SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1998 Commission file number 0-23044 AMERICAN MOBILE SATELLITE CORPORATION (Exact name of registrant as specified in its charter) DELAWARE 93-0976127 (State or other (I.R.S. Employer jurisdiction of Identification No.) incorporation or organization) 10802 Parkridge Boulevard Reston, VA 20191-5416 (Address of principal (Zip Code) executive offices) (703) 758-6000 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such report(s)), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Number of shares of Common Stock outstanding at October 31, 1998: 32,129,163 PART I--FINANCIAL INFORMATION Item 1. Financial Statements AMERICAN MOBILE SATELLITE CORPORATION AND SUBSIDIARIES CONSOLIDATED CONDENSED STATEMENTS OF LOSS (in thousands, except per share data) (Unaudited) Three Months Ended Nine Months Ended September 30, September 30, 1998 1997 1998 1997 ------------- ------------- -------------- -------------- REVENUES Services $17,661 $ 5,626 $ 40,749 $ 14,758 Sales of equipment 4,141 5,169 13,485 15,475 ------ ------- ---------- --------- Total Revenue 21,802 10,795 54,234 30,233 COSTS AND EXPENSES Cost of service and operations 16,435 7,910 41,081 24,984 Cost of equipment sold 4,826 6,348 14,122 18,930 Sales and advertising 4,539 2,860 12,272 9,140 General and administrative 4,514 3,058 13,918 10,863 Depreciation and amortization 13,864 10,441 38,484 31,461 -------- ----------- --------- ---------- Operating Loss ( 22,376) ( 19,822) ( 65,643) ( 65,145) INTEREST EXPENSE ( 15,504) ( 6,654) ( 37,848) (16,305) INTEREST AND OTHER INCOME 1,582 212 2,988 1,263 ------- ------------ --------- --------- NET LOSS ($36,298) ($26,264) ($100,503) ($80,187) ========= ========= ========== ========= BASIC AND DILUTED NET LOSS PER SHARE OF COMMON STOCK ($1.14) ($1.04) ($3.39) ($3.19) ======== ========= ======== ======== WEIGHTED AVERAGE COMMON SHARES OUTSTANDING DURING THE PERIOD (000'S) 31,773 25,145 29,604 25,125 ======== ========= ========= ========= See notes to consolidated financial statements. PART I-FINANCIAL INFORMATION Item 1. Financial Statements (continued) AMERICAN MOBILE SATELLITE CORPORATION AND SUBSIDIARIES CONSOLIDATED CONDENSED BALANCE SHEETS (In thousands) (Unaudited) September 30, December 31, 1998 1997 ------------- ------------- ASSETS CURRENT ASSETS: Cash and cash equivalents $10,595 $2,106 Inventory 35,838 40,321 Accounts receivable-trade, net 13,094 8,140 Restricted cash-current portion 41,038 -- Prepaid in-orbit insurance 4,830 4,564 Other current assets 20,401 9,608 ------ ----- Total current assets 125,796 64,739 PROPERTY AND EQUIPMENT - NET 256,016 233,174 GOODWILL AND INTANGIBLES - NET 51,398 -- DEFERRED CHARGES AND OTHER ASSETS 33,368 13,534 RESTRICTED CASH - NON-CURRENT 85,382 -- ------ -------- Total assets $551,960 $311,447 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable and accrued expenses $47,370 $35,861 Obligations under capital leases due within one year 5,513 798 Current portion of long-term debt 5,630 15,254 Other current liabilities 7,668 7,520 ------ ------ Total current liabilities 66,181 59,433 LONG-TERM LIABILITIES: Obligations under Bank Financing 137,000 198,000 Obligations under Senior Notes, net of discount 326,934 -- Capital lease obligations 7,427 3,147 Net assets acquired in excess of purchase price 2,203 2,725 Other long-term debt 1,076 1,364 Other long-term liabilities 565 647 ------- ------- Total long-term liabilities 475,205 205,883 ------- ------- Total liabilities 541,386 265,316 ------- ------- STOCKHOLDERS' EQUITY Preferred Stock, par value $0.01; no shares issued -- -- Common Stock, voting, par value $0.01 318 252 Additional paid-in capital 502,635 451,892 Common Stock purchase warrants 62,547 36,338 Unamortized guarantee warrants (35,659) (23,586) Retained loss (519,267) (418,765) --------- --------- Total stockholders' equity 10,574 46,131 ------- ------- Total liabilities and stockholders' equity $551,960 $311,447 ======== ======== See notes to consolidated financial statements. PART I-FINANCIAL INFORMATION Item 1. Financial Statements (continued) AMERICAN MOBILE SATELLITE CORPORATION AND SUBSIDIARIES CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (in thousands) (Unaudited) Nine Months Ended September 30 ------------------------- 1998 1997 CASH FLOWS FROM OPERATING ACTIVITIES: Net loss ($100,503) ($80,187) Adjustments to reconcile net loss to net cash used in operating activities: Amortization of guarantee warrants and debt related costs 11,622 6,825 Depreciation and amortization 38,484 31,461 Changes in assets and liabilities: Inventory 3,938 (10,989) Prepaid in-orbit insurance (266) 5,080 Trade accounts receivable 2,126 (1,029) Other current assets 281 11,448 Accounts payable and accrued 7,961 (8,671) expenses Deferred trade payables (5,330) 2,934 Deferred and other items - net 348 25 ---------- --------- Net cash used in operating activities (41,339) (43,103) CASH FLOWS FROM INVESTING ACTIVITIES: Additions to property and equipment (7,376) (6,370) Acquisition of ARDIS (51,440) -- Purchase of long-term, restricted cash securities (143,312) -- Investment in XM Radio -- (1,229) ---------- --------- Net cash used in investing activities (202,128) (7,599) CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of Common Stock 412 284 Principal payments under capital leases (2,541) (2,335) Proceeds from Bank Financing 39,000 59,000 Repayment of Bank Financing (100,000) -- Proceeds from bridge financing 10,000 -- Repayment of bridge financing (10,000) -- Proceeds from Senior Notes and Warrants 335,000 -- Payments on long-term debt (4,933) (5,225) Debt issuance costs (14,982) (612) ---------- --------- Net cash provided by financing activities 251,956 51,112 Net increase in cash and cash equivalents 8,489 410 CASH AND CASH EQUIVALENTS, beginning of period 2,106 2,182 ------ ------ CASH AND CASH EQUIVALENTS, end of period $ 10,595 $ 2,592 ========== ========= See notes to consolidated financial statements. PART I-FINANCIAL INFORMATION Item 1. Financial Statements (continued) AMERICAN MOBILE SATELLITE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998 (Unaudited) 1. Organization and Business - ---------------------------- American Mobile Satellite Corporation (with its subsidiaries, "American Mobile" or the "Company") was incorporated on May 3, 1988, by eight of the initial applicants for the mobile satellite services license, following a determination by the Federal Communications Commission ("FCC") that the public interest would be best served by granting the license to a consortium of all willing, qualified applicants. The FCC has authorized American Mobile to construct, launch, and operate a mobile satellite services system (the "Satellite Network ") to provide a full range of mobile voice and data services via satellite to land, air and sea-based customers in a service area consisting of the continental United States, Alaska, Hawaii, Puerto Rico, the U.S. Virgin Islands, U.S. coastal waters, international waters and airspace and any foreign territory where the local government has authorized the provision of service. In March 1991, American Mobile Satellite Corporation transferred the mobile satellite services license ("MSS license") to a wholly owned subsidiary, American Mobile Subsidiary Corporation ("AMSC Subsidiary"). On April 7, 1995, the Company successfully launched its first satellite ("MSAT-2"), from Cape Canaveral, Florida. On March 31, 1998 the Company (through its newly-formed, wholly-owned subsidiary, AMSC Acquisition Company, Inc. ("Acquisition Company")) acquired ARDIS Company ("ARDIS"), a wholly-owned subsidiary of Motorola Inc. that owns and operates a two-way wireless data communications network, for a purchase price of approximately $50 million in cash and $50 million in the Company's Common Stock and warrants (the "Purchase Price"). The Company, through the acquisition of ARDIS, becomes a nationwide provider of wireless communications services, including data, dispatch, and voice services, primarily to business customers in the United States. On October 16, 1997, XM Satellite Radio Inc., formerly American Mobile Radio Corporation, an indirect subsidiary of American Mobile through its subsidiary XM Satellite Radio Holdings Inc., formerly AMRC Holdings, Inc., (together with XM Satellite Radio Inc., "XM Radio"), was awarded a license by the FCC to provide satellite-based Digital Audio Radio Service ("DARS") throughout the United States, following its successful $89.9 million bid at auction on April 2, 1997. XM Radio has and will continue to receive funding for this business from an independent source in exchange for debt and an equity interest in XM Radio. Accordingly, it is not expected that the development of this business will have a material impact on the Company's financial position, results of operations, or cash flows. American Mobile is devoting its efforts to expanding a developing business. This effort involves substantial risk, including successfully integrating ARDIS. Specifically, future operating results will be subject to significant business, economic, regulatory, technical, and competitive uncertainties and contingencies. Depending on their extent and timing, these factors, individually or in the aggregate, could have an adverse effect on the Company's financial condition and future results of operations. 