companies and pension plans, as a
broker-dealer, and as managing general partner of various private investment
partnerships. During 1998, Lynch and its subsidiaries engaged in various
transactions with certain of these entities and the amount of commissions, fees,
and other remuneration paid to such entities, excluding reimbursement of certain
expenses related to Mr. Gabelli's employment by the Corporation (including
approximately $72,000 reimbursement in connection with an airplane in part owned
by a subsidiary of Gabelli Funds, Inc.), was less than $60,000.
As of August 12, 1996, Rivgam Communicators, L.L.C., a subsidiary of
GFI, agreed to pay a subsidiary of Lynch a 10% net profit interest (after a
capital charge) in Rivgam in return for certain services provided or to be
provided, by Lynch's subsidiary in connection with bidding on and developing PCS
licenses. In December, 1998, Rivgam transferred to the subsidiary of Lynch a 10
megahertz PCS license in the Las Cruces, NM BTA in full satisfaction of Rivgam's
obligations under the agreement. The cost of the license to Rivgam in the
Federal Communications Commission's auction in 1997 was $674,000. In March, 1997
and February 1998, Bal/Rivgam, L.L.C. and BCK/Rivgam, L.L.C., in which
affiliates of GFI have a 49.9% interest, agreed to pay the subsidiary a 5% net
profits interest (after a capital charge) in Bal/Rivgam and BCK/Rivgam,
respectively, in return for certain services provided or to be provided by
Lynch's subsidiary in connection with bidding on and developing wireless
communication service licenses and local multipoint distribution services
licenses. Mr. Gabelli is the principal shareholder of GFI and is its Chairman
and Chief Executive Officer.
In 1998, Lynch entered into a lease for approximately 5,000 square feet
in a building in Rye, New York, recently purchased by an affiliate of Mr.
Gabelli, which Interactive will become a party to. The lease runs through
December, 2002, and provides for rent at approximately $18.00 per square foot,
per annum plus
38
a minimum of $2.50 per square foot per annum for electricity, subject to
adjustment for increases in tax and other operating expenses. The amount of the
lease is currently approximately $8,620 per month.
In 1998, Interactive has entered into a non-exclusive agreement with
Gabelli & Company, Inc. ("G&C"), a subsidiary of GFI, pursuant to which G&C
would act as a financial advisor to assist the Corporation in the realization of
the value of its television investments. In the event that a transaction is
consummated with a party contacted by G&C, the Corporation would pay G&C a fee
of 0.75% of the consideration received.
PRINCIPAL STOCKHOLDERS OF INTERACTIVE
The following table sets forth certain information regarding beneficial
ownership of the Interactive's Common Stock effective as of the Spin Off by (i)
each person who is known by Interactive to own beneficially more than five
percent of Interactive's Common Stock, (ii) each of the Interactive's directors,
(iii) each of the Named Officers and (iv) all current executive officers and
directors as a group.
Name of Amount and Nature Percent
Beneficial Owner* of Beneficial Ownership of Class
----------------- ----------------------- --------
Dimensional Fund Advisors, Inc 86,900(1) 6.1%
Mario J. Gabelli 323,863(2) 22.8%
Paul J. Evanson 5,652 **
John C. Ferrara 414 **
David C. Mitchell 400(3) **
Salvatore Muoio 852 **
Ralph R. Papitto 952 **
Robert E. Dolan 235(4) **
Robert A. Hurwich 257(5) **
All Directors and Executive Officers
as a group (eight in total) 332,625 23.5%
* The address of each holder of more than 5% of the Common Stock is as follows:
Dimensional Fund Advisors - 1299 Ocean Avenue, Santa Monica, CA 90401; and Mr.
Gabelli - Corporate Center at Rye, Rye, NY 10580.
** Represents holdings of less than one percent.
<FN>
(1) Because of its investments and/or voting power over shares of Common
Stock of the Corporation held in the accounts of its investment
advisory clients, Dimensional Fund Advisors, Inc., an investment
adviser ("Dimensional"), is deemed to be the beneficial owner of 84,500
shares. Dimensional disclaims beneficial ownership of all such shares.
(2) Includes 252,836 shares of Common Stock owned directly by Mr. Gabelli
(including 2,922 held for the benefit of Mr. Gabelli under the
Corporation's 401(k) Savings Plan), 2,000 shares owned by a charitable
foundation of which Mr. Gabelli is a trustee and 70,000 shares owned by
a limited partnership in which Mr. Gabelli is the general partner and
has a 20% interest. Mr. Gabelli disclaims beneficial ownership of the
shares owned by the foundation and by the partnership, except for his
20% interest therein.
(3) 200 shares jointly owned with wife and sharing voting and investment
power.
(4) Includes 35 shares registered in the name of Mr. Dolan's children with
respect to which Mr. Dolan has voting and investment power.
(5) Held for the benefit of Mr. Hurwich under the Corporation's 401(k)
Savings Plan.
</FN>
Morgan is an approximately 55% owned subsidiary of the Company whose
stock is traded on the AMEX. As of 1999 Mr. Gabelli beneficially owns 10,000
shares (0.8%) of Morgan Group's Class A
39
Common Stock. He may also be deemed to be a beneficial owner of 155,900 shares
of Morgan's Class A Common Stock and 1,200,000 shares of Morgan's Class B Common
Stock owned by the Company, by virtue of his ownership of 22.8% of the shares of
Common Stock of the Company. Mr. Gabelli, however, specifically disclaims
beneficial ownership of all shares of Morgan Group stock held by Interactive.
DESCRIPTION OF CAPITAL STOCK OF INTERACTIVE
General
The Company is authorized to issue 10,000,000 shares of Common Stock,
$.0001 par value. The following description of the Company's capital stock does
not purport to be complete and is subject to and qualified in its entirety by
the Company's Certificate of Incorporation and Bylaws, and by the provisions of
applicable Delaware law.
Common Stock
There are 1,418,248 shares of Common Stock outstanding and held by
Lynch. Concurrently with the Spin Off, all of such shares will be transferred to
shareholders of Lynch. The holders of Common Stock are entitled to receive
ratably such dividends, if any, as may be declared from time to time by the
Board of Directors out of funds legally available therefor. See "Dividend
Policy." Each share of Common Stock will have one vote on all matters submitted
to a vote of shareholders. In the event of the liquidation, dissolution or
winding up of Interactive, the holders of Common Stock are entitled to share
ratably in all assets remaining after payment of liabilities, if any, then
outstanding.
Delaware Takeover Statute
The Company is subject to Section 203 of the Delaware General
Corporation Law ("Section 203"), which, subject to certain exceptions, prohibits
a Delaware corporation from engaging in any business combination with any
interested shareholder for a period of three years following the date that such
stockholder became an interested stockholder, unless: (i) prior to such date,
the board of directors of the corporation approved either the business
combination or the transaction that resulted in the stockholder becoming an
interested stockholder; (ii) upon consummation of the transaction that resulted
in the stockholder becoming an interested stockholder, the interested
stockholder owned at least 85% of the voting stock of the corporation
outstanding at the time the transaction commenced, excluding for purposes of
determining the number of shares outstanding those shares owned (a) by persons
who are directors and also officers and (b) by employee stock plans in which
employee participants do not have the right to determine confidentially whether
shares held subject to the plan will be tendered in a tender or exchange offer;
or (iii) on or subsequent to such date, the business combination is approved by
the board of directors and authorized at an annual or special meeting of
stockholders, and not by written consent, by the affirmative vote of at least 66
2/3% of the outstanding voting stock that is not owned by the interested
stockholder.
Section 203 defines business combination to include: (i) any merger or
consolidation involving the corporation and the interested stockholder; (ii) any
sale, transfer, pledge or other disposition of 10% or more of the assets of the
corporation involving the interested stockholder; (iii) subject to certain
exceptions, any transaction that results in the issuance or transfer by the
corporation of any stock of the corporation to the interested stockholder; (iv)
any transaction involving the corporation that has the effect of increasing the
proportionate share of the stock of any class or series of the corporation
beneficially owned by the interested stockholder; or (v) the receipt by the
interested stockholder of the benefit of any loans, advances, guarantees,
pledges or other financial benefits provided by or through the corporation. In
general, Section 203 defines an
40
interested stockholder as any entity or person beneficially owning 15% or more
of the outstanding voting stock of the corporation and any entity or person
affiliated with or controlling or controlled by such entity or person.
Transfer Agent and Registrar
The Transfer Agent and Registrar for the Common Stock of Interactive is
ChaseMellon Shareholder Services.
FEDERAL INCOME TAX CONSEQUENCES OF SPIN OFF
Lynch has received a private tax ruling from the Internal Revenue
Service ("IRS") to the effect that:
1. The Spin Off will qualify as a tax-free spin off under Section 355
and 368 (a)(1)(D) of the Internal Revenue Code of 1986, as amended
(the "Code").
2. No gain or loss with respect to the Interactive shares being spun
off will be recognized by Lynch on the Spin Off.
