FORM 10-K
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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(Mark one)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 For the fiscal year ended: September 30, 1997
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[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ____________ to ____________
Commission file number: 0-15056
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COMMNET CELLULAR INC.
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(Exact name of registrant as specified in its charter)
Colorado 84-0924904
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
8350 East Crescent Parkway, Suite 400, Englewood, Colorado 80111
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(Address of principal executive offices)
(Zip Code)
303/694-3234
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.001 per share
(Title of Class)
Preferred Stock Purchase Rights
(Title of Class)
Indicate by check mark whether the registrant (a) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
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Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ]
The aggregate market value of the voting stock held by nonaffiliates of the
registrant, computed by reference to the last sale price of such stock as of the
close of trading on December 19, 1997 was $483,183,800.
The number of shares of the registrant's common stock outstanding as of
December 19, 1997 was 13,796,836.
PART I
Item 1. Business.
(a) General Development of Business.
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CommNet Cellular Inc. was organized under the laws of Colorado in 1983.
Cellular, Inc. Financial Corporation ("CIFC") subsequently was organized to
provide financing to affiliates of the Company. Cellular Inc. Network
Corporation ("CINC") subsequently was organized to acquire interests in cellular
licenses. CommNet Paging Inc. ("CPI") subsequently was organized to provide
paging services. CIFC, CINC and CPI are wholly-owned subsidiaries of CommNet
Cellular Inc. Unless the context indicates otherwise, the "Company" refers to
CommNet Cellular Inc. and its consolidated subsidiaries.
As used herein, "pops" means the estimated total 1996 population of a
Metropolitan Statistical Area ("MSA") or Rural Service Area ("RSA") as initially
licensed by the Federal Communications Commission ("FCC"), based upon
Demographics On-Call population estimates. "Net Company pops" means an MSA's or
RSA's pops multiplied by the Company's net ownership interest in the entity
licensed by the FCC to operate a cellular telephone system in that MSA or RSA.
An MSA or RSA is referred to herein as a "market," and a market served by a
cellular telephone system that is managed, directly or indirectly, by the
Company is referred to herein as a "managed market." The radio signal from the
Company's managed systems covers virtually all of the pops within the managed
markets. The number of pops does not represent the current number of users of
cellular services and is not necessarily indicative of the number of users of
cellular services in the future. Those corporations and partnerships through
which the Company holds ownership interests in cellular licensees and those
cellular licensees in which the Company holds a direct ownership interest are
referred to herein as "affiliates." Any reference herein to an "affiliate" does
not necessarily imply that the Company exercises, or has the power to exercise,
control over the management and policies of such entity.
The Company operates, manages and finances cellular telephone systems,
primarily in rural markets in the mountain and plains regions of the United
States. The Company's cellular interests currently represent approximately
3,570,000 net Company pops in 82 markets located in 14 states. These markets
consist of 72 RSA markets having a total of 5,246,000 pops and 10 MSA markets
having a total of 1,315,000 pops, of which the Company's interests represent
2,885,000 net Company pops and 685,000 net Company pops, respectively. Systems
in which the Company holds an interest constitute one of the largest geographic
collection of contiguous cellular markets in the United States.
The Company was formed to acquire cellular interests through
participation in the licensing process conducted by the FCC. In order to
participate in that process, the Company formed affiliates which originally were
owned at least 51% by one or more independent telephone companies ("telcos") and
no more than 49% by the Company. See "-- Federal Regulation." In exchange for
the Company's 49% interest, the Company offered to sell shares of its Common
Stock to the telcos and agreed to provide financing to the affiliates. The
Company subsequently purchased additional interests in many of such affiliates,
as well as in additional cellular properties. The Company currently manages 56
of the 82 markets in which it holds an interest and owns a greater than 50%
interest in 46 of its 56 managed markets. The Company provides capital and
financing to entities holding interests representing approximately 4,206,000
pops, of which 3,570,000 are included in net Company pops and 636,000 are
attributable to parties other than the Company.
Since completion of the licensing process, the Company has concentrated
on creating an integrated network of contiguous cellular systems comprised of
markets which are managed by the Company. The network currently consists of 56
markets (49 RSA and 7 MSA markets) spanning nine states and represents
approximately 4,228,000 pops and 3,246,000 net Company pops. As of September 30,
1997, the RSA and MSA managed markets had 206,166 and 68,579 subscribers,
respectively. The Company significantly expanded radio signal coverage with
construction of 72 new cell sites in fiscal year 1997.
I-1
The Company believes that certain demographic characteristics of the
rural marketplace should further facilitate commercial exploitation of the
network. As compared to urban residents, rural residents travel greater
distances by personal vehicle and have access to fewer public telephones along
drive routes. The Company believes that these factors will sustain demand for
mobile telecommunication service in the rural marketplace. These same factors
produce "roaming" revenues that are higher as a percentage of total revenues
than would likely be the case in more densely populated urban areas. In-roaming
revenues tend to produce higher margins because roaming calls on average are
priced at higher rates than local calls and because there are no associated
sales commission costs.
On May 27, 1997, the Company and AV Acquisition Corp. ("Newco"), which
as of the date hereof is a wholly-owned subsidiary of Blackstone CCI Capital
Partners L.P., a Delaware limited partnership (the "Partnership") affiliated
with Blackstone Management Associates II L.L.C., a Delaware limited liability
company "Blackstone"), entered into an Agreement and Plan of Merger (the "Merger
Agreement") pursuant to which Newco will merge with and into the Company (the
"Merger"), with the Company being the surviving corporation in the Merger. Upon
consummation of the Merger, each share of Common Stock issued and outstanding
immediately prior to the effective time of the Merger (the "Effective Time")
(other than those shares described below) will be converted, at the election of
the holder thereof and subject to the terms of the Merger Agreement, into either
(a) the right to receive $36.00 in cash or (b) the right to retain one fully
paid and nonassessable share of Common Stock, including the associated right.
The following shares of Common Stock are not subject to conversion pursuant to
the Merger: shares of Common Stock held by the Partnership, partnerships
affiliated with Blackstone expected to acquire interests in Newco prior to the
consummation of the Merger (any such partnerships, together with the
Partnership, hereinafter referred to as the "Partnerships"), Newco, any wholly-
owned subsidiary of the Company or any wholly-owned subsidiary of Newco, which
will be canceled and retired; fractional shares which will be converted to cash;
and shares of Common Stock in respect of which dissenters' rights have been
properly exercised. The rights associated with the shares of Common Stock that
are converted into the right to receive $36.00 in cash will be extinguished in
the Merger for no additional consideration. The election to retain Common Stock
is subject to proration so that, following the Merger, 588,611 shares
(representing approximately 4% of the presently issued and outstanding Common
Stock) will be retained by existing shareholders of the Company, representing
approximately 13% of the shares of the Company to be issued and outstanding
immediately after the Merger. The shares of Common Stock to be owned by the
shareholders of Newco as a result of the Merger will represent approximately 87%
of the shares of the Company issued and outstanding immediately after the
Merger, resulting in such shareholders of Newco becoming the controlling
shareholders of the Company.
The obligations of the Company and Newco to consummate the Merger are
subject to various conditions, including, without limitation, obtaining
requisite approval of the Company's shareholders, obtaining the requisite
approval of relevant government authorities, including the FCC, and the absence
of any injunction or other legal restraint or prohibition preventing the
consummation of the Merger. On September 25, 1997, the Company's shareholders
voted in favor of the Merger. Newco's obligations to effect the Merger are
further subject, among other things, to (i) the Company amending the terms of
the 11 3/4% Senior Subordinated Discount Notes (the "Discount Notes") and the 11
1/4% Subordinated Notes (the "Subordinated Notes") and purchasing such
Securities in accordance with the provisions of the Merger Agreement, (ii) CIFC
repaying all amounts outstanding under the CoBank Credit Agreement, (iii) the
Company or CIFC receiving financing proceeds on terms and conditions set forth
in the commitment letter from Chase Manhattan Bank (the "Commitment Letter") or
upon terms and conditions which are substantially equivalent thereto and, to the
extent that any of the terms and conditions are not contemplated by the
Commitment Letter, on terms and conditions reasonably satisfactory to Newco,
(iv) the absence of certain litigation, (v) since May 27, 1997, no material
adverse change relating to the Company having occurred and being continuing,
(vi) all regulatory approvals, as described in the Merger Agreement, having been
obtained, having been declared or filed or having occurred, as the case may be,
and all such required regulatory approvals being in full force and effect and
(vii) Newco having been reasonably satisfied that the Merger will be recorded as
a recapitalization for financial reporting purposes.
The Merger is expected to be consummated shortly after all conditions
thereto have been satisfied, including the receipt of FCC approval. As
previously disclosed, certain petitions have been filed before the FCC
I-2
seeking to dismiss or deny the Company and the Partnership's joint application
to the FCC to transfer control of certain cellular licenses from the Company to
the Partnership. Although the Company is seeking to have the FCC dismiss such
petitions on an expedited basis, there can be no assurance as to the outcome of
such decision, or the time period that may elapse before a decision is reached
and consequently, of the time period that may elapse before the Merger is
consummated. The Company believes that it will prevail on the merits on the
petitions and is contesting the petitions vigorously.
(b) Financial Information About Industry Segments.
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The Company has only one principal industry being the management,
financing and operation of cellular telephone systems. Information concerning
revenue, operating profit or loss and identifiable assets of the Company's
primary industry segment are set forth in the consolidated financial statements
and related notes included in Part II of this Report.
(c) Narrative Description of Business.
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The Company's Operations
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General. Information regarding the Company's net ownership interests
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in each cellular licensee and the market subject to such license as of December
19, 1997 is summarized in the following table.
Net Company
MSA or Interest in 1996 Net Company
RSA Code (1)(7) State Licensee (2) Population (3)(6) Pops (4)
- --------------- ---------------------- ----------------- -------------------- ----------------
MSAs:
141 Minnesota 16.34% 240,234 39,254
185 Indiana 16.67% 170,755 28,465
241*(5) Colorado 73.99% 130,921 96,868
253*(5) Iowa 74.50% 120,902 90,072
267*(5) South Dakota 51.00% 137,742 70,248
268*(5) Montana 91.63% 126,711 116,105
279 Maine 11.11% 103,721 11,522
289*(5) South Dakota 100.00% 111,904 111,904
297*(5) Montana 91.63% 81,568 74,741
298*(5) North Dakota 51.00% 90,439 46,124
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Total MSA 1,314,897 685,303
RSAs:
348* Colorado 10.00% 47,002 4,700
349*(5) Colorado 61.75% 62,939 38,865
351*(5) Colorado 61.75% 74,044 45,722
352*(5) Colorado 66.00% 30,019 19,813
353*(5) Colorado 100.00% 72,920 72,920
354*(5) Colorado (B1) 69.40% 47,604 33,037
355* Colorado 49.00% 45,762 22,423
356* Colorado (B1) 49.00% 25,426 12,459
389 Idaho 50.00% 71,284 35,642
390 Idaho 33.33% 17,602 5,867
392*(5) Idaho (B1) 100.00% 141,031 141,031
393*(5) Idaho 91.64% 293,120 268,615
415 Iowa 10.11% 155,178 15,694
416 (5) Iowa 78.57% 109,023 85,659
I-3
Net Company
MSA or Interest in 1996 Net Company
RSA Code (1) State Licensee (2) Population (3)(6) Pops (4)
- --------------- ---------------------- ----------------- -------------------- ----------------
417*(5) Iowa 100.00% 155,268 155,268
419* Iowa 44.92% 54,745 24,591
420*(5) Iowa 100.00% 63,302 63,302
424* Iowa 50.00% 66,929 33,465
425* Iowa 13.28% 107,809 14,321
426* Iowa 49.14% 83,580 41,070
427* Iowa 49.17% 103,912 51,090
428 Kansas 3.07% 27,741 852
429 Kansas 3.07% 30,523 937
430 Kansas 3.07% 53,026 1,628
431 Kansas 3.07% 137,928 4,234
432 Kansas 3.07% 31,040 953
433 Kansas 3.07% 20,123 618
434 Kansas 3.07% 80,524 2,472
435 Kansas 3.07% 131,254 4,029
436 Kansas 3.07% 58,858 1,807
437 Kansas 3.07% 109,008 3,347
438 Kansas 3.07% 84,143 2,583
439 Kansas 3.07% 43,831 1,346
440 Kansas 3.07% 29,677 911
441 Kansas 3.07% 175,260 5,380
442 Kansas 3.07% 155,007 4,759
512 Missouri (B1) 14.70% 56,464 8,300
523*(5) Montana (B1) 91.63% 72,719 66,632
523*(5) Montana (B2) 91.63% 78,894 72,291
524*(5) Montana (B1) 91.63% 34,780 31,869
526*(5) Montana (B1) 91.63% 21,753 19,932
527*(5) Montana 91.63% 189,151 173,319
528*(5) Montana 91.63% 65,206 59,748
529*(5) Montana 91.63% 30,030 27,516
530*(5) Montana 91.63% 92,780 85,014
531*(5) Montana 91.63% 33,426 30,628
532*(5) Montana 91.63% 20,078 18,397
553*(5) New Mexico (B2) 58.36% 113,473 66,223
555 New Mexico 12.25% 89,939 11,018
557 New Mexico 16.33% 59,835 9,772
580*(5) North Dakota 53.36% 103,812 55,393
581* North Dakota 49.00% 60,895 29,839
582 North Dakota 41.45% 90,709 37,598
583* North Dakota 49.00% 63,305 31,019
584*(5) North Dakota 61.75% 48,606 30,014
634*(5) South Dakota 100.00% 37,096 37,096
635*(5) South Dakota 100.00% 23,000 23,000
636*(5) South Dakota 100.00% 53,557 53,557
638*(5) South Dakota (B1) 100.00% 17,069 17,069
638*(5) South Dakota (B2) 100.00% 9,102 9,102
639*(5) South Dakota (B1) 100.00% 36,886 36,886
639*(5) South Dakota (B2) 100.00% 3,233 3,233
I-4
Net Company
MSA or Interest in 1996 Net Company
RSA Code (1) State Licensee (2) Population (3)(6) Pops (4)
- --------------- ---------------------- ----------------- -------------------- ----------------
640*(5) South Dakota 64.49% 67,096 43,270
641*(5) South Dakota 61.13% 73,887 45,167
642* South Dakota 49.00% 96,725 47,395
675*(5) Utah 100.00% 56,209 56,209
676*(5) Utah 100.00% 107,882 107,882
677*(5) Utah (B3) 100.00% 39,506 39,506
678*(5) Utah 80.00% 28,326 22,661
718*(5) Wyoming 66.00% 50,273 33,180
719*(5) Wyoming 100.00% 76,440 76,440
720*(5) Wyoming 100.00% 147,595 147,595
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Total RSA 5,246,179 2,885,188
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Total MSA and RSA 6,561,076 3,570,483
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(1) MSA ranking is based on population as established by the FCC. RSAs have
been numbered by the FCC alphabetically by state.
(2) Represents the net ownership interest of the Company in the licensee for a
cellular telephone system in the respective market. Net ownership of
greater than 50% does not necessarily represent a controlling interest in
such licensee.
(3) Derived from the Demographics On-Call 1996 population estimates.
(4) Net Company Pops represents Net Company Interest in Licensee multiplied by
1996 population.
(5) The operations of these markets are currently reflected on a consolidated
basis in the Company's consolidated financial statements. The operations
of the other markets in which the Company holds an interest are reflected
in such financial statements on either an equity or a cost basis.
(6) Represents population within the market area initially licensed by the FCC.
The number of pops which are covered by radio signal in a market is
expected to be marginally lower than the market's total pops on a going-
forward basis.
Markets managed by the Company are denoted by an asterisk (*).
I-5
Subscriber Growth Table
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Information regarding subscribers to the MSA and RSA cellular systems
managed by the Company is summarized by the following table:
Number of Estimated Population
Managed Markets of Managed Markets Number of Subscribers
------------------- ---------------------------------------- -------------------------- Subscriber
Total MSA RSA Total MSA RSA Total MSA RSA Growth
----- --- ----- ---------- ------------ ------------- --------- ------ ------- ----------
Sept. 30, 1987 0 0 0 0 0 0 0 0 0
Sept. 30, 1988 4 4 0 504,529 504,529 (1) 0 424 424 0
Sept. 30, 1989 4 4 0 500,804 500,804 (2) 0 1,362 1,362 0 221.23%
Sept. 30, 1990 18 4 14 1,687,481 500,804 (2) 1,186,677 (2) 6,444 3,513 2,931 373.13%
Sept. 30, 1991 49 5 44 3,509,779 566,722 (3) 2,943,057 (3) 17,952 6,387 11,565 178.58%
Sept. 30, 1992 49 5 44 3,509,779 566,722 (3) 2,943,057 (3) 35,884 11,119 24,765 99.89%
Sept. 30, 1993 51 6 45 3,665,758 644,526 (4) 3,021,232 (4) 60,381 17,898 42,483 68.27%
Sept. 30, 1994 55 7 48 3,906,063 771,660 (5) 3,134,403 (5) 99,002 30,711 68,291 63.96%
Sept. 30, 1995 56 7 49 4,220,975 785,866 (6) 3,435,109 (6) 151,482 42,401 109,081 53.01%
Sept. 30, 1996 55 7 48 4,105,119 792,913 (7) 3,312,206 (7) 211,278 55,896 155,382 8.13%
Dec. 31, 1996 56(8) 7 49(8) 4,171,993(8) 792,913 (7) 3,379,080 (7)(8) 231,067(8) 60,421 170,646(8) 9.37%(8)
March 31, 1997 56 7 49 4,171,993 792,913 (7) 3,379,080 (7) 244,453 63,454 180,999 6.07%
June 30, 1997 56 7 49 4,329,904 798,807 (9) 3,537,369 (9) 257,273 66,004 191,269 5.24%
Sept. 30, 1997 56 7 49 4,329,904 798,807 (9) 3,537,369 (9) 274,745 68,579 206,166 6.79%
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(1) Derived from 1988 Donnelley Market Service population estimates.
(2) Derived from 1989 Donnelley Market Service population estimates.
(3) Derived from 1990 Census Report.
(4) Derived from 1992 Donnelley Market Service population estimates.
(5) Derived from 1993 Strategic Marketing Inc. population estimates.
(6) Derived from 1994 Strategic Marketing Inc. population estimates.
(7) Derived from 1995 Demographics On-Call population estimates.
(8) Includes pro forma impact of the acquisition of Iowa RSA No. 13.
(9) Derived from 1996 Demographics On-Call population estimates.
Network Construction and Operations. Construction of cellular
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telephone systems requires substantial capital investment in land and
improvements, buildings, towers, mobile telephone switching offices ("MTSOs"),
cell site equipment, microwave equipment, engineering and installation. The
Company believes that it has achieved significant economies of scale in
constructing the network. For example, the network uses cellular switching
systems capable of serving multiple markets. As a result of the contiguous
nature of the network, only ten MTSOs are currently required to serve all 56 of
the Company's managed markets. By consolidating and deploying high capacity
MTSOs, the Company intends to achieve further economies of scale. During fiscal
1997, four MTSO facilities were expanded and upgraded to provide additional
capacity for continued growth. Economies of scale generated by the network also
have permitted the Company to use one network operations center to centralize
services such as network design and engineering, traffic analysis,
interconnection, billing, roamer verification, maintenance and support and to
access volume discount purchasing of cellular system equipment.
The network also affords the Company certain technical advantages in
the provision of enhanced services, such as call delivery and call forwarding.
Through the use of single switching facilities serving multiple markets, the
Company has implemented continuous coverage on an intrastate basis throughout
the network. The Company has widened the area of coverage within the network by
interconnecting MTSOs located in adjoining markets. The Company has
substantially achieved its objective of providing subscribers with "seamless"
coverage throughout the network, which permits subscribers, as they travel
through the network, to receive calls and otherwise use their cellular
telephones as if they were in their home markets. This is a result of the
networking of the MTSOs managed by the Company and MTSOs of other carriers,
especially those operating adjoining markets within the nine-state area. The
Company has achieved a high degree of network reliability through the deployment
of standardized components and operating procedures, and the introduction of
redundancy in switching and cell site equipment, interconnect facilities and
power supply. Most of the Company's equipment is built by Northern Telecom, Inc.
("Nortel"), and interconnection between the Nortel MTSOs has been achieved using
Nortel's proprietary software and hardware.
I-6
The Company implemented the "IS-41" technical interface during fiscal
1995. This technical interface, developed by the cellular industry, allows
carriers that have different types of equipment to integrate their systems with
the eventual goals of establishing a national seamless network, substantially
reducing the cost of validating calls and reducing fraud exposure.
The Company also has entered into agreements with other cellular
carriers to enhance the range of markets and quality of service available to
cellular subscribers when traveling outside the network. Pursuant to existing
agreements with other cellular carriers, the Company's subscribers are able to
"roam" throughout most cellular markets in the United States and Canada. In
addition, the Company has entered into agreements with seven PCS carriers
operating or commencing operations using predominately the 30MHz Blocks A and B.
Expansion. The Company has completed the process of "filling in" the
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"cellular geographic service area" or "CGSA" (as defined by the FCC) within its
managed markets by adding network facilities which increased the coverage of the
radio signal. The Company significantly enhanced hand-held portable coverage
with construction of 72 new cell sites in fiscal year 1997 primarily within pre-
existing coverage areas. In addition, the Company analyzed the quality of
existing coverage based upon empirical data gathered using sophisticated mobile
testing equipment. These "drive tests" gave rise to changes in how certain sites
were configured or deployed in the network. For example, certain sites were
"sectorized" to reduce interference and provide additional capacity facing
particular directions. The Company expects to continue such efforts to improve
coverage, especially for low power portable cellular phones, throughout fiscal
year 1998. Expansion and optimization of signal coverage has increased
subscribers, enhanced the use of the systems by existing subscribers, increased
roamer traffic due to the larger geographic area covered by the radio signal and
improved the overall efficiency of the network. Under the rules and regulations
of the FCC, expansion of signal coverage has preserved the Company's right to
provide cellular service in valuable areas within the network.
The Company continually evaluates acquisitions of cellular properties
that are geographically and/or operationally compatible with the network. In
evaluating acquisition targets, the Company considers, among other things,
demographic factors, including population size and density, traffic patterns,
cell site coverage, required capital expenditures and the likely ability of the
Company to integrate the target market into the network.
Services and Products. Mobile subscribers in the Company's managed
---------------------
markets have available to them substantially all of the services typically
provided by landline telephone systems, including custom-calling features such
as call forwarding, call waiting, three-way conference calling and, in most
cases, voice mail services. Several price plans are presented to prospective
customers so that they may choose the plan that will best fit their expected
calling needs. The plans provide specific charges for custom-calling features
and voice mail to offer value to the customer while enhancing airtime use and
revenues for the Company. The Company also packages cellular equipment with its
cellular service as a way to encourage use of its mobile services, including
replacement of subscriber equipment to retain valuable customers. An ongoing
review of equipment and service pricing is maintained to ensure the Company's
competitiveness. Through a centralized procurement and equipment distribution
strategy, the Company obtains the benefits of favorable equipment costs through
bulk purchases. As appropriate, revisions to pricing of service plans and
equipment pricing are made to meet local marketplace demands.
The network affords the Company the opportunity to offer service over
expanded geographic territories at favorable rates. Customers that subscribe to
a stand-alone cellular system generally are charged premium roaming rates when
using a cellular system outside of their home service area. The Company's
subscribers are able to roam within the network and are afforded "home rate
follows" pricing, whereby subscribers are charged the rate applicable in their
home service area when traveling within the network. In addition, the Company's
simplified retail roaming rate structure allows the customer to roam on certain
adjacent carriers' systems at a preferred rate and minimizes confusion by
consolidating the remainder of the country into a uniform rate. Finally, the
Company offers toll-free calling across single or multiple states to its
subscribers for a nominal monthly fee, due to favorably negotiated interconnect
agreements.