2. Significant Accounting Policies - ---------------------------------- Basis of Presentation - --------------------- The unaudited consolidated condensed financial statements included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. While the Company believes that the disclosures made are adequate to make the information not misleading, these consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company's 1997 Annual Report on Form 10-K The consolidated balance sheet as of September 30, 1998, and the consolidated statements of loss and cash flows for the three months and nine months ended September 30, 1998 and 1997, have been prepared by the Company without audit. In the opinion of management, all adjustments (consisting of normal recurring adjustments) necessary to present fairly the financial position, result of operations and cash flows at September 30, 1998, and for all periods presented have been made. Certain amounts for the three months and nine months ended September 30, 1997 have been reclassified to conform with the current period presentation. The balance sheet at December 31, 1997 has been taken from the audited financial statements. Acquisition - ----------- The Company acquired ARDIS for a purchase price of approximately $50 million in cash and $50 million in the Company's Common Stock (the "Purchase Price"). Approximately 1.5 million of the shares that were issuable to Motorola (representing approximately $11.5 million) were contingent upon stockholder approval at the May 20, 1998 annual meeting of shareholders. Such approval was duly received and the remaining shares issued. The purchase method of accounting for business combinations was used for the recording of the acquisition. The operating results of ARDIS have only been included in the Company's consolidated statements of loss from the date of acquisition. The Company's preliminary estimate of the excess of the purchase price over the fair market value of net assets acquired is $54.3 million. The goodwill, intangibles and licenses are being amortized over twenty years. The unaudited pro forma results give effect to (i) the Acquisition, (ii) the Offering and (iii) the New Bank Financing as if such transactions had been consummated on January 1 of each of the periods presented. Nine Months Ended September 30, (dollars in thousands, except per share data) 1998 1997 ---- ---- Revenues $64,166 $63,264 Net loss ($114,110) ($125,069) Loss per share ($3.60) ($3.98) Weighted-average shares outstanding 31,731 31,387 Net Loss Per Share - ------------------ Basic and diluted loss per common share is based on the weighted-average number of shares of Common Stock outstanding during the period. Stock options and common stock purchase warrants are not reflected since their effect would be antidilutive. Recently Adopted Accounting Pronouncements - ------------------------------------------ In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income," and SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." The Company adopted both of these standards during the nine month period ended September 30, 1998. SFAS No. 130 requires "comprehensive income" and the components of "other comprehensive income" to be reported in the financial statements and/or notes thereto. Since the Company does not have any components of "other comprehensive income," reported net income is the same as "total comprehensive income" for the three months and nine months ended September 30, 1997 and 1998. SFAS No. 131 requires an entity to disclose financial and descriptive information about its reportable operating segments. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. SFAS No. 131 is not required for interim financial reporting purposes during 1998. The Company is in the process of assessing the additional disclosures, if any, required by SFAS No. 131. However, such adoption will not impact the Company's results of operations or financial position, since it relates only to disclosures. Other - ----- The Company paid approximately $7.6 million and $2.0 million in the nine-month periods ended September 30, 1998 and 1997, respectively, to related parties for capital assets, service-related obligations, and payments under financing agreements. Payments from related parties for communication services and equipment purchases totaled $4.3 million in the nine-month period ended September 30, 1998 and $1.8 million in the nine-month period ended September 30, 1997. Total net indebtedness to related parties as of September 30, 1998 approximated $850,000. 3. Liquidity and Financing - -------------------------- Million Unit Offering - -------------------------- In connection with the acquisition of ARDIS, discussed above, the Company issued $335 million of Units (the "Units") consisting of 12 1/4% Senior Notes due 2008 (the "Notes"), and Warrants to purchase shares of Common Stock of the Company. Each Unit consists of $1,000 principal amount of Notes and one Warrant to purchase 3.75749 shares of Common Stock at an exercise price of $12.51 per share. A value of $8.5 million was assigned to the Warrants and is reflected in the balance sheet as a debt discount. A portion of the net proceeds of the sale of the Units were used to finance the Acquisition. In connection with the Notes, the Company has purchased approximately $112.3 million of pledged securities that are intended to provide for the payment of the first six interest payments on the Notes. The Company incurred approximately $15 million in costs associated with the placement of the Notes and the Acquisition. Interest payments are due semi-annually, in arrears, beginning October 1, 1998. The Notes contain covenants that, among other things, limit the ability of Acquisition Company and its Subsidiaries to incur additional indebtedness, pay dividends or make other distributions, repurchase any capital stock or subordinated indebtedness, make certain investments, create certain liens, enter into certain transactions with affiliates, sell assets, enter into certain mergers and consolidations, and enter into sale and leaseback transactions. Acquisition Company consummated its offer to exchange up to $335 million aggregate principal amount of its registered 12 1/4 percent Senior Notes (due 2008, Series B) (the "New Notes") for outstanding unregistered 12 1/4 percent Senior Notes (due 2008, Series A) (the "Old Notes"). Holders tendered for exchange $334.75 million aggregate principal amount of the Old Notes as of the expiration of the offer. New Bank Financing - ------------------ In connection with the Acquisition, the Company, the Acquisition Company and its subsidiaries restructured the existing $200 million Bank Financing (the "Bank Financing") to provide for two facilities: (i) the Revolving Credit Facility, a $100 million unsecured five-year reducing revolving credit facility, and (ii) the Term Loan Facility, a $100 million five-year, term loan facility with up to three additional one-year extensions subject to the lenders' approval. The Revolving Credit Facility bears an interest rate, generally, of 50 basis points above LIBOR and is unsecured, with a negative pledge on the assets of the Acquisition Company and its subsidiaries ranking pari passu with the Notes. The Revolving Credit Facility will be reduced $10 million each quarter, beginning with the quarter ending June 30, 2002, with the balance due on maturity of March 31, 2003. Borrowings under the Revolving Credit Facility are subject to certain conditions beginning in the fourth quarter of 1998. In the event the Company is unable to borrow amounts under the Revolving Credit Facility, the Company's cash needs will significantly exceed its available resources, which would have a material adverse effect on the Company. The revolving Credit Facility ranks pari passu with the Notes. The Term Loan Facility is secured by the assets of the Company, principally its stockholdings in XM Radio and the Acquisition Company, and is effectively subordinated to the Revolving Credit Facility and the Notes. The New Bank Financing is severally guaranteed by Hughes Electronics Corporation ("Hughes"), Singapore Telecommunications Ltd. ("Singapore Telecom") and Baron Capital Partners, L.P. (collectively, the "Bank Facility Guarantors"). In exchange for the additional risks undertaken by the Bank Facility Guarantors in connection with the New Bank Financing, the Company agreed to compensate the Bank Facility Guarantors, principally in the form of 1 million additional warrants and re-pricing of 5.5 million warrants previously issued (together, the "Guarantee Warrants"). The Guarantee Warrants have an exercise price of $12.51 and have been valued at approximately $17.7 million. As of October 31, 1998, the Company had outstanding borrowings of $100 million of the Term Loan Facility at 5.8125%, and $32.0 million under the Revolving Credit Facility at rates ranging from 5.75% to 6.1875%. In connection with the New Bank Financing, the Company entered into an interest rate swap agreement, with an implied annual rate of 6.51%. The swap agreement reduces the impact of interest rate increases on the Term Loan Facility. The Company paid a fee of approximately $17.9 million for the swap agreement. Under the swap agreement, the Company will receive an amount equal to LIBOR plus 50 basis points, paid on a quarterly basis, on a notional amount of $100 million until the termination date of March 31, 2001. The Company has reflected as an asset the unamortized fee paid for the swap agreement in the accompanying financial statements. The Company is exposed to a credit loss in the event of non performance by the counter party under the swap agreement. The Company does not believe there is a significant risk of non performance as the counter party to the swap agreement is a major financial institution. Motorola Vendor Financing - ------------------------- Motorola has entered into an agreement with a subsidiary of Acquisition Company, the ARDIS Company, to provide up to $10 million of vendor financing (the "Vendor Financing Commitment"), which will be available to finance up to 75% of the purchase price of additional network base stations. Loans under this facility will bear interest at a rate equal to LIBOR plus 7.0% and will be guaranteed by the Company and each subsidiary of the Acquisition Company. The terms of the facility require that amounts borrowed be secured by the equipment purchased therewith. As of October 31, 1998, $591,707 was outstanding under this facility. Financing Summary - ----------------- The Company believes the proceeds from the issuance of the Notes, net of cash used for the Acquisition, together with the borrowings under the New