UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the Fiscal Year Ended December 31, 1996
or
[ ] 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 0-16560
VANGUARD CELLULAR SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
North Carolina 56-1549590
(State or other jurisdiction of incorporation organization) (I.R.S. Employer Identification No.)
2002 Pisgah Church Road, Suite 300,
Greensboro, North Carolina 27455-3314
(address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (910) 282-3690
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Class A Common Stock, par value $.01 per share
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES X NO
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 registrant's Common Stock held by those
other than executive officers and directors at March 17, 1997, based on the
NASDAQ closing sale price for the Registrant's Common Stock as of such date, was
approximately $446,510,000.
The number of shares outstanding of the issuer's common stock as of March
17, 1997 was 40,764,522.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement relating to its
1997 annual meeting of stockholders are incorporated by reference into Part III
as set forth herein. Such proxy statement will be filed with the Securities and
Exchange Commission not later than 120 days after the registrant's fiscal year
ended December 31, 1996.
TABLE OF CONTENTS
PART I
Item 1. Business....................................................................................................... 1
Item 2. Properties..................................................................................................... 16
Item 3. Legal Proceedings.............................................................................................. 16
Item 4. Submission of Matters to a Vote of Security Holders............................................................ 16
Item 4.(a) Executive Officers of the Registrant........................................................................ 16
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters....................................... 18
Item 6. Selected Consolidated Financial Data........................................................................... 19
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.......................... 21
Item 8. Financial Statements and Supplementary Data.................................................................... 27
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure........................... 27
PART III
Item 10. Directors and Executive Officers of the Registrant............................................................ 28
Item 11. Executive Compensation........................................................................................ 28
Item 12. Security Ownership of Certain Beneficial Owners and Management................................................ 28
Item 13. Certain Relationships and Related Transactions................................................................ 28
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.............................................. 29
Signatures............................................................................................................. 30
Index to Financial Statements and Schedules............................................................................ F-1
Exhibit Index
Item 1. Business
For definitions of certain terms used in this Form 10-K, see "Certain
Definitions" beginning on Page 14 hereof.
Overview
Vanguard Cellular Systems, Inc. ("the Company") is one of the largest
independent operators of cellular telephone systems in the United States based
on its 7.9 million aggregate POPs as of December 31, 1996. The Company serves
over 500,000 subscribers located in five "metro-clusters," or contiguous groups
of cellular markets, comprised of 29 markets in the Eastern United States,
including the Mid-Atlantic and Ohio Valley SuperSystems and the Florida,
Carolinas and New England metro-clusters. The Mid-Atlantic SuperSystem, which is
contiguous to the New York, Philadelphia and Baltimore/Washington MSAs and the
New England metro-cluster, which is contiguous to the Boston MSA, (four of the
nation's seven largest MSAs) collectively represent approximately 72% of the
Company's operating POPs. The Company's wireless products and services are
distributed under the CellularONET brand name, one of the most recognized brand
names in the wireless industry.
The Company's markets are located in predominantly suburban and rural areas
proximate to major urban areas, which the Company believes affords it several
advantages over traditional urban wireless operations, including (i) greater
network capacity, (ii) greater roaming revenue opportunities, (iii) lower
distribution costs and (iv) higher barriers to entry. Because there are limits
to the number of signals that can be transmitted simultaneously in a given area,
the Company's less densely populated suburban and rural locations allow for
greater frequency reuse, resulting in greater overall network capacity than in
high density urban markets. The Company is able to provide high quality voice
transmission with reduced instances of blocked or dropped calls. In addition to
these network advantages, the Company's metro-clusters enjoy greater roaming
revenue opportunities by virtue of their proximity to large urban centers. This
benefit is best exemplified in the Mid-Atlantic SuperSystem, which is located in
the heavily traveled corridor between New York, Philadelphia and
Baltimore/Washington D.C. Roaming revenue requires minimal incremental
administrative and marketing expenditures, and the Company believes that it is
well positioned to benefit from both cellular roaming and eventual roaming by
users of personal communication services ("PCS"). The Company has signed an
agreement with AT&T Wireless to provide roaming services to AT&T's PCS customers
who roam into the Company's markets with dual frequency phones. The Company also
believes that it experiences lower distribution costs due to its internal
distribution channels such as direct sales, retail stores and kiosks, which are
more economical outside of urban areas. Finally, the Company believes that the
lower population density and greater geographic coverage of its suburban and
rural metro-clusters act as barriers to entry given the relatively higher
per-subscriber costs of building competing wireless systems.
Since its inception until the introduction of PCS, the cellular industry
had two entities competing as facilities based carriers in each market.
Licensing for PCS broadband spectrum is substantially complete, and the Company
is currently competing with a PCS operator in one RSA and is aware of site
acquisition, zoning and construction of infrastructure by other competitive PCS
providers in several of its other markets. The Company is preparing for
increased competition by building out and enhancing its cellular telephone
networks, increasing the quality of coverage in its service areas, offering new
features, products and services to its customers and by expanding its service
areas through selected acquisitions of adjacent and nearby cellular systems. The
Company believes its management team's operating experience, developed
distribution channels and customer service orientation will be significant
components in providing effective competition to these new entrants. In
addition, the Company believes its extensive system footprint and the location
of its operations in suburban and rural markets provide significant barriers to
early competition from PCS competitors.
The Company's annual service revenue and subscriber growth over the last
three years has outpaced average industry growth over the three year period
ending December 31, 1996 according to the most recently published data by the
Cellular Telephone Industry Association. The number of subscribers in the
Company's majority-owned markets grew from 132,300 to 513,000 over the last
three years, a compound annual growth rate of approximately 57%, compared to an
industry growth rate of 40%. Service revenue grew from $99 million in 1993 to
$283 million in 1996, a compound annual growth rate of 42%, compared to an
industry growth rate of 27%. In addition, the Company's EBITDA grew from $25
million in 1993 to $103 million in 1996. See "Item 6 -- Selected Consolidated
Financial Data" and "Item 7 -- Management's Discussion and Analysis of
Financial Condition and Results of Operations."
1
Business Strategy
The Company's overall goal is to continue to pursue strong growth of
subscribers, revenues and EBITDA. The Company intends to achieve this goal
through its operating strategy of providing a broad range of high quality
integrated wireless communications products and services. Key elements of the
Company's strategy include:
(Bullet) Development of the Metro-Cluster Service Areas. The Company has
pursued a strategy of developing and supplementing its regional
metro-clusters to enable it to serve its customers better and to
achieve cost efficiencies through economies of scale. By operating
in contiguous markets, the Company can provide broad areas of
seamless service and achieve economies of scale in marketing and
operations as well as cost efficiencies in deploying its network
infrastructure. The Company continually evaluates opportunities
for acquisitions of new cellular properties in proximate suburban
and rural markets that will expand its metro-clusters.
(Bullet) Continuous Cellular Network Buildout. The Company continuously
improves its systems. In 1994, the Company began a cellular
network expansion and upgrade program in order to increase
geographic coverage and provide for additional portable usage in
the Company's cellular markets. In 1995 and 1996 combined, the
Company added 195 new cell sites and replaced or upgraded 100
others, bringing its total number of cell sites to 379 as of
December 31, 1996. The Company plans to add 80 cell sites in 1997
as it continues to enhance its network. The Company believes that
its networks have sufficient capacity in its spectrum to serve the
Company's growing subscriber base in the near future but plans to
implement a gradual transition to digital technology before analog
capacity constraints become a significant concern. The Company's
networks are currently digital-ready, with dual mode analog/Time
Division Multiple Access ("TDMA") digital radio technology already
built-in such that individual transmitters may be converted to
digital mode with minimal additional investment. See
" -- Expansion of Product Offerings" and "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of
Operations."
(Bullet) Investment in Brand Identity. The Company's wireless products and
services are distributed under the CellularONET brand name, one of
the most recognized brand names in the wireless industry. The
CellularONET brand name currently is used by cellular systems
covering more than 12,500 cities and towns, representing total
POPs of over 108 million. The Company has a minority ownership
interest in the partnership that owns the CellularONET brand name
and that controls the promotion and management of the brand. In
addition to benefitting from local advertising by licensees, the
CellularONET brand name is advertised on a national basis by the
partnership that owns the brand with funding provided by licensing
fees.
(Bullet) Emphasis on Customer Service and Advanced Billing Systems. The
Company provides on-line customer support, 24 hours a day, seven
days a week. The Company's internally developed, proprietary
FlexcellT billing and management information system enables the
Company to provide quality services to its expanding customer base
and affords it access to customer data, which it uses to
facilitate its marketing efforts. One such service is Rapid
Activation, which enables the Company to execute credit checks,
order entry, and subscriber activation within five minutes. See
" -- Customer Service."
(Bullet) Growth of Internal Distribution Channels. The Company distributes
its products and services through both its internal distribution
network (direct sales force, sales and service centers, and retail
stores) and external distribution channels (national retailers,
local agents and automotive dealers). The Company is continuing
its long-term emphasis on internal distribution channels,
particularly its own retail outlets, which the Company believes
offer substantial benefits. These benefits include lower cost,
higher effectiveness in selling to high margin customers, and a
consistent point of customer contact, resulting in greater ongoing
satisfaction for both internally and externally generated
customers. The Company is therefore building additional retail
outlets, as well as upgrading existing outlets. See " -- Marketing
and Distribution."
(Bullet) Expansion of Product Offerings. The Company continues to offer new
and innovative products and services in order to increase the
value of the basic voice product to the customer and to increase
airtime revenues. In addition to enhanced cellular voice service
packages, the Company has begun to offer data transmission, and
field trials are continuing for Cellular Digital Packet Data
protocol ("CDPD"). With the integration of digital technology, the
Company will be able to offer a variety of additional services
such as caller identification, short messaging and call
encryption.
(Bullet) Investments in Rapidly Expanding Businesses. The Company seeks
investment opportunities in development stage companies that have
fundamental similarities to the Company's core business and to
which it believes it can add value through its operational and
financial experience and expertise. To date, the Company has made
moderate investments in exchange for significant equity positions
and has been able to provide assistance to these investees in
financial and operational matters. See " -- Other Investments."
2
Markets and Clusters
The following table sets forth as of December 31, 1996, (i) the markets in
which the Company owns an interest in a cellular system by region and by
cluster, (ii) the Company's ownership percentage of the system, (iii) the total
POPs (as derived from 1996 population estimates) and (iv) the Company's POPs
based on its ownership percentage.