I-7
During the fourth fiscal quarter of 1997, CPI commenced revenue
generating paging operations. To date, revenues have been insignificant as has
been the impact of CPI to the Company's consolidated operating income. However,
during fiscal 1997, operating costs and expenses of CPI were a component of net
corporate expenses, the income statement classification within which such costs
and expenses were included during the development stage of CPI. In future
periods, revenues and costs and expenses of CPI will be classified on the
Company's consolidated income statement as a separate line of business as the
volume of paging customers and transactions reach significant levels.
The Company is committed to providing consistently high quality
customer service. The Company maintains a comprehensive, centralized customer
assistance department which offers the advantages of expanded customer service
hours, specialized roaming and key account representatives and an automated
customer information database that allows for efficiency and accuracy, while
decreasing the time spent on each customer contact. In addition, calls are
efficiently processed using sophisticated call center technologies. Inbound
calls are processed through an automatic call distribution system and an
integrated voice response system which route and track calls among customer
service representatives and permit customers to obtain information quickly and
accurately on their own. Outbound welcome, proactive retention and collection
calls are placed to select cross sections of the customer base using a
predictive dialing system. Recently, the Company began analyzing its customer
base to segment types of customers and their relative value to the Company. This
effort has led to the formation of a specialized group of customer service
representatives who offer tailored incentives to high value customers to
optimize retention and minimize bad debts. The customer assistance department
also supports the administrative functions required to activate a customer's
phone through a high speed, call-in process and to enter the customer into the
informational databases required for customer service and billing. The Company
believes this centralized approach provides cost efficiencies while also
addressing the need for quality control. To ensure that it is delivering a
consistently high level of quality service, the Company monitors customer
satisfaction with its network quality, sales and customer service support,
billing and quality of roaming through regular surveys conducted by an
independent research firm.
Marketing. The Company coordinates the marketing strategy for each of
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its managed markets. The Company markets cellular telephone service under the
CommNet Cellular name. The use of a single name over a broad geographic
territory creates strong brand-name recognition and allows the Company to
achieve advertising efficiencies. In addition, the Company packages services
which are marketed under a program called "Fun, Easy and Affordable." Benefits
to customers include high minutes of use with the monthly access fee, free use
of a base model phone, permissive dialing to complete calls, toll-free calling
in the home area code, free enhanced features such as call forwarding, call
waiting and itemized call listing and others.
The Company believes that a key competitive advantage in marketing its
service is the large geographic area covered by the network. Seamless coverage
in the network is critical to marketing, as customers are attracted to the
higher percentage of delivered calls that such coverage provides. Furthermore,
the Company's "home rate follows" pricing allows customers to make calls from
anywhere in the network without incurring additional daily fees or surcharges
which usually occur when customers roam outside of their home market.
Additionally, the Company uses the "INLink" and "Follow-Me-Roaming" services
provided by GTE Telecommunication Services, Inc. which permit customers to
receive calls in any market that is part of the INLink or Follow Me Roaming
system without having to dial complicated access codes. The Company also offers
discounted roaming prices and enhanced services in certain markets as a result
of arrangements to link with certain adjacent markets managed by other carriers.
See "Business -- The Company's Operations -- Network Construction and
Operations." The Company offers additional services such as toll-free calling
across multiple area codes, use of premium model phones, weekend blocks of usage
to its subscribers for nominal monthly fees. In a majority of the Company's
managed RSA markets, the Company was the first cellular system operator to
provide service in the market, thereby affording a significant competitive
advantage. Being first to market in the majority of the Company's managed RSA
markets has also allowed the Company to obtain exclusive marketing agreements
with the leading telecommunication retailers in a particular market and to
obtain prime locations for its sales centers.
Initially, the Company relied to a significant extent on direct sales
representatives and on independent sales agents. The Company currently
emphasizes a channel of distribution, which also performs local customer
I-8
service functions, represented by 32 full service and 72 single employee
Company-owned retail stores located within the network, which will be
supplemented by 6 additional Company-owned retail stores scheduled to open
during fiscal 1998. The retail distribution channel also includes 42 Wal-Mart(R)
kiosks staffed by Company personnel. The Company believes that development of
retail distribution channels owned or staffed by the Company maximizes customer
additions, generates cost efficiencies in the acquisition of such new
subscribers, and enhances customer service. (Virtually all of the current
customer base lives within commuting distance to a Company-owned retail store.)
The Company also maintains 49 direct sales representatives and 885 agents or
outlets, including 60 Radio Shack and 14 (C)Sears stores which have exclusive
distribution agreements with the Company. In general, such agents earn a fixed
commission, which can vary depending upon the price plan sold, when a customer
subscribes to the Company's cellular service and remains a subscriber for a
certain period of time. Additionally, the Company expects to affiliate with more
resellers, potentially including large telecommunications companies, which are
expected to package the Company's service with theirs to compete under new
regulatory conditions. A recently developed in-house telemarketing staff
contributes significantly to additions to the customer base and also provides
targeted communication to customers to optimize retention.
Subscribers. To date, a substantial majority of the subscribers who
-----------
use cellular service in markets managed by the Company have been business users
of mobile communication services. However, safety and combined personal and
business use are reasons newer customers subscribe. This trend is consistent
with the experience of the cellular industry generally, although given the
Company's geographic presence in the mountain and plains states, its customers
have tended to include proportionally more persons in agricultural, construction
and energy industries. The Company believes that certain demographic
characteristics of the rural marketplace will enhance the Company's ability to
market cellular service to its primary customer base within its managed RSA
markets. On average, rural residents spend a higher percentage of their annual
household income on transportation and travel a relatively greater distance by
personal vehicle than do urban residents. The relatively large average distance
between public telephones in the rural marketplace is an additional factor that
increases the need for mobile telecommunication services in that market.
Management Agreements. Management agreements applicable to the
---------------------
Company's managed RSA markets generally appoint the Company as exclusive
management agent of the licensee with specifically enumerated responsibilities
relating to the day-to-day business operation of the licensee, although the
licensee retains ultimate control over its cellular system. Generally, the RSA
management agreements were for initial terms of five years and are automatically
renewed for additional terms unless terminated by notice from either party prior
to expiration of the then current term. The agreements provide for reimbursement
to the Company of expenses incurred on behalf of the licensee. In October 1997,
three RSA licensees purported to notify the Company of termination of management
in those markets during fiscal 1998. The Company is assessing its response to
these notices.
The Company has entered into management agreements with three MSA
affiliates pursuant to which the Company has been appointed the exclusive
management agent for each such affiliate. The MSA management agreements appoint
the Company as managing agent of the MSA affiliate with specifically enumerated
responsibilities relating to the day-to-day business operation of the affiliate.
The affiliate is the general partner in the licensee, and the Company acts as
exclusive management agent for the licensee, although the licensee retains
ultimate control over its cellular system. The MSA management agreement provides
for compensation to the Company in an amount equal to 10% of the distributions
to the affiliate derived from the affiliate's interest in the licensee.
Compensation under this agreement was $133,000 during fiscal 1997 and is
expected to grow. The agreements also provide for reimbursement of reasonable
administrative and overhead expenses. The agreements generally were for an
initial term of five years, were extended for an additional one-year term and
are automatically renewed for one-year terms thereafter unless terminated by
notice from either party prior to expiration of the then current term.
The Company has also entered into a management agreement with CINC,
whereby it manages all systems owned by CINC and in which CINC is the general
partner.
I-9
History. The Company initially acquired its cellular interests by
-------
participating in the wireline licensing process conducted by the FCC. In order
to participate in that process, the Company formed affiliates which were
originally owned at least 51% by one or more telcos and no more than 49% by the
Company. In exchange for the Company's 49% interest, the Company offered to sell
shares of its Common Stock and agreed to provide financing to the affiliates for
certain capital needs, as well as certain management services. In addition to
obtaining interests in cellular markets through participation in the FCC
licensing process, the Company also has purchased direct interests in additional
markets in order to expand the network.
Financing Arrangements with Affiliates; CIFC. CIFC has entered into
--------------------------------------------
loan agreements with RSA and MSA affiliates to finance or refinance the costs
related to the construction, operation and expansion of cellular telephone
systems in which such affiliates own an interest. The loans are financed with
funds borrowed by CIFC from CoBank, ACB as agent for a syndicate of lenders
("CoBank") and the Company. As of September 30, 1997, CIFC had loan agreements
outstanding with 27 RSA affiliates, 4 MSA affiliates and CINC and had advanced
$241,898,000 thereunder, including $193,328,000 to entities which are
consolidated for financial reporting purposes. All loans to affiliates from CIFC
are secured by a lien upon all assets of the entity to which funds are advanced.
At September 30, 1997, six loans were charged interest at the average cost of
CoBank borrowings. The remaining 26 loans bore interest at the 90-day LIBOR rate
plus a margin (determined based on the affiliate's leverage ratio), adjusted
quarterly. The loan commitment between CIFC and CoBank will terminate December
31, 1997 and the outstanding balance of the loan will amortize over a three-year
period beginning April 15, 1998. Of the 32 affiliate loans, six had terminated
at September 30, 1997, four will terminate at December 31, 1997, 15 will
terminate at December 31, 1998 and seven will terminate at December 31, 2000.
Loans from CIFC to affiliates will be repaid from funds generated by operations
of the licensee or distributions to affiliates by licensees in which such
affiliates own an interest. If such funds are not adequate to meet required
principal payments, additional capital may be required. Amounts paid to CIFC
will be applied by CIFC towards payment of its obligations to CoBank or retained
to make future advances. The Company has made and will continue to make advances
to affiliates on an interim basis. Funds borrowed from CIFC by affiliates are
used to repay the Company for such interim advances. As of September 30, 1997,
the Company had net outstanding interim advances of $3,672,000 to
nonconsolidated affiliates, which advances bear interest at 2% over the prime
rate.
As of September 30, 1997, the Company and CIFC had net advances of
$244,127,000 to RSA and MSA affiliates. Based on its proportionate ownership
interests in these affiliates, the Company's share of total affiliate loans and
advances was $203,963,000. In addition, the Company had proportionate
obligations of additional debt of its affiliates from other financing sources of
$6,181,000. The assets of the affiliates in which the Company has investments or
advances represent 4,206,000 pops, which include 3,672,000 net Company pops.
Advances related to pops attributable to parties other than the Company total
$40,164,000.
As of September 18, 1997, CIFC and the Company entered into a new
senior bank credit facility with The Chase Manhattan Bank as administrative
agent and collateral agent, Chase Manhattan Bank Delaware, as rating bank, and
the other lenders named therein (the "Chase Credit Agreement"). Funding under
the Chase Credit Agreement will be used to pay off the CoBank Credit Agreement,
to tender for the Company's 11 3/4% Senior Subordinated Notes and 11 1/4%
Subordinated Notes, and to fund costs associated with the Merger Agreement and
will not occur unless and until the Merger is consummated. Advances made under
the Chase Credit Agreement will be used, when necessary, to fund loans made by
CIFC to the affiliates.
The Cellular Telephone Industry. Cellular telephone service is a form
-------------------------------
of wireless telecommunication capable of providing high quality, high capacity
service to and from mobile, portable and fixed radio telephones. Cellular
telephone technology is based upon the division of a given market area into a
number of regions, or "cells," which in most cases are contiguous. Each cell
contains a low-power transmitter-receiver at a "base station" or "cell site"
that communicates by radio signal with cellular telephones located in the cell.
The cells are typically designed on a grid, although terrain factors, including
natural and man-made obstructions, signal coverage patterns and capacity
constraints, may result in irregularly shaped cells and overlaps or gaps in
coverage. Cells generally have radii ranging from two miles to more than 25
miles. Cell boundaries are determined by the strength of the signal emitted by
the cell's transmitter-receiver. Each cell site is connected to a MTSO, which,
in turn, is connected to the local landline telephone network.
I-10
When a cellular subscriber in a particular cell dials a number, the
cellular telephone sends the call by radio signal to the cell's transmitter-
receiver, which then sends it to the MTSO. The MTSO completes the call by
connecting it with the landline telephone network or another cellular telephone
unit. Incoming calls are received by the MTSO which instructs the appropriate
cell to complete the communications link by radio signal between the cell's
transmitter-receiver and the cellular telephone. By leaving the cellular
telephone on, a signal is emitted so the MTSO can sense in which cell the
cellular telephone is located. The MTSO also records information on system usage
and subscriber statistics.
The FCC has allocated the cellular telephone systems frequencies in the
800 MHz band of the radio spectrum. Each of the two licensees in each cellular
market is assigned 416 frequency pairs. Each conversation on a cellular system
occurs on a pair of radio talking paths, thus providing full duplex (i.e.,
----
simultaneous two-way) service. Two distinguishing features of cellular telephone
systems are: (i) frequency reuse, enabling the simultaneous use of the same
frequency in two or more adequately separated cells, and (ii) call hand-off,
occurring when a deteriorating transmission path between a cell site and a
cellular telephone is rerouted to an adjacent cell site on a different channel
to obtain a stronger signal and maintain the call. A cellular telephone system's
frequency reuse and call hand-off features result in far more efficient use of
available frequencies and enable cellular telephone systems to process more
simultaneous calls and service more users over a greater area than pre-cellular
mobile telephone systems.
Call hand-off in a cellular telephone system is automatic and virtually
unnoticeable to either party to the call. The MTSO and base stations
continuously monitor the signal strength of calls in progress. The signal
strength of the transmission between the cellular telephone and the base station
declines as the caller moves away from the base station in that cell. When the
signal strength of a call declines to a predetermined threshold level, the MTSO
automatically determines if the signal strength is greater in another cell and,
if so, hands off the cellular telephone to that cell. The automatic hand-off
process within the system takes a fraction of a second. However, if the cellular
telephone leaves the reliable service areas of the cellular telephone system,
the call is disconnected unless an appropriate technical interface is
established with an adjacent system through intersystem networking arrangements.
Frequency reuse is one of the most significant characteristics of
cellular telephone systems. Each cell in a cellular telephone system is assigned
a specific set of frequencies for use between that cell's base station and
cellular telephones located within the cell, so that the radio signals being
used in one cell do not interfere with those being used in adjacent cells.
Because of the relatively low transmission power of the base stations and
cellular telephones, two cells sufficiently far apart can use the same
frequencies in the same market without interfering with one another.
A cellular telephone system's capacity can be increased in various
ways. Within certain limitations, increasing demand may be met by simply adding
available frequency capacity to cells as required or, by using directional
antennas, dividing a cell into discrete multiple sectors or coverage areas,
thereby facilitating frequency reuse in other cells. Furthermore, an area within
a system may be served by more than one cell through procedures which utilize
available channels in adjacent cells. When all possible channels are in use,
further growth can be accomplished through a process called "cell splitting."
Cell splitting entails dividing a single cell into a number of smaller cells
serviced by lower-power transmitters, thereby increasing the reuse factor and
the number of calls that can be handled in a given area. Digital transmission
technologies are expected to provide cellular licensees with additional capacity
to handle calls on cellular frequencies. As a result of present technology and
assigned spectrum, however, there are limits to the number of signals that can
be transmitted simultaneously in a given area. In highly populated MSAs, the
level of demand for mobile and portable service is often large in relation to
the existing capacity. Because the primary objective of the cellular licensing
process is to address mobile and portable uses, operators in highly populated
MSAs may have capacity constraints which limit their ability to provide
alternate cellular service. The Company does not anticipate that the provision
of mobile and portable services within the network will require as large a
proportion of the systems' available spectrum and, therefore, the systems will
have more spectrum with which to pursue data applications, which may enhance
revenues.
I-11
FCC rules require that all cellular telephones be functionally
compatible with cellular telephone systems in all markets within the United
States and with all frequencies allocated for cellular use, so that a cellular
telephone may be used wherever a subscriber is located, subject to appropriate
arrangements for service charges. Changes to cellular telephone numbers or other
technical adjustments to cellular telephones by the manufacturer or local
cellular telephone service businesses may be required, however, to enable the
subscriber to change from one cellular service provider to another within a
service area.
Because cellular telephone systems are fully interconnected with the
landline telephone network and long distance networks, subscribers can receive
and originate both local and long-distance calls from their cellular telephones.
Cellular telephone systems operate under interconnection agreements
with various local exchange carriers and interexchange carriers. The
interconnection agreements establish the manner in which the cellular telephone
system integrates with other telecommunications systems. The cellular operator
and the local landline telephone company must cooperate in the interconnection
between the cellular and landline telephone systems to permit cellular
subscribers to call landline subscribers and vice versa. The technical and
financial details of such interconnection arrangements are subject to
negotiation and vary from system to system. See "Federal Regulation--Recent
Legislation."
While most MTSOs process information digitally, most radio
transmissions of cellular telephone calls are done on an analog basis. Digital
technology offers advantages, including improved voice quality, larger system
capacity, and perhaps lower incremental costs for additional subscribers. The
conversion from analog to digital radio technology is expected to be an
industry-wide process that will take a number of years. However, based on
estimated capacity requirements, the Company does not foresee a need to convert
to digital radio transmission technology in the near term.
Competition
- -----------
General. The cellular telephone business is a regulated duopoly.
-------
Initially, the FCC awarded only two licenses in each market, although certain
markets have been subdivided as a result of voluntary settlements. Each licensee
has the exclusive use of a defined frequency band within its market.
The primary competition for the Company's mobile cellular service in
any market comes from the other licensee in such market, which may have
significantly greater resources than the Company and its affiliates. Competition
is principally on the basis of coverage, services and enhancements offered,
technical quality of the system, quality and responsiveness of customer service
and price. Such competition may increase to the extent that licenses pass from
weaker stand-alone operators into the hands of better capitalized and more
experienced cellular operators who may be able to offer consumers certain
network advantages similar to those offered by the Company. In addition, the
unserved area licensing process allows for new companies to apply with the FCC
to provide cellular service and for existing carriers to expand their service.
See "Cellular Service Area." Within the network, the Company has two primary
direct competitors, in addition to a number of stand-alone operators as
summarized in the following table.
Number of Competing Markets
---------------------------------------------
Competitor States (1) MSAs RSAs Total
-------------------- ------------------------- ---- ---- -----
Western Wireless CO, IA, MT, ND, SD UT, WY 7 33 40
US Cellular ID, IA - 7 7
Eight other carriers CO, IA, NM, UT, WY - 9 9
---- ---- -----
7 49 56
==== ==== =====
(1) States in which the competitor operates a competing cellular
licensee.
Competition From Other Technologies. The FCC is now licensing
-----------------------------------
commercial personal communications services ("PCS"). PCS is not a specific
technology, but a variety of potential technologies that could compete with
cellular telephone systems. The FCC has identified two categories of PCS:
broadband and narrowband. Licenses are awarded by competitive bidding. Auctions
for most of the spectrum blocks have been completed and several systems have
commenced operations in major metropolitan locations.
I-12
The FCC has adopted rules to authorize the operation of new narrowband
PCS systems in the 900 MHz band. The possible new services using this 900 MHz
band spectrum include advanced voice paging, two-way acknowledgment paging, data
messaging, electronic mail and facsimile transmissions. These services most
likely will be provided using a variety of devices, such as laptop and palmtop
computers and computerized "personal organizers" that allow receipt of office
messages, calendar planning and document editing from remote locations in some
circumstances. Because narrowband PCS does not allow real-time, two-way voice
communications, and allows only limited data transfer, it is not clear to what
extent this technology will offer direct competition to cellular.
The FCC also has adopted rules to authorize the operation of new,
broadband PCS systems in the 2 GHz band. Equipment proposed for broadband PCS
includes small, lightweight and wireless telephone handsets; computers that can
communicate over the airwaves wherever they are located; and portable facsimile
machines and other graphic devices. The regulatory plan adopted for broadband
PCS includes an allocation of spectrum, a flexible regulatory structure,
eligibility restrictions and technical and operational rules. In addition, the
FCC revised its cellular rules to state explicitly that cellular licensees may
provide any PCS-type services (including wireless PBX, data transmission and
telepoint services) on their 800 MHz band cellular channels without prior
notification to the FCC (other than the notification required to report the
construction of new cell sites).
The FCC has allocated 140 MHz of spectrum in the 2 GHz band for the
provision of licensed and unlicensed broadband PCS. Much of the spectrum
allocated for broadband PCS is already occupied by microwave licensees. As a
general proposition, broadband PCS licensees are required to pay the costs
associated with relocating these existing microwave users to other portions of
the radio spectrum within a specified time frame.
Of the 140 MHz of spectrum allocated to broadband PCS, 120 MHz has been
allocated for licensed PCS. The 120 MHz of spectrum allocated to licensed PCS
has been divided into six channel blocks, as follows: (i) two channel blocks
(Blocks A and B) have been allocated 30 MHz of spectrum each, and have been
licensed on the basis of the 51 Rand McNally Major Trading Areas ("MTAs"), (ii)
one channel block (Block C) has been allocated 30 MHz of spectrum and has been
licensed on the basis of the 493 Rand McNally Basic Trading Areas ("BTAs"),
(iii) three channel blocks (Blocks D, E and F) have been allocated 10 MHz of
spectrum each and have been licensed on the basis of BTAs. The FCC will allow a
single entity to combine all three 10 MHz blocks as long as the entity complies
with the 45 MHz spectrum cap described below. Licensing has thus far been
accomplished by spectrum auctions, but the FCC has recently adopted partitioning
rules that will allow PCS licensees to assign portions of their coverage area
and/or spectrum to other entities. Restrictions apply to those channel bands
(Blocks C & F) which have been set aside for licensing to small businesses and
other "designated entities."
Subject to certain cross-ownership benchmarks, spectrum aggregation is
permitted in broadband PCS, but is limited to 45 MHz of attributable Commercial
Mobile Radio Service ("CMRS") spectrum per service area to prevent any one
person or entity from exercising undue market power. Relevant CMRS spectrum
includes broadband PCS, cellular and certain specialized mobile radio systems
("SMRs") operations, and attributable interests can include management and joint
marketing arrangements, as well as partitioning. The 45 MHz spectrum cap is a
complex rule which is currently under legal challenge.
Broadband PCS licensees are subject to minimum construction
requirements. Broadband PCS licenses will be awarded for a period of ten years,
with provisions for a license renewal expectancy similar to those currently
applied to cellular licensees.
PCS carriers currently compete with the Company in one MSA and one RSA
market and other carriers have commenced construction of systems which the
Company believes will overlap at least in part with one additional MSA and two
additional RSA markets currently managed by the Company. To date, the Company
has experienced little impact from PCS competition, however, it is uncertain
what long-term effect these new personal communications services may have on the
Company. The Company believes that the cost to build out a PCS network in a
representative market of the Company would be three to four times as expensive
as the cost incurred by the Company for the same coverage. This higher cost is
due in part to the fact that PCS channels are higher in the
I-13
frequency band than cellular, and the radio signal does not travel as far. Thus,
more transmitter sites are required to cover the same area. Therefore, the
Company believes that PCS will have difficulty competing effectively with
cellular telephone service in the rural marketplace in the near future, but
there can be no assurance that this will be the case. In addition, technological
advances in cellular telephone technology provide essentially the same services
as the PCS proposals described above. The FCC issued operating authority for
personal communications services competitive to the Company's services in
markets managed by the Company. Because of the FCC's buildout requirements
(mandating certain level of population coverage at five and ten year
benchmarks), coupled with the higher construction costs and lower population
density in rural areas, it is likely that many PCS licensees will concentrate
buildout efforts in the largest urban and suburban areas, and may not reach
rural areas for several years, if at all.
Potential users of cellular systems may find an increasing number of
current and developing technologies able to meet their communication needs. For
example, SMRs of the type generally used by taxicab and tow truck services and
other communications services have the technical capability to handle mobile
telephone calls (including interconnection to the landline telephone network)
and may provide competition in certain markets.
Although SMR operators historically were subject to limitations that
made usage of SMR frequencies more appropriate for short dispatch messages, the
FCC has granted waivers of its rules to permit the construction and operation of
low powered "cellular-like" services using a collection of SMR frequencies
("ESMR") in a number of markets in the United States. In addition, recent
legislation permits commercial mobile service providers, including SMR
providers, to obtain upon demand physical interconnection with the landline
telephone network. Such interconnection enhances an SMR provider's ability to
compete with cellular operators, including the Company. The FCC has encouraged
ESMR activities and has amended its rules to establish an Expanded Mobile
Service Provider ("EMSP") licensing approach that facilitates such operations.