Bank Financing and the Vendor Financing Commitment, will be sufficient to fund operating losses, capital expenditures, working capital, and scheduled principal and interest payments on debt through 1998 and beyond; however, there can be no assurance that the Company's current projections regarding the timing of its ability to achieve positive operating cash flow will be accurate, and that the Company will not need additional financing in the future. XM Radio - -------- As previously mentioned (see "Organization and Business"), XM Radio was a winning bidder for, and on October 16, 1997, was awarded an FCC license to provide DARS throughout the United States. XM Radio has and will continue to receive funding for this business from an independent source in exchange for debt and an equity interest in XM Radio. Accordingly, it is not expected that the development of this business will have a material impact on the Company's financial position, results of operations, or cash flows. Through its investment in XM Radio, WorldSpace has an option to increase its ownership in XM Radio to approximately 82%, subject to FCC approval. On October 30, 1998 the Company and WorldSpace jointly filed an application for consent to the transfer of control of XM Radio in anticipation of future exercise, subject to FCC approval, of the WorldSpace options which, if exercised, would reduce the Company's ownership in XM Radio to 18.3%. The Company's equity interest in XM Radio may, however, even on a fully diluted basis, become a material asset of the Company. Summarized unaudited financial information for XM Radio as of September 30, 1998, and for the nine month periods ended September 30, 1998 and 1997, and for the period from December 15, 1992 (date of inception) through September 30, 1998 is set forth below. December 15, 1992 Nine Months through dollars in thousands Ended September 30, September 30, (unaudited) (unaudited) 1998 1997 1998 ---- ---- ---- Gross sales $ -- $ -- $ -- Operating expenses 11,989 236 13,099 Loss from operations 11,989 236 13,099 Interest expense -- 464 549 Net loss 11,989 700 13,648 As of September 30, As of December 31, 1998 1997 ---- ---- (unaudited) (unaudited) Current assets $ 101 $ -- Noncurrent assets 140,253 91,933 Current liabilities 120,984 82,949 Noncurrent liabilities 22,375 -- Total stockholders' equity (3,005) 8,984 Deferred Trade Payables - ----------------------- The Company has arranged the financing of certain trade payables, and as of September 30, 1998, $6.4 million of deferred trade payables were outstanding at rates ranging from 6.22% to 12% and are generally payable by the end of 1999. Purchase and Lease Agreement - ---------------------------- As previously disclosed, the Company has entered into certain agreements to acquire a one-half ownership interest in TMI Communications and Company, Limited Partnership's ("TMI") satellite, MSAT-1, at a cost of $60 million payable over a five-year period, as well as entered into a five-year lease of the Company's satellite, MSAT-2, with African Continental Telecommunications Ltd. that provides for aggregate lease payments to the Company of $182.5 million. Closing under the agreements is subject to a number of conditions, including: a successful financing by ACTEL of at least $120 million and completion of certain satellite testing, inversion and relocation activities with respect to AMSC-1. It is anticipated that if the conditions are met, closing under both the purchase and lease agreements would occur simultaneously in the first half of 1999; however, there can be no assurances that these conditions will be met and the transactions consummated. Other - ----- On October 29, 1998, the Company announced that it reached an agreement with Stratos Global Corporation to consolidate American Mobile's marine distribution channel, resulting in the transfer of inventory and contracts in exchange for $8.5 million. Apart from the initial cash inflow, it is not expected that this transaction will have a material impact on the Company's financial position, results of operations, or cash flows. On July 2, 1998, American Mobile filed an application for authority to launch and operate its second-generation mobile satellite system. This satellite is intended to support the Company's existing satellite services and also allow the provision of an expanded array of services, such as higher data rate services and services to lower-power terminals. There can be no assurance that the FCC will grant this application. If the Company proceeds with deployment of this second-generation satellite system, the Company would be required to raise substantial additional capital to finance this project. 4. Legal and Regulatory Matters - ------------------------------- Like other mobile service providers in the telecommunications industry, the Company is subject to substantial domestic, foreign and international regulation including the need for regulatory approvals to operate and expand the Satellite Network and operate and modify subscriber equipment. The ownership and operation of American Mobile's MSS system and ARDIS' ground-based two-way wireless data system are subject to the rules and regulations of the FCC, which acts under authority granted by the Communications Act and related federal laws. Among other things, the FCC allocates portions of the radio frequency spectrum to certain services and grants licenses to and regulates individual entities using the spectrum. American Mobile and ARDIS operate pursuant to various licenses granted by the FCC. The successful operation of the Satellite Network is dependent on a number of factors, including the amount of L-band spectrum made available to the Company pursuant to an international coordination process. The United States is currently engaged in an international process of coordinating the Company's access to the spectrum that the FCC has assigned to the Company. While the Company believes that substantial progress has been made in the coordination process and expects that the United States government will be successful in securing the necessary spectrum, the process is not yet complete. The inability of the United States government to secure sufficient spectrum could have an adverse effect on the Company's financial position, results of operations and cash flows. The Company has the necessary regulatory approvals, some of which are pursuant to special temporary authority, to continue its operations as currently contemplated. The Company has filed applications with the FCC and expects to file applications in the future with respect to the continued operations, change in operation and expansion of the Network and certain types of subscriber equipment. Certain of its applications pertaining to future service have been opposed. While the Company, for various reasons, believes that it will receive the necessary approvals on a timely basis, there can be no assurance that the requests will be granted, will be granted on a timely basis or will be granted on conditions favorable to the Company. Any significant changes to the applications resulting from the FCC's review process or any significant delay in their approval could adversely affect the Company's financial position, results of operations and cash flows. There are applications now pending before the FCC to use the Inmarsat system and TMI's Canadian-licensed system, both of which operate in the MSS L-band and have satellite footprints covering the United States, to provide service in the United States. American Mobile has opposed these filings. In addition to providing additional competition to American Mobile, a grant of domestic authority by the FCC to use any of these foreign systems may increase the demand by these systems for spectrum in the international coordination process and could adversely affect American Mobile's ability to coordinate its spectrum access. On July 20, 1998, the International Bureau of the FCC granted an application for Special Temporary Authority to use TMI's space segment to conduct market tests in the U.S. for the next six months using up to 500 mobile terminals. American Mobile has asked the full Commission to review this decision and stay the effectiveness of the temporary authorization. There can be no assurance that the FCC will stay the effectiveness of this decision or rescind the International Bureau's grant of Special Temporary Authority. On October 23, 1998, the FCC issued an order permitting Comsat Corporation via Inmarsat to provide aeronautical services to the domestic legs of the same aircraft in international flight. As the FCC noted, this action has a minimal effect on AMSC's access to L-band spectrum. Additionally, the Company does not believe this action will have any effect on revenues. American Mobile is authorized to build, launch, and operate three geosynchronous satellites in accordance with a specific schedule. American Mobile is not in compliance with the schedule for commencement and construction of its second and third satellites and has petitioned the FCC for changes to the schedule. Certain of these extension requests have been opposed by third parties. The FCC has not acted on American Mobile's requests. The FCC has the authority to revoke the authorizations for the second and third satellites and in connection with such revocation could exercise its authority to rescind American Mobile's license. American Mobile believes that the exercise of such authority to rescind the license is unlikely. The term of the license for each of American Mobile's three authorized satellites is ten years, beginning when American Mobile certifies that the respective satellite is operating in compliance with American Mobile's license. The ten-year term of MSAT-2 began August 21, 1995. Although American Mobile anticipates that the authorization to MSAT-2 is likely to be extended in due course to correspond to the useful life of the satellite and a new license granted for any replacement satellites, there is no assurance of such extension