3. No gain or loss will be recognized by the holders of Lynch Common
Stock solely as a result of their receipt of shares being spun
off.
4. The tax basis of Lynch Common Stock and the Interactive shares
held immediately after the Spin Off by any holder will equal such
holder's tax basis in its Lynch Common Stock before the Spin Off,
allocated in proportion to the relative fair market values of the
Lynch Common Stock and the Interactive shares on the Spin Off
date.
5. The holding period of the Interactive shares received in the Spin
Off will include the holding period of the Lynch Common Stock with
respect to which the Interactive shares were distributed, provided
that such Lynch Common Stock was held as a capital asset on the
Spin Off date.
The IRS Ruling is subject to certain assumptions and the accuracy of
certain representations made by Lynch. Neither Lynch nor Interactive is aware of
any present facts or circumstances that would cause such assumptions or
representations to be untrue.
If the Spin Off were not to qualify as a tax-free spin off under
Sections 355 and 368(a)(1)(D) of the Code, then (i) Lynch would recognize
capital gain equal to the excess of (x) the fair market value of the Interactive
shares on the Spin Off date, over (y) Lynch's adjusted tax basis in the
Interactive shares on such date, and (ii) each holder of Lynch Common Stock who
receives Interactive shares in the Spin Off would be treated as receiving a
taxable distribution in an amount equal to the fair market value of such
Interactive shares on the Spin Off date, taxed first as a dividend to the extent
of such holder's pro rata share of Lynch's current and accumulated earnings and
profits, and then as a nontaxable return of capital to the extent of such
holder's basis in the Lynch Common Stock, with any remaining amount being taxed
as capital gain.
Even if the Spin Off qualifies as a tax-free spin off under Sections
355 and 368(a)(1)(D) of the Code, Lynch (but not Lynch shareholders) also would
recognize taxable gain on the Spin Off (determined as if Lynch had sold all the
Interactive shares for fair market value on the Spin Off date) if (a) 50% or
more of the outstanding stock of Interactive or Lynch were acquired (or deemed
to be acquired pursuant to certain transactions involving the stock or assets of
Lynch, Interactive, or their subsidiaries, and (b) the Spin Off and such
acquisition were treated as part of a plan or series of related transactions
(such a transaction, a "Change in Control Transaction"). For that purpose, any
acquisition of stock of Lynch or Interactive within the period
41
beginning two years prior to the Spin Off date and ending two years after the
Spin Off date would be presumed to be part of such a plan or series of related
transactions, although Lynch or Interactive, as the case may be, may be able to
rebut such presumption.
Pursuant to the Separation Agreement, Interactive and Lynch will each
bear their respective share of any corporate level tax arising on the Spin Off,
except that Interactive or Lynch, as the case may be, will be obligated to
indemnify the other party on an after-tax basis for 100% of such corporate level
tax if such tax is primarily attributable to (i) actions of Interactive or Lynch
after the Spin Off (including any cessation, transfer to affiliates or
disposition of its active trades or businesses, and certain reacquisitions of
its stock and payments of extraordinary dividends to its shareholders) or (ii)
involvement by Interactive or Lynch in a Change in Control Transaction.
Notwithstanding the foregoing provisions, under the consolidated return
regulations, Interactive and Lynch will each be severally liable to the IRS for
the full amount of any corporate level tax arising on the Spin Off that is not
paid by the other party. Neither Interactive nor Lynch will indemnify any holder
of Lynch Common Stock who receives shares in the Spin Off for any tax
liabilities.
Certain restructuring transactions that Lynch will effect prior to the
Spin Off may trigger tax liabilities.
Current U.S. Treasury Regulations require each holder of Lynch Common
Stock who receives Interactive Common Stock pursuant to the Spin Off to attach
to his or her U.S. federal Income tax return for the year in which the Spin Off
occurs a detailed statement setting forth such data as may be appropriate in
order to show the applicability of Section 355 to the Spin Off. Following the
Spin Off, Lynch will convey the appropriate information to each holder of record
of Lynch Common Stock as of the Record Date.
This discussion of the anticipated Federal income tax consequences of
the Spin Off is for general information only and may not be applicable to
shareholders who are not citizens or residents of the United States or who are
otherwise subject to special treatment under the Code. Lynch stockholders should
consult their own advisers as to the specific tax consequences of the Spin Off,
including the effects of foreign, state and local tax laws and the effect of
possible changes in tax laws. See also "Risk Factors--Tax Free Spin Off Ruling."
AVAILABLE INFORMATION
Interactive has filed with the SEC a Registration Statement under the
Exchange Act with respect to the Shares being issued in the Spin Off. This
Information Statement does not contain all of the information set forth in the
Registration Statement and the exhibits thereto, to which reference is hereby
made. Statements made in this Information Statement as to the contents of any
contract, agreement or other document referred to herein are summaries only and
are not necessarily complete. With respect to each such contract, agreement or
other document filed as an exhibit to the Registration Statement, reference is
made to such exhibit for a more complete description of the matter involved, and
each such statement shall be deemed qualified in its entirety by such reference.
The Registration Statement and the exhibits thereto filed by Interactive with
the SEC may be inspected at the public reference facilities of the SEC listed
below.
After the Spin Off, Interactive will be subject to the informational
requirements of the Exchange Act, and in accordance therewith will file reports,
proxy statements and other information with the SEC. Such reports, proxy
statements and other information can be inspected and copied at the public
reference facilities maintained by the Commission at its principal offices at
Room 1024, 450 Fifty Street, N.W., Washington, D.C. 20549 and at the Regional
Offices of the Commission at Seven World Trade Center, Suite 1300, New York, New
York 10048 and in the Citicorp Center, Suite 1400, 500 West Madison Street,
Chicago, Illinois 60661. Copies of such information may be obtained from the
Public Reference Section of the Commission at 450 Fifth Street, N.W.,
Washington, D.C. 20549 at prescribed rates. The Commission also maintains a
World Wide
42
Web site (http://www.sec.gov) that contains reports, proxy and information
statements and other information regarding registrants that file electronically
with the Commission. In addition, it is expected that reports, proxy statements
and other information concerning Interactive will be available for inspection at
the offices of the American Stock Exchange, 86 Trinity Place, New York, NY,
10006-1881.
Interactive intends to furnish holders of Interactive's shares with
annual reports containing consolidated financial statements (beginning with the
year ending December 31, 1999) audited by independent auditors.
Lynch, Morgan and Spinnaker have filed Annual Reports on Form 10-K and
Quarterly Reports on Form 10-Q with the SEC for the year ended December 31, 1998
and the quarter ended March 31, 1999, which contain additional information on
Lynch, Morgan and Spinnaker.
NO PERSON IS AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS INFORMATION STATEMENT, AND,
IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS
HAVING BEEN AUTHORIZED. NEITHER THE DELIVERY OF THE INFORMATION STATEMENT NOR
ANY DISTRIBUTION OF SECURITIES MADE HEREUNDER SHALL IMPLY THAT THERE HAS BEEN NO
CHANGE IN THE INFORMATION SET FORTH HEREIN OR IN THE AFFAIRS OF INTERACTIVE
SINCE THE DATE HEREOF.
43
Lynch Interactive Corporation
Index to Combined Financial Statements
Page
Report of Independent Auditors F-2
Combined Balance Sheets as of March 31, 1999
(unaudited) and as of December 31, 1998 and 1997 F-3
Combined Statements of Operations for the three
months ended March 31, 1999 and 1998 (unaudited) and
for the years ended December 31, 1998, 1997 and 1996 F-5
Combined Statements of Changes In Equity, Investments by and advances from Lynch
Corporation for the three months ended March 31, 1999, and 1998 (unaudited)
and for the years ended December 31, 1998, 1997 and 1996 F-6
Combined Statements of Cash Flows for the three months ended March 31, 1999 and
1998 (unaudited)
and for the years ended December 31, 1998, 1997 and 1996 F-7
Notes to Combined Financial Statements F-8
F-1
REPORT OF INDEPENDENT AUDITORS
Board of Directors
Lynch Corporation
We have audited the accompanying combined balance sheets of the net assets and
operations to be contributed to Lynch Interactive Corporation (see Note 1) as of
December 31, 1998 and 1997, and the related combined statements of operations,
equity, investments by and advances from Lynch Corporation and cash flows for
each of the three years in the period ended December 31, 1998. These financial
statements are the responsibility of the management of Lynch Corporation (the
"Company"). Our responsibility is to express an opinion on these financial
statements based on our audits. We did not audit the 1996 financial statements
of Dunkirk and Fredonia Telephone Company, a wholly-owned subsidiary of DFT
Communications, Inc. (formerly Lynch Telephone VIII, a wholly-owned subsidiary
of Lynch Corporation) which statements reflect total revenues of $575,000 for
the two month period ended December 31, 1996, the 1997 and 1996 financial
statements of CLR Video, L.L.C., a wholly-owned subsidiary of Lynch Multimedia
(a wholly-owned subsidiary of Lynch Corporation) which statements reflect total
revenues of $1,505,000 and $1,399,000 for the years ended December 31, 1997 and
1996, respectively, and the 1997 and 1996 financial statements of Coronet
Communication Company and of Capital Communications Company, Inc. (corporations
in which the Company has a 20% and 49% interest, respectively). Those statements
were audited by other auditors whose reports have been furnished to us, and our
opinion, insofar as it relates to data included for Dunkirk and Fredonia in
1996, CLR Video, L.L.C. in 1997 and 1996, Coronet Communications Company in 1997
and 1996 and Capital Communications Company, Inc. in 1997 and 1996 , is based
solely on the reports of other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the reports of other auditors provide a
reasonable basis for our opinion.