The new rules grant a new type of 800 MHz wide-area license that would permit
channels to be aggregated for operation of systems throughout defined geographic
areas. The FCC has completed spectrum auctions to license these wide-area
systems, and at least one SMR carrier is advertising its service as competition
to cellular.
One-way paging or beeper services that feature voice message and data
display as well as tones may be adequate for potential cellular subscribers who
do not need to transmit back to the caller. SMR and paging systems are in
operation in many of the service areas within the network.
The FCC will soon auction licenses to operate wide-area systems in the
220 MHz band. However, the narrow bandwidth of these channels may hinder the
ability of licensees to compete effectively with cellular.
In early 1997, the FCC issued rules designating the 2305-2320 and 2345-
2360 MHz bands for new communications services to be called Wireless
Communications Service ("WCS"). The auction for these licenses were completed
during fiscal year 1997. Licensees will be allowed to offer any fixed, mobile or
radio location service or satellite Digital Audio Radio Services on a primary
basis. On a secondary basis, amateur radio service and aeronautical telemetry
operations will continue in certain portions of the band. Because of the
potential for interference from grandfathered satellite operations and other
technical constraints, the FCC has indicated that it is unlikely WCS licensees
will be able to effectively provide cellular-like mobile services.
Technological advances in the communications field continue to occur
and make it difficult to predict the extent of additional future competition for
cellular systems. See "Business -- The Company's Operations -- Expansion."
Although satellite service may offer a customer worldwide coverage, the
substantial investments required to initiate service, as well as significant
technical, political and regulatory hurdles that need to be overcome, may impede
the early growth of this technology. Recent legislation may make available up to
200 MHz of spectrum for new communications systems. Each of these systems could
provide services that compete with those provided by the Company. The FCC has
also authorized Basic Exchange Telecommunications Radio Service to make basic
telephone service more accessible to rural households and businesses. The FCC
will also soon auction spectrum for Local Multipoint Distribution Service
("LMDS") operations. Such licensees will likely provide wireless local loop and
video services, primarily on a fixed basis, but may compete indirectly with
cellular.
I-14
Federal Regulation
- ------------------
Overview. The construction, operation and acquisition of cellular
--------
systems in the United States are regulated by the FCC pursuant to the
Communications Act and the rules and regulations promulgated thereunder (the
"FCC rules"). The FCC rules govern applications to construct and operate
cellular systems, licensing and administrative appeals and technical standards
for the provision of cellular telephone service. The FCC also regulates
coordination of proposed frequency usage, height and power of base station
transmitting facilities and types of signals emitted by such stations. In
addition, the FCC regulates (or forbears from regulating) certain aspects of the
business operations of cellular systems. It has declined to regulate the price
and terms of offerings to the public. See "-- Recent Legislation."
Initial Regulation. For licensing purposes, the FCC established 734
------------------
discrete geographically defined market areas comprised of 306 MSAs and 428 RSAs.
In each market area, the FCC awarded only two licenses authorizing the use of
radio frequencies for cellular telephone service. The allocated cellular
frequencies were divided into two equal 25 MHz blocks. One block of frequencies,
and the associated operating license, was initially reserved for exclusive use
by an entity that was majority-owned and controlled by local landline telephone
companies or their affiliates. The second block of frequencies initially was
reserved for use by entities that did not provide landline telephone service in
the market area. Upon the issuance of a construction permit, such construction
permit could be sold to any qualified buyer, regardless of telephone company
affiliation. The FCC generally prohibits a single entity from holding an
interest in both licenses in the same market.
RSAs were divided along county lines and consisted of one or more
contiguous counties within a single state. The RSAs were numbered alphabetically
by state, rather than on the basis of population. The FCC applied a licensing
policy for RSA markets similar to that utilized in the MSAs. Applications for
both licenses in each RSA were filed simultaneously. The FCC chose among
mutually exclusive applicants for each license through the use of a lottery.
Upon favorable review of the lottery winner or settlement entity,
designation of the tentative selectee and following a public comment period, the
FCC issued a construction permit for the cellular telephone system on each
frequency block in a specified market. An operating license was then granted for
an initial term not to exceed ten years (although a license may be revoked
during its term for cause after formal proceedings by the FCC).
License Renewal. Cellular licenses are granted by the FCC for a term
---------------
not exceeding ten years, and are subject to renewal at the end of that term. The
cellular license expiration date has passed for six of CommNet's MSAs. The
remaining MSA expires in 1998 with the majority of the company's RSA licenses
expiring in 1999 or the year 2000. The FCC has established rules and procedures
to process cellular renewal applications filed by existing carriers, as well as
any competing applications filed by renewal challengers. At the end of the ten-
year license term, the FCC requires a license renewal application be submitted
for each station authorization. Upon the FCC's acceptance of the renewal
application, the application goes through a standard thirty-day Public Notice
process. Renewal applications for the six MSA's have been through this Public
Notice process and are currently awaiting FCC grant. Once the Public Notice
process is completed, provided there are no challenges, the FCC will grant a new
license for a second ten-year term. If there are challenges to a renewal
application, the FCC's renewal proceeding is initiated. Subject to one exception
discussed below, the renewal proceeding is a two-step hearing process. Under the
two-step procedure, the FCC will conduct a threshold proceeding (the "step-two"
hearing) to determine whether or not the incumbent licensee is entitled to a
license renewal expectance for its performance during the past license term and
remains basically qualified to hold a cellular license. Two criteria are
evaluated to determine whether the existing licensee will receive a renewal
expectancy. The first criterion is whether the licensee has provided
"substantial" service during its past license term, defined as service which is
sound, favorable and substantially above a level of mediocre service which
minimally might justify renewal. The second criterion requires that the licensee
must have substantially complied with applicable FCC rules and policies. Under
this second criterion, the FCC determines whether the licensee has demonstrated
a pattern of compliance. The second criterion does not require a perfect record
of compliance, but if a licensee has demonstrated a pattern of noncompliance it
will not receive a renewal expectancy. If the FCC grants the licensee a renewal
expectancy during the first step of the hearing process and the licensee is
basically qualified, its license renewal application
I-15
will be automatically granted and any competing applications will be denied. If,
however, the FCC denies the licensee's request for renewal expectancy, the
licensee's application will be comparatively evaluated under specifically
enumerated criteria with the applications filed by competing applicants.
The exception to the two-step renewal hearing process allows a
competing applicant proposing to provide service that far exceeds the service
presently being provided by the incumbent licensee to request a waiver of the
two-step process. If the waiver request is granted, the FCC will hold only a
comparative hearing, i.e., it will not make a threshold determination in the
----
first instance as to whether the incumbent licensee is entitled to a renewal
expectancy.
Cellular Service Area. In all markets, at least one cell site must
---------------------
have been placed into commercial service within 18 months after the award of the
initial construction permit. Under FCC rules, the authorized service area for a
cellular licensee in a market is referred to as the Cellular Geographic Service
Area ("CGSA"). The CGSA is defined as the area served by the cellular licensee
(as computed by a mathematical formula based on the height and power of
operating cell sites within which the licensee is entitled to protection from
interference on its frequencies). The CGSA will be smaller than the market if a
licensee has not fully built-out its system, or it may be larger than the market
if the licensee serves areas of adjacent markets. Cellular licensees do not need
to obtain FCC authority prior to increasing the CGSA within their market during
the five-year period after the construction permit is initially granted for the
market. However, FCC notification of construction is still generally required.
After the five-year exclusive period has expired, any entity may apply to serve
the unserved areas of the market that comprise at least 50 contiguous square
miles and are outside of the licensee's CGSA (an "unserved area application").
Unserved area applications are filed in two phases, Phase I and Phase
II. During the first half of 1993, the FCC accepted Phase I unserved area
applications for frequency blocks in all markets in which: the five-year fill-in
period had already expired or would expire on or before March 15, 1993; no
applications for initial authorizations were filed; or authorizations were
surrendered or canceled for failure to meet the 18-month construction deadline
or other reasons. For all other markets, Phase I applications were due on the
31st day following expiration of the five-year fill-in period. All Phase I
applications for a given market are deemed mutually exclusive even if their
proposed CGSAs do not overlap. Once an authorization has been granted to a Phase
I applicant, the permittee has 90 days within which to file an application
requesting FCC authority to make major modifications to its Phase I system.
During this period, the FCC will not accept any other applications for unserved
areas in a market that are mutually exclusive (overlap of proposed CGSAs) with
the Phase I carrier's major modification application.
Phase II unserved area applications for any remaining area may be filed
on the 121st day after the Phase I authorization has been granted (or if no
Phase I applications are filed, on the first day after Phase I applications for
that market are permitted). In the event mutually exclusive applications are
filed the authorization will be issued by auction. Phase II applications may
propose CGSAs that cover area in more than one market. Phase II applications
will be placed on public notice by the FCC, and all interested and qualified
parties will have an opportunity to apply for the same market area within 30
days of the public notice.
Unserved area applicants not proposing to expand an existing system,
i.e., applicants for new cellular systems must propose to serve a minimum of 50
contiguous square miles and must demonstrate their financial qualifications to
construct the proposed system and to operate it for one year (assuming no
revenues). Existing licensees proposing to expand their systems through the
filing of an unserved area application are not subject to the 50 square mile
minimum coverage rule, nor are they required to make a financial qualifications
showing. Under recent legislation described below, mutually exclusive unserved
area applications are processed by lottery selection procedures (for
applications filed prior to July 26, 1993) or by auctions (for applications
filed after July 26, 1993), and existing cellular carriers receive no preference
in the lottery selection or auction process.
Unserved area cellular carriers (both Phase I and Phase II) are allowed
one year within which to complete construction of their systems. Unserved area
cellular carriers are not permitted a five-year fill-in period.
I-16
If an unserved area cellular carrier forfeits its authorization for failure to
construct, the area which thereby reverts to "unserved" status may be applied
for under Phase II procedures.
Alien Ownership Restrictions. The Communications Act prohibits the
----------------------------
issuance of a license to, or the holding of a license by, any corporation of
which more than 20% of the capital stock is owned of record or voted by non-U.S.
citizens or their representatives or by a foreign government or a representative
thereof, or by any corporation organized under the laws of a foreign country.
The Communications Act also prohibits the issuance of a license to, or the
holding of a license by, any corporation directly or indirectly controlled by
any other corporation of which more than 25% of the capital stock is owned of
record or voted by non-U.S. citizens or their representatives or by a foreign
government or representative thereof, or by any corporation organized under the
laws of a foreign country, although the FCC has the power in appropriate
circumstances to waive these restrictions. The FCC has interpreted these
restrictions to apply to partnerships and other business entities as well as
corporations, with certain modifications. Failure to comply with these
requirements may result in denial or revocation of licenses. The Articles of
Incorporation of the Company contain prohibitions on foreign ownership or
control of the Company that are substantially similar to those contained in the
Communications Act.
The FCC recently adopted rules, which are expected to become effective
in early 1998, that will liberalize foreign investment in U.S.
telecommunications carriers, consistent with the 1997 World Trade Organization
(WTO) Basic Telecom Agreement. Foreign investors will be able to own up to 49
percent of a carrier in the U.S. market without special authorization. The FCC
has also enhanced its regulatory safeguards to prevent the exercise of foreign
market power in the U.S. telecommunications market.
Recent Legislation. The Telecommunications Act of 1996 (the "Act"),
------------------
which modifies and amends the Communications Act, covers virtually every element
of communications. Congress' main objective was to promote competition and
reduce regulation in order to secure lower prices and higher quality services
for telecommunications consumers and to encourage the rapid deployment of new
telecommunications technologies. A great portion of the Act is aimed at removing
restrictions which prevent local and long distance service providers from
offering competing services in the same territory and redefining compensation
arrangements between CMRS providers, which include cellular carriers such as the
Company, Interexchange Carriers ("IXCs"), Local Exchange Carriers ("LECs") and
Independent Local Exchange Carriers ("ILECs"). The major impact of the Act on
the Company will initially be to reduce the costs paid by the Company to
interconnect and terminate calls on LEC, ILEC and IXC networks. The Act requires
such carriers to base termination charges to CMRS providers on cost and to
compensate CMRS providers for calls they terminate. The Company began to benefit
from these changes in fiscal year 1997. While the FCC's interconnection rules
were being challenged in court, the Company successfully negotiated new
interconnection agreements throughout its operating territory based on interim
pricing rules. Although many of the FCC's rules were struck down by a federal
court, the portion of the rules setting lower interconnection rates for wireless
carriers was upheld. As a result, the Company anticipates maintaining these
favorable rates and, in some cases, possibly negotiating even lower rates in the
future.
The Act mandates CMRS providers pay into the Universal Service Fund
("USF"). The USF is to ensure basic telephone services are available, reasonable
and affordable for all citizens. In addition, the USF will promote access to
high capacity telecommunications services for schools, libraries and rural
health care providers. The FCC is now in the process of setting specific
contribution rates. Customers will begin seeing a new line item on their bills
from the Company as well as other carriers in general beginning January 1, 1998,
with the revenues passing through to the USF administrator. The rate charged by
the Company will initially be .75% of local service revenues and may be adjusted
upward or downward after six months. Additionally, states may create their own
funds imposing charges only on intrastate service to supplement the resources
available from USF. State governments will be responsible for determining who
will be eligible to receive federal or state USF subsidies. Most states have not
finalized their rules, but it is likely that any CMRS provider which seeks to
draw funds from the USF will be subject to additional regulation by that state.
In early 1997, the FCC issued rules designating the 2305-2320 and 2345-
2360 MHz bands for new communications services to be called Wireless
Communications Service ("WCS"). The auction for these licenses were completed
during fiscal year 1997. Licensees will be allowed to offer any fixed, mobile or
radio location
I-17
service or satellite Digital Audio Radio Services on a primary basis. On a
secondary basis, amateur radio service and aeronautical telemetry operations
will continue in certain portions of the band. Because of the potential for
interference from grandfathered satellite operations and other technical
constraints, the FCC has indicated that it is unlikely WCS licensees will be
able to effectively provide cellular-like mobile services.
State, Local and Other Regulation
- ---------------------------------
State. Following receipt of an FCC construction permit and prior to
-----
the commencement of commercial service (prior to construction in certain
states), a cellular licensee must also obtain any necessary approvals from the
appropriate regulatory bodies in each of the states in which it will offer
cellular service. Certain state authorities regulate certain service practices
of cellular system operators. While such state regulations may affect the manner
in which the Company's affiliates conduct their business and could adversely
affect their profitability, they should not place the Company's affiliates at a
competitive disadvantage with other service providers in the same markets. The
Company has not experienced and does not presently contemplate any regulatory
constraints, difficulties or delays.
FAA, Zoning and Other Land Use. The location and construction of
------------------------------
cellular transmitter towers and antennas are subject to Federal Aviation
Administration ("FAA") regulations and may be subject to federal, state and
local environmental regulation as well as state or local zoning, land use and
other regulation. Before a system can be put into commercial operation, the
grantee of a construction permit must obtain all necessary zoning and building
permit approvals for the cell sites and MTSO locations. The time needed to
obtain FAA approvals, zoning approvals and requisite state permits varies from
market to market and state to state. Likewise, variations exist in local zoning
processes. There can be no assurance that any state or local regulatory
requirements currently applicable to the systems in which the Company's
affiliates have an interest will not be changed in the future or that regulatory
requirements will not be adopted in those states and localities which currently
have none.
Employees
- ---------
As of December 19, 1997, the Company had 596 full-time employees. The
Company engages the services of independent contractors on an as-needed basis.
Item 2. Properties.
In addition to the direct and attributable interests in cellular
licensees discussed in this Report, the Company leases its principal executive
offices (consisting of approximately 62,400 square feet) located in Englewood,
Colorado. The Company and its affiliates lease and own locations for retail
sales, inventory storage, microwave, cell site and switching equipment and
administrative offices.
Item 3. Legal Proceedings.
On May 29, 1997 (the day after the proposed Merger was publicly
announced), the Company and each of its five directors (two of whom are
executive officers of the Company) were named as defendants in a complaint filed
in the Colorado District Court, County of Arapahoe, by Brickell Partners, an
entity claiming to be a shareholder of the Company, individually and purportedly
as a class action on behalf of shareholders of the Company. In general, the
complaint alleges that the Company's directors have breached their fiduciary
duties by, among other things, resolving to approve the Merger at an allegedly
inadequate price and by allegedly failing to take all reasonable steps to insure
maximization of shareholder value. The complaint seeks injunctive relief
prohibiting the Company from, among other things, consummating the Merger. The
complaint also seeks unspecified damages, attorneys' fees and other relief.
The Company believes that the allegations contained in the complaint
are without merit and intends to contest the action vigorously, on behalf of
itself and its directors, if the plaintiff elects to proceed with its action.
I-18
On July 8, 1997, Dakota Systems, Inc., the minority general partner in
the Sioux Falls Cellular Limited Partnership ("Sioux Falls"), and Splitrock
Telecom Cooperative, Inc., Union Telephone Company, Sioux Valley Telephone
Company and Baltic Cooperative Telephone Company, the limited partners in Sioux
Falls (collectively, the minority general partner and the limited partners are
referred to herein as "plaintiffs"), filed a lawsuit in the Circuit Court,
County of Minnehaha, State of South Dakota, against CINC, the Company, and Sioux
Falls. CINC is the general partner of Sioux Falls and a wholly-owned subsidiary
of the Company. The lawsuit alleges, among other things, that the Merger
triggers plaintiffs' alleged right of first refusal to purchase CINC's interest
in Sioux Falls under the Certificate and Agreement Establishing Sioux Falls
Limited Partnership. The lawsuit seeks, among other things, a declaratory
judgment concerning the terms of plaintiffs' alleged right of first refusal to
purchase CINC's interest in Sioux Falls, a temporary and permanent injunction
prohibiting the Merger until plaintiffs' rights are clarified, and damages. The
lawsuit also seeks to enjoin a proposed sale of a telecommunications switch by
Sioux Falls to the Company and to void certain amendments to the switch user
agreements. The Company intends to defend the lawsuit vigorously if the
plaintiffs elect to proceed with the litigation.
On October 22, 1997, The Rye Telephone Company ("Rye"), a shareholder
in Pueblo Cellular, Inc. ("Pueblo") filed an action in the District Court,
Pueblo County, State of Colorado, against the Company. The lawsuit alleges
intentional interference with contract, breach of contract and breach of
covenant of good faith in connection with a proposed sale of shares in Pueblo by
Rye and Pine Drive Telephone Company ("Pine Drive") and a related lawsuit filed
by the Company against Pine Drive in Arapahoe County court. The lawsuit seeks,
among other things, general and special damages of not less than $5,493,840,
exemplary damages, fees and costs. The Company has filed a motion to stay the
Pueblo lawsuit until adjudication of the Arapahoe County lawsuit. In December
1997, the court denied the motion to stay. The Company intends to defend the
lawsuit vigorously.
There are no other material, pending legal proceedings to which the
Company or any of its subsidiaries is a party or of which any of their property
is the subject which, if adversely decided, would have a material adverse effect
on the Company.
Item 4. Submission of Matters to a Vote of Security Holders.
A special meeting of the shareholders of the Company was held on
September 25, 1997 to consider and vote upon the Merger. At that meeting
9,393,415 shares voted in favor of the Merger, 24,065 voted against the Merger
and 63,597 shares abstained from voting.
I-19
PART II
Item 5. Market for Registrant's Common Stock and Related Security Holder
Matters.
The common stock of the Company ("Common Stock") is traded on the
Nasdaq National Market under the symbol "CELS." The following table sets forth
the range of high and low closing sale prices of the Common Stock for each
fiscal quarter since October 1, 1995 as reported by Nasdaq.
Fiscal Year 1996: High Low
---- ---
First Quarter.............................. $29 1/4 $ 24 3/4
Second Quarter............................. 29 1/2 25 1/2
Third Quarter.............................. 35 3/8 28 3/4
Fourth Quarter............................. 32 25 3/8
Fiscal Year 1997: High Low
---- ---
First Quarter.............................. $31 1/4 $ 27 1/8
Second Quarter............................. 29 1/2 24 3/8
Third Quarter.............................. 35 24 5/8
Fourth Quarter............................. 35 1/2 34 3/8
As of December 23, 1997, there were 355 holders of record of the
Common Stock.
The Company has not paid cash dividends on the Common Stock and does
not anticipate that any cash dividends will be paid on the Common Stock in the
foreseeable future. Furthermore, certain financing agreements to which the
Company is a party contain provisions which restrict the payment by the Company
of dividends or distributions on the Common Stock (other than dividends or
distributions payable in shares of Common Stock).
II-1
Item 6. Selected Financial Data. (Amounts in thousands, except share and per
share data)
Statement of Operations Data (1):
Years ended September 30,
---------------------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Revenues $ 150,867 $ 115,196 $ 89,844 $ 61,360 $ 33,689
Costs and expenses (net
of amounts allocated
to affiliates):
Cellular operations 92,598 76,123 68,929 50,856 30,289
Corporate 914 880 1,327 406 (1,119)
Total depreciation and
amortization 23,188 21,840 17,595 12,650 19,950
Write-down of investment in cellular
system equipment - - - 3,117 -
----------- ----------- ----------- ----------- ---------
Operating income (loss) 34,167 16,353 1,993 (5,669) (15,431)
Equity in net loss of
affiliates (7,589) (1,636) (5,028) (5,092) (6,339)
Minority interest in net
income of consolidated
affiliates (2,964) (1,123) (964) (544) -
Gains (losses) on sales of
affiliates 350 (250) 19,471 3,912 7,821
Interest expense (29,464) (28,208) (26,044) (21,339) (16,428)
Interest income 6,532 10,468 13,046 12,081 10,703
----------- ----------- ----------- ----------- ----------
Income (loss) before
income taxes and
extraordinary charge 1,032 (4,396) 2,474 (16,651) (19,674)
Income tax expense - - 400 100 -
----------- ----------- ----------- ----------- ----------
Income (loss) before
extraordinary charge 1,032 (4,396) 2,074 (16,751) (19,674)
Extraordinary charge - - (2,012) - (2,992)
----------- ----------- ----------- ----------- ----------
Net income (loss) $ 1,032 $ (4,396) $ 62 $ (16,751) $ (22,666)
=========== =========== =========== =========== ==========
Income (loss) per common
share before
extraordinary charge $ .07 $ (.32) $ .17 $ (1.45) $ (2.30)
Extraordinary charge - - (.16) - (.35)
----------- ----------- ----------- ----------- ----------
Net income (loss) per
common share $ .07 $ (.32) $ .01 $ (1.45) $ (2.65)
=========== =========== =========== =========== ==========
Weighted average shares
outstanding 13,767,130 13,727,203 12,153,592 11,577,191 8,551,785
=========== =========== =========== =========== ==========
Balance Sheet Data (1):
Years ended September 30,
---------------------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Working capital $ 15,840 $ 16,246 $ 39,911 $ 25,525 $ 63,561
Investments in and
advances to affiliates 47,211 57,245 56,919 61,909 55,892
Net property and
equipment 143,875 118,099 105,289 79,918 53,460
Total assets 352,916 331,837 325,668 282,638 269,524
Long-term debt 250,852 245,845 246,357 243,913 259,676
Total liabilities 291,016 268,855 267,012 266,731 278,946
Stockholders' equity
(deficit) (2) 61,900 62,982 58,656 15,906 (9,422)
II-2
Supplemental Financial Data:
Years ended September 30,
-------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
EBITDA (See "Management's
Discussion and Analysis--
General") $57,355 $38,193 $19,588 $10,098 $ 4,519
Net cash provided (used) by
operating activities $48,631 $20,751 $14,068 $(7,170) $(18,579)
Differences between EBITDA and net cash provided (used) by operating activities
were primarily cash interest expense and changes in operating assets and
liabilities.
(1) Markets in which the Company holds a greater than 50% net interest are
reflected on a consolidated basis in the Company's consolidated financial
statements. Markets in which the Company holds a net interest which is 50%
or less but 20% or greater are accounted for under the equity method.