or grants. On July 2, 1998, American Mobile filed an application for authority to launch and operate its second-generation mobile satellite system. This satellite is intended to support the Company's existing satellite services and, also, allow the provision of an extended array of services, such as higher data rate services and services to lower-power terminals. There is no guarantee that the FCC will grant this application. The filing of the application does not commit the Company to expend any resources toward this project; however, should the Company decide to proceed with the construction of the follow-on satellite, the Company would be required to raise substantial additional capital to fund this project. As a provider of interstate telecommunications services, the Company is required to contribute to the FCC's universal service fund for certain of its services, which supports the provision of telecommunication services to high-cost areas, and establishes funding mechanisms to support the provision of service to schools, libraries and rural health care providers. The regulation became effective on January 1, 1998. This cost generally is not borne by the Company, but passed on to its customers. On June 5, 1996, the FCC waived its one-year construction requirement and granted ARDIS extensions of time to complete buildouts of approximately 190 sites, as required to maintain previously granted licenses. The extended construction deadlines vary by site until March 31, 1999. While management believes that all buildouts will continue to be completed in a timely manner, there can be no assurances that future delays will not occur. Failure to complete the buildouts in a timely manner could result in a loss of licenses for such sites from the FCC. In 1992, a former director of American Mobile filed an Amended Complaint against the Company alleging violations of the Communications Act of 1934, as amended, and of the Sherman Act and breach of contract. The suit was dismissed on November 10, 1998, prior to the commencement of trial pursuant to an agreement to settle the suit by payment of $250,000, the Company's estimate of its cost of trial. 5. Other Matters - ---------------- At October 31, 1998, the Company had remaining contractual commitments to purchase both mobile data terminal inventory and mobile telephone inventory in the maximum amount of $11.1 million over the next year. Additionally, the Company had remaining contractual commitments in the amount of $1.3 million for the development of certain next generation data terminal inventory. Contingent upon the successful research and development efforts, the Company would have maximum additional contractual commitments for mobile communications data terminal inventory in the amount of $27.0 million over a three-year period. The Company has the right to terminate the research and development and inventory commitment by paying cancellation fees of between $1 million and $2.5 million, depending on when the termination option is exercised during the term of the contract. The Company also has the right to terminate the inventory commitment by incurring a cancellation penalty representing a percentage of the unfulfilled portion of the contract. The Company has also contracted for the purchase of $26.2 million next generation wireless data terminals to be delivered beginning early 1999. The contract contains a 50% cancellation penalty. Additionally, the Company has remaining contractual commitments for the purchase of $6.4 million of base stations necessary to complete the required site build-outs. 6. AMSC Acquisition Company Financial Statements - ------------------------------------------------ In connection with the Acquisition and related financing discussed above, the Company formed a new wholly-owned subsidiary, AMSC Acquisition Company, Inc. The Company transferred all of its inter-company notes receivables and its rights, title and interests in AMSC Subsidiary Corporation, American Mobile Satellite Sales Corporation, and AMSC Sales Corp. Ltd. (together with ARDIS, the "Subsidiary Guarantors") to AMSC Acquisition Company, Inc., and AMSC Acquisition Company, Inc. was the acquirer of ARDIS and the issuer of the $335 million of Senior Notes. American Mobile Satellite Corporation ("American Mobile Parent") is a guarantor of the Senior Notes. The Senior Notes contain covenants that, among other things, limit the ability of Acquisition Company, Inc. and its Subsidiaries to incur additional indebtedness, pay dividends or make other distributions, repurchase any capital stock or subordinated indebtedness, make certain investments, create certain liens, enter into certain transactions with affiliates, sell assets, enter into certain mergers and consolidations, and enter into sale and leaseback transactions. Acquisition Company is a holding company with no material operations. It holds the Senior Notes and Revolving Credit Facility, both of which are fully and unconditionally guaranteed on a joint and several basis by all of its Subsidiaries. Separate company financial statements for Acquisition Company have not been prepared, as management believes the differences between the two statements to be immaterial, and therefore not material information to the investors. Summarized financial information with respect to American Mobile Parent, Acquisition Company and with respect to the Subsidiary Guarantors on a combined basis as of September 30, 1998 and for the months ended September 30, 1998 and 1997 is as follows: American Mobile Parent Acquisition Company September 30, September 30, September 30, September 30, 1998 1997 1998 1997 ---- ---- ---- ---- Operating Statement Data (in thousands): Net Revenue $900 $900 -- -- Equity in loss of subsidiaries 102,879 102,893 89,561 -- Operating income (loss) 519 1,393 (71) -- Net loss 100,503 80,187 102,537 -- Balance Sheet Data: September 30, 1998 September 30, 1998 ------------------ ------------------ Current assets $6,374 $41,066 Non-current assets 105,768 442,666 Current liabilities 67 20,910 Non-current liabilities 101,501 363,935 Shareholders' Equity 10,574 98,887 Combined Subsidiary Guarantors September 30, 1998 September 30, 1997 ------------------ ------------------ Operating Statement Data (in thousands): Net revenue $54,234 $30,233 Equity in loss of subsidiaries -- -- Operating loss 66,091 66,538 Net loss 89,561 103,070 Balance Sheet Data (in thousands): Current assets $78,356 Non-current assets 325,926 Current liabilities 45,203 Non-current liabilities 693,563 Shareholders' equity (334,484) Major differences between the financial statements of Parent and Acquisition Company include (i) the Term Loan Facility which, as of the Acquisition, is an obligation of Parent and, as such, the related debt and interest costs are not included in the Acquisition Company financial statements for the periods ended and as of September 30, 1998, as discussed in Note 3, and (ii) certain immaterial intercompany management fees and expenses between the Parent and Acquisition Company are not eliminated at the Acquisition Company level. The combined condensed unaudited financial statements of Acquisition Company are set forth below. AMSC Acquisition Company, Inc. Consolidated Condensed Statements of Loss (dollars in thousands) (Unaudited) Three Months Ended Nine Months Ended September 30, September 30, ------------- ------------- 1998 1997 1998 1997 ---- ---- ---- ---- REVENUES Services $ 17,661 $ 5,626 $40,749 $ 14,758 Sales of equipment 4,141 5,169 13,485 15,475 -------- ------- ------- --------- Total Revenues 21,802 10,795 54,234 30,233 COSTS AND EXPENSES: Cost of service and operations 16,435 7,879 41,081 24,953 Cost of equipment sold 4,827 6,365 14,123 18,930 Sales and advertising 4,474 2,846 12,160 9,109 General and administrative 4,556 3,104 14,022 10,739 Depreciation and amortization 13,864 10,968 39,010 33,040 ------- -------- -------- ------- Operating Loss (22,354) (20,367) (66,162) (66,538) INTEREST AND OTHER INCOME 1,497 55 3,129 1,086 INTEREST EXPENSE (12,885) (13,346) (39,504) (37,618) -------- -------- -------- -------- NET LOSS ($33,742) ($33,658) ($102,537) ($103,070) ========= ========= ========== ========== AMSC Acquisition Company, Inc. Consolidated Condensed Balance Sheets (dollars in thousands) (Unaudited) September 30, December 31, ASSETS 1998 1997 ---- ---- CURRENT ASSETS: Cash and cash equivalents $ 10,595 $ 2,106 Inventory 35,838 40,321 Accounts receivable-trade, net of allowance for doubtful accounts 13,094 8,140 Restricted cash-current portion 41,038 -- Prepaid in-orbit insurance 4,830 4,564 Other current assets 14,027 9,608 -------- -------- Total current assets 119,422 64,739 PROPERTY AND EQUIPMENT - NET 256,016 250,335 GOODWILL AND INTANGIBLES - NET 51,398 -- RESTRICTED CASH - Non-Current 75,122 -- DEFERRED CHARGES AND OTHER ASSETS - NET 38,248 36,722 -------- -------- Total assets $ 540,206 $ 351,796 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable and accrued expenses $ 47,303 $ 35,825 Obligations under capital leases due within one year 5,513 798 Current portion of long-term debt 5,630 15,254 Other current liabilities 7,668 7,520 -------- --------- Total current liabilities 66,114 59,397 DUE TO PARENT -- 441,836 LONG-TERM LIABILITIES: Obligations under Bank Financing 37,000 198,000 Senior Notes, net of discount 326,934 -- Capital lease obligations 7,427 3,147 Other long-term debt 1,076 1,364 Net assets acquired in excess of purchase price 2,203 2,725 Other long-term liabilities 565 647 -------- --------- Total long-term liabilities 375,205 205,883 Total liabilities 441,319 707,116 -------- ------- STOCKHOLDERS' EQUITY 98,887 (355,320) -------- --------- Total liabilities and stockholders' equity $ 540,206 $ 351,796 ========= ========= AMSC Acquisition Company, Inc. Consolidated Condensed Statements of Cash Flows (dollars in thousands) (Unaudited) Nine Months Ended September 30, ------------------- 1998 1997 ---- ---- CASH FLOWS USED IN OPERATING ACTIVITIES: Net loss ($102,537) ($103,070) Adjustments