In our opinion, based on our audits and the reports of other auditors, the
combined financial statements referred to above present fairly, in all material
respects, the combined financial position of the net assets and operations to be
contributed to Lynch Interactive Corporation (see Note 1) at December 31, 1998
and 1997 and the combined results of its operations and its cash flows for each
of the three years in the period ended December 31, 1998, in conformity with
generally accepted accounting principles.
/S/ ERNST & YOUNG LLP
Stamford, Connecticut
March 26, 1999
F-2
Lynch Interactive Corporation
Combined Balance Sheets
(Unaudited)
March 31, December 31,
1999 1998 1997
---- ---- ----
(In Thousands)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 16,130 $ 27,021 $ 27,058
Marketable securities and short-term investments 1,287 967 985
Trade accounts receivable less allowances of $334,
$320 and $286 in 1999, 1998 and 1997, respectively 19,706 18,853 18,907
Deferred income taxes 4,863 4,265 4,148
Other current assets 7,225 6,941 6,821
----- ----- -----
TOTAL CURRENT ASSETS 49,211 58,047 57,919
------ ------ ------
PROPERTY, PLANT AND EQUIPMENT:
Land 1,247 1,247 1,098
Buildings and improvements 9,697 9,591 9,037
Machinery and equipment 130,970 129,251 121,435
------- ------- -------
141,914 140,089 131,570
Accumulated depreciation (51,669) (48,906) (39,797)
------- ------- -------
90,245 91,183 91,773
EXCESS OF COST OVER FAIR VALUE OF NET ASSETS
OF COMPANIES ACQUIRED, NET 47,091 47,740 49,232
INVESTMENTS IN AND ADVANCES TO AFFILIATED ENTITIES 12,958 25,575 27,042
OTHER ASSETS 7,077 6,934 8,410
----- ----- -----
TOTAL ASSETS $ 206,582 $ 229,479 $ 234,376
========= ========= =========
See accompanying notes.
F-3
(Unaudited)
March 31, December 31,
1999 1998 1997
-----------------------------------
(In Thousands)
LIABILITIES AND EQUITY
CURRENT LIABILITIES:
Notes payable to banks $ 3,005 $ 2,037 $ 4,285
Notes payable to Lynch 8,600 15,150 22,714
Trade accounts payable 4,653 4,662 4,228
Accrued interest payable 774 889 886
Taxes payable to Lynch 3,179 2,841 366
Accrued liabilities 16,845 16,176 16,437
Customer advances 1,720 1,996 1,820
Current maturities of long-term debt 7,855 8,639 7,583
TOTAL CURRENT LIABILITIES 46,631 52,390 58,319
-------- -------- --------
LONG-TERM DEBT 117,817 119,024 126,617
DEFERRED INCOME TAXES 7,798 13,007 14,752
OTHER LIABILITIES 5,221 4,987 3,455
MINORITY INTERESTS 9,602 10,527 9,246
EQUITY, INVESTMENTS BY AND ADVANCES FROM
LYNCH CORPORATION 19,513 29,544 21,987
-------- -------- --------
TOTAL LIABILITIES AND EQUITY $206,582 $229,479 $234,376
======== ======== ========
See accompanying notes.
F-4
Lynch Interactive Corporation
Combined Statements of Operations
(Unaudited)
Three Months Ended
March 31, Year ended December 31,
1999 1998 1998 1997 1996
----------------- ------------- ------------- -------------
(In Thousands)
SALES AND REVENUES:
Multimedia $ 13,387 $ 12,932 $ 54,622 $ 47,908 $ 28,608
Services 35,325 33,971 150,454 146,154 132,208
-------- --------- --------- --------- ---------
48,712 46,903 205,076 194,062 160,816
-------- --------- --------- --------- ---------
COSTS AND EXPENSES:
Multimedia 9,585 9,221 38,176 35,363 21,435
Services 32,312 31,950 138,193 135,431 127,236
Selling and administrative 3,248 3,409 12,050 11,980 10,205
-------- --------- --------- --------- ---------
OPERATING PROFIT 3,567 2,323 16,657 11,288 1,940
Other income (expense):
Investment income 816 571 1,865 1,678 2,150
Interest expense (2,684) (2,736) (10,383) (9,740) (6,293)
Equity in earnings of affiliated companies (258) (41) (629) (125) (309)
Reserve for impairment of investment in PCS
license holders (15,406) - - (7,024) -
Gain on sales of subsidiary stock and other
operating assets - - 3,198 263 1,072
(17,532) (2,206) (5,949) (14,948) (3,380)
INCOME (LOSS) BEFORE INCOME TAXES,
MINORITY INTERESTS AND EXTRA-
ORDINARY ITEM (13,965) 117 10,708 (3,660) (1,440)
Benefit (Provision) for income taxes 4,650 (37) (4,857) 830 251
Minority interests (199) 20 (1,224) (631) 747
INCOME (LOSS) BEFORE EXTRA-
ORDINARY ITEM (9,514) 100 4,627 (3,461) (442)
-------- --------- --------- --------- ---------
LOSS FROM EARLY EXTINGUISHMENT OF
DEBT, NET OF TAX BENEFIT OF $105 (160) - - - -
-------- --------- --------- --------- ---------
NET INCOME (LOSS) $ (9,674) $ 100 $ 4,627 $ (3,461) $ (442)
======== ========= ========= ========= =========
F-5
Lynch Interactive Corporation
Combined Statements of Changes in Equity, Investment
by and Advances from Lynch Corporation
(Unaudited)
Three Months Ended
March 31, Year Ended December 31,
1999 1998 1998 1997 1996
-------------------- --------- --------- ---------
(In Thousands)
Equity at beginning of period $ 29,544 $ 21,987 $21,987 $ 24,382 $ 19,820
Net income (loss) (9,674) 100 4,627 (3,461) (442)
Investment by and advances (to) from Lynch
Corporation (357) (641) 2,930 1,066 5,004
-------- -------- ------- -------- --------
$ 19,513 $ 21,446 $29,544 $ 21,987 $ 24,382
======== ======== ======= ======== ========
See accompanying notes.
F-6
Lynch Interactive Corporation
Combined Statements of Cash Flows
(Unaudited)
Three Months Ended Year Ended December 31,
1999 1998 1998 1997 1996
---------- ---------- -------- ----------- ---------
(In Thousands)
OPERATING ACTIVITIES
Net income (loss) $ (9,674) $ 100 $ 4,627 $ (3,461) $ (442)
Depreciation and amortization 3,612 3,593 14,243 13,258 10,158
Net effect of purchases and sales of trading
securities (320) 338 18 1,171 9,276
Minority interests 199 (20) 1,224 631 (747)
Morgan Special Charges - - - - 3,500
Earnings of affiliates 258 41 629 125 428
Reserve for impairment in PCS license holders 15,406 - - 7,024 -
Deferred taxes (5,804) 253 (1,862) (1,741) (344)
Gain on sale of subsidiary stock - - (489) 71 (998)
Changes in operating assets and liabilities,
net of effects of acquisitions:
Receivables - (2,995) 54 (1,858) (656)
Accounts payable and accrued liabilities (853) 3,565 3,173 118 402
Other 665 (446) 752 2,620 (1,038)
Other (284) (401) (2,654) (1,053) (234)
---- ---- ------ ------ ----
NET CASH PROVIDED BY OPERATING
ACTIVITIES 3,205 4,028 19,715 16,905 19,305
----- ----- ------ ------ ------
INVESTING ACTIVITIES
Acquisitions (total cost less debt assumed
and cash equivalents acquired):
Upper Peninsula Telephone Company - - - (24,568) -
Dunkirk and Fredonia - - - - (17,786)
Other - - - - (7,037)
Investment in Personal Communications Services
Partnerships, net (3,106) (100) 3,692 1,644 (27,106)
Capital expenditures (2,270) (2,186) (11,642) (11,837) (12,080)
Investment in Coronet Communications Company - - - 2,995 -
Sale of investments in DBS Operation and - -
cellular partnerships - - - 8,576 -
Other 48 30 272 1,573 (399)
-------- -------- -------- -------- --------
NET CASH USED IN INVESTING ACTIVITIES (5,328) (2,256) (7,678) (21,617) (64,408)
-------- -------- -------- -------- --------
FINANCING ACTIVITIES
Issuance of long-term debt 4,362 - 964 23,765 50,259
Payments to reduce long-term debt (6,353) (1,759) (7,501) (24,643) (7,951)
Net borrowings (payments), lines of credit (5,582) (7,448) (9,812) 8,742 9,610
Advances from Lynch Corp. (357) (641) 2,930 1,066 5,004
Other (838) (126) 1,345 (545) 1,050
-------- -------- -------- -------- --------
NET CASH (USED IN) PROVIDED BY
FINANCING ACTIVITIES (8,768) (9,974) (12,074) 8,385 57,972
-------- -------- -------- -------- --------
Net increase (decrease) in cash and cash
equivalents (10,891) (8,202) (37) 3,673 12,869
Cash and cash equivalents at beginning of year 27,021 27,058 27,058 23,385 10,516
Cash and cash equivalents at end of year $ 16,130 $ 18,856 $ 27,021 $ 27,058 $ 23,385
======== ======== ======== ======== ========
See accompanying notes.