Markets in which the Company holds a less than 20% interest are accounted
for under the cost method. The following table sets forth the number of
markets and relevant accounting methods at the end of each of the last five
fiscal years.
September 30,
-----------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Consolidated 46 46 45 42 36
Equity 18 18 20 35 38
Cost 18 18 18 18 6
---- ---- ---- ---- ----
82 82 83 95 80
==== ==== ==== ==== ====
(2) No cash dividends were declared or paid during any period presented.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
General
- -------
The Company generated net income during fiscal 1997, operating income
during fiscal 1997 and 1996 and focused on increasing penetration and subscriber
usage. In addition, the Company expects that operating income before
depreciation and amortization ("EBITDA"), which was positive during the fiscal
years ended September 30, 1997 and 1996, will also be positive in future fiscal
years (although there can be no assurance that this will be the case). Certain
financial analysts consider EBITDA a meaningful measure of an entity's ability
to meet long-term financial obligations, and growth in EBITDA a meaningful
barometer of future profitability, especially in a capital-intensive industry
such as cellular telecommunications. However, EBITDA should not be considered
in isolation to, or be construed as having greater significance than, other
indicators of an entity's performance. The results discussed below may not be
indicative of future results.
Consolidated results of operations include the revenues and expenses of
those markets in which the Company holds a greater than 50% interest. The
results of operations of 46 markets are included in the consolidated results for
both fiscal years ended September 30, 1997 and September 30, 1996. Consolidated
results of operations also include the operations of Cellular, Inc. Financial
Corporation ("CIFC"), the Company's wholly-owned financing subsidiary, as well
as the operations of Cellular Inc. Network Corporation ("CINC"), a wholly-owned
subsidiary through which the Company holds interests in certain cellular
licenses.
II-3
Equity in net loss of affiliates includes the Company's share of net loss
in the markets in which the Company's interest is 50% or less but 20% or
greater. Markets in which the Company's interest is less than 20% are accounted
for under the cost method. Eighteen markets were accounted for under the equity
method and 18 markets were accounted for under the cost method for both fiscal
years ended September 30, 1997 and September 30, 1996.
Interest income reflects interest income derived from the financing
activities of CIFC and the Company with nonconsolidated affiliates, as well as
interest income derived from cash and short-term investments of the Company and
its consolidated affiliates. CIFC has entered into loan agreements with the
Company's affiliates pursuant to which CIFC makes loans to such entities for the
purpose of financing or refinancing the affiliates' costs of construction and
operation of cellular telephone systems. Such loans are financed with funds
borrowed by CIFC from CoBank, ACB, as agent for a syndicate of lenders
("CoBank") and from the Company. At September 30, 1997, six loans bore interest
at the average cost of CoBank borrowings and 28 bore interest at the 90-day
LIBOR rate plus a margin (determined based on the affiliate's leverage ratio).
From time to time, the Company advances funds on an interim basis to affiliates.
These advances typically are refinanced through CIFC. To the extent that the
cellular markets in which the Company holds an interest generate positive cash
flow, the cash is generally used to repay borrowings by the affiliates from CIFC
and thereafter will be used to make cash distributions to equity holders,
including the Company.
Management believes there exists a seasonality in both service revenues,
which tend to increase more rapidly in the third and fourth fiscal quarters, and
operating expenses, which tend to be highest in the first fiscal quarter due to
increased marketing activities and customer growth, which may cause operating
income to vary from quarter to quarter.
In addition to historical information, this report includes certain
forward-looking statements regarding events and financial trends which may
affect the Company's future operating results and financial position. Such
statements represent the Company's reasonable judgment on the future and are
subject to risks and uncertainties that could cause the Company's actual results
and financial position to differ materially. Such factors include, but are not
limited to: a change in economic conditions in the Company's markets which
adversely affects the level of demand for wireless services; greater-than-
anticipated competition resulting in price reductions, new product offerings, or
higher customer acquisition costs; better-than-expected customer growth
necessitating increased investment in network capacity; negative economies that
could result if one or more agreements to manage markets are not renewed;
increased cellular fraud; the impact of new business opportunities requiring
significant initial investments; and the impact of deployment of new
technologies on capital spending.
Results of Operations
- ---------------------
Fiscal Year 1997 Compared With Fiscal Year 1996. Cellular service
-----------------------------------------------
revenues, including in-roaming revenues, increased by 31%, or $34,877,000, from
$112,387,000 for the year ended September 30, 1996 to $147,264,000 for the year
ended September 30, 1997. The growth was primarily due to the increase in the
number of subscribers in consolidated markets. In addition to increases in
market penetration, growth resulted from an increase in the number of markets
consolidated for the entire year from 44 during the year ended September 30,
1996 to 46 during the year ended September 30, 1997. Growth in subscribers
accounted for 87% of the increase, and the number of consolidated markets
accounted for 13% of the increase. In-roaming revenues increased by 35%, or
$10,293,000, from $29,588,000 for the year ended September 30, 1996 to
$39,881,000 for the year ended September 30, 1997 due to increased coverage in
cellular markets and to industry-wide subscriber increases. In-roaming revenues
are expected to increase in the future as a result of further industry-wide
growth in subscribers and expansion of the Company's coverage, particularly
along highway corridors; however, roaming rates are expected to decline,
consistent with industry trends.
Average monthly revenue per subscriber, including in-roaming, decreased
from $63 for the year ended September 30, 1996 to $60 for the year ended
September 30, 1997, reflecting the benefit of declining prices to the consumer
which is consistent with an overall industry trend. In-roaming revenues per
subscriber per month was unchanged at $16.
II-4
Cost of cellular service decreased as a percentage of service revenues from
19% in fiscal year 1996 to 18% in fiscal year 1997, as revenues derived from the
growing subscriber base outpaced the fixed components of cost of service. The
Company has renegotiated some interconnect agreements for lower prices and is in
the process of renegotiating others. The Company expects cost of cellular
service to continue to decline as a percentage of service revenues as revenues
continue to outpace the fixed components of cost of service and as a result of
negotiations completed during fiscal 1997 that reduced interconnection rates.
Equipment sales increased 28% from $2,809,000 for the year ended September
30, 1996 to $3,603,000 for the year ended September 30, 1997 due primarily to
increases in sales of accessories. This increase was partially offset by the
effects of the Company's customer satisfaction and pricing program which was
introduced in February 1996 allowing subscribers to use handsets and accessories
at virtually no cost at the time of activation. Cost of equipment sales
increased 19% from $10,588,000 for the year ended September 30, 1996 to
$12,598,000 for the year ended September 30, 1997. Approximately $7,565,000
and $2,380,000 of the year ended September 30, 1997 cost of equipment sales
relates to equipment provided to new and existing customers, respectively.
Customers are generally required to return equipment to the Company if service
is terminated. Although the Company retains ownership of the equipment, it
carries such equipment at no value on its balance sheet. The Company expects
negative equipment margins in the future as the Company subsidizes use of
handsets to shift consumer focus to the value of cellular service.
General and administrative costs of cellular operations increased 29% from
$23,038,000 during the year ended September 30, 1996 to $29,819,000 during the
year ended September 30, 1997, due to the growth in the customer base. The
majority of these costs were incremental customer billing expense, bad debt
expense and customer service support staff. In addition, bad debt expense
increased from 1.07% of total revenues during the year ended September 30, 1996
to 2.51% of total revenues during the year ended September 30, 1997. General and
administrative costs as a percentage of service revenues remained unchanged at
20% for the year ended September 30, 1996 and the year ended September 30, 1997.
The Company expects bad debt expense as a percentage of total revenues to
decrease in future periods as collection efforts intensify.
Marketing and selling costs increased 12% from $20,920,000 for the year
ended September 30, 1996 to $23,344,000 for the year ended September 30, 1997,
primarily as a result of increased advertising costs offset by reductions in
commission costs. Marketing costs per gross new subscriber decreased 6% from
$233 for the year ended September 30, 1996 to $220 for the year ended September
30, 1997, as a result of increased gross subscriber additions which outpaced
increases in costs incurred. In addition, the Company continues to expand its
retail presence to capitalize on retail trade while driving down commission
costs.
In October 1997, three RSA licensees purported to notify the Company of
termination of management agreements in those markets during fiscal 1998. The
Company is assessing its response to these notices. However, certain economies
of scale for the remaining managed markets may be diminished unless cost cutting
measures take effect concurrent with management changes should such changes
occur.
Depreciation and amortization relating to cellular operations increased 13%
from $18,149,000 for the year ended September 30, 1996 to $20,433,000 for the
year ended September 30, 1997, primarily related to increased property and
equipment balances.
Corporate costs and expenses for the year ended September 30, 1996 were
$4,571,000, which represented gross expenses of $11,037,000 less amounts
allocated to nonconsolidated affiliates of $6,466,000. Corporate costs and
expenses for the year ended September 30, 1997 were $3,669,000, which
represented gross expenses of $10,085,000 less amounts allocated to
nonconsolidated affiliates of $6,416,000. The decrease was due primarily to the
write-off of certain assets totaling approximately $1,800,000 related to the
Company's corporate office move during the year ended September 30, 1996, offset
by costs and expenses to develop operations of CPI incurred during the fiscal
year ended September 30, 1997 which were not allocated to affiliates. Corporate
costs and expenses are expected to decrease slightly in future periods because
CPI operations are expected to expand resulting in separate line of business
reporting of CPI revenues and costs and expenses.
II-5
Equity in net loss of affiliates increased 364% from $1,636,000 for the
year ended September 30, 1996 to $7,589,000 for the year ended September 30,
1997. The increase was due primarily to decreased losses in nonconsolidated
affiliates, offset by recognition of the entire $6,189,000 net loss of TVX, Inc.
which was $2,729,000 higher than the Company's proportionate share of the net
loss based upon ownership. This accounting reflects that the Company was the
sole source of funding of TVX, Inc. In addition, during the quarter ended
September 30, 1997, the Company recorded an approximate $3,288,000 reserve
related to its investment in TVX, Inc. which is reflected in equity in net loss
of affiliates. After giving effect to the reserve, the Company's carrying value
of its investment is zero. TVX, Inc. has entered into a letter of intent for
the sale of substantially all of its assets. However, there can be no assurance
that a sale will be consummated or that the Company would receive any proceeds
upon such sale.
Interest expense increased 4% from $28,208,000 for the year ended September
30, 1996 to $29,464,000 for the year ended September 30, 1997 due to the higher
accreted discount notes balance. Cash paid for interest decreased 10% from
$14,012,000 during the year ended September 30, 1996 to $12,548,000 during
the year ended September 30, 1997 due to lower average secured bank financing
balances.
Interest income decreased 38% from $10,468,000 for the year ended September
30, 1996 to $6,532,000 for the year ended September 30, 1997. The decrease was
due to lower average cash and cash equivalent balances and lower notes
receivable balances from nonconsolidated affiliates.
At September 30, 1997, the Company had net operating loss ("NOL")
carryforwards for income tax purposes of $45,165,000, compared to $50,808,000 at
September 30, 1996. The decrease was due to utilization of NOL carryforwards to
offset current year taxable income.
Fiscal Year 1996 Compared With Fiscal Year 1995. Cellular service
-----------------------------------------------
revenues, including in-roaming revenues, increased 37% from $81,939,000 for the
year ended September 30, 1995 to $112,387,000 for the year ended September 30,
1996. The growth was primarily due to the increase in the number of subscribers
in consolidated markets. In addition to increases in market penetration, growth
resulted from an increase in the number of markets consolidated for the entire
year from 42 during the year ended September 30, 1995 to 44 during the year
ended September 30, 1996. Growth in subscribers accounted for 82% of the
increase, and the number of consolidated markets accounted for 18% of the
increase. In-roaming revenues increased by 40%, or $8,503,000, from $21,085,000
for the year ended September 30, 1995 to $29,588,000 for the year ended
September 30, 1996 due to increased coverage in cellular markets and to
industry-wide subscriber increases. In-roaming revenues are expected to
increase in the future as a result of further industry-wide growth in
subscribers and expansion of the Company's coverage, particularly along highway
corridors; however, roaming rates may decline, consistent with expected industry
trends.
Average monthly revenue per subscriber, including in-roaming revenues,
decreased from $68 for the year ended September 30, 1995 to $63 for the year
ended September 30, 1996, reflecting the benefit of declining prices to the
consumer and lower usage by new subscribers which is consistent with an overall
industry trend. However, in-roaming revenues per subscriber per month decreased
only $1, from $17 to $16, reflecting the larger scale benefit of the Company's
cell site expansion program.
Cost of cellular service decreased as a percentage of service revenues from
20% in fiscal year 1995 to 19% in fiscal year 1996, as revenues derived from the
growing subscriber base outpaced the fixed components of cost of service.
Equipment sales decreased 64% from $7,905,000 in fiscal year 1995 to
$2,809,000 in fiscal year 1996 due to the introduction of the Company's new
customer satisfaction and pricing program, which was introduced in February
1996 allowing subscribers to use handsets and accessories at virtually no fee.
After January 1996, sales of accessories accounted for the majority of the
Company's equipment sales. Cost of equipment sales decreased 3% from $10,902,000
in fiscal year 1995 to $10,588,000 in fiscal year 1996. Approximately $4,850,000
and $1,671,000 of the fiscal year 1996 cost of equipment sales relates to
equipment provided to new and existing
II-6
customers, respectively, which the customers are required to return to the
Company if service is terminated. Although the Company retains ownership of the
equipment, it carries such equipment at no value on its balance sheet. The
Company expects negative equipment margins in the future as the Company
subsidizes use of handsets to shift consumer focus to the value of cellular
service.
General and administrative costs of cellular operations increased 14% from
$20,223,000 in fiscal year 1995 to $23,038,000 in fiscal year 1996, due to the
growth in the customer base and the number of consolidated markets. The
majority of these costs were incremental customer billing expense and customer
service support staff, offset by reductions to bad debt expense. General and
administrative costs as a percentage of service revenues decreased from 25% in
fiscal year 1995 to 20% in fiscal year 1996. The decrease was primarily due to
revenues increasing at a faster rate than incremental general and administrative
costs.
Marketing and selling costs decreased 3% from $21,642,000 in fiscal year
1995 to $20,920,000 in fiscal year 1996, primarily as a result of reductions in
commission costs offset by increased advertising costs. Marketing costs per
gross new subscriber decreased 20% from $279 in fiscal year 1995 to $223 in
fiscal year 1996, as a result of increased gross subscriber additions which
outpaced increases in costs incurred. In addition, the Company continues to
expand its retail presence to capitalize on retail trade while driving down
commission costs.
Depreciation and amortization relating to cellular operations increased 17%
from $15,454,000 in fiscal year 1995 to $18,149,000 in fiscal year 1996,
primarily related to increased property and equipment balances.
Corporate costs and expenses in fiscal year 1995 were $3,468,000, which
represented gross expenses of $9,533,000 less amounts allocated to
nonconsolidated affiliates of $6,065,000. Corporate costs and expenses in
fiscal year 1996 were $4,571,000, which represented gross expenses of
$11,037,000 less amounts allocated to nonconsolidated affiliates of $6,466,000.
The increase in corporate costs and expenses was due primarily to acceleration
of depreciation expense related to certain corporate assets, and expenses
related to paging activities which were not allocated to affiliates.
Equity in net loss of affiliates decreased 67% from $5,028,000 in fiscal
year 1995 to $1,636,000 in fiscal year 1996. The decrease was due primarily to
decreased losses in nonconsolidated affiliates. Management expects operating
results of the markets that are accounted for under the equity method to
continue to improve.
Interest expense increased 8% from $26,044,000 in fiscal year 1995 to
$28,208,000 in fiscal year 1996 due to the higher interest rate on the 11 1/4%
subordinated notes than on the 6 3/4% convertible subordinated debentures which
were redeemed with the proceeds of the sale of subordinated notes, and the
higher accreted discount note balance. Cash paid for interest increased 15%
from $12,209,000 in fiscal year 1995 to $14,012,000 in fiscal year 1996.
Interest income decreased 20% from $13,046,000 in fiscal year 1995 to
$10,468,000 in fiscal year 1996. The decrease was due to lower nonconsolidated
affiliate notes receivable balances and lower cash and cash equivalent balances.
During fiscal year 1995, the Company recognized gains on sales of
affiliates of $19,471,000 primarily as a result of the sale of its interest in
Nebwest Cellular, Inc., which held an interest in Nebraska Cellular Telephone
Corporation, the licensee for the ten wireline RSA markets in the state of
Nebraska. See "Acquisitions and Sales." No significant sales occurred during
fiscal 1996.
At September 30, 1996, the Company had net operating loss ("NOL")
carryforwards for income tax purposes of $50,808,000, compared to $40,503,000 at
September 30, 1995. The increase resulted from the NOL consolidation of two
affiliated corporations offset by fiscal year 1996 taxable income.
II-7
Acquisitions and Sales
- ----------------------
In January 1997, the Company purchased an additional 15% in one previously
nonmanaged RSA for approximately $876,000 in cash. The Company assumed
management of this market upon consummation of the transaction.
In April 1997, the Company sold a 10% interest in one of its managed MSA
markets to a partner in such market for approximately $436,000 in cash, pursuant
to an option granted at the time of the Company's purchase of such interest. In
June 1997, the Company sold an additional 9% interest in this market to the same
partner for approximately $393,000 in cash.
On May 27, 1997, the Company entered into the Merger Agreement with Newco
providing for the Merger. The Merger Agreement provides that each share of the
Company's Common Stock, par value $.001 per share (including each associated
Right, "CommNet Common Stock"), issued and outstanding immediately prior to the
effective time of the Merger will be converted, at the election of the holder,
into either (a) the right to receive $36.00 in cash or (b) the right to retain
one share of CommNet Common Stock. Because 588,611 shares of CommNet Common
Stock must be retained by existing CommNet shareholders either through election
or proration, the right to receive $36.00 in cash for each share of CommNet
Common Stock or to retain that share of CommNet Common Stock is subject to
proration, as set forth in the Merger Agreement. The shareholders of the Company
voted to approve the Merger at a special meeting held on September 25, 1997.
The Merger is expected to be consummated shortly after all conditions
thereto have been satisfied, including the receipt of FCC approval. As
previously disclosed, certain petitions have been filed before the FCC seeking
to dismiss or deny the Company and the Partnership's joint application to the
FCC to transfer control of certain cellular licenses from the Company to the
Partnership. Although the Company is seeking to have the FCC dismiss such
petitions on an expedited basis, there can be no assurance as to the outcome of
such decision, or the time period that may elapse before a decision is reached
and consequently, of the time period that may elapse before the Merger is
consummated. The Company believes that it will prevail on the merits on the
petitions and is contesting the petitions vigorously.
The Company continues to pursue acquisitions to the extent they enhance or
extend its network or increase shareholder value, although there can be no
assurance any such acquisitions will be consummated.
Changes in Financial Condition
- ------------------------------
Fiscal Year 1997. Net cash provided by operating activities was
----------------
$48,631,000 during the year ended September 30, 1997 composed primarily of
$46,259,000 from net income after adjustments to reconcile net cash provided by
operating activities and decreases in working capital requirements of
$2,372,000.
Net cash used by investing activities was $30,313,000 for the year ended
September 30, 1997. This was due primarily to $37,363,000 required to fund the
purchase of property and equipment and additions to other assets of $1,335,000
offset by proceeds of $8,480,000 from CIFC note repayments recorded as
reductions to investment and advances to affiliates.
Net cash used by financing activities was $15,678,000 for the year ended
September 30, 1997. This was due primarily to net reductions to long-term debt
and capital leases of $14,728,000, repurchases of Common Stock of $2,933,000
and distributions to minority interests of $2,349,000, offset by $4,111,000 of
capital contributions received from minority interests.
Fiscal Year 1996. Net cash provided by operating activities was
----------------
$20,751,000 during the year ended September 30, 1996 due primarily to operating
income before depreciation and amortization of $38,193,000, offset by increases
in working capital requirements of $6,700,000.
II-8
Net cash used by investing activities was $39,436,000 for the year ended
September 30, 1996. This was due primarily to $32,320,000 required to fund the
purchase of property and equipment and investment in cellular system equipment,
$4,112,000 to fund additional investments in and advances to affiliates, and
$3,676,000 to purchase additional interests in affiliates.
Net cash used by financing activities was $10,841,000 for the year ended
September 30, 1996. This was due primarily to net reductions to long-term debt
and capital leases of $9,412,000, repurchases of Common Stock of $1,378,000 and
distributions to minority interests of $1,029,000, offset by $978,000 of cash
received from the issuance of Common Stock upon exercise of options.
Liquidity and Capital Resources
- -------------------------------
General. CommNet Cellular Inc. (referred to herein as the "parent
-------
company") is effectively a holding company and, accordingly, must rely on
distributions, loan repayments and other intercompany cash flows from its
affiliates and subsidiaries to generate the funds necessary to satisfy the
parent company's capital requirements. On a consolidated basis, the Company's
principal source of financing is the loan facility with CoBank (the "CoBank
Credit Agreement"), pursuant to which CoBank has agreed to lend up to
$165,000,000 to CIFC. Of the $165,000,000, $140,000,000 may be reloaned by CIFC
to the Company's affiliates for the construction, operation and expansion of
cellular telephone systems including up to $5,000,000 for the construction and
operation of a paging network. The remaining $25,000,000 is reserved for
acquisitions by CINC. Of the $140,000,000, $80,000,000 may be borrowed by CIFC
to be repaid to the parent company and used for general corporate purposes,
including capital expenditures, debt service and acquisitions. The CoBank
Credit Agreement restricts the ability of the Company's affiliates and
subsidiaries, a substantial number of which are consolidated for financial
statement purposes, to make distributions to the parent company until such
affiliates and subsidiaries have repaid all outstanding debt to CIFC. As a
result, a portion of the Company's consolidated cash flows and cash balances is
not available to satisfy the parent company's capital and debt service
requirements.
The Company's budgeted capital requirements consist primarily of (i) parent
company capital expenditures, working capital and debt service and (ii) the
capital expenditures, working capital, other operating and debt service
requirements of the affiliates. In addition to budgeted capital requirements,
the Company is constantly evaluating the acquisition of additional cellular
properties, and to the extent the Company consummates future acquisitions,
additional capital may be required.
As of September 30, 1997, the Company had unused commitments under the
CoBank Credit Agreement of $155,238,000, of which $59,440,000 was available to
be repaid to the parent company for general corporate purposes. In addition to
the liquidity provided by the CoBank Credit Agreement, at September 30, 1997,
the Company, on a consolidated basis, had available $14,132,000 of cash and cash
equivalents.
Capital expenditures in managed markets, reflected as additions to
investments in and advances to affiliates, and additions to property and
equipment and investment in cellular system equipment, for the year ended
September 30, 1997 was $50,548,000. These expenditures were primarily for 72
new cell sites, switch upgrades, increased channel capacity, paging
infrastructure and corporate assets. The Company expects capital expenditures
for fiscal year 1998 to be $27,278,000 to optimize coverage, upgrade switching
capacity, increased channel capacity and for paging infrastructure.
Currently, the Company's near-term debt service requirements consist
primarily of principal and interest payments on the indebtedness incurred under
the CoBank Credit Agreement and interest payments on the 11 1/4% Subordinated
Notes due 2005. Interest on the Company's 11 3/4% Senior Subordinated Discount
Notes is payable in cash commencing March 1, 1999. The Company anticipates its
cash interest expense under its current debt structure for fiscal year 1998 will
be $10,773,000. Revolving loan indebtedness outstanding under the CoBank
Credit Agreement will convert to term loan indebtedness at December 31, 1997 to
be amortized over the next three years. The Company anticipates repaying debt
under the notes and CoBank Credit Agreement with funds to be drawn under the
Chase Credit Agreement in conjunction with consummation of the Merger. The
Company anticipates its cash interest expense under the Chase Credit Agreement
will be $49,314,000 during fiscal 1998
II-9
assuming the Merger closes on January 1, 1998, and additional fees associated
with the loan and the merger to be $37,500,000. Additional borrowings under the
Chase Credit Agreement may be required if cash from operating activities is not
sufficient to fund cash interest expense. See "The Credit Agreements" below.