to reconcile net loss to net cash used in operating activities: Amortization of debt discount 8,072 6,825 Depreciation and amortization 39,010 33,040 Changes in assets and liabilities: Inventory 3,938 (10,989) Prepaid in-orbit insurance ( 266) 5,080 Trade accounts receivable 2,126 (1,029) Other current assets 84 11,448 Accounts payable and accrued expenses 7,932 (9,427) Deferred trade payables ( 5,330) 2,934 Deferred items - net 6 202 ---------- ---------- Net cash used in operating activities (46,965) (64,986) CASH FLOWS USED IN INVESTING ACTIVITIES: Additions to property and equipment (7,376) (6,370) Acquisition of ARDIS (51,440) -- Purchase of long-term restricted cash securities (115,159) -- --------- ------- Net cash used in investing activities (173,975) (6,370) CASH FLOWS FROM FINANCING ACTIVITIES: Funding (to) from Parent (22,115) 20,938 Principal payments under capital leases (2,541) (2,335) Proceeds from Bank Financing 39,000 59,000 Repayment of Bank Financing (100,000) -- Proceeds from bridge financing 10,000 -- Repayment of bridge financing (10,000) -- Proceeds from Senior Notes 335,000 -- Payments on long-term debt (4,933) (5,225) Debt issuance costs (14,982) (612) -------- -------- Net cash provided by financing activities 229,429 71,766 Net increase in cash and cash equivalents 8,489 410 CASH AND CASH EQUIVALENTS, beginning of period 2,106 2,182 ---------- ---------- CASH AND CASH EQUIVALENTS, end of period $10,595 $2,592 ======== ====== PART I-FINANCIAL STATEMENTS Item 2. Management's Discussion and Analysis of Interim Financial Condition and Results of Operations This Quarterly Report on Form 10-Q includes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such statements are identified by the use of forward-looking words or phrases including, but not limited to, "believes," "intended," "will be positioned," "expects," "expected," "estimates," "anticipates" and "anticipated." These forward-looking statements are based on the Company's current expectations. All statements other than statements of historical facts included in this Quarterly Report, including those regarding the Company's financial position, business strategy, projected costs and financing needs, and plans and objectives of management for future operations, are forward-looking statements. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, there can be no assurance that such expectations will prove to have been correct. Because forward-looking statements involve risks and uncertainties, the Company's actual results could differ materially. Important factors that could cause actual results to differ materially from the Company's expectations ("Cautionary Statements") are disclosed under "Business" and "Management's Discussion and Analysis of Financial Condition and Results of Operations," and elsewhere in this Form 10-Q, including, without limitation, in conjunction with the forward-looking statements included in this Form 10-Q. These forward-looking statements represent the Company's judgment as of the date hereof and readers are cautioned not to place undue reliance on these forward-looking statements. All subsequent written and oral forward-looking statements attributable to the Company or persons acting on behalf of the Company are expressly qualified in their entirety by the Cautionary Statements. Readers should carefully review the risk factors described in other documents the Company files from time to time with the Securities and Exchange Commission, including the Form 10-K Annual Report and Form 10-Q Quarterly Reports filed by the Company prior to and subsequent to this Form 10-Q Quarterly Report and any Current Reports on Form 8-K and registration statements filed by the Company. General - ------- The following discussion and analysis provides information which management believes is relevant to an assessment and understanding of the financial condition and consolidated results of operations of American Mobile Satellite Corporation (with its subsidiaries, "American Mobile" or the "Company"). The discussion should be read in conjunction with the consolidated financial statements and notes thereto. American Mobile Satellite Corporation was incorporated in May 1988 and, until 1996, was a development stage company, engaged primarily in the design, development, construction, deployment and financing of a mobile satellite communication system. On March 31, 1998 the Company (through its newly-formed, wholly-owned subsidiary, AMSC Acquisition Company, Inc., ("Acquisition Company")) acquired ARDIS Company ("ARDIS"), a wholly-owned subsidiary of Motorola Inc. that owns and operates a two-way wireless data communications network, for a purchase price of approximately $50 million in cash and $50 million in the Company's Common Stock and warrants (the "Purchase Price"). With the acquisition of ARDIS, the Company becomes a leading provider of nationwide wireless communications services, including data, dispatch and voice services, primarily to business customers in the United States. The Company offers a broad range of end-to-end wireless solutions utilizing a seamless network consisting of the nation's largest, most fully-deployed terrestrial wireless data network (the "ARDIS Network") and a satellite in geosynchronous orbit (the "Satellite Network") (together, the "Network"). In connection with the Acquisition, the Company and its subsidiaries entered into agreements with respect to the following financings and refinancings: (1) $335 million of Units; (2) the restructuring of its existing $200 million Revolving Credit Facility and Term Loan Facility (collectively, the "New Bank Financings"); and (3) $10 million commitment with respect to Motorola vendor financing. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources." Additionally, in connection with the Acquisition and related financing, the Company transferred all of its rights, title and interests in AMSC Subsidiary Corporation, American Mobile Satellite Sales Corporation, and AMSC Sales Corp. Ltd. (together, "American Mobile Subsidiaries") to Acquisition Company. On October 16, 1997, XM Satellite Radio Inc., formerly American Mobile Radio Corporation, an indirect subsidiary of American Mobile through its subsidiary XM Satellite Radio Holdings Inc., formerly AMRC Holdings, Inc., (together with XM Satellite Radio Inc., "XM Radio"), was awarded a license by the FCC to provide satellite-based Digital Audio Radio Service ("DARS") throughout the United States, following its successful $89.9 million bid at auction on April 2, 1997. The operations and financing of XM Radio are maintained separate and apart from the operations and financing of American Mobile (see "Liquidity and Financing"). Through its investment in XM Radio, WorldSpace has an option to increase its ownership in XM Radio to approximately 82%, subject to FCC approval. On October 30, 1998 the Company and WorldSpace jointly filed an application for consent to the transfer of control of XM Radio in anticipation of future exercise, subject to FCC approval, of the WorldSpace options which, if exercised, would reduce the Company's ownership in XM Radio to 18.3%. Management believes the period to period comparison of the Company's financial results are not necessarily meaningful and should not be relied upon as an indication of future operating performance due to the Company's historically high growth rate and the acquisition of ARDIS. Overview - -------- Each of American Mobile and ARDIS has incurred significant operating losses and negative cash flows in each year since it commenced operations, due primarily to start-up costs, the costs of developing and building each network and the cost of developing, selling and providing its respective products and services. The Company is, and will continue to be, highly leveraged. As of September 30, 1998, the Company had indebtedness of approximately $483.6 million. The Company's future operating results could be adversely affected by a number of uncertainties and factors, including (i) the timely completion and deployment of future products and related services, including among other things, availability of mobile telephones, data terminals and other equipment to be used with the Network ("Subscriber Equipment") being manufactured by third parties over which the Company has limited control, (ii) the market's acceptance of the Company's services, (iii) the ability and the commitment of the Company's distribution channels to market and distribute the Company's services, (iv) the Company's ability to modify its organization, strategy and product mix to maximize the market opportunities in light of changes therein, (v) competition from existing companies that provide services using existing communications technologies and the possibility of competition from companies using new technology in the future, (vi) capacity constraints arising from the reconfiguration of MSAT-2, subsequent anomalies affecting MSAT-2 and MSAT-1, or the power management recommendation affecting both MSAT-2 and MSAT-1 previously reported, (vii) additional technical anomalies that may occur within the Satellite Network, including those relating to MSAT-1 and MSAT-2, which could impact, among other things, the operation of the Satellite Network and the cost, scope or availability of in-orbit insurance, (viii) subscriber equipment inventory responsibilities and liabilities assumed by the Company including the ability of the Company to realize the value of its inventory in a timely manner, (ix) the Company's ability to secure additional financing as may be necessary, (x) the Company's ability to respond and react to changes in its business and the industry as a result of being highly leveraged, (xi) the ability of the Company to successfully integrate ARDIS and to achieve certain business synergies, and (xii) the ability of the Company to manage growth effectively. As of September 30, 1998, there were approximately 101,500 units on the Network. Quarter and Nine Months Ended September 30, 1998 and 