F-7
Lynch Interactive Corporation
Notes to Combined Financial Statements
1. Accounting and Reporting Policies
Background
In 1999, the Board of Directors of Lynch Corporation ("Lynch") approved in
principle the spin off to its shareholders of its multimedia and services
businesses as an independent publicly-traded company (the "Spin- Off"). The
multimedia and services businesses and the independently publicly-traded company
to which the assets and liabilities will be contributed are hereinafter referred
to as Lynch Interactive Corporation (the "Company" or "Lynch Interactive").
Prior to and contemporaneous with the Spin Off, certain legal and regulatory
actions will be taken to perfect the existence of the above mentioned affiliated
multimedia and service companies as subsidiaries of Lynch Interactive
Corporation. At the Spin Off, Lynch will distribute 100 percent of the
outstanding shares of common stock of its wholly-owned subsidiary, Lynch
Interactive, to holders of record of Lynch's common stock as of the close of
business on a date to be determined. Lynch Interactive's operations will consist
primarily of Lynch's multimedia and services businesses. In addition, as part of
the Spin Off, Lynch Interactive will own one million shares of common stock of
Spinnaker Industries, Inc. representing an approximately 13.6% ownership
interest (and an approximate 2.5% voting interest) and Lynch Interactive will
assume certain short-term and long-term debt obligations of Lynch. Prior to the
Spin Off, it is anticipated that Lynch Interactive will succeed to the credit
facilities established by Lynch.
In April 1999, Lynch received an Internal Revenue Service private letter ruling
that the distribution to its shareholders of the stock of Lynch Interactive
qualifies as tax-free for Lynch and its shareholders. In connection with
obtaining the rulings from the Internal Revenue Service ("IRS") as to the
tax-free nature of the Spin Off, Lynch made certain representations to the IRS,
which include, among other things, certain representations as to how Lynch and
Interactive intend to conduct their businesses in the future. The distribution
is subject to various regulatory approvals and approval of a definitive plan of
Lynch's Board of Directors.
Basis of Presentation
The combined financial statements have been prepared using the historical basis
of assets and liabilities and historical results of operations of the multimedia
and services businesses and other assets which will be contributed to
Interactive. However, the historical financial information presented herein
reflects periods during which the Company did not operate as an independent
public company and accordingly, certain assumptions were made in preparing such
financial information. Such information, therefore, may not necessarily reflect
the results of operations, financial condition or cash flows of the Company in
the future or what they would have been had the Company been an independent
public company during the reporting periods. Investments in affiliates in which
the Company does not have majority voting control are accounted for in
accordance with the equity method. All material intercompany transaction and
balances have been eliminated.
Lynch has historically provided substantial support services such as finance,
cash management, legal, and human resources to its various business units. Lynch
allocates the cost for these services among the business units supported based
principally on informal estimates of time spent by the corporate office on both
Interactive and Lynch matters. In the opinion of management, the method of
allocating these costs is reasonable; however, the costs of these services
allocated to the Company are not necessarily indicative of the costs that would
have been incurred by the Company on a stand-alone basis. It is anticipated that
when the Company becomes an
F-8
independent public company administrative expenses will increase by
approximately $.5 million (unaudited) per year as a result of additional
financial reporting requirements, stock transfer fees, directors' fees,
insurance, compensation and other costs.
Lynch Interactive and Lynch will enter into certain agreements governing various
ongoing relationships, including the provision of support services and a tax
sharing agreement. The tax sharing agreement will provide for the allocation of
tax attributes to each company as if it had actually filed with the respective
tax authority.
The Company has a significant need for resources to fund the operations of the
Parent Company and fund future growth. The Company is currently considering
various alternative long and short-term financing arrangements. One such
alternative would be to sell a portion or all of certain investments in certain
operating entities. Additional debt and/or equity financing alternatives are
also being considered. While Lynch management expects to obtain adequate
financing resources to enable the Company to meet its obligations, there is no
assurance that such can be readily obtained or at reasonable costs.
Interim Financial Statements (Unaudited)
The interim financial information as of March 31, 1999 and for the three months
ended March 31, 1999 and 1998 is unaudited. In the opinion of management, the
information furnished in the unaudited interim combined financial statements
reflects all adjustments necessary for a fair presentation of the financial
position and results of operations as of March 31, 1999 and for the three months
ended March 31, 1999 and 1998.
Due to the fact that the services business is seasonal with reduced sales in
winter months, the results of operations for the three months ended March
31,1999 and 1998 may not be indicative of the Company's full year results.
Use of Estimates
The preparation of combined 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. Actual results could differ from those estimates.
Cash Equivalents
Cash equivalents consist of highly liquid investments with a maturity of less
than three months when purchased.
At March 31, 1999, and at December 31, 1998 and 1997, respectively, assets of
$12.3 million, $20.8 million and $19.9 million, which are classified as cash and
cash equivalents, are invested in United States Treasury money market funds for
which affiliates of the Company serve as investment managers to the respective
funds.
Marketable Securities and Short-term Investments
Marketable securities and short-term investments consist principally of common
stocks. At March 31, 1999, and at December 31, 1998, and 1997, respectively, all
marketable securities and United States Treasury money market funds classified
as cash equivalents were classified as trading, with the exception of certain
equity securities at March 31, 1999, and at December 31, 1998 and 1997 with
carrying values of $1.3 million, $1.2 million and $1.0 million, respectively,
which were classified as available-for-sale and included in other assets.
Trading and available-for-sale securities are stated at fair value with
unrealized gains or losses on trading
F-9
securities included in earnings and unrealized gains or losses on
available-for-sale securities included in equity and as a component of
comprehensive income. Unrealized gains (losses) of $320,000, $(203,000),
$82,000, $169,000 and $628,000 on trading securities has been included in
earnings for the three months ended March 31, 1999 and 1998 and for the years
ended December 31, 1998, 1997 and 1996, respectively. During 1998, equity was
adjusted by $59,000 for unrealized gains on available-for-sale securities. There
was no adjustment to equity for the available-for-sale securities at March 31,
1999 or December 31, 1997 and 1996.
The cost of marketable securities sold is determined on the specific
identification method. Realized gains of $0, $103,000, $382,000, $229,000 and
$102,000, and realized losses of $0, $0, $0, $9,000 and $112,000, are included
in investment income for the three months ended March 31, 1999 and 1998 and for
the years ended December 31, 1998, 1997 and 1996, respectively.
Property, Plant and Equipment
Property, plant and equipment are recorded at cost and include expenditures for
additions and major improvements. Maintenance and repairs are charged to
operations as incurred. Depreciation is computed for financial reporting
purposes using the straight-line method over the estimated useful lives of the
assets which range from 3 years to 35 years. For income tax purposes,
accelerated depreciation methods are used.
When a portion of the Company's depreciable property, plant and equipment is
retired, the gross book value of the assets, including cost of disposal and net
of any salvage value, is charged to accumulated depreciation.
Total rent expense was $2.6 million, $2.8 million, and $2.2 million for the
years ended December 31, 1998, 1997 and 1996, respectively.
Excess of Cost Over Fair Value of Net Assets of Companies Acquired, Net
Excess of cost over fair value of net assets of companies acquired (goodwill) is
being amortized on a straight-line basis over periods ranging from twenty to
forty years. The Company periodically reviews goodwill to assess recoverability,
and impairments would be recognized in operating results if a permanent
diminution in value were to occur. The Company measures the potential impairment
of recorded goodwill by the undiscounted value of expected future cash flows in
relation to its net capital investment in the subsidiary. Based on its review,
the Company does not believe that an impairment of its goodwill has occurred.
Excess of cost over fair value of net assets of companies acquired of $47.1
million, $47.7 million and $49.2 million are net of accumulated amortization of
$12.0 million, $11.4 million and $9.0 million at March 31, 1999 and at December
31, 1998 and 1997, respectively.
Equity, Investment By and Advances From Lynch Corporation
Equity represents the net investment in and advances to Interactive by Lynch. It
includes common stock, additional paid-in capital, net earnings and net
intercompany balances with Lynch which will be contributed at the tine of the
Spin Off.