Company Total Net
Ownership POPs POPs
Mid-Atlantic SuperSystem:
Allentown, PA/NJ....................................................................... 100.00% 714,074 714,074
Wilkes-Barre/Scranton, PA.............................................................. 100.00 661,071 661,071
Harrisburg, PA......................................................................... 100.00 498,397 498,397
Lancaster, PA.......................................................................... 100.00 451,951 451,951
York, PA............................................................................... 100.00 452,251 452,251
Reading, PA............................................................................ 100.00 351,545 351,545
Williamsport, PA....................................................................... 100.00 120,113 120,113
State College, PA...................................................................... 100.00 130,457 130,457
Wayne, PA (PA-5 RSA)................................................................... 100.00 83,059 83,059
Chambersburg, PA (PA-10 East RSA)...................................................... 100.00 142,089 142,089
Mifflin, PA (PA-11 RSA)................................................................ 100.00 114,088 114,088
Lebanon, PA (PA-12 RSA)................................................................ 100.00 117,383 117,383
Union, PA (PA-8 RSA)................................................................... 100.00 405,904 405,904
Altoona, PA............................................................................ 100.00 131,942 131,942
Binghamton, NY/PA...................................................................... 100.00 298,325 298,325
Elmira, NY............................................................................. 100.00 94,192 94,192
Subtotal............................................................................ 4,766,841
Ohio Valley SuperSystem:
Huntington, WV/KY/OH................................................................... 100.00 317,856 317,856
Charleston, WV......................................................................... 100.00 255,880 255,880
Parkersburg, WV........................................................................ 100.00 158,158 158,158
Chillecothe, OH (OH-9 RSA)............................................................. 100.00 249,392 249,392
Athens, OH (OH-10-South RSA)........................................................... 100.00 112,978 112,978
Logan, WV (WV-6 RSA)................................................................... 100.00 185,037 185,037
Ripley, WV (WV-1 RSA).................................................................. 100.00 76,605 76,605
Other.................................................................................. 1,156
Subtotal............................................................................ 1,357,062
Florida Metro-cluster:
Pensacola, FL.......................................................................... 100.00 385,724 385,724
Fort Walton Beach, FL.................................................................. 100.00 167,713 167,713
Panama City, FL........................................................................ 18.28 146,018 26,685
Columbus, GA........................................................................... 13.69 254,600 34,864
Albany, GA............................................................................. 10.29 118,527 12,194
Pascagoula, MS......................................................................... 3.99 128,966 5,146
Other.................................................................................. 9,418
Subtotal............................................................................ 641,744
Carolinas Metro-cluster:
Myrtle Beach, SC (SC-5 RSA)............................................................ 100.00 248,750 248,750
+Wilmington, NC......................................................................... 47.97 206,166 98,893
+Jacksonville, NC....................................................................... 47.79 149,109 71,261
Petersburg, VA......................................................................... 12.44 129,392 16,092
Subtotal............................................................................ 434,996
New England Metro-cluster:
Portland, ME........................................................................... 100.00 284,147 284,147
Portsmouth, NH/ME...................................................................... 100.00 279,427 279,427
Bar Harbor, ME (ME-4 RSA).............................................................. 100.00 86,125 86,125
Bangor, ME............................................................................. 5.31 147,250 7,812
Other.................................................................................. 15,587
Subtotal............................................................................ 673,098
Other Minority Interests................................................................. 39,354
TOTAL POPs............................................................................... 7,913,095
+ Jointly controlled through the Company's 50% ownership of a joint venture.
3
Subscribers
Management believes that the Company generates the majority of its revenue
from subscribers who are business users. Historically, the Company's business
users were individuals in such professions as construction and real estate who
worked extensively from their cars and utilize cellular telephone service to
improve productivity. As a result of the growing acceptance of cellular
communications and the declining cost of portable and transportable phones, as
well as the Company's marketing efforts, the Company is attracting larger
numbers of customers who are nonbusiness users and business users now are drawn
from a wider range of occupations. Business users normally generate more revenue
than nonbusiness consumers. While the Company anticipates increasing nonbusiness
consumer acceptance of cellular telephone service, business users are expected
to generate the majority of the Company's revenue for the foreseeable future.
The following table sets forth the aggregate number of subscribers in the
Company's majority-owned markets at the end of the periods indicated.
Quarter 1994 1995 1996
First................................................................ 150,000 280,000 405,000
Second............................................................... 169,000 314,000 430,000
Third................................................................ 190,000 340,000 461,000
Fourth............................................................... 245,000 381,000 513,000
The incremental subscriber growth and the rate of incremental subscriber
growth in the Company's majority-owned markets is set forth in the following
table for the periods indicated.
1994 1995 1996
Incremental Subscriber Growth........................................ 112,700 136,000 132,000
Rate of Incremental Subscriber Growth................................ 85% 56% 35%
The following table sets forth the number of subscribers and the
penetration percentages in majority-owned markets as of the dates indicated.
December 31,
1994 1995 1996
Subscribers Penetration* Subscribers Penetration* Subscribers
Mid-Atlantic SuperSystem..................... 163,600 3.50% 254,500 5.01% 324,500
Ohio Valley SuperSystem...................... 26,400 4.24 45,500 7.31 78,500
New England.................................. 23,500 3.71 35,500 5.50 48,500
Florida...................................... 18,900 3.54 29,000 5.33 39,000
Carolinas.................................... 12,600 5.17 16,500 6.82 22,500
Total...................................... 245,000 3.65 381,000 5.34 513,000
Penetration*
Mid-Atlantic SuperSystem..................... 6.81%
Ohio Valley SuperSystem...................... 5.79
New England.................................. 8.61
Florida...................................... 7.05
Carolinas.................................... 9.05
Total...................................... 6.77
* Penetration represents total year-end subscribers divided by year-end total
POPs in the Company's majority-owned markets.
The decrease in penetration from 1995 to 1996 in the Ohio Valley
SuperSystem was due entirely to the acquisition in 1996 of certain markets in
which the penetration was significantly lower than the Company's existing
markets. The Company expects this region to add subscribers at rates consistent
with its other operating regions in the future. The Company believes subscriber
growth and increased penetration in 1994, 1995 and 1996 were a product of the
growing acceptance of cellular communications and the Company's efforts to
capitalize on this increasing acceptance of cellular communications and an
expanded distribution network. In addition, 1994, 1995, and 1996 subscriber
growth was augmented by approximately 14,000, 9,000, and 5,000 subscribers,
respectively, associated with the acquisition of certain cellular markets. See
"Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations."
Products and Services
The Company's primary line of business is the provision of cellular
telephone services. Customers are offered several pricing options combining
different monthly access and usage charges and charges for related services.
The Company provides regional service among its contiguous markets, such as
those within the Mid-Atlantic SuperSystem. A customer in these regions can place
and receive calls throughout the network without any additional daily fee and
4
often at the same incremental rate per minute as in the customer's home market.
In certain adjacent cellular markets not owned by the Company, the Company
offers similar regional pricing options to its subscribers. The Company has
entered into agreements with other cellular companies that allow its subscribers
to roam in all 306 MSAs and a large majority of the 428 RSAs throughout the
country. These agreements allow the Company's subscribers to be preregistered in
cellular systems outside the Company's operating regions and to receive service
while they are outside their home systems, typically for a per minute usage
charge.
The Company has offered and will continue to offer new and innovative
products and services in order to increase the value of the basic voice product
to the customer and to increase airtime revenues. Recent service additions
include enhanced voice mail, which alerts the customer when a message has been
left, and single number service, which allows a customer to use the same phone
number in several locations. Other recent service additions include call
management, which directs incoming calls to a succession of locations until the
customer is reached, and voice dialing, which lets the customer make calls by
spoken command without having to touch the keypad.
The Company now offers digital data transmission over its existing cellular
network, which allows the rapid transfer of data to and from personal computers,
personal digital assistants, and other devices. Trials are underway for use of
the Cellular Digital Packet Data protocol ("CDPD"), an advanced data
transmission method which the Company began offering in 1996. The Company also
has agreed to be the primary field testing location for Nortel's implementation
of the TDMA digital protocol in the United States. Digital technology will allow
the Company to offer Integrated Services Digital Network ("ISDN") standard
services such as caller identification, short messaging, and call encryption and
the Company should benefit from developing a stronger technical relationship
with Nortel. See " -- Cellular Technology."
In 1995, the Company began marketing and installing cellular mini-networks,
which allow mobile communications across a business complex, building, or
facility. These mini-networks connect seamlessly into conventional cellular
networks. The Company is one of the first vendors to offer the mini-network
systems, which are profitable both in terms of service and equipment sales.
During 1997, other new product offerings are expected to include extensive
voice-mail and call-tracking options. The Company has begun reselling paging
services in its regional metro-clusters and intends to offer long distance
telephone service on a reselling basis. The Company also intends to expand its
product offering into Internet services as a facilities based provider or as a
reseller.
Marketing and Distribution
The Company markets its services under the CellularONET brand name, one of
the most recognized brand names in the wireless communications industry. In
addition to benefitting from local advertising by licensees, the CellularONET
brand name is advertised on a national basis by the partnership that owns the
brand using the proceeds of licensing fees. The CellularONET brand name
currently is used by cellular systems covering more than 12,500 cities and towns
with total POPs of more than 108 million. The Company is one of three owners of
the CellularONET brand name. The Company currently has an option to increase its
ownership interest in the partnership that owns the brand name, at a cost of
approximately $6.1 million, to one-third from the 2.5% interest it currently
owns. As an owner of the CellularONET name, the Company exercises influence over
the promotion and future services offered under the brand. As part of an ongoing
strategy to enhance the value of the CellularONET brand, the owners of the brand
currently plan to continue to license new carriers to operate under the
CellularONET name, both for cellular, as well as for paging, PCS, long distance
and for resellers of these services. Where CellularONET is licensed, existing
licensees currently have the exclusive right to use the brand name for cellular
and other services.
The Company uses multiple distribution channels in each of its service
areas to provide effective and extensive marketing of its products and services
and to reduce its reliance on any single distribution source. These distribution
channels fall into two broad categories: internally developed and controlled
channels, and external channels.
The Company is continuing its long-term focus on internal distribution
channels as a means to reduce the cost and improve the quality of new
subscribers. The Company's retail stores have been a historically low-cost
distribution channel, a benefit that is enhanced for the Company as a result of
relatively low facilities and other costs in the Company's suburban and rural
markets as compared to urban areas. Also, Company sales representatives are most
effective in selling to the high end customers and businesses, which tend to
provide the Company with the highest profit margins. The Company believes that
cellular customers prefer to deal directly with sales representatives employed
by the Company. In addition, Company stores provide an ongoing point of contact
for service to subscribers regardless of whether the point of purchase was
internal
5
or external. The Company plans to expand its base of retail stores and kiosks
and upgrade its existing retail outlets. The Company had over 100 retail
locations as of December 31, 1996 and intends to add 15 locations in 1997.
The Company's direct sales force consists of approximately 400 sales and
administrative employees, who target small-to-medium sized companies, a
high-margin area of business. In order to maintain a knowledgeable,
customer-oriented sales force, the Company developed and administers its own
sales training program designed to educate sales representatives for its
markets. The program offers a curriculum that highlights mobile technologies,
cellular equipment prospecting, sales techniques, and the customer service
process, and the Company believes that, following the program, sales
representatives are better able to address existing and potential customers'
needs in a professional, knowledgeable and productive manner.
The Company sells and rents cellular telephone equipment to its customers
in order to encourage use of its services. The Company continues its practice,
typical in the industry, of selling telephones at or below cost in response to
competitive pressures, and the magnitude of the losses experienced in connection
with providing cellular telephone equipment reflects the Company's increased
subscriber growth. The Company also offers an equipment rental program that many
subscribers have found to be an economical means of acquiring the use of
cellular equipment. Under the terms of the rental program, subscribers obtain
the use of a cellular telephone for a monthly charge. Although the Company
retains ownership of this equipment, subscribers have the option to purchase
their cellular telephones at any time during the rental period. The Company
often utilizes a promotion under which the first year's rental charge is waived
when the subscriber agrees to a one-year service contract.