1997 - --------------------------------------------------------- Service revenues, which include both the Company's voice and data services, approximated $17.7 million and $40.7 million for the three-month and nine-month periods ended September 30, 1998, respectively, which constitutes an $12.0 million and $26.0 million increase over the three-month and nine-month periods ended September 30, 1997, respectively. The significant increase in service revenues year over year is primarily attributable to the income of the ARDIS data service. Absent the acquisition of ARDIS on March 31, 1998, service revenues for the three-month and nine-month period ended September 30, 1998, respectively, increased 29% and 39% year to year, from $5.6 million and $14.8 million for the three and nine-month periods ended September 30, 1997, to $7.2 million and $20.4 million for the three and nine-month periods ended September 30, 1998, respectively. Service revenue from voice services increased 34% and 47% from approximately $2.9 million and $7.2 million in the third quarter and nine-months of 1997, respectively, to approximately $3.9 million and $10.6 million in the comparable periods of 1998. The increases were primarily a result of a 42% increase in voice customers during the nine months of 1998 as compared to the same period in 1997. Service revenue from the Company's data services approximated $12.8 million and $27.3 million for the three-month and nine-month periods ended September 30, 1998, respectively, as compared to $2.0 million and $5.5 million for the comparable periods of 1997. The dollar increases of $10.8 million and $21.8 million are primarily a result of a 32% increase in mobile data units during the nine months of 1998 and $20.3 million from the ARDIS data service. Service revenue from capacity resellers, who handle both voice and data services, approximated $966,000 in the third quarter of 1998 and $2.6 million for the nine-months ended September 30, 1998, as compared to $745,000 and $1.9 million for the same periods of 1997, an increase of $221,000 and $752,000, or 30% and 40%, respectively. Revenue from the sale of mobile data terminals and mobile telephones decreased 13% from $15.5 million in the first nine months of 1997 to $13.5 million in the same period of 1998 and, similarly, by 21% from $5.2 million to $4.1 million in the third quarter of 1997 and 1998, respectively. The decrease was primarily attributable to reduced sales of voice products, as well as certain price reductions made in the first quarter of 1998. ARDIS equipment sales for the third quarter and nine months ended September 30, 1998 were $491,000 and $875,000, respectively. Cost of service and operations for the three-months and the nine-months ended September 30, 1998, which includes costs to support subscribers and to operate the Network, was $16.4 million and $41.1 million compared to $7.9 million and $25.0 million for the same periods of 1997. Cost of service and operations, as a percentage of revenues, was 75% and 73% for the third quarters of both 1998 and 1997, respectively, and 76% and 83% for the first nine-months of 1998 and 1997, respectively. The increase in cost of service and operations was primarily attributable to (i) $17.7 million of ARDIS costs (ii) increased interconnect charges associated with increased service usage offset by (iii) a reduction in information technology costs affected by reducing the dependence on outside consultants. Absent the acquisition of ARDIS on March 31, 1998, cost of service and operations for the three-month and nine-month period ended September 30, 1998, respectively, was $7.8 million and $23.4 million, and represented approximately 36% and 43% of revenue, compared to $7.9 million and $25.0 million for the same periods in 1997. The cost of equipment sold decreased 24% from $6.3 million for the three-months ended September 30, 1997, to $4.8 million for the three-months ended September 30, 1998, and 25% from $18.9 million for the nine-month period ended September 30, 1997, to $14.1 million for the same period in 1998. The dollar decrease in the cost of equipment sold was primarily attributable to (i) a corresponding decrease in voice equipment sales and (ii) the impact of the inventory write-down in the fourth quarter of 1997. Sales and advertising expenses were $4.5 million and $12.3 million for the three-months and the nine-months ended September 30, 1998, respectively, compared to $2.9 million and $9.1 million for the same periods in 1997. Sales and advertising expenses as a percentage of revenue were 21% and 23% in the third quarter and nine months of 1998, respectively, as compared to 27% and 30% during the same periods of 1997. The increase in sales and advertising expenses was primarily attributable to ARDIS. Absent the acquisition of ARDIS, sales and advertising expenses for the three-month and nine-month period ended September 30, 1998 were $3.0 million and $9.4 million, respectively, and represented 14% and 17% of revenue, respectively, compared to $2.9 million and $9.1 million, or 27% and 30% of revenue, for the same periods in 1997. General and administrative expenses for the three-months and the nine-months ended September 30, 1998, were $4.5 million and $13.9 million, respectively, compared to $3.1 million and $10.9 million in the same periods of 1997. As a percentage of revenue, general and administrative expenses represented 21% and 26% in the third quarter and nine months of 1998, respectively, compared to 29% and 36% in the same periods of 1997. The dollar increase in general and administrative expenses for the nine months ended September 30, 1998 compared to the same period in 1997 was primarily attributable to $3.6 million of ARDIS costs offset by a $341,000 reduction in personnel expenses as a result of reduced headcount. Absent the acquisition of ARDIS, general and administrative expenses for the three-month and nine-month period ended September 30, 1998 were $3.0 million and $10.3 million, respectively, approximating 14% and 19% of revenue, compared to $3.1 million and $10.9 million for the same periods in 1997. Depreciation and amortization expense was $13.9 million and $38.5 million for the three-months and the nine-months ended September 30, 1998, respectively, representing approximately 64% and 71% of revenue for the respective periods. During the same periods of 1997 depreciation and amortization expense was $10.4 million and $31.5 million, approximating 96% and 104% of revenue. The increase in depreciation and amortization expense was primarily attributable to the addition of ARDIS assets and amortization of goodwill associated with the ARDIS acquisition. Absent the acquisition of ARDIS, depreciation and amortization expense for the three-month and nine-month period ended September 30, 1998 was $14.2 million and $34.7 million, respectively, approximating 65% and 64% of revenue, compared to $10.4 million and $31.5 million for the same periods in 1997. Interest and other income was $1.6 million and $3.3 million for the third quarter and nine months of 1998, respectively, as compared to $212,000 and $1.3 million for the same periods in 1997. The increase was primarily a result of interest earned on escrows required under the terms of the $335 million debt offering at the end of the first quarter. The Company incurred $15.5 million and $37.9 million of interest expense in the third quarter and nine months of 1998, respectively, compared to $6.7 million and $16.3 million for the same periods in 1997, reflecting (i) the amortization of debt discount and debt offering costs in the amount of $8.6 million in 1998, compared to $6.8 million in 1997 and (ii) higher outstanding loan balances as compared to 1997. Interest expense in the first nine months of 1998 was significant as a result of borrowings under the Bank Financing, the amortization of borrowing costs incurred in conjunction with securing the facility, and interest accrual on the Notes issued in the ARDIS acquisition. It is anticipated that interest costs will continue to be significant as a result of the Bank Financing and Acquisition, (see "Liquidity and Capital Resources"). Net capital expenditures, for the first nine months of 1998 for property and equipment were $7.4 million compared to $6.4 million for the same period in 1997. Liquidity and Capital Resources - ------------------------------- $335 Million Unit Offering - -------------------------- In connection with the Acquisition, discussed above, the Company issued $335 million of Units (the "Units") consisting of 12 1/4% Senior Notes due 2008 (the "Notes"), and Warrants to purchase shares of Common Stock of the Company. Each Unit consists of $1,000 principal amount of Notes and one Warrant to purchase 3.75749 shares of Common Stock at an exercise price of $12.51 per share. The Warrants were valued at $8.5 million and are reflected in the balance sheet as a debt discount. A portion of the net proceeds of the sale of the Units were used to finance the Acquisition. In connection with the Notes, the Company has purchased approximately $112.3 million of pledged securities that are intended to provide for the payment of the first six interest payments on the Notes. The Company incurred approximately $15 million in costs associated with the placement of the Notes and the Acquisition. Interest payments are due semi-annually, in arrears, beginning October 1, 1998. The Notes contain covenants that, among other things, limit the ability of Acquisition Company and its Subsidiaries to incur additional indebtedness, pay dividends or make other distributions, repurchase any capital stock or subordinated indebtedness, make certain investments, create certain liens, enter into certain transactions with affiliates, sell assets, enter into certain mergers and consolidations, and enter into sale and leaseback transactions. Acquisition Company consummated its offer to exchange up to $335 million aggregate principal amount of its registered 12 1/4 percent Senior Notes (due 