Multimedia
Multimedia revenues include local and intrastate telephone company service
revenues which are subject to review and approval by state public utility
commissions, and long distance network revenues, which are based upon charges to
long distance carriers through a tariff filed by the National Exchange Carriers
Association with the Federal Communications Commission. Revenues are based on
cost studies for the Company's exchanges,
F-10
and have been estimated pending completion of final cost studies. Estimated
revenue is adjusted to actual upon the completion of the cost studies.
Services
Service revenues and related estimated costs of transportation are recognized
when transportation of the manufactured housing, recreational vehicle or other
product is completed. Other operating expenses are recognized when incurred.
Morgan maintains personal injury and property damage insurance of up to
$25,000,000 per occurrence; with a deductible of $150,000 beginning April 1,
1998, and $250,000 for prior periods. Morgan maintains cargo damage insurance of
$1,000,000 per occurrence with a deductible of $150,000 beginning April 1, 1998,
and $250,000 for prior periods. Morgan's cargo damage insurance policy includes
a stop-loss provision, under which Morgan has recorded a receivable of $767,000
at December 31, 1998. Morgan carries statutory insurance limits on workers'
compensation with a deductible of $50,000. Claims and insurance accruals reflect
the estimated ultimate cost of claims for cargo loss and damage, personal injury
and property damage not covered by insurance. Morgan accrues its self-insurance
liability using a case reserve method based upon claims incurred and estimates
of unasserted and unsettled claims. These liabilities have not been discounted.
Comprehensive Income
Effective January 1, 1998, the Company adopted SFAS No. 130, Reporting
Comprehensive Income. SFAS No. 130 establishes new standards for the reporting
and display of comprehensive income and its components. However, the adoption of
SFAS No. 130 had no impact on the Company's net income or equity. SFAS No. 130
requires unrealized gains or losses on the Company's available-for-sale
securities, which prior to adoption were reported separately in equity, to be
included in other comprehensive income. Comprehensive income was not materially
different from net income (loss) in each of the periods presented.
Segment Information
Effective December 1998, the Company adopted SFAS No. 131, Disclosures About
Segments of an Enterprise and Related Information. SFAS No. 131 superseded SFAS
No. 14, Financial Reporting for Segments of a Business Enterprise. SFAS No. 131
establishes new standards for reporting information about operating segments.
SFAS No. 131 requires disclosure of selected financial and descriptive
information for each operating segment based on management's internal
organizational decision-making structure. Additional information is required on
a company-wide basis for revenues by product or service, revenues and
identifiable assets by geographic location and information about significant
customers. The adoption of SFAS No. 131 did not affect results of operations or
financial position.
Pensions and Other Post-Retirement Benefits
In February 1998, the FASB issued SFAS No. 132, Employers Disclosures About
Pensions and Other PostRetirement Benefits, which is an amendment to SFAS No.'s
87, 88, and 106. This SFAS revises employers' disclosures about pension and
other post-retirement benefit plans. It does not change the measurement or
recognition of those plans. The adoption of SFAS No. 132 in 1998 did not have a
significant impact on the Company's financial statements as the Company's
benefit plans are not material.
F-11
Impairments
The Company periodically assesses the net realizable value of its long-lived
assets and evaluates such assets for impairment whenever events or changes in
circumstances indicate the carrying amount of an asset may not be recoverable.
For assets to be held, impairment is determined to exist if estimated
undiscounted future cash flows are less than the carrying amount. For assets to
be disposed of, impairment is determined to exist if the estimated net
realizable value is less than the carrying amount.
Stock Based Compensation
In 1996, the Company adopted SFAS No. 123, Accounting for Stock Based
Compensation. SFAS No. 123 establishes a fair value method of accounting and
reporting standards for stock based compensation plans. However as permitted by
SFAS No. 123, the Company elected to continue to apply the provisions of
Accounting Principles Board Opinion ("APB") No. 25, Accounting for Stock Issued
to Employees and related interpretations. Under APB No. 25, if the exercise
price of the Company's employee stock options was not less than the market price
of the underlying stock on the date of grant, no compensation expense is
recognized. The Company is required to disclose the pro forma net income (loss)
and net income (loss) per share as if the fair value method defined in SFAS No.
123 had been applied to all grants made on or after January 1, 1995.
The effect of these pro forma calculations is immaterial.
Fair Value of Financial Instruments
Cash and cash equivalents, trade accounts receivable, short-term borrowings,
trade accounts payable and accrued liabilities are carried at cost which
approximates fair value due to the short-term maturity of these instruments. The
carrying amount of the Company's borrowings under its revolving lines of credit
approximates fair value, as the obligations bear interest at a floating rate.
The fair value of other long-term obligations approximates cost based on
borrowing rates for similar instruments. A subsidiary of the Company is a party
to an interest rate swap agreement (which is accounted for as an adjustment to
interest expense) with a principal amount of $9.3 million at December 31, 1998
which expires in December 2000. At December 31, 1998 and 1997, the Company
estimated it would have paid $390,000 and $406,000, respectively, to terminate
the swap agreement. The amount at March 31, 1999 is approximately the same as on
December 31, 1998.
Issuance of Stock by Subsidiaries and Investees
Changes in the Company's equity in a subsidiary or an investee caused by
issuances of the subsidiary's or investees' stock are accounted for as gains or
losses where such issuance is not part of a broader reorganization There were
$0.5, $0.0, and $1.1 million of such gains in 1998, 1997 and 1996, respectively.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities. SFAS No 133 is
currently required to be adopted in years beginning after June 15, 1999.
However, the FASB has issued a proposal to delay the required date of the
adoption by one additional year. SFAS No. 133 requires the Company to recognize
all derivatives on the balance sheet at fair value. Derivatives that are not
hedges must be adjusted to fair value through income. If the derivative is a
hedge, depending on the nature of the hedge, changes in fair value are either
offset against the changes in fair value of assets and liabilities through
earnings or recognized in other comprehensive income until the hedged item is
recognized in earnings. Because of the Company's minimal use of derivatives,
Lynch management does
F-12
not anticipate that the adoption of SFAS No. 133 will have a significant effect
on Interactive's earnings or financial position.
2. Acquisitions and Dispositions
Acquisitions
On March 18, 1997, Lynch Michigan Telephone Holding Company, a wholly-owned
subsidiary of Lynch acquired approximately 60% of the outstanding shares of
Upper Peninsula Telephone Company for $15.2 million and completed the
acquisition of the remaining 40% on May 23, 1997 (the "Upper Peninsula
Acquisition"). The total cost of the acquisition was $26.5 million. As a result
of this transaction, the Company recorded $7.4 million in goodwill which is
being amortized over 25 years.
On December 30, 1996, The Morgan Group, Inc., 53% owned by Lynch, 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
"Transit Homes Acquisition"). The purchase price was approximately $4.4 million,
including assumed obligations. As a result of this transaction, the Company
recorded $4.1 million of goodwill which is being amortized over twenty years.
On November 26, 1996, DFT Communications, Inc., a wholly-owned subsidiary of
Lynch, acquired all of the outstanding shares of Dunkirk & Fredonia Telephone
Company, a local exchange company serving portions of western New York (the
"Dunkirk & Fredonia Acquisition"). The total cost of this transaction was $27.7
million. As a result of this transaction, the Company recorded $13.8 million in
goodwill which is being amortized over 25 years.
On June 3, 1996, Inter-Community Telephone Company, a Lynch Telephone
Corporation II subsidiary acquired four telephone exchanges in North Dakota
containing approximately 1,400 access lines from U.S.
West Communications, Inc. for approximately $4.7 million.
All of the above acquisitions were accounted for as purchases, and accordingly,
the assets acquired and liabilities assumed were recorded at their estimated
fair market values on their respective dates of acquisition. The operating
results of the acquired companies are included in the Combined Statements of
Operations from their respective acquisition dates.
Disposition
As of December 9, 1998, WNM Communications, Inc. a Lynch Telephone Corporation
subsidiary, sold the assets of its direct broadcast satellite business serving
portions of New Mexico for approximately $3.1 million (the "DBS Disposition").
As a result of the transaction, a pre-tax gain on the sale of the assets of
approximately $2.7 million was recognized and classified as gain on sale of
subsidiary stock and other operating assets in the Combined Statements of
Operations.
The following unaudited combined pro forma information shows the results of the
Company's operations presented as if the Upper Peninsula Acquisition, Transit
Homes Acquisition, Dunkirk & Fredonia Acquisition, and DBS Disposition were made
at the beginning of 1996. The unaudited proforma information is not necessarily
indicative of the results of operations that would have occurred had the
transactions been made at that date nor is it necessarily indicative of future
results of operations.