The Company is extending its control of the distribution process into
certain external channels by offering the prepackaged CellularOne phone, a
cellular telephone sold "off the shelf " at retail establishments. Company
retail stores and kiosks also offer the CellularOne phone. The prepackaged unit
offers consumers attractive service options such as free weekend usage and
remote activation, and delivers substantially higher profit margins to the
Company than do phones activated by retailers through more conventional methods
because of the lower associated commission costs.
The Company also utilizes a telemarketing program as part of its sales and
customer service efforts. This program is intended to aid the customer by
providing sales follow-up and support, and helps the Company in securing
additional and better sales referrals, upgrading existing subscribers to higher
rate plans and promoting new custom-calling features.
External distribution channels include national retailers such as WalMart,
automobile dealers, and local agents and resellers. The Company enters into
exclusive short-term contracts with each of its external distribution channels.
Rapid growth in the wireless communications business, especially from customers
contracted through external channels, reduced the percentage of
internally-generated customers from 70% in 1992 to 52% in 1995. While the
Company has benefitted from the increased success of external distribution
channels, the Company continues to emphasize internal distribution channels,
which it believes result in higher long-term profit margins. The Company has
discontinued its agent relationship with the Radio ShackT chain, effective
January 1, 1997. The Company has chosen to do so as a result of the escalating
per activation commission charges which Radio Shack would have required had the
relationship continued. The loss of the 60 Radio Shack locations from the retail
distribution channel is an important event but management believes that its own
increasing presence in the retail marketplace will help mitigate any effect on
gross subscriber additions. In addition, management believes that attracting new
subscribers through its own internal retail channel at a cost that is more
reasonable is in the best long-term interest of the Company. See "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Customer Service
The Company places a high priority on providing consistently high quality
customer service. The central customer service department located in Greensboro,
North Carolina, is open 24 hours daily, including weekends and holidays, and is
available to handle all types of customer service inquiries. In 1996, the
Company opened regional call centers in each of its metro-clusters to handle
certain types of customer issues. The benefits of regional call centers include
having service delivery as close to the customer as possible to cover specific
regional circumstances, being a more significant local employer and reducing the
risk of encountering a lack of experienced customer service employees in the
Greensboro, North Carolina area. The central customer service facility continues
to provide service as backup and overflow for the regional centers, as primary
service provider in certain instances and for the critical evening, night and
weekend duty. All customer service personnel are trained in certain key areas
such as general mobile telephone technology, available cellular equipment,
cellular billing and roaming. The Company believes that this training provides
these employees with the requisite knowledge to handle customer inquiries
quickly and competently, resulting in greater customer satisfaction. The
Company's training program, which was developed and is administered internally,
requires employees to demonstrate competency through testing.
6
The Company has developed a proprietary billing and management information
system, FlexcellT, which it believes provides several service advantages to its
customers. Using FlexcellT, customer service representatives are able to access
current billing information quickly in order to respond promptly to customer
inquiries. In addition, this system allows for integration of customer-related
data from various operations within the Company into a single database. Using
this database, service calls are systematically analyzed each month to highlight
key customer issues. The customer database also provides the basis for customer
satisfaction information. The Company has entered into a contract to provide
FlexcellT software and support to American Mobile Satellite Corporation, but is
not currently marketing FlexcellT to third parties in order to assure that it
can meet the needs of the Company and American Mobile Satellite Corporation.
To supplement the Company's customer service operations, Company
telemarketers contact customers periodically to determine their satisfaction
with the Company's service and to identify problems that can lead to subscriber
cancellations. In 1995, the Company developed an integrated feature called
"Rapid Activation," designed to reduce the time required to activate service for
a new customer. Rapid Activation now allows the Company to perform a credit
check, complete order entry and activate a cellular subscriber in approximately
five minutes. Previously, this process required approximately one hour.
To ensure quality installation for automotive customers and overall
customer satisfaction, the Company has established its own installation and
repair centers in most of its markets. These CellularONET installation and
repair centers provide one-stop shopping for the Company's customers and enable
the Company to control installation quality and scheduling and inventory levels.
These centers are also authorized to perform warranty repair work for certain
cellular telephone manufacturers.
Cellular Telephone Technology
Cellular telephone service is a form of telecommunications capable of
delivering high quality, high capacity mobile and portable telephone services.
Cellular systems are engineered so that a service area is divided into multiple
cells approximately two to 10 miles in radius. Each cell contains a relatively
low power transmitter, a receiver and signaling equipment (the base station).
The base station in each cell is connected by microwave or telephone line to the
mobile telephone switching office ("MTSO"). The MTSO controls the automatic
transfer of calls from cell to cell as a subscriber travels, coordinates calls
to and from a mobile unit, allocates calls among the cells within the system,
and connects calls to the local landline telephone system or to a long-distance
telephone network. Each conversation in a cellular system involves a radio
transmission between a subscriber unit and a base station and the transmission
of the call between the base station and the MTSO.
The MTSO and base stations periodically monitor the signal strength of
calls in progress. The signal strength of the transmission between a subscriber
unit and the base station in any cell declines as the unit moves away from the
base station. When the signal strength of a call declines to a predetermined
level, the MTSO hands off the call in a fraction of a second to the base station
of another cell where the transmission strength is greater. If the subscriber
unit leaves the service area of the cellular system, the call is disconnected
unless an appropriate technical interface has been established with an adjacent
system.
The FCC has allocated the cellular telephone systems frequencies in the 800
MHz band of the radio spectrum. Each of the two licenses in a 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 significant features of cellular telephone systems are:
(i) frequency reuse, enabling the simultaneous use of the same frequency in two
adequately separated cells, and (ii) call hand-off. A cellular telephone
system's frequency reuse and call hand-off features result in highly efficient
use of available frequencies and enable cellular telephone systems to process
more simultaneous calls and service more users over a greater area than
conventional mobile telephone systems.
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. Furthermore, an area within a system may
be served by more than one cell through procedures that utilize available
channels in adjacent cells. When all possible channels are in use, further
growth can be accomplished through a process known as "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.
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 of most systems.
7
Based on the demographics of its markets, the Company does not anticipate that
the provision of mobile and portable service within its networks will require as
large a proportion of the systems' capacities as is required in higher density
MSAs. Therefore, the Company's systems are expected to have more capacity with
which to pursue data applications and other expanded cellular services, which
the Company believes may enhance its revenue potential and limit market
opportunities for competitive mobile data systems.
All cellular telephones are designed to be compatible with cellular systems
in all market areas within the United States so that a cellular telephone may be
used wherever a subscriber is located. Changes of cellular telephone numbers or
other technical adjustments to mobile units by the manufacturer or local
cellular telephone service businesses are generally required to enable the
subscriber to change from one cellular service provider to another within a
service area. Cellular system operators may provide service to roamers
temporarily located in, or traveling through, their service area. The cellular
system providing service to the roamer generally receives 100% of the revenues
from such service and such roaming charges are billed to the roamer's local
service provider.
The cellular mobile telephone services available to customers and the
sources of revenue available to a system operator are similar to those available
with standard home and office telephones. For example, cellular systems can
offer a variety of features, including call forwarding, call waiting, conference
calling, voice message and retrieval, and data transmission. Because cellular
systems are fully interconnected with the landline telephone network,
subscribers can receive and originate both local and long distance calls from
their cellular telephones. The subscribers generally are charged separately for
monthly access, air time, toll calls and custom calling features.
Cellular telephone systems operate under interconnection agreements with
various local exchange carriers ("LECs") and interexchange (long distance)
carriers ("IXCs"). 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.
There are a number of recent technical developments in the cellular
industry. Currently, while most of the MTSOs process information digitally, the
radio transmission of cellular telephone calls is done predominantly 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.
There are two digital technologies that currently are being considered by
cellular companies: TDMA, presently in commercial service, and CDMA, which is
now predominantly in the testing phase with limited commercial service. In
addition, at least one cellular company offers an enhanced analog technology as
an intermediate step which is designed to increase capacity and thereby enable
such company to delay implementing digital technology.
The Company has chosen TDMA as its digital technology which has been
deployed on a very limited test basis in one Mid-Atlantic SuperSystem market.
Rather than immediately converting additional markets to digital technology,
however, the Company has adopted a strategy of deferring implementation until
its capacity needs require it, or there is a demonstrable demand for services
that can only be provided with digital technology, and the use of the requisite
technology becomes more widespread. The substantial majority of the cellular
equipment currently employed by the Company in its systems is "TDMA ready" and
can work in either an analog or digital mode. As a result, the Company should be
able to transition from analog to digital mode with minimal expense. At the time
of any conversion, the Company's subscribers may not have digital handsets and,
as a result, the Company may have to provide such devices to some of its
subscribers. If this is necessary the Company will analyze usage patterns to
determine the most effective means of distributing these handsets to a small
segment of its subscribers who have disproportionately high use. However, one or
more of the technologies currently utilized by the Company or implemented in the
future may not be preferred by its customers or may become obsolete. If either
event occurs, it could result in the Company undergoing a conversion which could
involve significant expense. Pending such a conversion, the Company could be at
a competitive disadvantage.
Competition
Other Cellular Competition. The cellular telephone business is a regulated
duopoly. Until 1994, the FCC provided for only two licenses in each market
(although certain markets have been subdivided as a result of voluntary
settlements), one to a nonwireline company and one to a wireline company, which
is usually the local telephone company or its affiliate. Each licensee has the
exclusive grant of a defined frequency band within each market. The Company
holds exclusively nonwireline licenses. The primary competition, therefore, for
the Company's cellular service in any market has traditionally come
8
from the wireline licensee in that market. Competition is principally on the
basis of services and enhancements offered (including the provision of cellular
equipment at or below cost), the technical quality of the system, price and the
quality and responsiveness of customer service.
In the Company's majority-owned markets, its competitors are affiliates of
the following companies:
Market Cellular Competitor
Allentown, PA/NJ Bell Atlantic/NYNEX Mobile
Altoona, PA 360(degree) Communications Company
Harrisburg, PA 360(degree) Communications Company
Lancaster, PA 360(degree) Communications Company
Reading, PA Bell Atlantic/NYNEX Mobile
State College, PA 360(degree) Communications Company.
Wilkes Barre/Scranton, PA 360(degree) Communications Company
Williamsport, PA 360(degree) Communications Company
York, PA 360(degree) Communications Company
Wayne, PA (PA-5 RSA) 360(degree) Communications Company
Union, PA (PA-8 RSA) 360(degree) Communications Company
Chambersburg, PA (PA-10 East RSA) 360(degree) Communications Company
Mifflin, PA (PA-11 RSA) Bell Atlantic/NYNEX Mobile
Lebanon, PA (PA-12 RSA) 360(degree) Communications Company
Binghamton, NY/PA Frontier/Bell Atlantic/NYNEX Mobile
Elmira, NY Frontier/Bell Atlantic/NYNEX Mobile
Charleston, WV 360(degree) Communications Company
Huntington, WV/OH/KY 360(degree) Communications Company
Parkersburg/Marietta WV/OH 360(degree) Communications Company
Jackson, WV (WV-l East RSA) Bell Atlantic/NYNEX Mobile
Logan, WV (WV-6 RSA) 360(degree) Communications Company
Athens, Ohio (OH-10 RSA) 360(degree) Communications Company
Chillicothe, Ohio (OH-9 RSA) U.S. Cellular Corp.