2008, Series B) (the "New Notes") for outstanding unregistered 12 1/4 percent Senior Notes (due 2008, Series A) (the "Old Notes"). Holders tendered for exchange $334.75 million aggregate principal amount of the Old Notes as of the expiration of the offer. New Bank Financing - ------------------ In connection with the Acquisition, the Company, the Acquisition Company and its subsidiaries restructured the existing $200 million Bank Financing (the "Bank Financing") to provide for two facilities: (i) the Revolving Credit Facility, a $100 million unsecured five-year reducing revolving credit facility, and (ii) the Term Loan Facility, a $100 million five-year, term loan facility with up to three additional one-year extensions subject to the lenders' approval. The Revolving Credit Facility bears an interest rate, generally, of 50 basis points above LIBOR and is unsecured, with a negative pledge on the assets of the Acquisition Company and its subsidiaries ranking pari passu with the Notes. The Revolving Credit Facility will be reduced $10 million each quarter, beginning with the quarter ending June 30, 2002, with the balance due on maturity of March 31, 2003. Borrowings under the Revolving Credit Facility are subject to certain conditions beginning in the fourth quarter of 1998. In the event the Company is unable to borrow amounts under the Revolving Credit Facility, the Company's cash needs will significantly exceed its available resources, which would have a material adverse effect on the Company. The revolving Credit Facility ranks pari passu with the Notes. The Term Loan Facility is secured by the assets of the Company, principally its stockholdings in XM Radio and the Acquisition Company, and is effectively subordinated to the Revolving Credit Facility and the Notes. The New Bank Financing is severally guaranteed by Hughes Electronics Corporation ("Hughes"), Singapore Telecommunications Ltd. ("Singapore Telecom") and Baron Capital Partners, L.P. (collectively, the "Bank Facility Guarantors"). In exchange for the additional risks undertaken by the Bank Facility Guarantors in connection with the New Bank Financing, the Company agreed to compensate the Bank Facility Guarantors, principally in the form of 1 million additional warrants and re-pricing of 5.5 million warrants previously issued (together, the "Guarantee Warrants"). The Guarantee Warrants have an exercise price of $12.51 and have been valued at approximately $17.7 million. As of October 31, 1998, the Company had outstanding borrowings of $100 million of the Term Loan Facility at 5.8125%, and $32.0 million under the Revolving Credit Facility at rates ranging from 5.75% to 6.1875%. In connection with the New Bank Financing, the Company entered into an interest rate swap agreement, with an implied annual rate of 6.51%. The swap agreement reduces the impact of interest rate increases on the Term Loan Facility, and fixes The Company paid a fee of approximately $17.9 million for the swap agreement. Under the swap agreement, the Company will receive an amount equal to LIBOR plus 50 basis points, paid on a quarterly basis, on a notional amount of $100 million until the termination date of March 31, 2001. The Company has reflected as an asset the unamortized fee paid for the swap agreement in the accompanying financial statements. The Company is exposed to a credit loss in the event of non performance by the counter party under the swap agreement. The Company does not believe there is a significant risk of non performance as the counter party to the swap agreement is a major financial institution. Motorola Vendor Financing - ------------------------- Motorola has entered into an agreement with a subsidiary of Acquisition Company, the ARDIS Company, to provide up to $10 million of vendor financing (the "Vendor Financing Commitment"), which will be available to finance up to 75% of the purchase price of additional network base stations. Loans under this facility will bear interest at a rate equal to LIBOR plus 7.0% and will be guaranteed by the Company and each subsidiary of the Acquisition Company. The terms of the facility require that amounts borrowed be secured by the equipment purchased therewith. As of October 31, 1998, $591,707 was outstanding under this facility. Financing Summary - ----------------- The Company believes the proceeds from the issuance of the Notes, net of cash used for the Acquisition, together with the borrowings under the New Bank Financing and the Vendor Financing Commitment, will be sufficient to fund operating losses, capital expenditures, working capital, and scheduled principal and interest payments on debt through 1998 and beyond; however, there can be no assurance that the Company's current projections regarding the timing of its ability to achieve positive operating cash flow will be accurate, and that the Company will not need additional financing in the future. XM Radio - -------- As previously mentioned (see "Organization and Business"), XM Radio was a winning bidder for, and on October 16, 1997, was awarded an FCC license to provide DARS throughout the United States. XM Radio has and will continue to receive funding for this business from an independent source in exchange for debt and an equity interest in XM Radio. Accordingly, it is not expected that the development of this business will have a material impact on the Company's financial position, results of operations, or cash flows. The Company's equity interest in XM Radio may, however, even on a fully diluted basis, become a material asset of the Company. Deferred Trade Payables - ----------------------- The Company has arranged the financing of certain trade payables, and as of September 30, 1998, $6.4 million of deferred trade payables were outstanding at rates ranging from 6.22% to 12% and are generally payable by the end of 1999. Purchase and Lease of Satellite - ------------------------------- As previously disclosed, the Company has entered into certain agreements to acquire a one-half ownership interest in TMI Communications and Company, Limited Partnership's ("TMI") satellite, MSAT-1, at a cost of $60 million payable over a five-year period, as well as entered into five-year lease of the Company's satellite, MSAT-2, with African Continental Telecommunications Ltd. that provides for aggregate lease payments to the Company of $182.5 million. Closing under the agreements is subject to a number of conditions, including: a successful financing by ACTEL of at least $120 million and completion of certain satellite testing, inversion and relocation activities with respect to AMSC-1. It is anticipated that if the conditions are met, closing under both the purchase and lease agreements would occur simultaneously in the first half of 1999; however, there can be no assurances that these conditions will be met and the transactions consummated. Other - ----- At October 31, 1998, the Company had remaining contractual commitments to purchase both mobile data terminal inventory and mobile telephone inventory in the maximum amount of $11.1 million over the next year. Additionally, the Company had remaining contractual commitments in the amount of $1.3 million for the development of certain next generation data terminal inventory. Contingent upon the successful research and development efforts, the Company would have maximum additional contractual commitments for mobile communications data terminal inventory in the amount of $27.0 million over a three-year period. The Company has the right to terminate the research and development and inventory commitment by paying cancellation fees of between $1 million and $2.5 million, depending on when the termination option is exercised during the term of the contract. The Company also has the right to terminate the inventory commitment by incurring a cancellation penalty representing a percentage of the unfulfilled portion of the contract. The Company has also contracted for the purchase of $26.2 million next generation wireless data terminals to be delivered beginning early 1999. The contract contains a 50% cancellation penalty. Additionally, the Company has remaining contractual commitments for the purchase of $6.4 million of base stations necessary to complete the required site build-outs. On July 2, 1998, the Company filed an application with the Federal Communications Commission ("FCC") to construct and launch a follow-on geostationary mobile satellite for its business. The filing of the application does not commit the Company to expend any resources toward this project; however, should the Company decide to proceed with the construction of the follow-on satellite, the Company would be required to raise substantial additional capital to fund this project. On October 29, 1998, the Company announced that it reached an agreement with Stratos Global Corporation to consolidate American Mobile's marine distribution channel, resulting in the transfer of inventory and contracts in exchange for $8.5 million. Apart from the initial cash inflow, it is not expected that this transaction will have a material impact on the Company's financial position, results of operations, or cash flows. Cash used in operating activities for the first nine months of 1998 was $41.3 million as compared to $43.1 million for the same period of 1997. The decrease in cash used in operating activities was primarily attributable to reduced inventory spending. Cash used by investing activities was $202.1 million for the first nine months of 1998 compared to $7.6 million during the first six months of 1997. The increase was primarily attributable to the acquisition of ARDIS and the funding of certain escrows required in connection with the Acquisition and issuance of Notes. Cash provided by financing activities was $252.0 million during the first nine months of 1998 as compared to $51.1 million during the first nine months of 1997, reflecting (i) the proceeds from the Notes, offset by (ii) the repayment of a portion of the Bank Financing and (iii) payment of financing fees