F-13
Year ended December 31,
1998 1997 1996
-----------------------------
(In thousands)
Sales $204,281 $ 195,816 $ 209,426
Net income (loss) $ 2,775 $ (3,397) $ (1,012)
3. Special Charges
Morgan Drive Away recorded in the fourth quarter of 1996, special charges of
$3,500,000 before income taxes relating to exiting the truckaway operation
($2,675,000) and a write down of properties in accordance with SFAS
121($825,000). Morgan recorded a special charge in 1997 of $624,000 before taxes
comprised of gains in excess of the net realizable value associated with exiting
the truckaway operation of $361,000, offset by charges related to driver pay of
$985,000. These charges have been included in the Company's operating profit.
4. Wireless Communications Services
Lynch Interactive, through limited partnerships, participated in the auctions
conducted by the Federal Communications Commission ("FCC") for 30 megahertz and
10 megahertz of broadband spectrum to be used for personal communications
services, the "C-Block" and "F-Block" auctions, respectively. These two
auctions, which were part of six auctions conducted by the FCC for a total 90
megahertz of spectrum, were specially designated by the FCC to encourage small
businesses to participate in the wireless telecommunications industry, so-called
"entrepreneurial blocks." To effectuate this, the FCC provided certain
qualifying bidders a 25% bidding credit to be used during the auction as well as
long-term financing for a substantial portion of the cost of the licenses
acquired. The licenses represent the right to provide wireless communications
services to territorial areas of the United States. Under FCC regulations,
service must be provided to one-third of the population within the area of the
license within five years of the date of the award and to two-thirds of the
population within ten years of the date of award. Failure to comply may result
in the forfeiture of the license. Lynch Interactive held a 49.9% limited
partnership interest in each of these partnerships and had committed to funding
the government interest and certain other expenses up to a specified amount as
discussed below.
In the C-Block auction, which ended in May 1996, Lynch Interactive was a limited
partner in Fortunet Communications, L.P. ("Fortunet"), which acquired 31
licenses at a net cost, after the bidding credit, of $216 million. These
licenses were awarded in September 1996. The FCC provided 90% of the financing
of the cost of these licenses. Lynch Interactive had agreements to provide a
total of $41.8 million of funding to such partnership, of which $21.6 million
was funded through December 31, 1998. These loans carry an annual commitment fee
of 20% and an interest rate of 15% which are payable when the loans mature in
2003. For accounting purposes, all cost and expenses, including interest
expense, associated with the licenses are currently being capitalized until
service is provided.
Events during and subsequent to the auction, as well as other externally driven
technological and market forces, made financing the development of C-Block
licenses through the capital markets much more difficult than previously
anticipated. Fortunet, as well as many of the license holders from this auction,
petitioned the FCC for certain forms of financial and ownership structure
relief. The response from the FCC, which was announced in September 1997,
afforded license holders a choice of four options, one of which was the
resumption of current debt payments which had been suspended in 1997. The
ramifications of choosing the other three courses of action could have resulted
in Lynch Interactive ultimately forfeiting either 30%, 50%, or 100% of its
investment in these licenses.
F-14
On June 8, 1998, Fortunet elected to apply its eligible credits relating to its
original deposit to the purchase of three licenses for 15 MHZ of PCS spectrum in
Tallahassee, Panama City and Ocala, Florida. Fortunet returned all the remaining
licenses and forfeited 30% of its original deposit in full satisfaction of the
government debt. Accordingly, Fortunet is currently the licensee for 15 MHZ of
spectrum in the three Florida markets covering a population ("POP") of
approximately 785,000 at a net cost at auction of $20.09 per POP.
During 1997, Lynch Interactive provided a reserve on its investment in Fortunet
of $7.0 million, representing 30% of its investment, Lynch's management's
estimate of its impairment at the time.
The balance sheets of Fortunet at December 31, 1998 and 1997 are as follows (in
thousands):
December 31,
1998 1997
-------- ---------
Assets
Cost of licenses acquired $ 26,982 $ 243,693
-------- ---------
Total assets $ 26,982 $ 243,693
======== =========
Liabilities and Deficit
Due to the Department of Treasur$ - $ 208,188
Due to Lynch Interactive 61,857 49,513
Partnership Deficit (34,875) (14,008)
Total liabilities and deficit $ 26,982 $ 243,693
======== =========
Included in "Due to Lynch Interactive" are interest and other financing fees
aggregating $40.9 million and $24.8 million at December 31, 1998 and 1997,
respectively. The net investment in Lynch Interactive's combined balance sheet
is $18.8 million at December 31, 1998, which includes cash advances plus
capitalized interest of $3.5 million ($1.6 million, $1.5 million and $0.4
million capitalized in 1998, 1997, and 1996, respectively).
On April 15, 1999, the Federal Communications Commission completed a reauction
of all the "C-Block" licenses that were returned to it subsequent to the
original auction, including the 15MHz licenses that Fortunet returned on June 8,
1998, in the basic trading areas of Tallahassee, Panama City, and Ocala,
Florida. In that reauction, the successful bidders paid a total of $2.7 million
for the three licenses as compared to the $18.8 million carrying amount of
Interactive's investment in Fortunet. Accordingly, for the quarter ended March
31, 1999, Interactive has provided a reserve of $15.4 million to write down its
investment in Fortunet to reflect the amount bid for similar licenses in the
reauction, plus an additional $0.7 million of capitalized expenses and interest,
to leave a carrying value of $3.4 million.
In the F-Block Auction, East/West Communications, Inc. ("East/West," formerly
Aer Force Communications B L.P.), acquired five licenses to provide personal
communications services in geographic areas of the United States with a total
population of 20 million at a net bid of $19.0 million. In order to fund
East/West's participation in the auction, the Company borrowed $11.8 million
under a short-term facility from Gabelli Funds, Inc. ("GFI"), an affiliate of
the Chairman and CEO of the Company. The money was repaid after completion of
the auction. $10.0 million of this was repaid with monies returned from the FCC
upon completion of the auction. In May and July 1997, the licenses were awarded.
$15.2 million of the cost of the licenses is financed with a loan from the
United States Government. As of November 30, 1997, Lynch Interactive had
invested $225,000 in partnership equity and provided the partnership with a loan
of $3.5 million. In December 1997, the partnerships converted to a corporation
with Lynch Interactive receiving 49.9% of the common stock. Lynch Interactive
spun off 39.9% of the common stock of East/West to its shareholders and
transferred 10% of East/West stock to GFI in satisfaction of an obligation to
pay it 10% of
F-15
the net profits (after a capital charge) as partial compensation for a loan.
Prior to the conversion, Lynch Interactive contributed a portion of the debt
owed to it as a contribution to capital and immediately after the conversion the
remaining debt owed to it ($4.5 million book value) was converted into 7,800
shares ($7,800,000 liquidation preference) of Redeemable Preferred Stock. At
that time Lynch Interactive obligation to make further loans was terminated. The
Redeemable Preferred Stock has a 5% payment-in-kind dividend and is mandatorily
redeemable in 2009 subject to earlier payment in certain circumstances.
During 1998, Rivgam Communicators, LLC ("Rivgam"), a subsidiary of GFI,
transferred to Lynch PCS Corporation G ("Lynch PCS G") a subsidiary of Lynch
Interactive, its 10 MHZ PCS license covering the Rand-McNally basic trading area
of Las Cruces, New Mexico. This transfer was in full settlement of an agreement
between Lynch PCS G and Rivgam. This agreement provided that Lynch PCS G would
be compensated for certain bidding and administrative services it provided to
Rivgam in the PCS D and E Block Auctions by receiving a 10% net profit interest
(after capital charges) in any PCS licenses acquired by Rivgam. The transfer was
accounted for as a non-monetary transaction and resulted in Lynch Interactive
recognizing management service income of $1.0 million in 1998 based upon the
estimated fair value of the license. Lynch PCS G has similar arrangements with
two separate entities in which GFI has minority interests in which Lynch PCS G
is entitled to receive a 5% net profit interest (after capital charges) in
licenses acquired in the WCS and LMDS Auctions.
5. Investments in Affiliated Companies
In the accompanying financial statements, Interactive's ownership of Spinnaker
has been accounted for using the equity method of accounting due the to overall
influence and ownership of Lynch. The market value of this investment is
$13,625,000, $17,125,000, and $20,225,000 at March 31, 1999 and December 31,
1998 and 1997, respectively. The carrying value of this investment for the same
periods is $820,000, $1,137,000, and $1,594,000, respectively.
Lynch Entertainment Corporation ("LENCO"), a wholly-owned subsidiary of the
Company, has a 20% investment in Coronet Communications Company ("Coronet"),
which operates television station WHBF-TV, a CBS affiliate in Rock Island,
Illinois. Lynch Entertainment Corporation II ("LENCO II"), a wholly-owned
subsidiary of the Company, has a 49% investment in Capital Communications
Company ("Capital"), which operates television station WOI-TV, an ABC affiliate
in Des Moines, Iowa. These investments are accounted for on an equity basis.
At December 31, 1998 and 1997, LENCO's investment in Coronet was carried at a
negative $1,262,000 and a negative $1,612,000, respectively, due to LENCO's
guarantee of $3.8 million of $13.6 million of Coronet's third party debt. In
1997, Coronet repaid a $2.9 million loan to LENCO plus accrued interest.