Pensacola, FL GTE Mobilnet
Fort Walton Beach, FL 360(degree) Communications Company
Myrtle Beach, SC (SC-5 RSA) 360(degree) Communications Company
Portland, ME Northeast Cellular/U.S. Cellular Corp.
Portsmouth, NH/ME Saco River Cellular, Inc./U.S. Cellular Corp.
Bar Harbor, ME (ME-4 RSA) U.S. Cellular Corp.
Many of the Company's wireline company competitors are affiliates of large
telecommunications corporations and may have access to greater capital resources
than the Company. In addition, many of the Company's competitors may have
greater marketing and technical resources than the Company.
Competition from Other Technologies. In addition to competition from the
other cellular carrier in each of its markets, the Company faces or will face
competition from PCS, Enhanced Specialized Mobile Radio ("ESMR") system
operators, and resellers of cellular and other facilities-based services.
Licensing for broadband PCS has been divided by the FCC into 51 Major
Trading Areas ("MTAs") and 493 Basic Trading Areas ("BTAs") based upon
geographic boundaries described in the 1992 Rand McNally Commercial Atlas &
Marketing Guide. Two licensees each will hold 30 MHz of PCS spectrum in each
MTA, one licensee will hold 30 MHz of PCS spectrum in each BTA and three
licensees will hold 10 MHz of PCS spectrum in each BTA. The FCC's rules limit a
cellular licensee to 45 MHz of aggregate spectrum in an area in which the
cellular licensee provides cellular services to 10% or more of the population.
The FCC's imposed 45 MHz cap for combined PCS/cellular spectrum means that
cellular carriers may acquire two 10 MHz PCS licenses now. Cellular licensees
are not limited by the two 10 MHz PCS license limitations outside of the areas
in which they operate cellular systems.
PCS services include wireless two-way telecommunications for voice, data
and other transmissions employing digital micro-cellular technology. PCS
operates in the 1850 to 1990 MHz band. PCS requires a network of small,
low-powered transceivers placed throughout a neighborhood, business office or
office complex, city or metropolitan area. PCS customers
9
communicate using digital devices similar to portable cellular telephones. The
Company is studying currently-available technology to offer similar services on
the 800 MHz cellular frequencies. There is no assurance that the Company will be
able to implement such technology, or if it decides to do so, that it can
implement these service features profitably and in a timely manner.
The Company is currently competing with a PCS operator in its Myrtle Beach
RSA and is aware of the construction of towers and other wireless infrastructure
by other competitive PCS providers in many of its other markets. PCS license
winners from which the Company faces the highest concentration of competition
are AT&T PCS and Omnipoint which have been awarded licenses in 69% and 45% in
the Company's markets, respectively. Many PCS license winners who will compete
with the Company have access to greater capital resources than the Company. Many
of these companies or their affiliates also own and operate cellular telephone
networks of substantial size and bring significant wireless communications
experience to their PCS operations.
The Company is preparing for the more competitive environment represented
by the introduction of PCS and other digitally-based communications technologies
by building out and enhancing its cellular telephone networks including the
conversion of its own networks to digital technology, increasing the quality of
coverage in its service areas, expanding its service areas by selected
acquisitions of adjacent and nearby cellular systems and by offering new
features, products and services to its customers that the Company believes will
be competitive with future communications providers that may utilize digital
technology. See " -- Products and Services." The Company believes that it can
effectively compete by utilizing its experience in developing and operating
cellular networks and by virtue of the barriers imposed by its extensive
existing system footprint. The Company believes that it has developed strong
distribution channels and customer service capabilities overseen by an
experienced management team. The Company's cellular systems are primarily
located in suburban and rural markets into which management believes new PCS
licensees are likely to enter only after initiation of PCS operations in higher
density markets which may be more economically attractive. The Company will
offer roaming services to PCS customers and has already entered into several
roaming contracts to do so.
The FCC has licensed ESMR system operators to construct digital mobile
communications systems on existing ESMR frequencies in many metropolitan areas
throughout the United States. One ESMR operator, NEXTEL, has announced the
initiation of nationwide service in over 200 cities. At this time, the Company
is unable to predict the extent to which and when ESMR system operators will
offer competitive services in the Company's markets or in adjacent areas.
Cellular system licensees are required by FCC policy to provide wholesale
cellular service to qualified resellers. A reseller provides cellular service to
customers but is not itself an FCC cellular license holder. A reseller typically
buys capacity on a cellular telephone network and is assigned a block of
cellular telephone numbers from a cellular carrier. The reseller markets provide
wireless telephone service through their own distribution channels to the
public. In this way, a reseller is not only a customer of the cellular telephone
licensee's service, but also competes with the licensee for customers.
The Company intends to explore mutually advantageous relationships with
resellers to supplement its existing distribution channels. Recently, MCI
Communications, Inc. and other large communications companies have begun
negotiating resale agreements in certain larger markets throughout the country.
The Company believes that it will receive increasing interest from persons
interested in reselling the Company's cellular service but there can be no
assurance that this will occur or that pursuing any such opportunities will be
profitable.
Regulation of Cellular Systems
Federal Regulation. The Company is subject to extensive regulation by the
Federal Government as a provider of cellular communications services. Pursuant
to the Communications Act of 1934, as amended (the "Communications Act"), the
licensing, construction, operation, acquisition and transfer of cellular
communications systems in the United States are regulated by the FCC. The FCC
has promulgated rules governing the construction and operation of cellular
communications systems and licensing and technical standards for the provision
of cellular telephone service ("FCC Rules"). For licensing purposes, the United
States is divided into 734 discrete geographically defined market areas
comprised of 306 MSAs and 428 RSAs.
In each market, the frequencies allocated for cellular telephone use are
divided into two equal 25 MHZ blocks and designated as Block A and Block B.
Block A licenses were initially reserved for nonwireline entities, such as the
Company. Block B licensees were initially reserved for entities affiliated with
a wireline telephone company. Under current FCC Rules, a Block A or Block B
License may be transferred with FCC approval without restriction as to wireline
affiliation, but generally, no entity may own a substantial interest in both
block A and Block B in any one MSA or RSA. The FCC may prohibit or impose
conditions on sales or transfers of licenses.
10
Cellular service providers must satisfy a variety of FCC requirements
relating to technical and reporting matters. One such requirement is the
coordination of proposed frequency usage with adjacent cellular users, permitees
and licensees in order to avoid interference between adjacent systems. In
addition, the height and power of base station transmitting facilities and the
type of signals they emit must fall within specified parameters. The FCC also
regulates cellular service resale practices and the terms under which certain
ancillary services may be provided through cellular facilities.
The Company also regularly applies for FCC authority to use additional
frequencies, to modify the technical parameters of existing licenses, to expand
its service territory and to provide new services. The Communications Act
requires prior FCC approval for transfers to or from the Company of a
controlling interest in any license or construction permit, or any rights
thereunder. Although there can be no assurance that any future requests for
approval of applications filed will be approved or acted upon in a timely manner
by the FCC, the Company has no reason to believe such requests or applications
would not be approved or granted in due course.
Initial operating licenses are generally granted for terms of up to 10
years, beginning on the dates of the grant of the initial operating authority
and are renewable upon application to the FCC. Licenses may be revoked and
license renewal applications denied for cause after appropriate notice and
hearing. The FCC generally grants current licensees a license renewal if they
have complied with their obligations under the Communications Act during their
license terms. A potential challenger would bear a heavy burden to demonstrate
that a license should not be renewed if the licensee's performance merits
renewal expectancy.
Near the conclusion of the license term, licensees must file applications
for renewal of licenses to obtain authority to operate for up to an additional
10-year term. Applications for license renewal may be denied if the FCC
determines that the grant of an application would not serve the public interest.
In addition, at license renewal time, other parties may file competing
applications for authorization. In the event that qualified competitors file,
the FCC may be required to hold a hearing to determine whether the incumbent or
the competitor will receive the license. In 1993, the FCC adopted specific
standards to apply to cellular renewals, concluding that it will award a renewal
expectancy to a cellular licensee that meets certain standards of past
performance. If the existing licensee receives a renewal expectancy, it is
likely that the existing licensee's cellular license will be renewed without a
full comparative hearing. To receive a renewal expectancy, a licensee must show
that it (i) has provided "substantial" service during its past license term, and
(ii) has substantially complied with applicable FCC Rules and policies and the
Communications Act. "Substantial" service is defined as service which is sound,
favorable and substantially above a level of mediocre service that might only
minimally warrant renewal.
In 1994, the Company filed for renewal of one expiring license (for the
Allentown-Bethlehem-Easton, PA/NJ MSA) which was originally granted by the FCC
in 1985. In 1995, the Company filed for renewal of two expiring licenses (for
the Northeast Pennsylvania, PA and Harrisburg, PA MSAs) which were originally
granted by the FCC in 1986. All three license renewals were granted without
challenge. The Company believes that it has met and will continue to meet all
requirements necessary to secure renewal of its remaining cellular licenses
which are scheduled to expire between 1997 and 2005. However, there can be no
assurances that any such licenses will be renewed.
In July 1994, the FCC issued a notice proposing a requirement whereby all
cellular carriers would have to provide interexchange carriers with equal
access. Currently, only AT&T-affiliated cellular carriers and the cellular
affiliates of the Regional Bell Operating Companies ("RBOCs") are required to
provide equal access. The FCC also proposed requiring all commercial mobile
radio service providers to provide interconnection to other mobile service
providers. In April 1995, however, the FCC tentatively concluded that it would
be premature to adopt such a requirement. The Telecommunications Act of 1996
(the "Telecom Act") provides that a cellular carrier need not provide equal
access unless such denial is contrary to the public interest.
The Telecommunications Act of 1996. The Telecom Act makes changes to the
Communications Act and the antitrust consent decree applicable to the RBOCs,
affecting the cellular industry. This legislation, among other things, affects
competition for local telecommunications services, interconnection arrangements
for carriers, universal service funding and the provision of interexchange
services by the RBOCs' wireless systems.
The Telecom Act requires state public utilities commissions and/or the FCC
to implement policies that mandate cost-based reciprocal compensation between
cellular carriers and local exchange carriers for interconnection services. The
Company believes that implementation of these policies may result in a
substantial decrease in interconnection expenses incurred by the Company.
Pursuant to the requirements of the Act, the Company has entered into
negotiations with all of the local exchange carriers who provide interexchange
service to the Company and its customers. These negotiations have resulted in
contracts containing significant decreases in the rates charged by many of the
LEC's and have also provided for the LEC to
11
pay reciprocal compensation to the Company for calls the Company terminates to
its customers. Although, the Company has not yet concluded negotiations with all
of these LEC's, the Company believes that ultimately it will achieve significant
cost savings along with reciprocal compensation as mandated under the Act. These
contractual arrangements must be reviewed by state public utility commissions
within 90 days of submission, or the agreements will become effective
automatically.