The Company believes operating cash flow, existing cash balances and
borrowing availability under either the CoBank Credit Agreement or the Chase
Credit Agreement will be sufficient to meet all future anticipated capital
requirements of the parent company and its affiliates and debt service
requirements of the Company at both the parent company level and on a
consolidated basis.
Although the Company believes that the foregoing sources of liquidity will
be sufficient to meet budgeted capital expenditures and debt service
requirements of the parent company and the affiliates, there can be no assurance
that this will be the case. In such event, the Company believes it will be able
to satisfy its capital expenditure and debt service requirements with
unrestricted operating cash flow; however, the Company may be required to reduce
discretionary capital spending. To the extent the Company's cash flow is not
sufficient to satisfy such requirements, the Company will be required to raise
funds through additional financings or asset sales.
The Company continually evaluates the acquisition of cellular properties.
Acquisitions are likely to require capital in addition to the budgeted capital
requirements described above, and such requirements may in turn require the
issuance of additional debt or equity securities. The Company's ability to
finance the acquisition of additional cellular properties with debt financing
may be constrained by certain restrictions contained in its existing debt
instruments. Although all existing debt covenants are anticipated to be
amended in connection with the Merger, new covenants will be contained in the
Chase Credit Agreement.
In August 1996, the Company announced a program to repurchase, from time to
time, up to $20,000,000 of its outstanding Common Stock using available
liquidity to fund the repurchases. From August 1996 to October 1996, the
Company repurchased 149,500 shares at prices ranging from $27.75 to $29.125 for
an aggregate price of $4,310,938. The Company has discontinued this program.
The Credit Agreements. Pursuant to an agreement (the "CoBank Credit
---------------------
Agreement"), CoBank has agreed to loan up to $165,000,000 to CIFC to be reloaned
by CIFC to affiliates of the Company for the construction, operation and
expansion of cellular telephone systems including $25,000,000 to fund the
acquisitions of additional cellular systems, subject to certain conditions. As
of September 30, 1997, $59,440,000 was available under the CoBank Credit
Agreement to be borrowed from CoBank by CIFC and repaid to the parent company
for general corporate purposes. The CoBank Credit Agreement provides, at the
Company's option, for interest at a margin over prime or LIBOR (.25% and 1.75%
at September 30, 1997, respectively). The interest rate margin is determined
based upon the maintenance of certain debt to cash flow ratios. At October 1,
1996 the interest rate margin was 1.00% over prime and 2.50% over LIBOR. On
January 1, 1997 the interest rate margin was reduced to .50% over prime and
2.00% over LIBOR and on May 16, 1997, the interest rate margins were reduced to
.25% and 1.75% over prime and LIBOR, respectively. The outstanding balance under
the CoBank Credit Agreement was approximately $9,762,000 at September 30, 1997,
all of which was fixed at the LIBOR based rate of 7.41% for terms of one to
three months.
Effective January 1, 1997, CIFC and CoBank amended the CoBank Credit
Agreement to extend the term period of the facility to December 31, 1997 with a
three-year principal amortization upon the loan termination. The loan is
secured by a first lien upon all of the assets of CIFC and each of the
affiliates to which funds are advanced by CIFC. In addition, the Company has
guaranteed the obligations of CIFC to CoBank and has granted CoBank a first lien
on all of the assets of the Company as security for such guaranty.
The CoBank Credit Agreement prohibits the payment of cash dividends, limits
the use of borrowings, prohibits any other senior borrowings, restricts
expenditures for certain investments, requires positive working capital and
requires the maintenance of certain liquidity, capitalization, debt, debt
service and cash interest ratios. The requirements of the CoBank Credit
Agreement were established in relation to the anticipated capital and financing
needs of the Company's affiliates and their anticipated results of operations.
The Company is currently in compliance with all covenants and anticipates it
will continue to meet the requirements of the CoBank Credit
II-10
Agreement. Approval may be required from the syndicate for waivers or other
amendments to the CoBank Credit Agreement requested by CIFC or the Company.
As of September 18, 1997, CIFC and the Company entered into a new senior
bank credit facility with The Chase Manhattan Bank as administrative agent and
collateral agent, Chase Manhattan Bank Delaware, as fronting bank, and the other
lenders named therein (the "Chase Credit Agreement"). Funding under the Chase
Credit Agreement will be used to pay off the CoBank Credit Agreement, to tender
for the Company's 11 3/4% Senior Subordinated Notes and 11 1/4% Subordinated
Notes, and to fund costs associated with the Merger Agreement and will not occur
unless and until the Merger is consummated. Advances made under the Chase Credit
Agreement will be used, when necessary, to fund loans made by CIFC to the
affiliates.
The Chase Credit Agreement provides for aggregate credit commitments of up
to $760 million. All obligations of CIFC and the guarantors under the Chase
Credit Agreement and the guarantees will be secured by first priority security
interests in substantially all tangible and intangible assets, trademarks,
tradenames and equipment of CIFC and the guarantors. In addition, the Chase
Credit Agreement will be secured by a first priority security interest in
substantially all of the assets held by the Company and certain of its wholly-
owned subsidiaries, to the extent the Company and such subsidiaries have the
legal ability to pledge such assets. The Chase Credit Agreement includes
limitations on dividends and distributions on capital stock and other
significant operating and financial restrictions and covenants, including limits
on the ability of the Company and its subsidiaries to incur or prepay
indebtedness, create liens, enter into leases or transactions with affiliates,
sell assets, engage in mergers or acquisitions, make investments, and redeem or
repurchase capital stock or debt.
II-11
Supplemental Information:
SELECTED COMBINED AND PROPORTIONATE
OPERATING RESULTS OF CELLULAR LICENSEES
(Amounts in thousands, except statistical data)
The following unaudited table presents operating data for all cellular
licensees in which the Company holds an interest. The "Combined," "Financed
Proportionate" and "Company Proportionate" operating results, which are not
included in the Company's consolidated financial statements, are provided to
assist in understanding the results of the licensees in which the Company holds
an interest. Generally accepted accounting principles ("GAAP") prescribe
inclusion of revenues and expenses for consolidated interests (generally
interests of more than 50%), but not for equity interests (generally interests
of 20% to 50%) or cost interests (generally interests of less than 20%). Equity
accounting ordinarily results in the same net income as consolidation; however,
the net operating results are reflected on one line below operating income.
Operating activity related to interests accounted for under the cost method are
not reflected at all in a GAAP operating statement.
Years ended September 30,
--------------------------------------------------------------------------------------
1997 1996 1997 1996 1997 1996
---------------------- -------------------------- -------------------------
Combined(1) Financed Proportionate (2) Company Proportionate (3)
---------------------- -------------------------- -------------------------
Managed Markets
Revenues:
Cellular service $126,755 $ 99,736 $116,238 $ 93,066 $ 96,034 $ 74,112
In-roaming 46,389 36,027 42,504 33,732 36,023 27,243
Equipment sales 3,969 3,094 3,636 2,851 3,184 2,341
-------- -------- -------- -------- -------- --------
Total revenues 177,113 138,857 162,378 129,649 135,241 103,696
Costs and expenses
involving cash:
Cost of sales:
Cellular service
(including in-roaming) 29,058 25,967 27,027 24,470 22,648 19,484
Equipment sales 14,231 11,900 13,012 10,868 11,193 8,926
General and administrative 35,178 27,883 32,271 25,859 26,690 20,541
Marketing and selling 28,391 25,608 26,123 23,838 21,361 18,942
-------- -------- -------- -------- -------- --------
Total cash costs and
expenses 106,858 91,358 98,433 85,035 81,892 67,893
-------- -------- -------- -------- -------- --------
EBITDA $ 70,255 $ 47,499 $ 63,945 $ 44,614 $ 53,349 $ 35,803
======== ======== ======== ======== ======== ========
Capital expenditures $ 50,548 $ 33,694 $ 47,623 $ 32,291 $ 38,384 $ 29,064
Subscriber count 274,745 211,278 242,975 196,780 204,420 157,816
Total markets 56 55 56 55 56 55
Nonmanaged Markets
Revenues:
Cellular service
(including in-roaming) $119,194 $ 92,177 $ 18,802 $ 14,457 $ 13,761 $ 9,607
Equipment sales 7,453 6,889 690 689 551 531
-------- -------- -------- -------- -------- --------
Total revenues 126,647 99,066 19,492 15,146 14,312 10,138
Costs and expenses
involving cash:
Cost of sales:
Cellular service 25,440 21,368 4,242 3,941 3,114 2,591
Equipment sales 9,665 7,717 1,171 893 880 655
General and administrative 25,276 17,940 4,374 3,390 3,093 2,152
Marketing and selling 26,162 19,683 4,119 3,017 3,188 2,141
-------- -------- -------- -------- -------- --------
Total cash costs
and expenses 86,543 66,708 13,906 11,241 10,275 7,539
-------- -------- -------- -------- -------- --------
EBITDA $ 40,104 $ 32,358 $ 5,586 $ 3,905 $ 4,037 $ 2,599
======== ======== ======== ======== ======== ========
Capital expenditures $ 17,280 $ 20,071 $ 2,177 $ 2,529 $ 1,435 $ 1,803
Subscriber count 194,563 158,613 31,909 23,241 23,559 17,312
Total markets 26 27 26 27 26 27
II-12
Years ended September 30,
-------------------------
1997 1996
-------------------------
Reconciliation From Company Proportionate EBITDA to Consolidated Net Income (Loss):
Total proportionate EBITDA (managed and nonmanaged markets) $ 57,386 $ 38,402
Depreciation and amortization (17,681) (15,766)
Interest expense (11,203) (9,555)
Equity in nonlicensee affiliates (11,550) (4,735)
Minority interests 3,035 2,423
Intercompany interest 10,075 8,202
Depreciation and amortization not owned by affiliates (2,525) (2,605)
Unallocated corporate expenses (3,669) (4,570)
Gain (loss) on sales of affiliates 350 (250)
Interest expense (net) and other (23,186) (15,942)
-------- --------
Consolidated net income (loss) $ 1,032 $ (4,396)
======== ========
_______________
(1) Includes 100% of the operating activity of all licensees, regardless of the
Company's ownership interest. This is essentially equivalent to
consolidating all licensees regardless of ownership percentage.
(2) Includes that percentage of a licensee's operating results which equals the
Company's ownership interest as well as the ownership interest held by
affiliates of the Company that are financed by CIFC.
(3) Includes only that percentage of a licensee's operating results which
corresponds to the Company's ownership interest. This is essentially
equivalent to a pro rata consolidation.
II-13
Item 8. Financial Statements and Supplementary Data.
The consolidated financial statements of the Company are filed under this
item, beginning on page II-14. The consolidated financial statement schedules
required under Regulation S-X are filed pursuant to Item 14 of this report.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
None.
II-14
Report of Independent Auditors
------------------------------
The Board of Directors and Stockholders
CommNet Cellular Inc.
We have audited the accompanying consolidated balance sheets of CommNet Cellular
Inc. as of September 30, 1997 and 1996, and the related consolidated statements
of operations, stockholders' equity, and cash flows for each of the three years
in the period ended September 30, 1997. Our audits also included the financial
statement schedules listed in the Index at Item 14 (a)(2). These financial
statements and schedules are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements and
schedules based on our audits.
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 provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements listed in the accompanying
index to financial statements (Item 14 (a)(1)) present fairly, in all material
respects, the consolidated financial position of CommNet Cellular Inc. at
September 30, 1997 and 1996, and the consolidated results of its operations and
its cash flows for each of the three years in the period ended September 30,
1997, in conformity with generally accepted accounting principles. Also, in our
opinion, the related financial statement schedules, when considered in relation
to the basic financial statements taken as a whole, present fairly in all
material respects the information set forth therein.
ERNST & YOUNG LLP
Denver, Colorado
December 5, 1997
II-15
COMMNET CELLULAR INC.
CONSOLIDATED BALANCE SHEETS
September 30, 1997 and 1996
(Amounts in thousands, except share data)
ASSETS (Note 4) 1997 1996
- ------ ---- ----
Current assets:
Cash and cash equivalents $ 14,132 $ 11,492
Accounts receivable, net of allowance for
doubtful accounts of $2,122 and $1,947 in
1997 and 1996, respectively 25,386 19,933
Current portion of advances to affiliates 2,873 -
Inventory and other 4,558 3,949
-------- --------
Total current assets 46,949 35,374
Investment in and advances to affiliates (Notes 2 and 3) 47,211 57,245
Investment in cellular system equipment 10,243 11,809
Property and equipment, at cost:
Cellular system equipment 159,436 126,305
Land, buildings and improvements 31,688 25,977
Furniture and equipment 19,505 17,144
-------- --------
210,629 169,426
Less accumulated depreciation 66,754 51,327
-------- --------
Net property and equipment 143,875 118,099
Other assets, less accumulated amortization of
$36,883 and $33,166 in 1997 and 1996,
respectively:
FCC licenses and filing rights (Note 2) 98,216 103,251
Deferred loan costs and other 6,422 6,059
-------- --------
Total other assets 104,638 109,310
-------- --------
$352,916 $331,837
======== ========
See accompanying notes.
II-16
COMMNET CELLULAR INC.
CONSOLIDATED BALANCE SHEETS (continued)
September 30, 1997 and 1996
(Amounts in thousands, except share data)
LIABILITIES AND STOCKHOLDERS' EQUITY 1997 1996
- ------------------------------------ ---- ----
Current liabilities:
Accounts payable - trade $ 7,695 $ 3,468
Accounts payable - property and equipment purchases 8,228 2,116
Accrued commissions 1,118 1,197
Accrued interconnect costs 1,851 650
Accrued operating taxes 2,809 2,334
Other accrued liabilities 5,988 3,124
Interest payable 2,302 2,556
Current portion of secured bank financing and
other long-term debt 1,118 3,683
--------- ---------
Total current liabilities 31,109 19,128
Long-term debt:
Secured bank financing (Note 4) 8,803 20,825
Note payable and other long-term debt (Note 4) 2,916 3,057
11 3/4% senior subordinated discount notes (Note 5) 159,133 141,963
11 1/4% subordinated notes (Note 5) 80,000 80,000
Minority interests 9,055 3,882
Commitments and contingencies (Note 6)
Stockholders' equity
(Notes 2, 3, 4, 5, 8, 9, and 10):
Preferred Stock, $.01 par value; 1,000,000 shares
authorized; no shares issued - -
Common Stock, $.001 par value; 40,000,000 shares
authorized; 13,785,211 and 13,859,740 shares issued
at September 30, 1997 and 1996, respectively 14 14
Capital in excess of par value 165,989 168,103
Accumulated deficit (104,103) (105,135)
--------- ---------
Total stockholders' equity 61,900 62,982
--------- ---------
$ 352,916 $331,837
========= =========
See accompanying notes.
II-17
COMMNET CELLULAR INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended September 30, 1997, 1996 and 1995
(Amounts in thousands, except share and per share data)
1997 1996 1995
---- ---- ----
Revenues:
Cellular service $ 107,383 $ 82,799 $ 60,854
In-roaming 39,881 29,588 21,085
Equipment sales 3,603 2,809 7,905
----------- ----------- -----------
150,867 115,196 89,844
Costs and expenses:
Cellular operations:
Cost of cellular service 26,837 21,577 16,162
Cost of equipment sales 12,598 10,588 10,902
General and administrative 29,819 23,038 20,223
Marketing and selling 23,344 20,920 21,642
Depreciation and amortization 20,433 18,149 15,454
Corporate:
General and administrative 7,330 7,346 7,392
Depreciation and amortization 2,755 3,691 2,141
Less amounts allocated to
nonconsolidated affiliates (6,416) (6,466) (6,065)
----------- ----------- -----------
116,700 98,843 87,851
----------- ----------- -----------
Operating income 34,167 16,353 1,993
Equity in net loss of affiliates (Note 3) (7,589) (1,636) (5,028)
Minority interest in net income of
consolidated affiliates (2,964) (1,123) (964)
Gains (losses) on sales of affiliates and
other (Note 2) 350 (250) 19,471
Interest expense (29,464) (28,208) (26,044)
Interest income (Note 3) 6,532 10,468 13,046
----------- ----------- -----------
Income (loss) before income taxes and
extraordinary charge 1,032 (4,396) 2,474
Income tax expense (Note 7) - - 400
----------- ----------- -----------
Income (loss) before extraordinary charge 1,032 (4,396) 2,074
Extraordinary charge related to early
extinguishment of long-term debt
(Note 5) - - (2,012)
----------- ----------- -----------
Net income (loss) $ 1,032 $ (4,396) $ 62
----------- ----------- -----------
Income (loss) per common share:
Income (loss) before extraordinary
charge $ .07 $ (.32) $ .17
Extraordinary charge - - (.16)
----------- ----------- -----------
Net income (loss) per common share $ .07 $ (.32) $ .01
=========== =========== ===========
Weighted average shares outstanding 13,767,130 13,727,203 12,153,592
=========== =========== ===========
See accompanying notes.
II-18
COMMNET CELLULAR INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years ended September 30, 1995, 1996 and 1997
(Amounts in thousands, except share data)
Capital in
Common Stock Excess of Unrealized Accumulated
Shares Amount Par Value Gains/Losses Deficit
------------------------ ---------- ------------ ---------
Balance at October 1, 1994 11,739,108 $ 12 $117,147 $ (450) $(100,801)
Exercise of options 101,875 - 815 - -
Debenture conversion (Note 5) 1,320,785 1 34,088 - -
Issuance of Common Stock
acquisitions (Note 2) 262,178 - 6,780 - -
Issuance of Common Stock
ESOP (Note 9) 19,021 - 552 - -
Reversal of unrealized losses - - - 450 -
Net income - - - - 62
----------- ------- -------- ------------ ---------
Balance at September 30, 1995 13,442,967 13 159,382 - (100,739)
Exercise of options 48,000 - 978 - -
Debenture and note
conversion (Note 5) 200,000 1 2,908 - -
Issuance of Common Stock -
acquisitions (Note 2) 191,786 - 5,506 - -
Issuance of Common Stock -
ESOP (Note 9) 24,487 - 707 - -
Common Stock repurchased (47,500) - (1,378) - -
Net loss - - - - (4,396)
----------- ------- -------- ------------ ---------
Balance at September 30, 1996 13,859,740 14 168,103 - (105,135)
Exercise of options 10,750 - 221 - -
Issuance of Common Stock -
ESOP (Note 9) 16,721 - 598 - -
Common Stock repurchased (102,000) - (2,933) - -
Net income - - - - 1,032
----------- ------- -------- ------------ ---------
Balance at September 30, 1997 13,785,211 $ 14 $165,989 $ - $(104,103)
=========== ======= ======== ============ =========
See accompanying notes.
II-19
COMMNET CELLULAR INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended September 30, 1997, 1996 and 1995
(Amounts in thousands)
1997 1996 1995
---- ---- ----
Operating activities:
Net income (loss) $ 1,032 $(4,396) $ 62
Adjustments to reconcile net income (loss)
to net cash provided by operating
activities:
Extraordinary charge related to early
extinguishment of long-term debt - - 2,012
Minority interests 2,964 1,123 964
Compensation expense related
to ESOP and option grants 598 707 552
Depreciation 19,266 16,933 13,992
Amortization 3,922 4,907 3,603
Equity in net loss of affiliates 7,589 1,636 5,028
Losses (gains) on sales of affiliates
and other (350) 250 (19,471)
Interest expense on 11 3/4%
senior discount notes 17,170 15,318 13,665
CoBank patronage income (99) (289) (535)
Accrued interest on advances to
affiliates (5,833) (8,738) (11,247)
Loss on sale of short-term investments - - 221
Change in operating assets and liabilities,
net of effects from consolidating acquired
interests (Note 2):
Accounts receivable (5,453) (5,435) 927
Inventory and other (609) (1,018) 4,387
Accounts payable and
accrued liabilities 8,688 462 (1,026)
Accrued interest (254) (709) 934
---------- -------- ---------
Net cash provided by operating activities 48,631 20,751 14,068
See accompanying notes.
II-20
COMMNET CELLULAR INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
Years ended September 30, 1997, 1996 and 1995
(Amounts in thousands)
1997 1996 1995
---- ---- ----
Investing activities:
Reductions in (additions to) investments
in and advances to affiliates, net $ 8,480 $ (4,112) $ (6,016)
Additions to property and equipment
and investment in cellular system
equipment (37,363) (32,320) (31,797)
Reductions in (additions to) other assets (1,335) 58 (240)
Proceeds from sales of interests in
affiliates (Note 2) 829 614 26,140
Purchase of interests in affiliates, net
of cash acquired and net of assets
and liabilities recorded due to
consolidation (Note 2) (924) (3,676) (2,487)
Purchases of available-for-sale
securities - (987) (82)
Sales of available-for-sale
securities - 987 21,510
------- ------- -----
Net cash (used) provided by investing activities (30,313) (39,436) 7,028
See accompanying notes.
II-21
COMMNET CELLULAR INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
Years ended September 30, 1997, 1996 and 1995
(Amounts in thousands)
1997 1996 1995
---- ---- ----
Financing activities:
Proceeds from secured bank financing $ 43,336 $ 16,250 $ 23,366
Payments of secured bank financing (57,763) (28,270) (38,643)
Extraordinary charge related to early
extinguishment of long-term debt - - (1,130)
Loan fees and offering costs related
to long-term debt - - (1,511)
Reductions of obligation
under capital leases (301) (308) (605)
Additions to notes payable - 2,916 -
Distributions to minority interest (2,349) (1,029) -
Capital contributions from minority interest 4,111 - -
Issuance of subordinated notes - - 77,400
Redemption of convertible
subordinated debentures - - (41,852)
Issuance of Common Stock, net of
offering costs 221 978 815
Repurchases of Common Stock (2,933) (1,378) -
--------- -------- --------
Net cash (used) provided by financing
activities (15,678) (10,841) 17,840
--------- -------- --------
Net increase (decrease) in cash and
cash equivalents 2,640 (29,526) 38,936
Cash and cash equivalents at beginning
of year 11,492 41,018 2,082
--------- -------- --------
Cash and cash equivalents at end of year $ 14,132 $ 11,492 $ 41,018
========= ======== ========
See accompanying notes.
II-22
COMMNET CELLULAR INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
Years ended September 30, 1997, 1996 and 1995
(Amounts in thousands)
Supplemental schedule of additional cash flow information and noncash
activities:
1997 1996 1995
---- ---- ----
Cash paid during the year for interest $12,548 $14,012 $12,209
Purchase of cellular system equipment
through accounts payable 8,228 2,116 4,235
Purchases of interests in affiliates by
issuance of Common Stock - 5,506 6,780
Conversion of convertible subordinated
debentures and notes to Common Stock - 2,909 34,090
Additions to deferred loan costs related
to 11 1/4% subordinated notes - - 2,600
Write-off of offering costs included in
extraordinary loss on early extinguish-
ment of long-term debt - - 882
See accompanying notes.
II-23
COMMNET CELLULAR INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of significant accounting policies
------------------------------------------
Organization and basis of presentation
CommNet Cellular Inc. and its majority-owned affiliates (the "Company")
operates, manages and finances cellular telephone systems principally in the
mountain and plains regions of the United States. Cellular telephone systems
are capable of providing a wide variety of telecommunication services including
high quality wireless local and long-distance telephone service within a
specified market area through mobile, portable or fixed telephone equipment.
The Federal Communications Commission ("FCC") initially granted only two
licenses in each cellular market area, one to a telephone company with an
exchange presence in the area ("wireline" license), and one to an entity other
than a telephone company ("nonwireline" license).
The Company initially acquired its cellular interests by participating in
the wireline licensing process conducted by the FCC. In order to participate in
that process, the Company formed affiliates which were originally owned at least
51% by one or more independent telephone companies and no more than 49% by the
Company. In addition to obtaining interests in cellular markets through
participation in the FCC licensing process, the Company also has purchased
direct interests in additional markets in order to expand the network.