Long-term debt of Coronet, at December 31, 1998, is comprised of $13.6 million
due to a third party lender which is due quarterly through December 31, 2003.
The Company recorded interest income on the LENCO debt of $30,000 and $287,000
for the years ended December 31, 1997 and 1996, respectively.
At December 31, 1998 and 1997, LENCO II's investment in Capital is carried at
zero as its share of net losses recognized to date have exceeded its net
investment. LENCO II also owns $10,000 of Preferred Stock B of Capital, which is
convertible at any time into the Common Stock of Capital in a sufficient amount
to bring LENCO II's ownership to 50%.
F-16
Summarized financial information for companies listed above accounted for by the
equity method is as follows:
Combined Information
1998 1997 1996
-------------------------------
(In thousands)
Current assets $ 92,093 $ 73,167 -
Property, plant & equipment, intangibles & other 156,741 107,076 -
Current liabilities 91,801 31,717 -
Long term debt & other long term liabilities 156,590 147,574 -
Net revenues 298,326 247,497 262,401
Gross profit 40,743 37,811 38,403
Net loss before extraordinary item (4,563) (1,191) (123)
Net loss (4,563) (1,191) (1,966)
6. Notes Payable and Long-term Debt
Long term debt represents borrowings by specific entities which will become
subsidiaries of Interactive.
Long-term debt consists of (all interest rates are at December 31, 1998):
Interest rates at March 31, 1999 have not significantly changed except where
noted.
(Unaudited)
March 31, December 31,
1999 1998 1997
-------------- -------------- ------------
(In thousands)
RuralElectrification Administration (REA) and Rural Telephone Bank (RTB) notes
payable in equal quarterly installments through 2027 at fixed interest
rates ranging from 2% to 7.5% (4.7% weighted average), secured by assets of
the telephone companies of $107.2 million $ 49,345 $ 45,264 $ 47,109
Bank credit facilities utilized by certain telephone and telephone holding
companies through 2009, $33.7 million at a fixed interest rate averaging 8.9%
(8.7% at March 31, 1999) and $16.9 million at variable interest rates
averaging 7.3% (6.7% at March 31, 1999) 44,412 50,623 54,633
Unsecured notes issued in connection with acquisitions; all at fixed interest rates
averaging 9% 28,243 28,003 28,049
Other 3,672 3,773 4,409
--------- --------- ---------
125,672 127,663 134,200
Current maturities (7,855) (8,639) (7,583)
------ ------ ------
$ 117,817 $ 119,024 $ 126,617
========= ========= =========
REA debt of $12.2 million bearing interest at 2% has been reduced by a purchase
price allocation of $2.6 million reflecting an imputed interest rate of 5%.
Unsecured notes issued in connection with the telephone company acquisitions are
predominantly held by members of management of the telephone operating
companies.
On a combined basis, at December 31, 1998, the company maintains short-term and
long-term line of credit facilities totaling $48.7 million (subject to
limitations that reduce the availability to $40.4 million), of which $16.6
million ($15.8 million at March 31, 1999) was available for future borrowings.
Lynch maintains $20.0 million short-term line of credit facilities, of which
$4.9 million was available at December 31, 1998. Borrowings under these
facilities have been allocated to Interactive (Parent Company) as it anticipates
that these facilities will be transferred to Interactive. Borrowings under these
facilities, which are at the same terms as between Lynch and third party
lenders, are included under the caption "Notes Payable to Parent." The
F-17
Morgan Group maintains lines of credit totaling $15.0 million, $8.7 million of
which was available at December 31, 1998 ($3.3 million was available at March
31, 1999). On January 28, 1999, Morgan executed a new two year renewable $20.0
million revolving credit facility which replaces the $15.0 million line. If not
renewed, this credit facility will convert to a three year term loan. The
interest rates will be variable and adjusted quarterly. These facilities, as
well as facilities at other subsidiaries of Lynch Interactive, generally limit
the credit available under the lines of credit to certain variables, such as
receivables and other current assets, and are secured by the operating assets of
the subsidiary, and include various financial covenants. At December 31, 1998,
$21.7 million of these total facilities expire within one year. The weighted
average interest rate for short-term borrowings at December 31, 1998 was 7.8%.
The Company pays fees ranging from 0% to 0.375% on its unused lines of credit.
Morgan has $6.6 million of letters of credit outstanding at December 31, 1998,
which are required for self-insurance retention reserves and other business
needs.
In general, the long-term debt facilities are secured by substantially all of
the Company's property, plant and equipment, receivables and common stock of
certain subsidiaries and contain certain covenants restricting distributions to
Lynch Interactive. At December 31, 1998 and 1997, substantially all the
subsidiaries' net assets are restricted.
Cash payments for interest were $10.1 million, $9.8 million and $5.4 million for
the years ended December 31, 1998, 1997 and 1996, respectively, and $2.6 million
and $3.1 million for the three months ended March 31, 1999 and 1998,
respectively.
Aggregate principal maturities of long-term debt at December 31, 1998 for each
of the next five years are as follows: 1999--$8.6 million; 2000--$15.8 million;
2001--$11.9 million, 2002--$11.1 million and 2003--$5.3 million.
7. Minority Interests and Other Related Party Transactions
Interactive owns all of the Class B common stock of The Morgan Group, Inc. and
155,900 shares of Morgan's Class A common stock, which in the aggregate
represents 68% of the combined voting power of the combined classes of Morgan's
common stock and 53% of the economic equity ownership. The Class B Morgan common
stock is entitled to two votes per common share.
During 1998, Lynch entered into a five-year lease for its corporate headquarters
for an annual payment of $90,000 with an affiliate of its Chairman and Chief
Executive Officer. It is anticipated that Interactive will be added as a lessee
to this lease.
8. Stock Option Plans
On June 4, 1993, the Board of Directors of Morgan approved the adoption of a
stock option plan which provides for the granting of incentive or non-qualified
stock options to purchase up to 200,000 shares of Class A Common Stock to
officers, including members of Morgan's Board of Directors, and other key
employees. No options may be granted under this plan at less than the fair
market value of the Common stock at the date of the grant, except for certain
non-employee directors. Although the exercise period is determined when options
are actually granted, an option shall not be exercised later than 10 years and
one day after it is granted.
Stock options granted will terminate if the grantee's employment terminates
prior to exercise for reasons other than retirement, death, or disability. Stock
options vest over a four year period pursuant to the terms of the plan, except
for stock options granted to a non-employee director, which are immediately
vested.
Morgan employees have been granted non-qualified stock options to purchase
113,000 shares of Class A
F-18
Common stock, net of cancellations and exercises, at prices ranging from $7.00
to $9.39 per share. Non- employee directors have been granted non-qualified
stock options to purchase 57,000 shares of Class A Common stock, net of
cancellations and exercises, at prices ranging from $6.20 to $10.19 per share.
As of December 31, 1998, there were 123,625 options to purchase shares granted
to Morgan's employees and non-employee directors which were exercisable based
upon the vesting terms, of which 30,375 shares had option prices less than the
December 31, 1998 closing price of $73/8.
On February 29,1996, Lynch Corporation adopted a Stock Appreciation Rights
program for certain employees. To date, 43,000 of Stock Appreciation Rights
("SAR") have been granted at prices ranging from $63 to $85 per share. Upon the
exercise of a SAR, the holder is entitled to receive an amount equal to the
amount by which the market value of the Company's common stock on the exercise
date exceeds the grant price of the SAR. Effective September 30, 1998, Lynch
amended the SAR program so that the SAR's became exercisable only if the market
price for the Lynch's shares exceeds 200% of the SAR exercise price within five
years from the original grant date. This amendment eliminated the recording of
the profit and loss effect of the SAR's for changes in the market price in the
Company's common stock until it becomes probable that the SAR's will become
exercisable. With respect to the 43,000 units currently outstanding, each
representing on share of Lynch stock outstanding at the time of the Spin Off,
the units will be divided into two units, one representing one share of
Interactive stock and one representing one share of Lynch stock. The original
unit grant price will be divided between the two new units based upon the
average relative market price of Interactive stock versus Lynch stock for the
five trading days beginning on the eleventh trading day after the effective date
of the Spin Off. The net income (expense) relating to this program that was
allocated to Interactive prior to the time of the amendment was $139,000 in
income in 1998 and ($329,000) of expense in 1997. There was no expense for this
program in 1996.
9. Income Taxes
Lynch Corporation files consolidated federal and state income tax returns which
include all eligible subsidiaries, including Interactive. The provisions
(benefits) for income taxes in the combined statements of operations for all
periods presented have been computed assuming Interactive had not been included
in a consolidated income tax return with Lynch. All income tax payments are made
by Interactive through Lynch.