The Telecom Act also eases the restrictions on provision of interexchange
telephone services by wireless carriers affiliated with RBOCs. RBOC-related
wireless carriers have interpreted the legislation to permit immediate provision
of long distance call delivery for their cellular customers and have begun
providing this service.
State and Local Approvals. Congress amended the Communications Act to
preempt, as of August 10, 1994, state or local regulation of the entry of, and
the rates charged by, any commercial mobile service or any private mobile
service, which includes cellular telephone service. The Company is free to
establish rates and offer new products and services with a minimum of regulatory
requirements. Several of the nine states in which the Company operates still
maintain nominal oversight jurisdiction, primarily focusing upon resolution of
customer complaints.
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 and must secure state certification and tariff approvals, if required.
The time needed to obtain zoning approvals and requisite site permits varies
from market to market and state to state. Similarly, 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.
Zoning and planning regulation may become more restrictive in the future
with the addition of PCS carriers which are seeking sites for network
construction as well. The industry is seeking relief from local laws which
arbitrarily restrict the expansion of cellular networks. The Telecom Act
provides potential limited relief by permitting the FCC to preempt states and
localities from applying regulations in a manner which has the effect of
prohibiting construction and operation of new cell sites. The Company is
currently the plaintiff in one of the first lawsuits in Federal Court
challenging a local zoning denial on the basis of the provisions of the Telecom
Act.
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.
The FCC does however have the power to waive these restrictions in appropriate
circumstances. The FCC has interpreted these restrictions to apply to
partnerships and other business entities as well as corporations, subject to
certain modifications. Failure to comply with these requirements may result in
denial or revocation of licenses.
Other Investments
International Wireless Communications Holdings, Inc. and Foreign
Investments. The Company believes that foreign markets offer significant
opportunities for wireless communications providers because of the limited
availability of traditional landline telephone systems in many countries and the
increasing demand for communications services. The Company's strategy is to
pursue opportunities in the international arena as they arise without diverting
the Company's financial and personnel resources from its primary business.
Accordingly, the Company has pursued such opportunities through joint ventures
with local entities and others and its investment in International Wireless
Communications Holdings, Inc. ("IWC"). As of December 31, 1996, the Company had
invested approximately $13.8 million and owned a 36% equity interest in IWC. IWC
is a development stage company specializing in securing, building and operating
wireless businesses, generally other than cellular telephone systems, primarily
in Asia and Latin America.
Subsequent to December 31, 1996, the Company entered into a stock purchase
agreement to purchase from an unrelated third party 7% of the outstanding shares
of Star Digitel Limited ("SDL"), a Hong Kong company whose principal business
activities relate to the provision and development of cellular
telecommunications services in the People's Republic of China. Pursuant to the
stock purchase agreement, the Company's purchase of such shares will occur in
two closings, which are
12
subject to the satisfaction of certain conditions, for an aggregate cash
consideration of $8.4 million. IWC also recently acquired and maintains a 40%
ownership interest in SDL.
There is no assurance that the Company's international activities will
prove successful.
Inter(Bullet)Act Systems, Incorporated. The Company has invested
approximately $10 million in Inter(Bullet)Act Systems, Incorporated
("Inter(Bullet)Act") common stock for an aggregate ownership interest of
approximately 26%. In addition, during 1996 the Company purchased for $12.0
million a total of 18,000 units consisting of $18.0 million principal amount at
maturity of 14% Senior Discount Notes Due 2003 and warrants to purchase 132,012
shares of common stock at $.01 per share, subject to certain adjustments.
Inter(Bullet)Act is a development stage company that provides targeted
promotions to retail customers at the point of entry at a retail outlet,
primarily supermarkets, through a computer-equipped ATM-like terminal. Certain
officers and directors of the Company, as well as entities affiliated with
certain directors of the Company, have made investments in Inter(Bullet)Act. As
a group, these persons and entities had an ownership interest of approximately
27% as of December 31, 1996. (See "Item 13. Certain Relationships and Related
Transactions.")
Geotek Communications, Inc. In 1994, the Company purchased for $30 million
from Geotek Communications Inc. ("Geotek") 2.5 million shares of its common
stock and options to invest up to $167 million for an aggregate of 10 million
additional shares and also entered into a five-year management consulting
agreement to provide operational and marketing support to Geotek in exchange for
300,000 shares of Geotek common stock per year. Geotek is a telecommunications
Company that is developing a wireless communications network in certain
metropolitan markets in the United States based on its FHMA digital technology.
Its common stock is traded on the Nasdaq National Market System. In September
1995, the Company purchased for $5 million in cash 531,463 shares of convertible
preferred stock of Geotek with a stated value of $9.408 per share. On September
15, 1996, the Company allowed the initial series of options to expire
unexercized and, as a result, all other options and the management consulting
agreement also expired.
Employees
As of December 31, 1996, the Company had approximately 1,800 full-time
employees, including approximately 600 employees associated with its direct
sales force. None of those employees are represented by a labor organization.
Management considers its employee relations to be good.
13
CERTAIN DEFINITIONS
Certain terms used in this Annual Report are defined with particular
meanings as used herein.
Analog: Transmission method employing a continuous (rather than pulsed or
digital) electrical signal that varies in amplitude or frequency in response to
changes in sound, light or position.
Bandwidth: (1) Difference between the top and bottom limiting frequencies
of a continuous frequency band. (2) Indicates the information-carrying capacity
of a channel. FCC-licensed cellular operators have been allocated a continuous
25 MHZ bandwidth in the 824-849 MHZ band or 869-894 MHz band.
BTA: One of the 493 Basic Trading Areas, which are smaller than MTAs, into
which the licensing for broadband PCS has been divided based on the geographic
divisions in the 1992 Rand McNally Commercial Atlas & Marketing Guide.
CDMA: Code Division Multiple Access digital technology. Technique that
spreads a signal over a frequency band that is larger than the signal to enable
the use of a common band by many users and to achieve signal security and
privacy.
CDPD: Cellular Digital Packet Data, a new packet data network protocol
which offers fast and reliable data transmission without using large amounts of
network capacity.
Cell site: The entire infrastructure and radio equipment associated with
acellular transmitting and receiving station, including the land, building,
tower, antennas and electrical equipment.
Clusters: A group of contiguous markets, the provision of which facilitates
wide areas of uninterrupted cellular service, reduced airtime rates, automatic
delivery of inbound calls and simplified dialing patterns.
Communications Act: The Communications Act of 1934, as amended.
Controlled markets: Markets in which the Company's ownership interest is
greater than 50% as well as the Wilmington and Jacksonville, North Carolina
markets which are jointly controlled by the Company and a subsidiary of GTE
Corporation.
CTIA: The Cellular Telecommunications Industry Association.
Digital: Transmission system in which information is transmitted in a
series of pulses.
ESMR: Enhanced Specialized Mobile Radio communications services, supplied
by converting analog SMR services into an integrated, digital transmission
system providing for call hand-off, frequency reuse and wide-call delivery
networks.
FAA: The United States Federal Aviation Administration.
FCC: The United States Federal Communications Commission.
FCC Rules: The rules promulgated by the FCC governing the construction and
operation of cellular communications systems and licensing and technical
standards for the provision of cellular communications service.
IXC: Usually referred to as long-distance providers. There are many
facilities-based IXCs including AT&T, MCI, WorldCom, Sprint and Frontier, as
well as competitive access providers that are authorized for IXC services.
LEC: A Company providing local telephone services.
Market: An MSA or RSA.
Metro-cluster: A group of contiguous markets, the provision of which
facilitates wide areas of uninterrupted cellular service, reduced airtime rates,
automatic delivery of inbound calls and simplified dialing patterns.
MSA: One of the Metropolitan Statistical Areas for which the FCC licensed
cellular communications systems.
MTA: One of the 51 Major Trading Areas into which the licensing for
broadband PCS has been divided based on the geographic divisions in the 1992
Rand McNally Commercial Atlas & Marketing Guide.
MTSO: A mobile telephone switching office, through which cell sites are
connected to the local landline telephone network.
Net POPs: The estimated population with respect to a given service area
multiplied by the percentage interest that the Company owns in the entity
licensed by the FCC to operate a cellular communications system within that
service area.
14
Nonwireline license: The license for a market initially awarded to a
Company or group that was not affiliated with a local landline telephone carrier
in such market.
PCS: Personal Communications Services. Emerging technologies providing
wireless access to the local and long distance telephone system. Most PCS plans
call for low-powered, light weight pocket phones with individual, personal
telephone numbers that can be accessed without geographic restriction.
Penetration: Customers divided by POPs in a given area.
POPs: The estimate of the 1996 population of a MSA or RSA, as derived from
the 1996 population estimates prepared by Strategic Mapping, Inc.
RBOCs: The Regional Bell Operating Companies.
Reseller: A Company that provides cellular service to customers but does
not hold an FCC cellular license or own cellular facilities. A reseller secures
blocks of cellular telephone numbers from a licensed carrier and, in turn, sells
service through its own distribution network to the public.
RF: Radio frequency.
Roamer: A cellular customer who makes or receives calls when traveling in
another cellular Company's market using his/her home cellular phone.
Roaming: The ability of cellular customers to make or receive calls when
traveling in another cellular Company's market. Occurs when a cellular customer
leaves the cellular carrier's home area and uses his cellular phone.
Roaming agreement: Agreement entered into with other domestic cellular
companies that allow the Company's customers to make or receive calls when
traveling in another cellular Company's market.
RSA: One of the Rural Service Areas for which the FCC licensed cellular
communications systems.
Service area: An MSA or RSA.
SMR: Specialized Mobile Radio communications services.
TDMA: Time Division Multiple Access digital technology, which designates a
time frame for cellular users to transmit within a frequency.
Wireline license: The license for a market initially awarded to a Company
or group that was affiliated with a local landline telephone carrier in such
market.
15
Item 2. Properties
The Company owns or leases certain properties in addition to the interests
in cellular licenses presently owned by the Company. The Company leases its
principal executive offices located in Greensboro, North Carolina, consisting of
approximately 86,000 square feet of office space. In addition, in April 1997,
the Company will occupy an additional 55,000 square feet of office space
adjacent to its principal executive offices. The Company either owns or leases
under long-term contracts 400 cell site locations, eight cellular switch
locations and certain office and retail space in its operating cellular markets.
Rent expense under operating leases was $9.3 million in 1996.
Item 3. Legal Proceedings
The only legal proceedings pending against the Company or any of its
subsidiaries are routine filings with the FCC and state regulatory authorities
and customary regulatory proceedings pending in connection with acquisitions and
interconnection rates and practices, proceedings concerning the
telecommunications industry generally and other proceedings arising in the
ordinary course of business which management believes, even if resolved
unfavorably to the Company, would not have a materially adverse effect on the
company's business.
Item 4. Submission of Matters to a Vote of Security Holders
There were no matters that were submitted to a vote of security holders of
the Company during the quarter ended December 31, 1996.