All affiliate investments in which the Company has greater than a 50%
interest are consolidated. All affiliate investments in which the Company has a
50% or less but 20% or greater interest are accounted for under the equity
method. All affiliate investments in which the Company has less than a 20%
interest are accounted for under the cost method.
The Company and its affiliates participated in the following markets as of
September 30, 1997:
Net Company
MSA or Interest in
RSA Code (1) State Licensee (2)
------------ ---------- -----------
MSAs: 141 Minnesota 16.34%
185 Indiana 16.67%
241 Colorado 73.99%
253 Iowa 74.50%
267 South Dakota 51.00%
268 Montana 91.63%
279 Maine 11.11%
289 South Dakota 100.00%
297 Montana 91.63%
298 North Dakota 51.00%
II-24
COMMNET CELLULAR INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of significant accounting policies (continued)
------------------------------------------
Organization and basis of presentation (continued)
Net Company
MSA or Interest in
RSA Code (1) State Licensee (2)
------------ ---------- -----------
RSAs: 348 Colorado 10.00%
349 Colorado 61.75%
351 Colorado 61.75%
352 Colorado 66.00%
353 Colorado 100.00%
354 Colorado (B1) 69.40%
355 Colorado 49.00%
356 Colorado (B1) 49.00%
389 Idaho 50.00%
390 Idaho 33.33%
392 Idaho (B1) 100.00%
393 Idaho 91.64%
415 Iowa 10.11%
416 Iowa 78.57%
417 Iowa 100.00%
419 Iowa 44.92%
420 Iowa 100.00%
424 Iowa 50.00%
425 Iowa 13.28%
426 Iowa 49.14%
427 Iowa 49.17%
428 Kansas 3.07%
429 Kansas 3.07%
430 Kansas 3.07%
431 Kansas 3.07%
432 Kansas 3.07%
433 Kansas 3.07%
434 Kansas 3.07%
435 Kansas 3.07%
436 Kansas 3.07%
437 Kansas 3.07%
438 Kansas 3.07%
439 Kansas 3.07%
440 Kansas 3.07%
441 Kansas 3.07%
442 Kansas 3.07%
512 Missouri (B1) 14.70%
523 Montana (B1) 91.63%
523 Montana (B2) 91.63%
524 Montana (B1) 91.63%
526 Montana (B1) 91.63%
II-25
COMMNET CELLULAR INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of significant accounting policies (continued)
------------------------------------------
Organization and basis of presentation (continued)
Net Company
MSA or Interest in
RSA Code (1) State Licensee (2)
----------- ------ ------------
527 Montana 91.63%
528 Montana 91.63%
529 Montana 91.63%
530 Montana 91.63%
531 Montana 91.63%
532 Montana 91.63%
553 New Mexico (B2) 58.36%
555 New Mexico 12.25%
557 New Mexico 16.33%
580 North Dakota 53.36%
581 North Dakota 49.00%
582 North Dakota 41.45%
583 North Dakota 49.00%
584 North Dakota 61.75%
634 South Dakota 100.00%
635 South Dakota 100.00%
636 South Dakota 100.00%
638 South Dakota (B1) 100.00%
638 South Dakota (B2) 100.00%
639 South Dakota (B1) 100.00%
639 South Dakota (B2) 100.00%
640 South Dakota 64.49%
641 South Dakota 61.13%
642 South Dakota 49.00%
675 Utah 100.00%
676 Utah 100.00%
677 Utah (B3) 100.00%
678 Utah 80.00%
718 Wyoming 66.00%
719 Wyoming 100.00%
720 Wyoming 100.00%
(1) Metropolitan Statistical Area ("MSA") ranking is based on population as
established by the FCC. Rural Service Areas ("RSAs") have been numbered
by the FCC alphabetically by state.
(2) Represents the net ownership interest held by the Company in the
licensee for the respective market.
II-26
COMMNET CELLULAR INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of significant accounting policies (continued)
------------------------------------------
Principles of consolidation
The consolidated financial statements include the accounts of the Company
and its majority-owned affiliates. All significant intercompany transactions
have been eliminated.
Minority interests are recognized by the Company only when other
stockholders or partners provide funding to the affiliates or the underlying
affiliate has attained a positive accumulated earnings position.
For those affiliates which do not have other stockholders or partners which
provide funding to the affiliates and the underlying affiliate has not attained
a positive accumulated earnings position, the Company records all operating
losses recognizing that the minority interests have no funding obligations.
The Company also recognizes all operating income from these affiliates until the
underlying affiliate has attained a positive accumulated earnings position.
Use of estimates
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities,
disclosure of contingent assets and liabilities at the date of financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Cash and cash equivalents
The Company considers all highly liquid debt instruments purchased with a
maturity of three months or less to be cash equivalents.
Accounts receivable
The Company performs credit evaluations of its customers' financial
condition prior to initial activation and generally does not require collateral.
Receivables generally are due within 30 days. Credit losses relating to the
Company's customers consistently have been within management's expectations.
The Company's provision for doubtful accounts receivable was approximately
$3,789,000, $1,231,000 and $5,096,000 for the years ended September 30, 1997,
1996 and 1995, respectively.
Inventory
Inventories are stated at the lower of cost (first-in, first-out) or market
and are comprised of cellular communication equipment and accessories held for
resale to the Company's subscribers.
Investment in cellular system equipment
Investment in cellular system equipment relates to cellular system
equipment under construction or held in inventory at the Company's warehouse
facility.
II-27
COMMNET CELLULAR INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of significant accounting policies (continued)
------------------------------------------
Long-lived assets
In March 1995, the Financial Accounting Standards Board ("FASB") issued
Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for
----------------------------------------------------------
Long-Lived Assets to be Disposed Of, which requires impairment losses to be
- -----------------------------------
recorded on long-lived assets used in operations when indicators of impairment
are present. The Company adopted Statement No. 121 in the first quarter of
fiscal year 1997 and the effect of adoption was not material.
Deferred loan costs
Deferred loan costs relate to the offerings of senior notes and to loan
agreements (see Notes 4 and 5). These costs are being amortized over the
respective terms of the notes and loans.
FCC licenses and filing rights
FCC licenses represent the costs of the FCC licenses acquired by
consolidated affiliates. Filing rights represent costs associated with
acquiring the rights to file for cellular telephone licenses. The excess of the
purchase price of affiliate interests acquired over the fair market value of the
related net assets acquired is included as the cost of FCC licenses and filing
rights and is amortized over 40 years from the date of acquisition.
Revenue recognition
Cellular service revenues based upon subscriber usage are recognized at the
time service is provided. Access and special feature cellular service revenues
are recognized when earned. Equipment sales are recognized at the time
equipment is delivered to the subscriber or to an unaffiliated agent.
Cost of equipment sold
During 1996, the Company introduced a new customer service program whereby
a handset is provided to the customer and returned to the Company at the end of
the service agreement. The cost of providing the handset to the customer is
included in cost of equipment sales, with no corresponding recognition of
equipment revenue, as any revenue related to the program is recognized in
cellular service revenue.
Depreciation and amortization
Depreciation of property and equipment is provided principally on the
straight-line method over estimated useful lives as follows:
Years
-----
Cellular system equipment 8-15
Building and improvements 6-10
Furniture and equipment 3-5
II-28
COMMNET CELLULAR INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of significant accounting policies (continued)
------------------------------------------
Cost allocations
The Company allocates shared operating costs to its managed affiliates.
Costs which bear an identifiable causal relationship are allocated directly to
the affiliate. Indirect costs are allocated based on a methodology negotiated
with the affiliates and applied consistently to all managed markets. This
methodology allocates functional cost pools on a pro rata basis taking into
consideration total property, plant and equipment, population, subscribers and
other attributes of the managed markets.
The Company incurs certain overhead costs related to expansion. As a
result, the Company capitalized $2,870,000, $1,937,000 and $2,536,000 for the
years ended September 30, 1997, 1996 and 1995, respectively, which is included
in property and equipment, and investment in cellular system equipment. In
addition, the Company allocated $749,000, $429,000 and $816,000 to
nonconsolidated affiliates for the years ended September 30, 1997, 1996 and
1995, respectively.
Advertising
The Company expenses advertising costs as incurred. Advertising expense
was approximately $4,453,000, $2,825,000 and $2,624,000 for the years ended
September 30, 1997, 1996 and 1995, respectively.
Earnings per common share
Net income (loss) per common share is based on the weighted average number
of common shares outstanding during the periods. Common Stock equivalents
consist of stock options. The difference between earnings per common share and
fully diluted earnings per share is insignificant.
In February 1997, the Financial Accounting Standards Board issued Statement
No. 128, Earnings Per Share, which is required to be adopted on December 31,
------------------
1997. At that time, the Company will be required to change the method currently
used to compute earnings per share and to restate all prior periods. Under the
new requirements for calculating earnings per share, the dilutive effect of
stock options will be excluded from basic earnings per share. The impact of
Statement No. 128 on these statements is not expected to be material.
Certain reclassifications
Certain reclassifications have been made to the 1995 and 1996 financial
statements to conform with the 1997 financial statement presentation.
II-29
COMMNET CELLULAR INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Business acquisitions and dispositions
--------------------------------------
1995
In November 1994, the Company purchased an additional 5.97% interest in
Nebwest Cellular, Inc. for $1,600,000 in cash. Pursuant to the terms of a
shareholders' agreement, the Company subsequently sold a portion of that
interest to the other shareholders on a pro rata basis for approximately
$450,000 in cash. In February 1995, the Company purchased an additional 3.37%
interest in this corporation for 34,688 shares of the Company's Common Stock.
In March 1995, the Company purchased an additional 2.57% interest in this
corporation for 28,638 shares of the Company's Common Stock. In July 1995, the
Company sold its 61.50% interest in Nebwest Cellular, Inc. which owned 25.52%
of Nebraska Cellular Telephone Corporation, the licensee for the ten wireline
RSA markets in the state of Nebraska, for approximately $24,300,000 which
resulted in a gain after tax of approximately $19,600,000.
In January 1995, the Company sold a wholly-owned subsidiary for
approximately $86,000 which resulted in a loss of approximately $297,000.
In January 1995, the Company transferred its 25% interest in one nonmanaged
RSA market to a partner in that market pursuant to a judgment. The Company
received approximately $1,699,000 upon transfer of the interest which resulted
in a gain of approximately $497,000.
In February 1995, the Company purchased additional interests ranging from
2% to 41% in eleven managed and one nonmanaged markets for approximately
$1,259,000 in cash and the issuance of 49,738 shares of the Company's Common
Stock.
In May and June 1995, the Company acquired additional interests ranging
from 17% to 51% in two managed markets and two nonmanaged markets for an
aggregate of 138,168 shares of the Company's Common Stock.
In August and September 1995, the Company acquired additional interests
ranging from 3% to 26% in two managed markets for 3,592 shares of the Company's
Common Stock and approximately $38,000 in cash.
1996
In November 1995, the Company purchased additional interests ranging from
18% to 19% in three managed markets for 28,283 shares of the Company's Common
Stock.
In March 1996, the Company purchased additional interests ranging from 43%
to 44% in two managed RSA markets for 79,520 shares of the Company's Common
Stock.
In April 1996, the Company acquired interests in one managed MSA and one
managed RSA market for a net purchase price of $1,011,000, comprised of the
Company's interest in one managed RSA market (transferred in November 1995),
common stock, cash and forgiveness of certain obligations.
Also in April 1996, the Company purchased additional interests ranging from
8% to 38% in one managed and one nonmanaged RSA markets and one nonmanaged MSA
market for approximately $392,000 in cash and 44,415 shares of the Company's
Common Stock.
II-30
COMMNET CELLULAR INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Business acquisitions and dispositions (continued)
--------------------------------------
In May 1996, the Company partitioned the New Mexico 1 RSA, sold its
interest in the southern portion of the market and acquired the interest of U S
WEST NewVector Group, Inc. in the northern portion of the market. As a result
of the transaction, the Company paid approximately $1,105,000 in cash, and net
Company pops increased 24,289.
In June 1996, the Company purchased an additional 40% interest in one
nonmanaged RSA market for 27,258 shares of the Company's Common Stock and
approximately $790,000 in cash.
In September 1996, the Company acquired 577,812 shares of convertible
preferred stock in TVX, Inc. for approximately $800,000. TVX develops and
markets products for the management of digital video and images, including
visual observation and verification products for the security industry. Prior
to this acquisition, the Company held 1,157,022 shares of Common Stock or 39%
voting interest in TVX, Inc. and 484,756 shares of redeemable convertible
preferred stock with a redemption value of $484,756. During fiscal 1997, the
Company wrote off its investment in TVX, Inc. recognizing an approximate
$3,288,000 reserve reflected in equity in net loss of affiliates, and as of
September 30, 1997, the Company carried its net investment in TVX, Inc. at $0.
1997
In January 1997, the Company purchased an additional 15% in one previously
nonmanaged RSA for approximately $876,000 in cash. The Company assumed
management of this market upon consummation of the transaction.
In April 1997, the Company sold a 10% interest in one of its managed MSA
markets to a partner in such market for approximately $436,000 in cash, pursuant
to an option granted at the time of the Company's purchase of such market. In
June 1997 the Company sold an additional 9% interest in this market to the same
partner for approximately $393,000 in cash.
Each of the above acquisitions was accounted for using the purchase method
of accounting. The applicable results of operations of the acquired interests
have been included in the Company's consolidated statements of operations from
the respective acquisition dates.
The following represents the pro forma results of operations as if the
above noted acquisitions and dispositions had occurred at the beginning of the
respective period in which the acquisition or disposition occurred, as well as
at the beginning of the immediately preceding period:
Years ended September 30,
------------------------------
1997 1996 1995
---- ---- ----
(Amounts in thousands, except per share data)
Revenues $150,867 $118,603 $94,948
Equity in net loss of affiliates (7,600) (1,933) (4,258)
Income (loss) before extraordinary
charge 918 (5,694) (399)
Net income (loss) 918 (5,694) (2,411)
Net income (loss) per common share .07 (.41) (.19)
II-31
COMMNET CELLULAR INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. Investment in and advances to affiliates
----------------------------------------
Investment in and advances to the Company's nonconsolidated affiliates
consisted of the following:
September 30,
-------------------
1997 1996
---- ----
(Amounts in thousands)
Investment $ 22,912 $ 17,620
Equity in loss cumulative (28,629) (20,935)
Advances and other 55,801 60,560
-------- --------
$ 50,084 $ 57,245
The combined financial position of the nonconsolidated affiliates is as
follows:
September 30,
-------------
1997 1996
---- ----
(Amounts in thousands)
Current assets $ 8,315 $ 8,938
Investment in affiliated limited partnerships 9,229 8,664
Property and equipment, net of accumulated depreciation 19,179 16,742
Other assets 3,582 4,356
------------ ------------
Total assets $ 40,305 $ 38,700
============ ============
Due to CommNet Cellular Inc. $ 14,833 $ 8,678
Due to Cellular, Inc. Financial Corporation 38,464 46,719
Other liabilities 6,577 9,351
Minority interests 842 692
Owners' deficit (20,461) (26,740)
------------ ------------
Total liabilities and owners' deficit $ 40,305 $ 38,700
============ ============
Combined operations of these nonconsolidated affiliates are summarized as
follows:
Years ended September 30,
-------------------------
1997 1996 1995
---- ---- ----
(Amounts in thousands)
Revenues $ 28,539 $ 21,826 $ 14,260
Operating costs (33,729) (29,262) (23,345)
Minority interests (486) (276) (4)
Equity in income (loss) of affiliates 2,445 3,811 (4)
------------ ------------ ------------
Net loss $ (3,231) $ (3,901) $ (9,093)
============ ============ ============
II-32
COMMNET CELLULAR INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. Investment in and advances to affiliates (continued)
----------------------------------------
Interest income from affiliates on advances was $5,833,000, $8,738,000 and
$11,247,000 for the years ended September 30, 1997, 1996 and 1995, respectively.
Certain advances to affiliates bear interest at the prime rate of Norwest
Bank (8.50% at September 30, 1997, 8.25% at September 30, 1996 and 8.75% at
September 30, 1995) plus 2%. These advances to and receivables from affiliates
are temporary in nature, and are generally refinanced under loan agreements with
CIFC. The CIFC loans generally bear interest at the 90-day LIBOR rate plus a
margin (determined based upon the affiliates leverage ratio) and will be repaid
from income derived from the operation of the cellular system or income derived
from the affiliates' interest in the licensee providing cellular service.
4. Secured bank financing and note payable
---------------------------------------
CIFC has a secured financing agreement with CoBank. The secured bank
financing is due January 15, 2001, with interest only payable quarterly or upon
the maturity of fixed interest rate loans through January 15, 1998, and
quarterly principal and interest payments payable thereafter through maturity.
Amounts outstanding under the agreement were $9,762,000 and $24,190,000, of
which $976,000 and $3,365,000 are classified as current, for the years ended
September 30, 1997 and 1996, respectively. Under the terms of the CoBank Credit
Agreement, CoBank has agreed to loan to CIFC a maximum of $165,000,000 to be
reloaned by CIFC to affiliates of the Company for the construction, operation
and expansion of cellular telephone systems, including $25,000,000 for the
acquisition of cellular systems. At September 30, 1997, interest was payable at
prime plus .25% or LIBOR (London InterBank Offered Rate) plus 1.75%. The
interest rate margin is determined based upon the maintenance of certain debt to
cash flow ratios. At October 1, 1996 the interest rate margin was 1.00% over
prime and 2.50% over LIBOR. On January 1, 1997 the interest rate margin was
reduced to .50% over prime and 2.00% over LIBOR and on May 16, 1997, the
interest rate margins were reduced to .25% and 1.75% over prime and LIBOR,
respectively. For the fiscal year ended September 30, 1996, interest was payable
at either the prime rate plus 1.00% for variable rate loans or the LIBOR rate
plus 2.50%. CIFC maintains fixed interest rates on all loans outstanding for
terms ranging from one to three months at an average rate of 7.41% at September
30, 1997. The loans are secured by a first lien on all assets of CIFC, as well
as all assets of each of the affiliates to which loans are made by CIFC. CIFC's
assets totaled approximately $252,451,000 and $276,044,000 at September 30, 1997
and 1996, respectively. In addition, the Company has guaranteed the obligations
of CIFC to CoBank and has granted CoBank a first security interest in all of the
assets of the Company as security for such guaranty. A commitment fee of .5% per
annum is payable by CIFC to CoBank on the average daily unborrowed commitment.
The CoBank Credit Agreement prohibits the payment of cash dividends,
prohibits any other senior borrowings, limits the use of borrowings, restricts
expenditures for certain acquisitions and investments, requires positive working
capital and financed proportionate operating cash flow and requires the
maintenance of certain liquidity, capitalization, debt, debt service and cash
interest ratios. The requirements of the CoBank Credit Agreement were
established in relation to the anticipated capital and financing needs of the
Company's affiliates and their anticipated results of operations. The Company is
currently in compliance with all covenants and anticipates it will continue to
meet the requirements of the CoBank Credit Agreement. CoBank acts as agent for a
syndicate of lenders whose approval may be required for waivers or other
amendments to the CoBank Credit Agreement requested by CIFC or the Company.
One consolidated affiliate of the Company has entered into a financing
arrangement with CoreStates Bank, N.A. to refinance prior indebtedness, finance
working capital and capital expenditures and fund distributions to its partners.
The affiliate may borrow up to $3,500,000 through September 30, 1999 at which
time the loan becomes a reducing revolving loan through September 30, 2001. At
September 30, 1997, the affiliate had borrowed $2,916,000 at an interest rate of
7.56%.
II-33
COMMNET CELLULAR INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. Secured bank financing and note payable (continued)
---------------------------------------
Aggregate maturities of the secured bank financing and note payable for
each of the next five years ending September 30 are as follows: 1998 -
$976,000; 1999 - $2,440,000; 2000 - $4,421,000; 2001 - $3,541,000; 2002 -
$1,300,000.
As of September 18, 1997, CIFC and the Company entered into a new senior
bank credit facility with The Chase Manhattan Bank as administrative agent and
collateral agent, Chase Manhattan Bank Delaware, as fronting bank, and the other
lenders named therein (the "Chase Credit Agreement"). Funding under the Chase
Credit Agreement will be used to pay off the CoBank Credit Agreement, to tender
for the Company's 11 3/4% Senior Subordinated Notes and 11 1/4% Subordinated
Notes, and to fund costs associated with the Merger Agreement and will not occur
unless and until the Merger is consummated. Advances made under the Chase
Credit Agreement will be used, when necessary, to fund loans made by CIFC to the
affiliates.
The Chase Credit Agreement provides for aggregate credit commitments of up
to $760 million. All obligations of CIFC and the guarantors under the Chase
Credit Agreement and the guarantees will be secured by first priority security
interests in substantially all tangible and intangible assets, trademarks,
tradenames and equipment of CIFC and the guarantors. In addition, the Chase
Credit Agreement will be secured by a first priority security interest in
substantially all of the assets held by the Company and certain of its wholly-
owned subsidiaries, to the extent the Company and such subsidiaries have the
legal ability to pledge such assets. The Chase Credit Agreement includes
limitations on dividends and distributions on capital stock and other
significant operating and financial restrictions and covenants, including limits
on the ability of the Company and its subsidiaries to incur or prepay
indebtedness, create liens, enter into leases or transactions with affiliates,
sell assets, engage in mergers or acquisitions, make investments, and redeem or
repurchase capital stock or debt.
5. Senior and subordinated debt
----------------------------
In August 1989, the Company completed a public offering of $74,750,000
aggregate principal amount of 6 3/4% Convertible Subordinated Debentures due
2009. The debentures were convertible at any time prior to maturity, unless
previously redeemed or repurchased, into Common Stock of the Company at a
conversion price of $27 5/8 per share, subject to adjustment under certain
conditions. During the first fiscal quarter of 1995, $3,000 of the debentures
were converted into 108 shares of the Company's Common Stock. In July 1995, the
Company called all outstanding 6 3/4% debentures for redemption. As a result,
$32,895,000 of the debentures were converted into 1,190,673 shares of the
Company's Common Stock, and $41,852,000 were redeemed for cash. The Company
redeemed the debentures at a price of 102.7% resulting in a premium of
$1,130,004. In addition, the Company wrote off $882,253 in offering costs
previously capitalized. As a result of the redemption, the Company recognized an
extraordinary charge related to early extinguishment of long-term debt of
$2,012,257 in the Company's 1995 statement of operations. The Company also
charged $758,228 of offering costs against capital in excess of par value as a
result of the conversion.
In January 1993, the Company completed a private placement of $4,950,000 of
8.75% Convertible Senior Subordinated Notes Due 2001. The notes were general
unsecured obligations of the Company, were subordinate in right of payment to
all Senior Debt of the Company, and were convertible into shares of the
Company's Common Stock at the price of $15.00 per share. In September 1995,
$1,950,000 of the notes were converted into 130,004 shares of the Company's
Common Stock. On December 7, 1995, the Company notified the remaining
noteholders of its intent to call for redemption the balance of the notes
outstanding. In January 1996, the remaining $3,000,000 in notes were converted
into 200,000 shares of the Company's Common Stock. Loss per share would not
have been materially effected had this conversion occurred at the beginning of
the year.
II-34
COMMNET CELLULAR INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. Senior and subordinated debt (continued)
----------------------------
In September 1993, the Company completed an offering of $176,651,000
aggregate principal amount of 11 3/4% Senior Subordinated Discount Notes Due
2003. The notes were issued at a substantial discount from their principal
amount resulting in gross proceeds to the Company of approximately $100,000,000.
After deducting offering costs, net proceeds were $96,740,000. The notes are
general unsecured obligations of the Company and are subordinate in right of
payment to all Senior Debt of the Company. From September 1993 through August
1998 interest will accrete into the principal balance. Commencing September 1,
1998, interest will accrue until maturity on the notes at the rate of 11 3/4%
per annum. Interest on the discount notes is payable semi-annually on March 1
and September 1, commencing March 1, 1999. The discount notes mature on
September 1, 2003 and are redeemable commencing September 1, 1998, in whole at
any time or in part from time to time, at the option of the Company at the
redemption prices (together with accrued interest) of 105.87% if redeemed in
1998 decreasing to 101.46% of the principal amount in 2001. The discount note
holders may require the Company to repurchase the discount notes, in whole or in
part, in certain instances constituting a change of control of the Company.