associated with the acquisition of the Notes. As of September 30, 1998, the Company had $10.6 million of cash and cash equivalents and working capital of $59.6 million. Year 2000 - --------- The Company has developed and is implementing a Year 2000 Compliance Program ("Year 2000 Program") to address Year 2000 issues. Under the Year 2000 Program, the Company has prioritized the systems that are undergoing an assessment of Year 2000 vulnerability and, if necessary, remediation of the problem. The Company's core business systems are those systems--both hardware and software--that could have a material impact on the Company's financial condition and results of operations. Vendors that provide critical products and services to American Mobile are also included in this assessment of core business systems. Although the core business systems are the top priority in the Year 2000 Program, the Company is assessing all software and hardware for Year 2000 Compliance. The Company is tracking its progress on the Year 2000 Program with reference to the following phases: Awareness Phase: educating employees about the problem and how the ---------------- Year 2000 Plan will be implemented; Inventory Phase identifying all software programs and hardware systems --------------- and business relationships with third parties; Assessment Phase contacting the vendors of commercial off the shelf ----------------- software and hardware regarding Year 2000 compliance; contacting business partners and service providers regarding their company's Year 2000 compliance status; analyzing software source code if available to the Company; prioritizing non-compliant software and systems based on criticality to the business; Renovation Phase obtaining and installing software upgrades or patches ---------------- for software that is not Year 2000 compliant; replacing software or hardware that is not Year 2000 compliant; Validation/Testing Phase conducting testing of upgraded/repaired ------------------ software and hardware systems; Implementation/Rollout Phase installing upgraded/repaired software and ---------------------- hardware systems; conducting user training; updating documentation; The Inventory of all systems, including software and hardware, that are in use by the Company was completed in August 1998. Although many systems that are not Year 2000 Compliant are currently in the Renovation Phase, overall, the Company is nearing the completion of the Assessment Phase and anticipates that it will be complete by the end of 1998. Management believes that when completed, the Assessment Phase will enable the completion of planning currently underway for the Renovation and Validation/Testing Phases and provide sufficient timing and planning for the Implementation/Rollout Phase. The Company anticipates that it will complete the Implementation/Rollout Phase for all core business systems and will be Year 2000 Compliant by fourth quarter 1999, with compliance with respect to its voice operations and deployment of certain of its renovated data terminals to customers to present the most significant schedule completion risk. While there can be no assurances that the Company will be successful in its efforts to make all core business systems Year 2000 Compliant by December 31, 1999, the Company believes it will be able to successfully complete the required remediation of its core business systems in a timely manner. The total cost of the Company's Year 2000 Compliance Program is estimated to be $2.4 million for 1998 of which approximately $1.2 million has been incurred through October 1998. Expenditures for the Year 2000 Compliance Program in 1999 are estimated to be up to $13 million. Some modification costs--including the purchase of software upgrades and consulting services--are expensed as incurred while other modification costs--such as hardware purchases--are being treated as capital expenditures. The estimated cost and date on which the Company believes it will be Year 2000 compliant are based on management's best estimates, yet there is no guarantee that these estimates will be achieved and actual results could differ materially from those anticipated. Some of the Company's critical business systems are dependent on a significant number of software programs and on services provided by third parties that are not within the Company's control. Failure to solve Year 2000 errors within its critical business systems could result in possible service outages, miscalculations or disruption of operations that could have a material impact on the Company's business. While management believes that the Company will be able to achieve Year 2000 Compliance in a timely manner the schedule for completing the implementation of several core business systems extends to the third or fourth quarter 1999 and there is a possibility that compliance may not be accomplished in a timely manner or within budget. Contingency planning, as discussed below, is currently underway to minimize the risk of business interruptions caused by Year 2000 problems within the core business systems. Certain contingency plans already existing within the company to minimize service interruptions are expected to mitigate--although not eliminate--interruptions caused by problems resulting from Year 2000 issues. For example, the Company has backup power supplies and generators in place for certain portions of its networks in the event of electrical power outages. In addition, for some services the Company has contracted with more than one service provider. These systems already in place are being incorporated into the Company's Year 2000 contingency planning. To the extent that it is commercially reasonable to do so, the Company will include other redundant or alternative sources of services in its Year 2000 contingency planning efforts. The Company anticipates having its additional Year 2000 contingency plans in place by June 1999. Other Matters - ------------- In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income," and SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." The Company adopted both of these standards during the nine month period ended September 30, 1998. SFAS No. 130 requires "comprehensive income" and the components of "other comprehensive income" to be reported in the financial statements and/or notes thereto. Since the Company does not have any components of "other comprehensive income," reported net income is the same as "total comprehensive income" for the three months and nine months ended September 30, 1997 and 1998. SFAS No. 131 requires an entity to disclose financial and descriptive information about its reportable operating segments. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. SFAS No. 131 is not required for interim financial reporting purposes during 1998. The Company is in the process of assessing the additional disclosures, if any, required by SFAS No. 131. However, such adoption will not impact the Company's results of operations or financial position, since it relates only to disclosures. PART II - OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K (a)Exhibits 3.1 - Restated Certificate of Incorporation of AMSC (as restated effective May 1, 1996) (Incorporated by reference to Exhibit 3.1 to the Company's Annual Report on Form 10-K for the period ending December 31,1997 (File No. 0-23044)) 3.2 - Amended and Restated Bylaws of AMSC (as amended and restated effective May 20, 1998) (Incorporated by reference to Exhibit 3.2 to the Company's Annual Report on Form 10-K for the fiscal year ending December 31, 1997 (File No. 0-23044)) 10.62a - Letter Agreement dated October 8, 1998 regarding the Satellite Lease Agreement for the AMSC-1 Satellite by and among AMSC Subsidiary Corporation, American Mobile Satellite Corporation and African Continental Telecommunications Ltd. dated December 2, 1997 and the Satellite Purchase Agreement dated December 2, 1997 among TMI Communications and Company, Limited Partnership and AMSC Subsidiary Corporation and American Mobile Satellite Corporation (filed herewith). 10.63a - Amendment No. 1 to Satellite Purchase Agreement dated as of October 9, 1998 between TMI Communications and Company, Limited Partnership and AMSC Subsidiary Corporation and American Mobile Satellite Corporation (filed herewith). 11.1 - Computations of Earnings Per Common Share (filed herewith) 27.0 - Financial Data Schedule (filed herewith) SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. AMERICAN MOBILE SATELLITE CORPORATION (Registrant) Date: November 13, 1998 By: /s/ STEPHEN D. PECK ------------------------------------- Stephen D. Peck Vice President and Chief Financial Officer principal financial and accounting officer) EXHIBIT INDEX Number Description 3.1 - Restated Certificate of Incorporation of AMSC (as restated effective May 1, 1996) (Incorporated by reference to Exhibit 3.1 to the Company's Annual Report on Form 10-K for the period ending December 31,1997 (File No. 0-23044)) 3.2 - Amended and Restated Bylaws of AMSC (as amended and restated effective May 20, 1998) (Incorporated by reference to Exhibit 3.2 to the Company's Annual Report on Form 10-K for the fiscal year ending December 31, 1997 (File No. 0-23044)) 10.62a - Letter Agreement dated October 8, 1998 regarding the Satellite Lease Agreement for the AMSC-1 Satellite by and among AMSC Subsidiary Corporation, American Mobile Satellite Corporation and African Continental Telecommunications Ltd. dated December 2, 1997 and the Satellite Purchase Agreement dated December 2, 1997 among TMI Communications and Company, Limited Partnership and AMSC Subsidiary Corporation and American Mobile Satellite Corporation (filed herewith). 10.63a - Amendment No. 1 to Satellite Purchase Agreement dated as of October 9, 1998 between TMI Communications and Company, Limited Partnership and AMSC Subsidiary Corporation and American Mobile Satellite Corporation (filed herewith). 11.1 - Computations of Earnings Per Common Share (filed herewith) 27.0 - Financial Data Schedule (filed herewith)