Deferred income taxes for 1998 and 1997 are provided for the temporary
differences between the financial reporting basis and the tax basis of the
Company's assets and liabilities. Cumulative temporary differences at December
31, 1998 and 1997 are as follows:
Dec. 31, 1998 Dec. 31, 1997
Deferred Tax Deferred Tax
Asset Liability Asset Liability
--------------------------------------
(In Thousands)
Fixed assets revalued under purchase accounting and $ - $ 7,535 $ - $ 7,455
tax over book depreciation
Discount on long-term debt - 1,085 - 1,184
Basis difference in subsidiary and affiliate stock - 1,740 - 1,796
Partnership tax losses in excess of book losses - 1,309 - 2,849
Other reserves and accruals 4,145 - 3,759 -
Other 120 1,338 389 1,468
--- ----- --- -----
Total deferred income taxes $4,265 $13,007 $4,148 $14,752
====== ======= ====== =======
F-19
The provision (benefit) for income taxes is summarized as follows:
1998 1997 1996
-------------------------
(In Thousands)
Current payable taxes:
Federal $ 5,868 $(3,000) $(708)
State and local 850 429 113
6,718 (2,571) (595)
Deferred taxes:
Federal (1,858) 1,707 343
State and local (3) 34 1
(1,861) 1,741 344
------ ----- ---
$ 4,857 $ (830) $(251)
======= ======= =====
A reconciliation of the provision (benefit) for income taxes from continuing
operations and the amount computed by applying the statutory federal income tax
rate to income before income taxes, minority interest, and extraordinary item
follows:
1998 1997 1996
----------------------------
(In Thousands)
Tax at statutory rate $ 3,641 $(1,244) $(490)
Increases (decreases):
State and local taxes, net of federal benefit 558 306 75
Amortization of goodwill 387 314 81
Operating losses of subsidiaries 313 (224) 209
Reduction attributable to special election by
captive insurance company - (155) (194)
Other (42) 173 68
$ 4,857 $ (830) $(251)
======= ======= =====
Net cash payments (receipts) for income taxes were $5.6 million, $0.7 million
and $1.9 million for the years ended December 31, 1998, 1997 and 1996,
respectively, and $0.7 million and $0.2 million for the three months ended March
31, 1999 and 1998, respectively.
10. Employee Benefit Plans
The company, through its operating subsidiaries, has several and various
employee retirement type plans including defined benefit, defined contribution
(including profit sharing and 401(k) and multi-employer plans. The following
table sets forth the combined expenses for these plans (dollars in thousands):
1998 1997 1996
---- ---- ----
Defined Contribution $688 $691 $423
Defined Benefit 101 58 81
Multi-Employer - 61 56
---- ---- ----
Total $789 $810 $560
==== ==== ====
There were no unfunded pension liabilities for any of the years from 1998 to
1996.
F-20
12. Contingencies
Lynch Interactive has pending claims incurred in the normal course of business.
Management believes that the ultimate resolution of these claims will not have a
material adverse effect on the combined liquidity, financial position or
operations of Lynch Interactive.
13. Segment Information
The Company is principally engaged in two business segments: multimedia and
services. All businesses are located domestically, and substantially all
revenues are domestic. The multimedia segment includes local telephone
companies, the investment in PCS entities and investments in two
network-affiliated television stations. The services segment includes
transportation and related services.
Services provided by Morgan to Oakwood Homes Corporation accounted for
approximately $31.8 million, $21.6 million and $12.9 million in 1998, 1997, and
1996, respectively. In addition, another Morgan customer, Fleetwood Enterprises,
Inc. accounted for approximately $26.0 million, $28.1 million, and $26.6 million
of revenues in 1998, 1997, and 1996, respectively. $13.4 million of the
Company's accounts receivable are related to the services segment and are
principally due from companies in the mobile home and recreational vehicle
industry located throughout the United States. The Company believes that its
telecommunications businesses are not dependent on any single customer.
EBITDA (before corporate allocation) for operating segments is equal to
operating profit before interest, taxes, depreciation, amortization and
allocated corporate expenses. EBITDA is presented because it is a widely
accepted financial indicator of value and ability to incur and service debt.
EBITDA is not a substitute for operating income or cash flows from operating
activities in accordance with generally accepted accounting principles.
Operating profit (loss) is equal to revenues less operating expenses, excluding
unallocated general corporate expenses, interest and income taxes. Lynch
allocates a portion of its general corporate expenses to its operating segments.
Such allocation to the Company was $639,000, $632,000 and $632,000 during the
years ended December 31, 1998, 1997 and 1996, respectively and $533,000 and
$158,000 for the three months ended March 31, 1999 and 1998, respectively.
Identifiable assets of each industry segment are the assets used by the segment
in its operations excluding general corporate assets. General corporate assets
are principally cash and cash equivalents, short-term investments and certain
other investments and receivables.
F-21
(Unaudited)
Three Months Ended
March 31, Year ended December 31
1999 1998 1998 1997 1996
------------ ------------ ------------ ------------ ------------
Revenues
Multimedia $ 13,387 $ 12,932 $ 54,622 $ 47,908 $ 28,608
Services 35,325 33,971 150,454 146,154 132,208
------ ------ ------- ------- -------
Combined total $ 48,712 $ 46,903 $ 205,076 $ 194,062 $ 160,816
========= ========= ========= ========= =========
EBITDA (before corporate allocation)
Multimedia $ 7,123 $ 6,995 $ 29,389 $ 24,666 $ 15,863
Services 659 (27) 3,337 2,190 (1,665)
Corporate expenses, gross (587) (1,046) (1,826) (2,310) (2,100)
---- ------ ------ ------ ------
Combined total $ 7,195 $ 5,922 $ 30,900 $ 24,546 $ 12,098
========= ========= ========= ========= =========
Operating profit
Multimedia $ 3,498 $ 3,324 $ 15,757 $ 11,845 $ 6,611
Services 325 (347) 2,007 1,015 (3,263)
Unallocated corporate expense (256) (654) (1,107) (1,572) (1,408)
---- ---- ------ ------ ------
Combined total $ 3,567 $ 2,323 $ 16,657 $ 11,288 $ 1,940
========= ========= ========= ========= =========
Depreciation and amortization
Multimedia $ 3,322 $ 3,320 $ 12,995 $ 12,175 $ 8,653
Services 309 295 1,230 1,075 1,498
All other (19) (22) 18 8 7
--- --- ----- ------ ------
Combined total $ 3,612 $ 3,593 $ 14,243 $ 13,258 $ 10,158
========= ========= ========= ========= =========
Capital expenditures
Multimedia $ 1,812 $ 1,924 $ 11,028 $ 10,914 $ 11,056
Services 458 255 566 919 1,007
General corporate - 7 48 4 17
------- -------- -------- -------- --------
Combined total $ 2,270 $ 2,186 $ 11,642 $ 11,837 $ 12,080
========= ========= ========= ========= =========
Total assets
Multimedia $ 171,545 $ 195,125 $ 195,010 $ 146,285 $ 178,415
Services 33,226 35,329 33,590 83,784 34,046
General corporate 1,811 4,130 879 4,307 1,310
----- ----- --- ----- -----
Combined total $ 206,582 $ 234,584 $ 229,479 $ 234,376 $ 213,771
========= ========= ========= ========= =========
Total operating profit for
reportable segments $ 3,567 $ 2,323 $ 16,657 $ 11,288 $ 1,940
Other profit or loss:
Investment income 816 571 1,865 1,678 2,150
Interest expense (2,684) (2,736) (10,383) (9,740) (6,293)
Equity in earnings of
affiliated companies (258) (41) (629) (125) (309)
Reserve for impairment of investment
in PCS license holders (15,406) - - (7,024) -
Gain on sales of subsidiary and
affiliate stock and other
operating assets - - 3,198 263 1,072
--------- --------- --------- --------- ---------
Income (loss) before income taxes,
minority interests
and extraordinary item $ (13,965) $ 117 $ 10,708 $ (3,660) $ (1,440)
========= ========= ========= ========= =========
F-22
14. Subsequent Events
On February 22, 1999, Lynch's 53%-owned subsidiary, The Morgan Group, Inc.
announced a tender offer to purchase shares of its Class A common stock. Under
terms of the offer, Morgan would determine the price to be paid for shares
between $8.50 and $10.00 per share. The tender offer concluded on March 19,
1999, whereby Morgan purchased 102,528 shares at $9.00 per share. Lynch did not
tender any of its Morgan shares. The effect of this transaction on Interactive
was to increase the voting power in Morgan's combined classes of common stock
from 68% to 70% and to increase the economic equity ownership from 53% to 55%.
On May 26, 1999, Interactive subsidiaries entered into an agreement to acquire
by merger Central Scott Telephone Company ("Scott") for approximately $28.1
million in cash. Scott has approximately 6,000 access lines in Scott County,
Iowa. Interactive expects to fund the acquisition principally through
borrowings. Consummation of the transactions is subject to certain conditions,
including approval by the holders of a majority of the common stock of Scott.
Scott had revenues of $4.4 million in 1998. While Scott was profitable in 1998,
Scott is not expected to contribute to Interactive's earnings in 1999 due to
interest expense on the expected financing debt.
F-23