Item 4 (a). Executive Officers of the Registrant
The following table sets forth certain information about each of the
Company's executive officers:
Name Age Position
Haynes G. Griffin 50 Chairman of the Board of Directors,
Co-Chief Executive Officer
Stephen R. Leeolou 41 President, Co-Chief Executive Officer, Director
Stuart S. Richardson 50 Vice Chairman of the Board of Directors
L. Richardson Preyer, Jr. 49 Vice Chairman of the Board of Directors,
Executive Vice President, Treasurer
Stephen L. Holcombe 40 Executive Vice President, Chief Financial
Officer
Richard C. Rowlenson 47 Executive Vice President, General Counsel
Timothy G. Biltz 38 Executive Vice President -- Marketing and
Customer Service, President of U.S. Wireless
Operations
S. Tony Gore, III 50 Executive Vice President -- Acquisitions and
Corporate Development
Dennis B. Francis 44 Executive Vice President -- Technical Services
Haynes G. Griffin is a co-founder of the Company and has been a director
since 1985 and was elected Chairman of the Board of Director in November, 1996.
Mr. Griffin serves also as Co-Chief Executive Officer and served as Chief
Executive Officer from the Company's inception until November 1996. Mr. Griffin
is Chairman of the Board of International Wireless Communications Holdings, Inc.
and is a member of the Boards of Directors of Lexington Global Asset Managers,
Inc., Inter(Bullet)Act Systems, Inc. and Geotek Communications, Inc. Mr. Griffin
currently serves on the United States Advisory Council on the National
Information Infrastructure. He is a past Chairman of the Cellular
Telecommunications Industry Association.
Stephen R. Leeolou is President and Co-Chief Executive Officer, a director
and a co-Founder of the Company. Prior to becoming President in November 1996,
Mr. Leeolou served as Executive Vice President, Chief Operating Officer and
Secretary and a director of the Company. Mr. Leeolou is the Chairman of the
Board of Inter(Bullet)Act Systems, Inc. and is a director and former Chairman of
the Board of International Wireless Communications, Inc. Prior to joining the
Company, from 1983 to 1984, Mr. Leeolou was President and Secretary of Caro-Cell
Communications, Inc., and from 1978 to 1983 was a television news anchorman with
three successive network-affiliated stations.
16
Stuart S. Richardson has been a director since 1985 and was elected
Chairman of the Board of Directors in 1986 and currently serves as Vice Chairman
of the Board of Directors. Since 1995, Mr. Richardson has been Chairman of the
Board of Lexington Global Asset Managers, Inc., a diversified financial services
holding Company. From 1985 to 1995, Mr. Richardson was an executive of Piedmont
Management Company, Inc., formerly the parent corporation of Lexington Global
Asset Managers, Inc., and served as its Vice Chairman from 1986 to 1995. Mr.
Richardson also serves as a director of Chartwell Reinsurance Co. and
Inter(Bullet)Act Systems, Inc. and is the former Chairman of the Board of
Richardson-Vicks, Inc. Mr. Richardson's second cousin, L. Richardson Preyer,
Jr., and Mr. Preyer's father, L. Richardson Preyer, Sr., are also directors.
L. Richardson Preyer, Jr. is Vice Chairman of the Board, Executive Vice
President, Treasurer and a co-founder of the Company. Mr. Preyer serves as
Administrative Trustee of Piedmont Associates and Southeastern Associates,
investment partnerships, and is a director of Inter(Bullet)Act Systems, Inc.
Stephen L. Holcombe is Executive Vice President and Chief Financial Officer
of the Company. From 1978 to 1985, Mr. Holcombe served in various positions with
KPMG Peat Marwick and was a senior audit manager when he left to join the
Company in 1985. Mr. Holcombe is a member of the North Carolina Association of
Certified Public Accountants.
Richard C. Rowlenson is Executive Vice President and General Counsel of the
Company. From 1975 until joining the Company in 1987, Mr. Rowlenson was engaged
in the practice of communications law in Washington, D.C. Mr. Rowlenson is a
member of the Federal Communications Bar Association.
Timothy G. Biltz joined the Company as Vice President -- Marketing and
Customer Service in August 1989 and was promoted to Senior Vice President in
November 1990 and Executive Vice President in November 1996. Prior to joining
the Company, Mr. Biltz was Regional Manager for Providence Journal Cellular
Management Services, Inc. in Raleigh, N.C. from 1987 to 1989, and was
responsible for the development of regional marketing and operations programs
for several markets.
S. Tony Gore, III is Executive Vice President of Acquisitions and Corporate
Development. He is presently a task force member of the North Carolina
International Commission on Economic Development. Prior to joining the Company
in 1985, Mr. Gore was Chief Executive Officer of Atlantic Coast Entertainment
Systems, Inc.
Dennis B. Francis joined the Company as Director of Technical Services in
September 1992 and was promoted to Vice President in 1993 and Senior Vice
President in 1995 and Executive Vice President in November 1996. Prior to
joining the Company, Mr. Francis was with Southwestern Bell Mobile Systems for
nine years, most recently as Vice President of Network Operations for the
Washington/Baltimore cellular system.
17
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters
Price Range of Common Stock
1996 1995
High Low High Low
First Quarter.................................................. $23.50 $18.00 $28.25 $22.25
Second Quarter................................................. 24.66 20.00 25.50 21.50
Third Quarter.................................................. 23.75 17.50 29.66 23.50
Fourth Quarter................................................. 19.38 14.25 25.75 19.75
The high and low bid prices are as reported by the NASDAQ National
Market System. These price quotations reflect inter-dealer prices, without
mark-down or commissions, and may not necessarily represent actual
transactions. On March 1, 1997, there were approximately 978 shareholders of
record.
As discussed in Note 4 to the Consolidated Financial Statements in Item 8
and Management's Discussion and Analysis of Financial Condition and Results of
Operations in Item 7, the convenants under the Company's long-term credit
facility and its Senior Debentures due 2006 limit the payment of cash dividends
on common stock. The Company has not paid any cash dividends on its common stock
since its inception and does not anticipate paying dividends in the foreseeable
future.
18
Item 6. Selected Consolidated Financial Data
For the Years Ended December 31,
1996 1995 1994 1993 1992
(Amounts in thousands, except per share data)
Statement of Operations Data:
Revenue:
Service revenue (a)........................................... $282,694 $217,440 $146,417 $ 98,960 $ 72,791
Cellular telephone equipment revenue.......................... 15,120 15,647 18,529 9,929 5,999
Other......................................................... 4,240 2,984 3,055 175 --
302,054 236,071 168,001 109,064 78,790
Costs and expenses:
Cost of service............................................... 31,678 27,043 21,008 14,461 11,044
Cost of cellular telephone equipment.......................... 25,372 25,605 29,933 13,410 7,579
General and administrative.................................... 80,057 60,489 44,019 34,218 29,334
Marketing and selling......................................... 62,384 54,906 37,102 21,693 16,877
Depreciation and amortization (b)............................. 48,635 36,170 24,073 25,160 22,100
248,126 204,213 156,135 108,942 86,934
Income (loss) from operations.................................... 53,928 31,858 11,866 122 (8,144)
Net gains (losses) on disposition................................ 6,716 1,787 (339) (657) (2,655)
Interest expense................................................. (46,199) (38,293) (22,126) (15,389) (16,177)
Equity in earnings (losses) of unconsolidated affiliates......... (13,816) (2,261) 206 500 (329)
Other, net....................................................... 1,680 (101) (3,399) (295) 342
Income tax benefit (c)........................................... 4,109 -- -- -- --
Minority interests............................................... 31 (3) (153) (154) 304
Income (loss) before extraordinary item.......................... 6,449 (7,013) (13,945) (15,283) (26,659)
Extraordinary charge (d)......................................... -- -- (8,402) (3,715) --
Net income (loss)................................................ $ 6,449 $ (7,013) $(22,347) $(18,998) $(26,659)
Net income (loss) per share before extraordinary item (e)........ $ 0.16 $ (0.17) $ (0.36) $ (0.40) $ (0.72)
Net income (loss) per share (e).................................. $ 0.16 $ (0.17) $ (0.58) $ (0.50) $ (0.72)
Weighted average number of common shares outstanding............. 41,320 41,100 38,628 38,038 37,110
Other Data:
Capital expenditures (f)......................................... $130,805 $129,894 $ 62,632 $ 21,009 $ 18,243
EBITDA (g)....................................................... 102,563 68,028 35,939 25,282 13,956
Total subscribers in majority owned markets at year end.......... 513.0 381.0 245.0 132.3 92.3
Balance Sheet Data (end of period):
Working capital (deficiency)..................................... $ (5,962) $ 4,997 $ (1,778) $ 4,696 $ (1,185)
Property and equipment, net...................................... 313,800 225,206 120,325 71,716 72,026
Total assets..................................................... 730,581 596,577 431,711 284,429 251,820
Long-term debt (including current portion)....................... 629,954 522,143 348,649 238,153 199,712
Shareholders' equity............................................. 33,451 29,048 39,207 21,898 30,265
19
(a) In 1994, in order to conform to industry practice, the Company
reclassified certain pass-through items previously recognized as service
revenue to offset the related cost of service expenses. These reclassified
items relate to charges associated with the Company's subscribers roaming
into adjacent cellular markets. Appropriate reclassifications have been
made in each period presented.
(b) Effective January 1, 1994, the Company changed its depreciation expense
period for approximately 30% of its property and equipment from seven years
to a 10 to 20 year schedule. The effect of this change was to reduce
depreciation for the year ended December 31, 1994 by $4.5 million.
(c) In 1996, the Company recognized a deferred income tax benefit of $5.0
million, net of current income tax expense of $891,000. In prior years,
the Company made the determination that it was uncertain that its net
deferred income tax assets would be realized. See -- Item 7. Management's
Discussion and Analysis of Results of Operations and Financial Position.
(d) The extraordinary charges for the years ended December 31, 1994 and 1993 of
$8.4 million and $3.7 million, respectively, reflect the write-off of
deferred financing costs associated with the Company's credit facilities
that were replaced during 1994 and 1993.
(e) Adjusted to reflect the Company's three-for-two Class A common stock split
effected August 24, 1994.
(f) Capital expenditures exclude acquisitions.
(g) EBITDA consists of income (loss) from operations before depreciation and
amortization. Although EBITDA is not a measure of performance calculated in
accordance with Generally Accepted Accounting Principles ("GAAP"),
management believes that it is useful to a prospective investor because it
is a measure widely used in the cellular industry to evaluate a Company's
operating performance. EBITDA, however, should not be considered in
isolation or as a substitute for net income, cash flows from operating
activities and other income or cash flow statement data prepared in
accordance with GAAP or as a measure of liquidity or profitability.
20
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following is a discussion and analysis of the historical financial
condition and results of operations of the Company and factors affecting the
Company's financial resources. This discussion should be read in conjunction
with the Company's consolidated financial statements, including the notes
thereto.
Years Ended December 31, 1996 and 1995
Service revenue in 1996 rose 30% to $282.7 million from $217.4 million in
1995. This increase was primarily the result of a 132,000 or 35% increase in the
number of subscribers in majority-owned markets to approximately 513,000 in
1996, including 5,000 added as a result of acquisitions, as compared to
approximately 381,000 in 1995. Penetration, computed as a percentage of the
Company's subscribers to total POPs in majority owned cellular markets,
increased to 6.8% in 1996 from 5.3% in 1995. The increase in subscribers is the
result of the growing acceptance of cellular communications and the Company's
efforts to capitalize on this increasing acceptance through an expanded sales
and distribution network. This increase was offset slightly by an increase in
"churn" in 1996 to 2.2% from 2.1% in the same period in 1995 due to economic
concerns felt by certain segments of the Company's subscriber base and by
increased price competition at lower end rate plans. Churn is the monthly rate
of customer deactivations expressed as a percentage of the subscriber base.