In July 1995, the Company completed an offering of $80,000,000 in aggregate
principal amount of 11 1/4% Subordinated Notes due 2005. The notes are
subordinate to all existing and future Senior Debt of the Company. Interest on
the notes accrues from the original date of issuance at the rate of 11 1/4% per
annum. Interest is payable in cash semi-annually on each January 1 and July 1.
The notes mature on July 1, 2005 and are redeemable in whole or in part from
time to time, at the option of the Company, at any time on or after July 1, 2000
at the redemption prices of 106% if redeemed in 2000 decreasing to 101.5% of the
principal amount in 2003. The note holders may require the Company to
repurchase the notes, in whole or in part, in certain instances constituting a
change of control of the Company at a price equal to 101% of the principal
amount.
All outstanding senior and subordinated debt is to be tendered in
connection with the Merger (see Note 12).
6. Commitments and contingencies
-----------------------------
The Company leases office space and equipment under agreements which
provide for rental payments based on lapse of time. Certain of these lease
agreements contain renewal option clauses. Rent expense was $5,266,000,
$3,798,000 and $2,410,000 for the years ended September 30, 1997, 1996 and 1995,
respectively.
The aggregate annual rental commitment as of September 30, 1997 is as
follows (amounts in thousands):
1998 $ 3,735
1999 3,058
2000 2,724
2001 2,430
2002 2,223
Future years 5,461
-------
$19,631
=======
On May 15, 1989, the Company adopted a retirement savings plan (pursuant to
Section 401(k) under the Internal Revenue Code) providing for a deferred
compensation and Company matching provision. Under the plan, all full-time
employees are permitted to contribute up to 15% of gross compensation, subject
to certain limitations into the retirement plan and the Company will match at
the minimum 25% of each employee's contribution up to 6% (3% prior to January 1,
1997) of the employee's eligible compensation.
II-35
COMMNET CELLULAR INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. Commitments and contingencies (continued)
-----------------------------
On January 31, 1996, the Company entered into two Option to Sell Agreements
as part of the New Mexico 1 RSA transaction pursuant to which the minority
owners in that market can require the Company to purchase their interests at a
price based upon a multiple of EBITDA. If the transaction occurs after January
1, 2001, the minimum purchase price will be $10,000,000, plus any capital
contributed by the minority owners subsequent to October 1, 1995.
On May 29, 1997 (the day after the proposed Merger was publicly announced),
the Company and each of its five directors (two of whom are executive officers
of the Company) were named as defendants in a complaint filed in the Colorado
District Court, County of Arapahoe, by Brickell Partners, an entity claiming to
be a shareholder of the Company, individually and purportedly as a class action
on behalf of shareholders of the Company. In general, the complaint alleges
that the Company's directors have breached their fiduciary duties by, among
other things, resolving to approve the Merger at an allegedly inadequate price
and by allegedly failing to take all reasonable steps to insure maximization of
shareholder value. The complaint seeks injunctive relief prohibiting the
Company from, among other things, consummating the Merger. The complaint also
seeks unspecified damages, attorneys' fees and other relief.
The Company believes that the allegations contained in the complaint are
without merit and intends to contest the action vigorously, on behalf of itself
and its directors, if the plaintiff elects to proceed with its action.
On July 8, 1997, Dakota Systems, Inc., the minority general partner in the
Sioux Falls Cellular Limited Partnership ("Sioux Falls"), and Splitrock Telecom
Cooperative, Inc., Union Telephone Company, Sioux Valley Telephone Company and
Baltic Cooperative Telephone Company, the limited partners in Sioux Falls
(collectively, the minority general partner and the limited partners are
referred to herein as "plaintiffs"), filed a lawsuit in the Circuit Court,
County of Minnehaha, State of South Dakota, against CINC, the Company, and Sioux
Falls. CINC is the general partner of Sioux Falls and a wholly-owned subsidiary
of the Company. The lawsuit alleges, among other things, that the Merger
triggers plaintiffs' alleged right of first refusal to purchase CINC's interest
in Sioux Falls under the Certificate and Agreement Establishing Sioux Falls
Limited Partnership. The lawsuit seeks, among other things, a declaratory
judgment concerning the terms of plaintiffs' alleged right of first refusal to
purchase CINC's interest in Sioux Falls, a temporary and permanent injunction
prohibiting the Merger until plaintiffs' rights are clarified, and damages. The
lawsuit also seeks to enjoin a proposed sale of a telecommunications switch by
Sioux Falls to the Company and to void certain amendments to the switch user
agreements. The Company intends to defend the lawsuit vigorously if the
plaintiffs elect to proceed with the litigation.
On October 22, 1997, The Rye Telephone Company ("Rye"), a shareholder in
Pueblo Cellular, Inc. ("Pueblo") filed an action in the District Court, Pueblo
County, State of Colorado, against the Company. The lawsuit alleges intentional
interference with contract, breach of contract and breach of covenant of good
faith in connection with a proposed sale of shares in Pueblo by Rye and Pine
Drive Telephone Company ("Pine Drive") and a related lawsuit filed by the
Company against Pine Drive in Arapahoe County court. The lawsuit against the
Company seeks, among other things, general and special damages of not less than
$5,493,840, exemplary damages, fees and costs. The Company has filed a motion to
stay the Pueblo lawsuit until adjudication of the Arapahoe County lawsuit. In
December 1997, the court denied the motion to stay. The Company intends to
defend the lawsuit vigorously.
II-36
COMMNET CELLULAR INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. Income taxes
------------
At September 30, 1997, the Company had cumulative NOL carryforwards of
$45,165,000 for income tax purposes and tax credit carryforwards of $993,000.
If not offset against taxable income, the tax loss carryforwards will expire
between 2001 and 2012 and the tax credit carryforwards, if not offset against
regular taxes, will expire between 2008 and 2012. There was no income tax
provision for the year ended September 30, 1997 as a result of the utilization
of $5,643,000 of the Company's NOL carryforwards.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. As of September 30, 1997
and 1996, the Company's net deferred tax asset has been fully reserved with a
valuation allowance. Significant components of the Company's deferred tax
assets and liabilities are as follows:
September 30,
------------------------
1997 1996
---- ----
(Amounts in thousands)
Deferred tax assets:
Net operating loss carryforwards $ 17,163 $ 19,307
Tax credit carryforwards 993 302
Equity method investments - 1,576
Intangible asset differences 7,684 8,182
Inventory adjustments 491 508
Accrued liabilities 270 298
Interest expense on 11 3/4% discount notes 22,471 15,946
Other, net 349 303
Other capitalized costs, net 2,700 1,709
-------- --------
Total deferred tax assets 52,121 48,131
-------- --------
Deferred tax liabilities:
Difference in license costs 21,928 32,455
Equity method investments 1,912 -
Fixed asset differences 5,619 4,720
-------- --------
Total deferred tax liabilities 29,459 37,175
-------- --------
Net deferred tax asset 22,662 10,956
Valuation allowance (22,662) (10,956)
-------- --------
Net deferred taxes $ - $ -
======== ========
II-37
COMMNET CELLULAR INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. Income taxes (continued)
------------
The following table reconciles the amount which would be provided by
applying the 35% federal statutory rate to income before income tax expense to
the federal income taxes actually provided:
Years ended September 30,
-------------------------
1997 1996 1995
---- ---- ----
(Amounts in thousands)
Income tax at federal statutory rate of 35% $ 361 $(1,539) $ 866
Benefit of tax losses not recognized - 1,539 -
Benefit due to utilization of regular tax
NOL carryforwards (361) - (866)
Alternative Minimum Tax (AMT) arising
from the inability to fully utilize
AMT NOL carryforwards - - 400
----- ------- -----
Total income tax expense $ $ - $ 400
===== ======= =====
8. Common Stock options
--------------------
The Company adopted an Omnibus Stock and Incentive Plan, effective November
1, 1991, pursuant to which 500,000 shares of the Company's Common Stock were
reserved for issuance pursuant to Options, Stock Appreciation Rights, Stock
Bonuses or Phantom Stock Rights. In February 1993, the Company's shareholders
approved an additional 500,000 shares of the Company's Common Stock to be
reserved for issuance pursuant to the Omnibus Stock and Incentive Plan plus 1%
of the number of shares outstanding at the end of each fiscal year commencing
October 1, 1993. In February 1995, the Company's shareholders approved an
additional 750,000 shares of the Company's Common Stock to be reserved for
issuance under this plan.
II-38
COMMNET CELLULAR INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. Common Stock options (continued)
--------------------
An analysis of options related to the Company's benefit plans is as
follows:
Omnibus Stock Weighted Average
and Exercise Exercise
Incentive Plan Price Range Price Range
-------------- ----------- ----------------
Outstanding options at
September 30, 1995 1,209,625 $ 11.75 - $25.63
Granted 529,000 $ 25.56
Forfeitures (100,500)
Exercised (36,750) $ 13.00 - $25.63
---------
Outstanding options at
September 30, 1996 1,601,375 $ 11.75 - $25.63
Granted 295,250 $ 29.375 $29.375
Forfeitures (8,875)
Exercised (10,750) $ 13.00 - $25.63 $24.27
---------
Outstanding options at
September 30, 1997 1,877,000 $11.75 - $29.375 $23.71
=========
Options available for grant
at September 30, 1997 420,206
=========
Options exercisable at
September 30, 1997 1,877,000
=========
Options issued under this plan vest ratably over a four-year period from
the date of grant.
In addition to the plans described above, in July 1993, the Company granted
options to purchase 152,500 shares of Common Stock to two former officers at
exercise prices ranging from $7.00 - $15.75. As a result, the Company
recognized compensation expense of approximately $370,000. The options became
exercisable at various intervals through November 1995 and, as of September 30,
1996, all of these options had been exercised. In September 1995, the Company
granted options to purchase 60,000 shares of Common Stock to a former officer at
an exercise price of $30.375. These options are exercisable over a period of
four years from the date of grant. In June 1996, options to purchase 30,000 of
these shares were canceled. No such options were exercised.
On October 1, 1996, the Company granted options to purchase 900 shares of
Common Stock to three key agents, under the Key Agent Stock Option Plan, at a
price of $28.875. No options have been exercised.
Upon shareholder approval of the Merger (see Note 12) on September 25,
1997, all outstanding options became fully exercisable.
II-39
COMMNET CELLULAR INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. Common Stock options (continued)
--------------------
As of September 30, 1997, 2,427,000 shares of the Company's Common Stock
were reserved for issuance pursuant to these plans.
Stock-based compensation
In October 1995, the FASB issued Statement No. 123, Accounting and
--------------
Disclosure of Stock-Based Compensation. Statement No. 123 is applicable to
- --------------------------------------
fiscal years beginning after December 15, 1995 and gives the issuer the option
to either follow fair value accounting or to follow Accounting Principles Board
Opinion No. 25 Accounting for Stock Issued to Employees ("APB No. 25") and
----------------------------------------
related interpretations. The Company complied with the disclosure rules of
Statement No. 123 for fiscal year 1997, and has elected to continue to follow
APB No. 25 and related interpretations in accounting for its employee stock
options because, as discussed below, the alternative fair value accounting
provided for under FASB Statement No. 123, requires use of option valuation
models that were not developed for use in valuing employee stock options. Under
APB 25, because the exercise price of the Company's employee stock options
equals the market price of the underlying stock on the date of grant, no
compensation expense is recognized.
Pro forma information regarding net loss and loss per share is required by
Statement No. 123, and has been determined as if the Company had accounted for
its employees stock options under the fair value method of that Statement. The
fair value for these options was estimated at the date of grant using a Black-
Scholes option pricing model with the following weighted-average assumptions for
1997 and 1996, respectively: risk-free interest rates of 6.10% and 5.85%;
dividend yields of 0%; volatility factors of the expected market price of the
Company's Common Stock of .359 and .387; and a weighted-average expected life of
the option of eight years.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
pro forma information follows (in thousands except for loss per share
information):
1997 1996
---- ----
Pro forma net loss $(9,798) $(5,607)
Pro forma loss per share $ (.71) $ (.41)
II-40
COMMNET CELLULAR INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. Employee stock ownership plan
-----------------------------
On October 1, 1988, the Company adopted an Employee Stock Ownership Plan
("ESOP"). The cost of the ESOP is borne by the Company through annual
contributions to a Trustee in amounts determined by the Board of Directors.
Employees are eligible to participate in the ESOP after one year of service.
Shares of Common Stock acquired by the ESOP are to be allocated to each employee
and held until the employee's retirement or death. The employee can also choose
early withdrawal under certain circumstances. Each employee's account vests
ratably over a period of five years. Contributions totaling approximately
$598,000 (16,721 shares), $707,000 (24,487 shares) and $552,000 (19,021
shares) were made to the ESOP for the years ended September 30, 1997, 1996, and
1995, respectively. Shares are deemed issued for accounting purposes in the
year that ESOP contribution expense is recognized.
10. Stockholders' equity
--------------------
In December 1990, the Board of Directors declared a dividend distribution
of one right (a "Right") attached to each outstanding share of the Company's
Common Stock at any point in time. Each Right, when exercisable, entitles the
registered holder to purchase from the Company one one-hundredth of a share of
Series A Preferred Stock, at a price of $45 per one one-hundredth of a share,
subject to adjustment (the "Purchase Price").
The Rights will detach from the Common Stock and a "Distribution Date" will
occur upon the earliest of (i) ten days following a public announcement that a
person or group has acquired, or obtained the right to acquire, beneficial
ownership of 25% or more of the outstanding shares of the Company's Common Stock
(the "Stock Acquisition Date"), (ii) ten business days following commencement of
a tender offer or exchange offer that would result in a person or group
beneficially owning 30% or more of the Company's Common Stock, or (iii) ten
business days after the Board of Directors have made a determination that
someone has become the beneficial owner of a substantial amount of the Company's
Common Stock and that such ownership is adverse to the Company's interest.
Should these events occur, each holder of a Right will thereafter have the right
to receive, upon exercise, the Company's Common Stock (or, in certain
circumstances, cash, property or other securities of the Company) having a value
equal to two times the Purchase Price. Similarly, in the event that at any time
following a Stock Acquisition Date, the Company is acquired in a merger or other
business combination transaction in which the Company is not the surviving
corporation or 50% or more of its assets, cash flow or earning power is sold or
transferred, each holder of a Right shall thereafter have the right to receive,
upon exercise, Common Stock of the acquiring entity having a value equal to two
times the Purchase Price. Under certain circumstances, any Rights that are
owned by the acquiring person or the adverse person will be null and void.
In general, the Company may redeem the Rights in whole, but not in part, at
a price of $.01 per Right, at any time until ten days following the acquisition
by a person or group of 25% or more of the Company's outstanding Common Stock or
the declaration by the Board of Directors that a person is an adverse person.
The Rights will expire on December 24, 2000, unless earlier redeemed.
In August 1996, the Company announced a program to repurchase, from time to
time, up to $20,000,000 of its outstanding Common Stock using available
liquidity to fund the repurchases. At September 30, 1997, the Company had
repurchased 149,500 shares at prices ranging from $27.75 to $29.125 per share
for an aggregate price of $4,310,938. The program was discontinued during
fiscal 1997.
II-41
COMMNET CELLULAR INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. Fair values of financial instruments
------------------------------------
FAS Statement No. 107, Disclosures about Fair Value of Financial
-----------------------------------------
Instruments, requires disclosure of fair value information about financial
- -----------
instruments for which it is practicable to estimate that value, whether or not
recognized in the balance sheet. In cases where quoted market prices are not
available, fair values are based on estimates using present value or other
valuation techniques. Statement No. 107 excludes certain financial instruments
and all nonfinancial instruments from its disclosure requirements. Accordingly,
the aggregate fair value amounts do not represent the underlying value of the
Company.
The following methods and assumptions were used by the Company in
estimating its fair value disclosures for financial instruments:
Advances to affiliates: The carrying amounts of the Company's advances to
----------------------
and receivables from affiliates approximate their fair value.
Long and short-term debt: The carrying amounts of the secured bank
------------------------
financing and note payable borrowings approximate their fair value as all
borrowings either carry a variable interest rate or fixed interest rates having
a term of three months or less. Other long-term debt is valued based on quoted
market prices.
The carrying amounts and fair values of the Company's financial instruments
at September 30, 1997 are as follows:
Carrying Amount Fair Value
--------------- ----------
(Amounts in thousands)
Cash and cash equivalents $ 14,132 $ 14,132
Advances to affiliates and other 55,801 55,801
Notes payable 2,916 2,916
Secured bank financing 9,921 9,921
11 1/4% subordinated notes 80,000 91,800
11 3/4% senior subordinated discount notes 159,133 173,780
II-42
COMMNET CELLULAR INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. The Merger
----------
On May 27, 1997, the Company and AV Acquisition Corp. ("Newco"), which as
of the date hereof is a wholly-owned subsidiary of Blackstone CCI Capital
Partners L.P., a Delaware limited partnership (the "Partnership") affiliated
with Blackstone Management Associates II L.L.C., a Delaware limited liability
company "Blackstone"), entered into an Agreement and Plan of Merger (the "Merger
Agreement") pursuant to which Newco will merge with and into the Company, with
the Company being the surviving corporation in the Merger. Upon consummation of
the Merger, each share of Common Stock issued and outstanding immediately prior
to the effective time of the Merger (the "Effective Time") (other than those
shares described below) will be converted, at the election of the holder thereof
and subject to the terms of the Merger Agreement, into either (a) the right to
receive $36.00 in cash or (b) the right to retain one fully paid and
nonassessable share of Common Stock, including the associated right. The
following shares of Common Stock are not subject to conversion pursuant to the
Merger: shares of Common Stock held by the Partnership, partnerships affiliated
with Blackstone expected to acquire interests in Newco prior to the consummation
of the Merger (any such partnerships, together with the Partnership, hereinafter
referred to as the "Partnerships"), Newco, any wholly-owned subsidiary of the
Company or any wholly-owned subsidiary of Newco, which will be canceled and
retired; fractional shares which will be converted to cash; and shares of Common
Stock in respect of which dissenters' rights have been properly exercised. The
rights associated with the shares of Common Stock that are converted into the
right to receive $36.00 in cash will be extinguished in the Merger for no
additional consideration. The election to retain Common Stock is subject to
proration so that, following the Merger, 588,611 shares (representing
approximately 4% of the presently issued and outstanding Common Stock) will be
retained by existing shareholders of the Company, representing approximately 13%
of the shares of the Company to be issued and outstanding immediately after the
Merger. The shares of Common Stock to be owned by the shareholders of Newco as
a result of the Merger will represent approximately 87% of the shares of the
Company issued and outstanding immediately after the Merger, resulting in such
shareholders of Newco becoming the controlling shareholders of the Company.
The obligations of the Company and Newco to consummate the Merger are
subject to various conditions, including, without limitation, obtaining
requisite approval of the Company's shareholders, obtaining the requisite
approval of relevant government authorities, including the FCC, and the absence
of any injunction or other legal restraint or prohibition preventing the
consummation of the Merger. On September 25, 1997, the Company's shareholders
voted in favor of the Merger. Newco's obligations to effect the Merger are
further subject, among other things, to (i) the Company amending the terms of
the Discount Notes and the Subordinated Notes and purchasing such Securities in
accordance with the provisions of the Merger Agreement, (ii) CIFC repaying all
amounts outstanding under the CoBank Credit Agreement, (iii) the Company or CIFC
receiving financing proceeds on terms and conditions set forth in the Commitment
Letter or upon terms and conditions which are substantially equivalent thereto
and, to the extent that any of the terms and conditions are not contemplated
by the Commitment Letter, on terms and conditions reasonably satisfactory to
Newco, (iv) the absence of certain litigation, (v) since May 27, 1997, no
material adverse change relating to the Company having occurred and being
continuing, (vi) all regulatory approvals, as described in the Merger Agreement,
having been obtained, having been declared or filed or having occurred, as the
case may be, and all such required regulatory approvals being in full force and
effect and (vii) Newco having been reasonably satisfied that the Merger will be
recorded as a recapitalization for financial reporting purposes.
II-43
COMMNET CELLULAR INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
13. Quarterly Financial Data (unaudited)
-----------------------------------
Quarterly financial data and per share data are presented below (amounts in
thousands, except for per share data):
First Second Third Fourth
Quarterly Financial Data Quarter Quarter Quarter Quarter
------------------------ ------- ------- ------- -------
1997
Revenues $34,496 $31,734 $38,118 $46,519
Operating income 5,194 4,403 8,257 16,313
Net income (loss) (1,375) (2,913) (627) 5,947
Net income (loss) per share $ (0.10) $ (0.21) $ (0.05) $ 0.43
----------------------------------------------------------------------------
1996
Revenues $25,071 $23,590 $29,765 $36,770
Operating income (loss) 1,536 (41) 4,320 10,538
Net income (loss) (3,354) (4,734) (968) 4,660
Net income (loss) per share $ (0.25) $ (0.35) $ (0.07) $ 0.34
II-44
PART III
Item 10. Directors and Executive Officers of the Registrant.
The following table sets forth certain information regarding the
executive officers and directors of the Company:
Name Age Position
- ---- --- --------
Arnold C. Pohs 69 Chairman of the Board, President, Chief Executive Officer and
Director
Daniel P. Dwyer(1) 38 Executive Vice President, Treasurer, Chief Financial Officer and
Director
Andrew J. Gardner 43 Senior Vice President and Controller
Homer Hoe 48 Executive Vice President and Chief Information Officer
David S. Lynn 40 Senior Vice President - Network Operations
Timothy C. Morrisey 44 Executive Vice President - Sales Operations
Amy M. Shapiro 44 Senior Vice President, Secretary and General Counsel
John E. Hayes, Jr.(1)(2) 60 Director
Robert J. Paden (2) 42 Director
David E. Simmons (1)(2) 40 Director
__________
(1) Member Audit Committee.
(2) Member Compensation Committee.
The Company's Articles of Incorporation provide for a classified Board
of Directors consisting of three classes, each class to be as nearly equal in
number as possible. The members of each class are elected to a three-year term
and one class is elected at each annual meeting. Messrs. Pohs and Paden are
members of Class I with terms expiring at the 1997 Annual Meeting; Mr. Simmons
is a member of Class II with a term expiring at the 1998 Annual Meeting; and
Messrs. Dwyer and Hayes are members of Class III with terms expiring at the 1999
Annual Meeting of Stockholders.
Arnold C. Pohs has been Chairman of the Board of the Company since
February 1991, President and Chief Executive Officer since August 1989 and a
director since September 1985. Mr. Pohs served as Executive Vice President of
the Company from January 1986 through August 1989. Mr. Pohs was designated Chief
Operating Officer of the Company in August 1987, prior to which time he was the
Chief Financial Officer of the Company. Mr. Pohs currently serves as Chairman
and a member of the Executive Committee of the Board of Directors of the
Cellular Telecommunications Industry Association. He is a director, and former
Chairman, of the CTIA Foundation for Wireless Telecommunications and is also a
member of the CEO Council. He also serves as Chairman of the Board of TVX, Inc.
III-1
Daniel P. Dwyer has been Executive Vice President of the Company since
November 1992, a director of the Company since March 1990, and Chief Financial
Officer since August 1988 and Treasurer since August 1987. He was Vice
President -Finance of the Company from November 1989 until November 1992,
Secretary from August 1987 until March 1990, Assistant Secretary from January
1987 until August 1987, Controller from May 1986 until November 1988 and
accounting manager for the Company from March 1986 until May 1986. He is a
Certified Public Accountant and a member of the American Institute of Certified
Public Accountants and the Colorado Society of Certified Public Accountants. Mr.
Dwyer currently serves as a director of TVX, Inc.