Service revenue attributable to the Company's own subscribers (local
revenue) increased 34% during 1996 to $236.1 million as compared to $175.9
million in 1995. Average monthly local revenue per subscriber declined 4% to $45
in 1996 compared to $47 in the prior year. This decline was primarily due to the
continued pattern of increased incremental penetration into the segment of
consumers who generally use their cellular phones less frequently. Service
revenue generated by nonsubscribers roaming into the Company's markets increased
12% to $46.6 million in 1996 as compared to $41.5 million in the prior year.
This increase was the result of increased usage and was partially offset by
continued reductions in daily access and usage rates which is occurring in the
industry with increasing frequency. The reduced rates affect the Company both as
a provider and purchaser of roaming services. The revenue from the Company's
customers combined with roaming revenue resulted in overall average monthly
revenue per subscriber for the year of $54, a decline of 7% from $58 in the
prior year.
Cellular telephone equipment revenue decreased $527,000 or 3.4% to $15.1
million in 1996 as compared to 1995. Cost of cellular telephone equipment
decreased 1% to $25.4 million during the same period. Net loss on cellular
equipment was $10.3 million, an increase of 3% from $10.0 million net loss on
cellular equipment experienced in 1995. The Company continues to sell telephones
at or below cost for marketing purposes in response to competitive pressures and
also continues the availability of its rental program.
Cost of service as a percentage of service revenue decreased to 11% during
1996 from 12% during 1995 primarily as a result of the Company's continuing
effort to reduce the charges associated with roamer fraud. The Company estimates
that charges associated with roamer fraud included in cost of service decreased
from approximately 4% of service revenue in the fourth quarter of 1995 to
approximately 1% during 1996. To address the industry wide issue of fraud, the
Company continues its detection procedures such as the use of computerized
systems which trigger alarms when cellular usage conflicts with subscriber
profiles. In addition, implementation of additional technology designed to
authenticate valid users will assist the Company in preventing fraud in the
future. The costs of these continued detection efforts and implementation of new
technologies are expected to be approximately $1.5 million in 1997. Cellular
fraud is expected to be a significant industry issue for the foreseeable future.
General and administrative expenses increased 32% or $19.5 million during
1996 as compared to 1995, but as a percentage of service revenue remained
constant at approximately 28% during both years. This increase is due primarily
to compensation expense resulting from increases in the Company's employee base.
General and administrative expenses as a percentage of service revenue are
expected to decline slowly as the Company adds more subscribers without
commensurate increases in general and administrative overhead and experiences
higher utilization of the Company's existing personnel and systems.
Marketing and selling expenses increased 14% to $62.4 million during 1996,
compared to $54.9 million in 1995. As a percentage of service revenue, these
expenses decreased from 25% in 1995 to 22% in 1996. During 1996, marketing and
selling expenses including the net loss on cellular equipment ("Combined
Marketing and Selling Expenses") increased to $72.6 million from $64.9 million
in 1995. Combined Marketing and Selling Expenses per net subscriber addition
(excluding subscribers gained through acquisitions) increased 12% to $572 in
1996 from $511 in 1995. This increase was primarily due to an increase in churn
discussed above. Combined Marketing and Selling Expenses per gross subscriber
addition (excluding subscribers gained through acquisitions) decreased to $301
in 1996 from $327 in 1995. While the Company has benefitted
21
from the increased success of external distribution channels, the Company
continues to emphasize internal distribution channels, which it believes result
in higher long-term profit margins. The Company has discontinued its agent
relationship with the Radio Shack chain, effective January 1, 1997. The Company
has chosen to do so as a result of the escalating per activation commission
charges which Radio Shack would have required had the relationship continued.
The loss of the 60 Radio Shack locations from the retail distribution channel is
an important event but management believes that its own increasing presence in
the retail marketplace will help mitigate any effect on gross subscriber
additions. In addition, management believes that attracting new subscribers
through its own internal retail channel at a cost that is more reasonable is in
the best long-term interest of the Company.
Depreciation and amortization expenses increased $12.5 million or 34%
during 1996 as compared to 1995. Property and equipment placed in service in
1996 of approximately $130.8 million together with property and equipment placed
in service in 1995 of $129.9 million, which had its first complete year of
depreciation in 1996, accounted for substantially all of this increase.
Interest expense increased $7.9 million or 21% during 1996. This increase
primarily resulted from an increase in average borrowings of approximately
$110.6 million, and an increase in interest rates on $200 million of borrowings
represented by the Debentures, offset slightly by a decrease in average interest
rates charged.
Equity in losses of unconsolidated investments increased by $11.6 million.
This increase resulted primarily from higher operating, amortization and
interest expenses incurred by both Inter(Bullet)Act and IWC as a result of
expanding operations which were made possible by high yield debt financings
completed during the third quarter of 1996 by each company aggregating
approximately $200 million. Due to the increased losses by these investees the
Company has recognized an amount of losses equal to its investment and
accordingly has suspended recognition of losses on IWC as of December 31, 1996
and expects to do so for Inter(Bullet)Act during 1997. See "Liquidity and
Capital Resources".
In 1996, the Company recognized a deferred income tax asset of $5.0
million, net of current income tax expense of $891,000. Management concluded at
December 31, 1996 that it is "more likely than not" that $5.0 million of the
Company's net deferred income tax assets will be realized. This assessment
considered the Company's historical operating trends, current forecasts and
certain other factors. Prior to 1996, the Company made the assessment that
realization of its net deferred income tax assets was uncertain due primarily to
its history of operating losses. See "Liquidity and Capital Resources -- Income
Taxes."
The Company reported net income of $6.4 million or $0.16 per share for 1996
as compared to a net loss of $7.0 million or $0.17 per share for 1995. This
$13.4 million positive change in net income is due primarily to the rate of
revenue growth exceeding the rate of growth in related operating expenses and
due to the recognition of a $4.1 million net income tax benefit in 1996.
Years Ended December 31, 1995 and 1994
Service revenue rose 49% to $217.4 million from $146.4 million in 1994
primarily as a result of a 56% increase in the number of subscribers in
majority-owned markets to approximately 381,000 as of December 31, 1995, as
compared to approximately 245,000 subscribers at the end of 1994. Approximately
88% of the increase in the number of subscribers was due to subscriber growth in
markets controlled by the Company at the end of both years, and the remainder
was due to the acquisition of new markets and subsequent subscriber additions in
those markets.
Total net subscribers in the Company's majority-owned markets increased by
136,000 during 1995 as compared to an increase of 112,700 in 1994. Of the total
1995 increase, 14,400 and 9,000 net activations were attributable to subscribers
in markets acquired by the Company during 1995 and 1994, respectively.
Penetration increased from 3.65% at December 31, 1994 to 5.34% at December 31,
1995. The increase in subscribers and incremental penetration is the result of
the growing acceptance of cellular communications and the Company's marketing
efforts and expanded distribution network.
Service revenue attributable to the Company's own subscribers (local
revenue) increased 60% during 1995 to $175.9 million as compared to $110.1
million in 1994. Average monthly local revenue per subscriber declined 11% to
$47 in 1995 compared to $53 in the prior year. This decline was primarily due to
increased incremental penetration into the segment of consumers who generally
use their cellular phones less frequently and, to a lesser extent, to the
acquisition of markets with subscribers who produce lower local revenue. Service
revenue generated by nonsubscribers roaming into the Company's markets increased
14% to $41.5 million as compared to $36.3 million in the prior year period. This
increase was the result of
22
increased usage and was partially offset by reductions in daily access and usage
rates of approximately 30% initiated by the Company and agreed to by certain
other cellular providers in the mid-Atlantic region in 1995. The revenue from
the Company's customers combined with roaming revenue resulted in overall
average monthly revenue per subscriber for the year of $58, a decline of 17%
from $70 in the prior year period.
Cellular telephone equipment revenue decreased $2.9 million or 16% to $15.6
million for 1995 as compared to 1994. Cost of cellular telephone equipment
decreased 14% to $25.6 million during 1995 due to increased activity in the
Company's rental phone program and a corresponding reduction in sales. Net loss
on cellular equipment was $10.0 million, a decrease of 12% from the $11.4
million net loss on cellular equipment experienced in the prior year period.
Cost of service as a percentage of service revenue improved from 14% during
1994 to 12% during 1995, primarily as a result of the intercarrier roaming rate
reductions described above. The balance of the decrease was due to the continued
negotiation of more favorable long distance and interconnection agreements with
service providers and, to a lesser extent, the higher utilization of the
Company's cellular systems. Cost of service would have shown greater improvement
as a percentage of service revenues were it not for the effects of roaming fraud
experienced by the Company in the last three months of 1995.
General and administrative expenses increased 37% or $16.5 million during
1995, but decreased as a percentage of service revenue to 28% from 30% in 1994.
These expenses declined as a percentage of service revenue primarily as a result
of limited increases in many overhead expenses resulting in higher utilization
of the Company's existing personnel and systems.
Marketing and selling expenses increased 48% to $54.9 million during 1995,
compared to $37.1 million in 1994. As a percentage of service revenue, these
expenses remained at 25%. During 1995, Combined Marketing and Selling Expenses
increased to $64.9 million from $48.5 million in 1994. This increase was
primarily attributable to sales commissions associated with the growth in
subscribers for the 1995 period as compared to the 1994 period and an increase
in salesperson salaries. Combined Marketing and Selling Expenses, excluding the
number of subscribers in acquired markets at the time of acquisition, per net
subscriber addition increased 4% to $511 in 1995 from $493 in 1994. This
increase was primarily due to increases in the proportion of total subscriber
activations effected through independent agents and increases in subscriber
churn.
Depreciation and amortization expenses increased $12.1 million or 50%
during 1995 as compared to 1994. Capital expenditures of approximately $129.9
million during 1995 accounted for substantially all of the $8.4 million increase
in depreciation expense. The balance of the increase is the result of the
amortization of licenses and customer base acquired through acquisitions during
the same period.
Interest expense increased $16.2 million or 73% during 1995. This increase
primarily resulted from an increase in average borrowings of approximately
$162.0 million.
The Company reported a net loss of $7.0 million or $0.17 per share as
compared to a net loss before extraordinary item of $13.9 million or $0.36 per
share for 1994. This reduction in net loss before extraordinary item is due to
the rate of revenue growth exceeding the rate of growth in related operating
expenses as discussed above.
Liquidity and Capital Resources
The Company requires capital to acquire, construct, operate and expand its
cellular systems. The Company also explores, on an ongoing basis, possible
acquisitions of cellular systems and properties as well as other investment
opportunities, some of which may involve significant expenditures or
commitments. In addition, although the initial buildout of its cellular system
is complete, the Company will continue to construct additional cell sites and
purchase cellular equipment to increase capacity as subscribers are added and
usage increases, to expand geographic coverage and to provide for increased
portable usage. The Company spent approximately $38.8 million and exchanged
certain cellular assets in connection with acquisitions in 1996 and spent
approximately $130.8 million on total capital expenditures in 1996. The Company
spent approximately $69.9 million and exchanged certain cellular assets in
connection with acquisitions in 1995 and spent $129.9 million on total capital
expenditures in 1995.