Andrew J. Gardner was named Senior Vice President of the Company in
July 1994. He was Vice President and Controller from November 1992 to July 1994
and Assistant Vice President - Accounting and Tax from July 1990 to October
1992.
Homer Hoe was elected Executive Vice President and Chief Information
Officer of the Company in October 1994. From August 1992 until joining the
Company in October 1994, he was a self-employed consultant to the Information
Services industry, and was contracted by the Company as interim CIO from April
to October 1994. From August 1991 to August 1992, Mr. Hoe was Director of
Information Services for Tenneco Minerals, a subsidiary of Tenneco, Inc. From
May 1986 to August 1991, he was employed by Digital Equipment Corporation, most
recently as Senior Consultant, specializing in multi-vendor computer system
integration.
David S. Lynn was named Senior Vice President-Network Operations of the
Company in July 1994. He was Vice President-Network Operations from March 1993
until July 1994, Vice President-Network Development from February 1992 until
March 1993, Assistant Vice President-Finance from June 1990 until February 1992,
Controller from November 1988 until June 1990 and Manager, Financial Reporting
from August 1988 until November 1988.
Timothy C. Morrisey was named Executive Vice President - Sales
Operations of the Company in November 1996. He was Senior Vice President-Sales
Operations from February 1995 until November 1996 and General Sales Manager of
the Company's Midwest Region from July 1993 until February 1995. From February
1990 until joining the Company in July 1993, Mr. Morrisey was President and
General Manager of the Washington D.C. and Baltimore cellular operations for
Southwestern Bell Mobile Systems.
Amy M. Shapiro was named Senior Vice President of the Company in
November 1995. She was Vice President of the Company from November 1992 to
November 1995 and has been Secretary of the Company since March 1990 and General
Counsel since October 1989.
John E. Hayes, Jr. was elected a director of the Company in October
1990. Mr. Hayes has served as Chairman of the Board, President and Chief
Executive Officer of Western Resources, Inc. since October 1989. From May 1989
to October 1989, Mr. Hayes was Chairman of the Board of Triad Capital Partners,
a venture capital firm. Mr. Hayes was President and Chief Executive Officer of
Southwestern Bell Telephone Company from September 1986 to January 1989. Mr.
Hayes is a director of the Automobile Club of Missouri, Boatmen's Bancshares,
Inc., American Gas Association, Edison Electric Institute, Security Benefit
Group, the Topeka Community Foundation, Boys Hope, Kansas Wildscape and Boy
Scouts of America and a Trustee of Midwest Research Institute, Menninger
Foundation and Rockhurst College.
Robert J. Paden has been a director of the Company since December 1985.
For the past 13 years, Mr. Paden has been General Manager/Vice President of the
Stanton Telephone Company, Stanton, Nebraska. He is also a board member of the
Nebraska Telephone Association.
David E. Simmons has been a director of the Company since August 1987.
Mr. Simmons has served as President of Simmons Family Incorporated, a
broadcasting and communications company, since 1989 and as its Executive Vice
President from 1985 to 1989.
The Merger Agreement provides that the directors of Newco at the
Effective Time will be the directors of the Company following the Merger and
that the officers of the Company following the Merger will be those
III-2
persons designated by AV Acquisition Corp. prior to the Effective Time, until
the earlier of their resignation or removal or otherwise ceasing to be an
officer or director or until their respective successors are duly elected and
qualified, as the case may be. The present directors of AV Acquisition Corp. are
Mark T. Gallogly, Lawrence H. Guffey and Simon P. Lonergan. It is expected that
Messrs. Pohs and Dwyer and two additional individuals will also be directors of
the Company at the Effective Time. After the Effective Time, the Board of
Directors will be subject to change from time to time. The following table sets
forth certain information regarding the directors of AV Acquisition Corp. who
are expected to serve as directors of the Company after the Effective Time.
Name Age Position
- ---- --- --------
Mark T. Gallogly 40 Director
Lawrence H. Guffey 29 Director
Simon P. Lonergan 29 Director
Mark T. Gallogly is a Senior Managing Director of The Blackstone Group
L.P., with which he has been associated since 1989. Mr. Gallogly is a member of
the board of directors of TW Fanch-One Co. and Great Lakes Dredge & Dock
Corporation.
Lawrence H. Guffey is a Vice President of The Blackstone Group L.P.,
with which he has been associated since 1991. Mr. Guffey is a member of the
board of directors of TW Fanch-One Co.
Simon P. Lonergan is an Associate of The Blackstone Group L.P., with
which he ahs been associated since 1996. Prior thereto, Mr. Lonergan was an
Associate at Bain Capital, Inc. and a Consultant at Bain and Co.
Item 11. Executive Compensation.
III-3
SUMMARY COMPENSATION TABLE
The following table sets forth the compensation received by the named
Executive Officers for each of the three years ended September 30, 1997.
Long-Term
---------
Annual Compensation Compensation
------------------- ------------
Name and Principal Position Year Salary($) Bonus($) All Others Options(#) All Others
- --------------------------- ---- --------- -------- ---------- ---------- ----------
($)(1) ($)(2)
------ ------
Arnold C. Pohs . . . . . . . . . 1997 400,000 234,944 10,778 -- 9,750
Chairman of the Board, 1996 350,000 149,306 11,473 100,000 10,125
President and Chief Executive 1995 300,000 126,455 10,861 200,000 8,625
Officer
Daniel P. Dwyer . . . . . . . . . 1997 300,000 140,966 4,242 -- 9,750
Executive Vice President, 1996 250,000 83,598 2,880 50,000 10,125
Treasurer and Chief Financial 1995 200,000 66,203 3,734 100,000 8,625
Officer
Homer Hoe . . . . . . . . . . . . 1997 210,000 96,156 2,061 -- 9,750
Executive Vice President and 1996 200,000 63,878 2,259 20,000 8,112
Chief Information Officer 1995 170,000 55,253 2,206 35,000 975
Timothy C. Morrisey . . . . . . . 1997 158,000 72,978 11,463 -- 9,750
Executive Vice President - 1996 132,000 36,753 -- 20,000 10,125
Sales Operations 1995 115,000 23,820 -- 20,000 8,625
David S. Lynn . . . . . . . . . . 1997 148,000 51,950 -- -- 9,650
Senior Vice President - 1996 132,000 35,103 -- 20,000 10,125
Network Operations 1995 120,000 33,095 -- 20,000 8,625
__________
(1) The amounts shown represent premiums paid on supplemental health benefits
for certain named executives.
(2) The amounts shown represent contributions by the Company to defined
contribution plans.
67
Change in Control Agreements
- ----------------------------
In July 1993, the Board of Directors approved change in control
agreements with Messrs. Pohs and Dwyer. In October 1994, the Board authorized a
comparable agreement with Mr. Hoe, the Company's Chief Information Officer. In
November 1995, the Board authorized comparable agreements with Messrs. Gardner,
Lynn and Morrisey, the Company's Senior Vice President and Controller, Senior
Vice President - Network Operations, and Executive Vice President - Sales
Operations, respectively, and Ms. Shapiro, the Company's Senior Vice President
and General Counsel. The purpose of these agreements is to reinforce and
encourage the officers to maintain objectivity and a high level of attention to
their duties without distraction from the possibility of a change in control of
the Company. These agreements provide that in the event of a change in control
of the Company, as that term is defined in the agreements, each officer is
entitled to receive certain severance benefits upon the subsequent termination
or constructive termination of employment, unless such termination is due to
death, disability or voluntary retirement; unless the termination is by the
Company for cause (as defined in the agreements) or is by the officer for other
than good reason (as defined in the agreements).
The severance benefits include the payment of the officer's full base
salary through the date of termination. The severance benefits also include a
lump sum payment equal to 2.99 times the sum of (a) the officer's annual base
salary in effect immediately prior to the circumstances giving rise to
termination, and (b) the actual bonus earned by the officer in the year prior to
the year in which termination occurs. In addition, each officer will be provided
with life and health benefits and a continuation of all other employee benefits
for 12 months following the date of termination. In addition, the officers will
be fully vested in all benefit plans to the extent not otherwise entitled to
100% of all contributions made by the Company on their behalf.
On March 30, 1997, CommNet and Mr. Pohs entered into a Retirement and
Consulting Agreement (the "Consulting Agreement") pursuant to which Mr. Pohs
will receive the following upon his retirement from the Company: (i) a payment
equal in amount to the additional employment contributions and matching
contributions under the CommNet Cellular Inc. Retirement Savings Plan and the
ESOP to which Mr. Pohs would have been entitled had such contributions been
determined without regard to the statutory limits applicable to such
contributions under the Code for the five year period ending on Mr. Pohs'
retirement date; (ii) a payment equal to the present value of five times the
annual premium cost with respect to Mr. Pohs' coverage level and plan option of
the Company's health plan and the Exec-U-Care Medical Reimbursement Insurance;
and (iii) a grant of 50,000 shares of restricted stock under the CommNet
Cellular Inc. Omnibus Stock and Incentive Plan (which shares will vest upon
death, disability, the end of the consulting period described below or a change
of control). The Consulting Agreement, (I) if Mr. Pohs has not yet retired, he
may elect to receive the benefits set forth in his change of control agreement,
as described in the two preceding paragraphs, or to receive the benefits
provided for in the Consulting Agreement, and (ii) if Mr. Pohs has retired, he
will be entitled to receive a lump-sum payment of all consulting fees due for
the remaining portion of the consulting arrangement, and all restrictions on the
shares granted pursuant to the Consulting Agreement will lapse.
The occurence of the Merger will constitute a change in control of the
Company under these agreements. In the event any payment or benefit to be
received by an officer pursuant to the Agreements would be subject to the
federal excise tax, the amount of the benefits payable under the Agreement will
be increased such that the net amount retained by the officer after deduction of
any excise tax on such payment and any federal, state and local tax and excise
tax upon such additional payment shall be equal to the full severance benefits
contemplated by the Agreement.
III-5
1997 AGGREGATED OPTION EXERCISES
AND YEAR-END OPTION VALUES
The following table provides information on the value of unexercised
options at September 30, 1997.
Number of Unexercised Options at Value of Unexercised
Fiscal Year End (#) In-the-Money Options
at Fiscal Year End
-------------------------------- ----------------------
Name Vested Unvested Vested Unvested
- ---- ------ -------- ------ --------
Arnold C. Pohs 990,000(1) -- $8,327,000(1) --
Daniel P. Dwyer 547,500(1) -- 4,789,000(1) --
Homer Hoe 80,000 -- 682,000 --
Timothy C. Morrisey 51,250 -- 418,000 --
David S. Lynn 93,500 -- 1,127,000 --
- -----------
(1) Includes options to purchase 250,000 and 150,000 shares of TVX, Inc. held
by Arnold C. Pohs and Daniel P. Dwyer, respectively. There is currently no
public market for shares of TVX, Inc., however the Company believes the
fair market value is not in excess of the option exercise price.
Accordingly, the table attributes no value to such options.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
At December 19, 1997, there were 13,796,836 shares of Common Stock of
the Company issued and outstanding. As of such date options to purchase
1,896,275 shares were outstanding. Each holder of Common Stock, but not
unexercised options, is entitled to one vote per share on each matter which may
be presented at a meeting of stockholders. Cumulative voting is not allowed. The
Company's Common Stock is traded on the Nasdaq National Market under the symbol
CELS.
The following table sets forth information regarding ownership of the
Company's Common Stock at December 19, 1997 by each person who is known by
management of the Company to own beneficially more than 5% of the Common Stock,
by each director of the Company and by all directors and executive officers of
the Company as a group. Shares issuable on exercise of options are deemed to be
outstanding for the purpose of computing the percentage ownership of persons
beneficially owning such options, but have not been deemed to be outstanding for
the purpose of computing the percentage ownership of any other person. Insofar
as is known to the Company, the persons indicated below have sole voting and
investment power with respect to the shares indicated as owned by them except as
otherwise stated in the notes to the table.
III-6
Name and Address of Amount and Nature of Percent of
Beneficial Owner Beneficial Ownership Class
---------------- -------------------- -----
Arnold C. Pohs 830,794 (1) 5.72%
8350 East Crescent Parkway
Englewood, Colorado 80111
Daniel P. Dwyer 418,870 (2) 2.95%
8350 East Crescent Parkway
Englewood, Colorado 80111
John E. Hayes, Jr. 7,500 .05%
818 Kansas Avenue
Topeka, Kansas 66612
The Equitable Companies Inc. 1,128,200(3) 8.18%
787 Seventh Avenue
New York, New York 10019
All executive officers and 1,659,681(4) 10.83%
directors (10 persons)
__________
(1) Includes options to purchase 740,000 shares of Common Stock.
(2) Includes options to purchase 397,500 shares of Common Stock.
(3) A Schedule 13G, dated as of December 31, 1996, filed on behalf of The
Equitable Companies Incorporated; five French mutual insurance companies,
AXA Assurance I.A.R.D. Mutuelle, AXA Assurances Vie Mutuelle, Alpha
Assurances I.A.R.D. Mutuelle, Alpha Assurances Vie Mutuelle and AXA
Courtage Assurance Mutuelle, as a group; AXA; and their subsidiaries
reflects that such group has sole voting power over 1,108,300 shares of
Common Stock of the Company. No information is given in respect of voting
power over the remaining shares.
(4) Includes options to purchase 1,521,750 shares of Common Stock held by
directors and executive officers of the Company.
Item 13. Certain Relationships and Related Transactions.
None.
III-7
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a)(1) Financial Statements
--------------------
1. Report of Independent Auditors
2. Consolidated Balance Sheets, September 30, 1997 and 1996
3. Consolidated Statements of Operations, Years ended
September 30, 1997, 1996 and 1995
4. Consolidated Statements of Stockholders' Equity,
Years ended September 30, 1995, 1996 and 1997
5. Consolidated Statements of Cash Flows, Years ended
September 30, 1997, 1996 and 1995
6. Notes to Consolidated Financial Statements
(a)(2) Financial Statement Schedules
-----------------------------
Schedule I. Condensed Financial Information of Registrant
Schedule II. Valuation and Qualifying Accounts
All other schedules are omitted because they are not applicable or the
required information is shown in the financial statements or notes thereto.
(a)(3) Exhibits
--------
3.1 Amended and First Restated Articles of Incorporation, as
amended, of the Company.
Incorporated herein by reference to Exhibit 3.1 to the
Company's annual report on Form 10-K for the fiscal year ended
September 30, 1994.
3.2 Bylaws, as amended, of the Company.
Incorporated herein by reference to Exhibit 3.2 to the
Company's registration statement on Form S-18, SEC File No.
33-2700.
4.1 Specimen certificate representing Common Stock.
Incorporated herein by reference to Exhibit 4.1 to the
Company's registration statement on Form S-18, SEC File No.
33-2700.
4.2 Indenture between the Company and State Street Bank and Trust
Company, as Trustee, relating to the 11 3/4% Senior
Subordinated Discount Notes.
Incorporated herein by reference to Exhibit 4.1 to the
Company's registration statement on Form S-3, SEC File No.
33-66492.
IV-1
(a)(3) Exhibits (continued)
--------
4.3 Indenture between the Company and America Bank N.A., as
Trustee, relating to the 11 1/4% Subordinated Notes.
Incorporated herein by reference to Exhibit 4.1 to the
Company's registration statement on Form S-3, SEC File No.
33-60393.
4.4 Rights Agreement between the Company and State Street Bank and
Trust Company, as Rights Agent.
Incorporated herein by reference to Exhibit 2 to the Company's
registration statement on Form 8-A dated December 19, 1990.
4.5 Amendment Three to Rights Agreement between the Company and the
Rights Agent.
Incorporated herein by reference to Exhibit 4.5 to the
Company's annual report on Form 10-K for the fiscal year ended
September 30, 1996.
10.1 Lease Agreement dated August 8, 1995 between the Company and
TCD North, Inc.
Incorporated herein by reference to Exhibit 10.1 to the
Company's annual report on Form 10-K for the fiscal year ended
September 30, 1995.
10.2 Amended and Restated Employee Stock Ownership Plan and Trust.
Incorporated herein by reference to Exhibit 10.1 to the
Company's quarterly report on Form 10-Q for the quarter ended
June 30, 1996.
10.3 Short-Term Incentive Plan.
Incorporated herein by reference to Exhibit 10.6 to Company's
annual report on Form 10-K for the fiscal year ended September
30, 1990.
10.4 Omnibus Stock and Incentive Plan.
Incorporated herein by reference to Exhibit 10.7 to the
Company's annual report on Form 10-K for the fiscal year ended
September 30, 1991.
10.5 Consolidated Loan Agreement between CoBank and CIFC.
Incorporated herein by reference to Exhibit 10.5 to the
Company's annual report on Form 10-K for the fiscal year ended
September 30, 1995.
10.6 Third Amended and Restated Guaranty of the Company to CoBank.
Incorporated herein by reference to Exhibit 10.6 to the
Company's annual report on Form 10-K for the fiscal year ended
September 30, 1995.
10.7 Form of change in control agreement between the Company and its
senior management.
Incorporated herein by reference to Exhibit 10.7 to the
Company's annual report on Form 10-K for the fiscal year ended
September 30, 1995.
10.8 Retirement and Consulting Agreement.
Incorporated herein by reference to Exhibit 10.1 to the
Company's quarterly report on Form 10-Q for the quarter ended
March 31, 1996.
10.9 Agreement and Plan of Merger dated May 27, 1997 between the
Company and AV Acquisition Corp.
Incorporated herein by reference to Exhibit 2.1 to the
Company's report on Form 8-K dated May 29, 1997.
IV-2
(a)(3) Exhibits (continued)
--------
10.10 Credit Agreement among the Company and CIFC and The Lenders
Party Hereto and The Chase Manhattan Bank, as Administrative
Agent, and Chase Manhattan Bank Delaware, as Fronting Bank
dated September 18, 1997.
Incorporated herein by reference to Exhibit 99.1 to the
Company's report on Form 8-K dated November 24, 1997.
*12.1 Computation of ratio of earnings to fixed charges.
*21.1 Subsidiaries of the Company.
*23.1 Consent of Independent Auditors.
__________
* Filed herewith
(b) Reports on Form 8-K during the quarter ended September 30, 1997:
Date of Report Item Reported Financial Statements Filed
-------------- ------------- --------------------------
August 20, 1997 Item 5 None
September 26, 1997 Item 5 None
IV-3
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
COMMNET CELLULAR INC.
By: /s/ Arnold C. Pohs
-------------------------
Arnold C. Pohs, President
Date: December 29, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons in the capacities and
on the date indicated.
Signature Title Date
--------- ----- ----
/s/ Arnold C. Pohs President, Chief Executive Officer December 29, 1997
- --------------------- and Director
Arnold C. Pohs
/s/ Daniel P. Dwyer Executive Vice President, Treasurer, December 29, 1997
- --------------------- Chief Financial Officer and
Daniel P. Dwyer Director
/s/ Andrew J. Gardner Senior Vice President and Controller December 29, 1997
- --------------------- (Principal Accounting Officer)
Andrew J. Gardner
/s/John E. Hayes, Jr. Director December 29, 1997
- ---------------------
John E. Hayes, Jr.
/s/ Robert J. Paden Director December 29, 1997
- ---------------------
Robert J. Paden
/s/ David E. Simmons Director December 29, 1997
- ---------------------
David E. Simmons
IV-4
COMMNET CELLULAR INC.
SCHEDULE I
Condensed Financial Information of Registrant
(Amounts in thousands)
CONDENSED BALANCE SHEETS
- ------------------------
September 30,
------------------
1997 1996
-------- --------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 13,992 $ 10,204
Accounts receivable 12 16
Inventory and other 4,546 3,933
-------- --------
Total current assets 18,550 14,153
Property, plant and equipment 54,511 48,719
Less allowance for depreciation 18,051 15,308
-------- --------
36,460 33,411
OTHER ASSETS
Investment in and advances to subsidiaries and affiliates 259,710 241,695
Other 11,160 9,596
-------- --------
270,870 251,291
-------- --------
$325,880 $298,855
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES $ 24,830 $ 13,770
LONG-TERM DEBT
Subordinated debentures and discount notes 239,133 221,963
Other 17 140
-------- --------
239,150 222,103
STOCKHOLDERS' EQUITY
Common stock 14 14
Other stockholders' equity 61,886 62,968
-------- --------
61,900 62,982
-------- --------
$325,880 $298,855
======== ========
See accompanying notes.
COMMNET CELLULAR INC.
SCHEDULE I
Condensed Financial Information of Registrant
(continued)
(Amounts in thousands)
CONDENSED STATEMENTS OF OPERATIONS
- ----------------------------------
Years ended September 30,
------------------------------
1997 1996 1995
-------- -------- --------
COST AND EXPENSES
General and administrative $ 35,820 $ 31,248 $ 28,969
Depreciation and amortization 7,217 8,077 6,076
Less amounts allocated to subsidiaries
and affiliates (42,526) (40,527) (31,577)
-------- -------- --------
NET INCOME (LOSS) BEFORE EQUITY IN
NET LOSS OF SUBSIDIARIES AND
AFFILIATES AND INTEREST INCOME
AND EXPENSE (511) 1,202 (3,468)
Equity in net income (loss) of subsidiaries
and affiliates 12,814 (3,528) (12,122)
Gains (loss) on sales of affiliates 350 (250) 18,580
Interest expense (26,170) (24,474) (20,465)
Interest income 14,549 22,654 17,537
-------- -------- --------
NET INCOME (LOSS) $ 1,032 $ (4,396) $ 62
======== ======== ========
See accompanying notes.
COMMNET CELLULAR INC.
SCHEDULE I
Condensed Financial Information of Registrant
(continued)
(Amounts in thousands)
CONDENSED STATEMENTS OF CASH FLOWS
- ----------------------------------
Years ended September 30
---------------------------------
1997 1996 1995
---- ---- ----
CASH PROVIDED (USED) BY
OPERATING ACTIVITIES $ 34,611 $ (495) $ 2,632
INVESTING ACTIVITIES
Purchase of short-term investments - (987) (82)
Sale of short-term investments - 987 21,509
Additions to property and equipment (5,792) (5,715) (1,305)
Additions to investment in affiliates (19,581) (23,518) (11,299)
Additions to other assets (2,437) 461 (1,633)
------- ------- -------
(27,810) (28,772) 7,190
FINANCING ACTIVITIES
Payment on secured bank financing - - (4,023)
Extraordinary charge related to
extinguishment of long-term debt - - (1,130)
Offering costs related to the issuance
of subordinated notes - - (518)
Additions/Reductions to cap lease (301) (308) (335)
Issuance of subordinated notes - - 77,400
Redemption of convertible
subordinated debentures - - (41,852)
Repurchase Common Stock (2,933) (1,378) -
Issuance of common stock 221 978 815
------- ------- -------
(3,013) (708) 30,357
------- ------- -------
INCREASE (DECREASE) IN CASH $ 3,788 $(29,975) $ 40,179
========= ======== ========
See accompanying notes.
COMMNET CELLULAR INC.
SCHEDULE I
Condensed Financial Information of Registrant
(continued)
BASIS OF PRESENTATION
- ---------------------
In the accompanying parent company only, CommNet Cellular Inc. (the
"Company") financial statements, the Company's investment in subsidiaries and
affiliates is stated at cost plus equity in undistributed net loss of
subsidiaries and affiliates since date of acquisition. The Company's share of
net loss of its subsidiaries and affiliates is included in the accompanying
condensed statement of operations using the equity method. Parent company only
financial statements should be read in conjunction with the Company's
consolidated financial statements.
Certain amounts for 1995 and 1996 have been reclassified to conform to the
1997 presentation.
COMMNET CELLULAR INC.
SCHEDULE II
Valuation and Qualifying Accounts
Additions
--------------------------------
Charged to
Beginning Charged to Other Ending
Description Balance Costs & Expenses Accounts Deductions (1) Balance
----------- ----------- ----------------- ---------- -------------- ----------
Allowance for doubtful
accounts $1,947,000 $3,789,000 $ - $ 3,614,000 $2,122,000
(1) All deductions are the result of actual write-offs to accounts receivable.