The specific capital requirements of the Company will depend primarily on
the timing and size of any additional acquisitions and other investments as well
as property and equipment needs. EBITDA has been a growing source of internal
23
funding in recent years, but the Company does not expect EBITDA to grow
sufficiently to meet both its property and equipment and debt service
requirements for at least the next two years. In recent years, the Company has
met its capital requirements primarily through bank financing, issuance of
public debentures, private issuances of its Class A Common Stock and internally
generated funds and the Company intends to continue to use external financing
sources in the future.
EBITDA does not represent and should not be considered as an alternative to
net income or operating income as determined by generally accepted accounting
principles. It should not be considered in isolation from other measures of
performance according to such principles, including operating results and cash
flows. EBITDA increased to $102.6 million in 1996 from $68.0 million in 1995 and
net cash provided by operating activities as shown on the Statement of Cash
Flows increased to $60.4 million in 1996 from $30.0 million in 1995. Net cash
provided by operating activities in 1996 reflects a $7.9 million increase in
interest expense, attributable primarily to increased borrowings and a decrease
in working capital items of $4.5 million. Investing activities, primarily
purchases of property and equipment and acquisitions of investments, used net
cash of $152.9 million and $204.6 million in 1996 and 1995, respectively.
Financing activities provided net cash of $95.6 million in 1996, primarily by
proceeds from long-term debt of $107.8 million net of repayments. In 1995, the
proceeds from issuances of long-term debt represented substantially all of the
cash provided by financing activities.
Financing Agreements. The Company's long-term debt consists primarily of a
$675 million credit facility (the "Credit Facility") and $200 million of 9 3/8%
Senior Debentures due 2006 (the "Debentures"). On December 23, 1994, the Company
completed the closing of its Credit Facility, pursuant to an Amended and
Restated Loan Agreement, with various lenders led by The Toronto-Dominion Bank
and The Bank of New York. The Credit Facility, which refinanced the Company's
$390 million 1993 Loan Agreement, consists of a $325 million term loan ("Term
Loan") and a $350 million revolving loan ("Revolving Loan"). The Revolving Loan
is available for capital expenditures, acquisitions of and investments in
cellular and other wireless communication interests, and for other general
corporate purposes. On April 10, 1996, the Company issued $200 million aggregate
principal amount of the Debentures through an underwritten public offering and
entered into a related amendment to the Credit Facility. The Credit Facility was
amended to permit the issuance of the Debentures and require the structural
subordination of the Debentures by making a subsidiary the primary obligor of
the Credit Facility and all liabilities of the Company (other than the
Debentures) and the owner of all stock and partnership interests of the
Company's operating subsidiaries. The net proceeds of the sale of the Debentures
were approximately $194.8 million.
As of the end of 1996, $430.0 million had been borrowed under the Credit
Facility and $245.0 was available under the Facility, subject to certain
limitations. Under the restrictive covenants of the Credit Facility, future
borrowing availability under the Revolving Loan generally increases as the
Company's operating performance improves. The Company does not expect these
covenants to curtail planned borrowings.
According to the terms of the Credit Facility, the outstanding amount of
the Term Loan as of March 30, 1998 is to be repaid in increasing quarterly
installments commencing on March 31, 1998 and terminating at maturity on
December 23, 2003. The quarterly installment payments begin at 1.875% of the
outstanding principal amount at March 30, 1998 and gradually increase to 5.625%
of the principal amount at March 31, 2003, at which time the Term Loan will be
repaid. The available borrowings under the Revolving Loan will also be reduced
on a quarterly basis commencing on March 31, 1998 and terminating on December
31, 2003. The quarterly reduction begins at 1.875% of the Revolving Loan
commitment at March 30, 1998 and gradually increases to 5.625% of the commitment
on March 31, 2003, at which time the Revolving Loan will be repaid.
The Term Loan and the Revolving Loan bear interest at a rate equal to the
Company's choice of the Prime Rate (as defined) or Eurodollar Rate (as defined)
plus an applicable margin based upon a leverage ratio for the most recent fiscal
quarter. As of December 31, 1996, the applicable margins on the borrowings were
0.0% and 1.125% per annum for the Prime Rate and Eurodollar Rate, respectively.
The Debentures mature in 2006 and are redeemable at the Company's option,
in whole or in part, at any time on or after April 15, 2001. There are no
mandatory sinking fund payments for the Debentures. Interest is payable
semi-annually. Upon a Change of Control Triggering Event (as defined in the
Indenture for the Debentures), the Company will be required to make an offer to
purchase the Debentures at a purchase price equal to the 101% of the principal
amount thereof plus accrued and unpaid interest, if any, to the date of
purchase.
Among other restrictions, the Credit Facility restricts the payment of cash
dividends, limits the use of borrowings, limits the creation of additional
long-term indebtedness and requires the maintenance of certain financial ratios.
The requirements
24
of the Credit Facility have been established in relation to the Company's
projected capital needs, projected results of operations and cash flow. These
requirements were generally designed to require continued improvement in the
Company's operating performance such that EBITDA would be sufficient to continue
servicing the debt as repayments are required. The Indenture for the Debentures
contains limitations on, among other things, (i) the incurrence of additional
indebtedness, (ii) the payment of dividends and other distributions with respect
to the capital stock of the Company, (iii) the incurrence of certain liens, (iv)
the ability of the Company to allow restrictions on distributions by
subsidiaries, (v) asset sales, (vi) transactions with affiliates and (vii)
certain consolidations, mergers and transfers of assets. The Company is in
compliance with all requirements of the Credit Facility and the Indenture.
Borrowings under the Credit Facility are secured by substantially all of
the tangible and intangible assets and future cash flows of the Company. The
Debentures are unsecured obligations of the Company.
Acquisitions. The Company completed several acquisitions in 1995 and 1996.
In January 1995, the Company purchased the Union, Pennsylvania (PA-8) RSA for a
cash price of $51.3 million. The PA-8 RSA lies in the center of the Company's
Mid-Atlantic SuperSystem. Condensed pro forma financial information for the
acquisition of PA-8 as of December 31, 1995 and 1994 is contained in Note 3 to
the consolidated financial statements.
On August 12, 1996, the Company acquired the Logan, WV RSA ("WV-6 RSA") for
a cash purchase price of $16.7 million. The WV-6 RSA is an operating cellular
system and is contiguous to the Company's West Virginia markets and its
operations will be managed as part of its Ohio Valley SuperSystem.
On October 17, 1996, the Company completed the closing of an agreement to
exchange certain cellular properties for four cellular markets contiguous to its
Ohio Valley SuperSystem. In this transaction, the Company received four markets,
OH-9 RSA, OH-10 RSA (excluding Perry and Hocking counties),
Parkersburg-Marietta, WV-OH MSA, and the remaining county in the WV-1 RSA, in
exchange for the Company's Orange County, NY cellular market and ownership
interests in several minority owned cellular markets. The Company surrendered
324,000 POPs in Orange County and 76,000 POPs in minority owned markets, in
exchange for 542,000 POPs in the Ohio Valley SuperSystem.
The Company explores, on an ongoing basis, possible acquisitions of
additional cellular systems and licenses. The Company currently has no
agreements in principle regarding any such acquisition.
International Wireless Communication Holdings, Inc and Foreign Investments.
As of December 31, 1996, the Company had invested $13.8 million in International
Wireless Communication Holdings, Inc. ("IWC") and owns approximately 36% of the
outstanding stock of IWC. IWC is a development stage company specializing in
securing, building and operating wireless businesses, generally other than
cellular telephone systems, primarily in Asia and Latin America.
During 1996, IWC completed the sale of 14% Senior Secured Discount Notes
Due 2001, which have been exchanged for identical notes registered with the
Securities and Exchange Commission ("SEC"), and warrants to purchase shares of
IWC common stock. IWC received approximately $100 million in net proceeds from
this financing which will be used to fund existing projects and the exploration
of other opportunities. As existing and new projects are in the network buildout
phase, the losses of IWC are expected to grow significantly in future years. The
Company records its proportionate share of these losses under the equity method
of accounting. During 1995 and 1996, the Company recognized on the equity method
an amount of losses from IWC that is equal to the Company's equity investment in
IWC. As a result, the Company has suspended the recognition of losses
attributable to IWC until such time that the equity method income is available
to offset the Company's share of IWC's future losses.
Subsequent to December 31, 1996, the Company entered into a stock purchase
agreement to purchase from an unrelated third party 7% of the outstanding shares
of Star Digitel Limited ("SDL"), a Hong Kong company whose principal business
activities relate to the provision and development of cellular
telecommunications services in the People's Republic of China. Pursuant to the
stock purchase agreement, the Company's purchase of such shares will occur in
two closings, which are subject to the satisfaction of certain conditions, for
an aggregate cash consideration of $8.4 million. IWC also recently acquired and
maintains a 40% ownership interest in SDL.
Inter(Bullet)Act Systems, Incorporated. As of December 31, 1996, the
Company had invested $10.0 million in Inter(Bullet)Act Systems, Incorporated
("Inter(Bullet)Act") for an ownership interest of approximately 26% of
Inter(Bullet)Act's outstanding common stock. Inter(Bullet)Act is a development
stage company that provides consumer products manufacturers and retailers
(currently supermarkets) the ability to offer targeted promotions to retail
customers at the point of entry of a retail outlet through an interactive
multi-media system utilizing ATM-like terminals.
25
During 1996, Inter(Bullet)Act completed the sale of 142,000 units ("Units")
of 14% Senior Discount Notes Due 2003, which have been exchanged for identical
notes registered with the SEC, and warrants to purchase shares of common stock
at $.01 per share. The Company purchased for $12.0 million a total of 18,000
Units consisting of $18.0 million principal amount at maturity of these 14%
Senior Discount Notes and warrants to purchase 132,012 shares of common stock.
These warrant shares presently represent approximately 2% of Inter(Bullet)Act's
outstanding common stock. In addition, an existing warrant held by the Company
was restructured whereby the Company has the right to acquire at any time prior
to May 5, 2005 an aggregate of 900,113 shares of common stock for $23.50 per
share, which shares presently represent approximately 10% of the outstanding
common stock of Inter(Bullet)Act.
Inter(Bullet)Act has incurred net losses since its inception.
Inter(Bullet)Act received approximately $91 million in net proceeds from the
above financing which will be used to accelerate the roll-out of its systems in
retail supermarkets and, as a result, the net losses incurred by
Inter(Bullet)Act are expected to grow significantly in future years. The Company
records its proportionate share of these losses under the equity method of
accounting. The Company anticipates that during 1997 its cumulative
proportionate share of Inter(Bullet)Act losses will exceed the remaining portion
of its investment in Inter(Bullet)Act. Accordingly the Company will suspend the
recognition of losses attributable to Inter(Bullet)Act until such time that the
equity method income is available to offset the Company's share of
Inter(Bullet)Act's future losses.
Geotek Communications, Inc. In 1994, the Company purchased from Geotek
Communications, Inc. ("Geotek") 2.5 million shares of Geotek common stock for
$30 million and received a series of options to purchase additional shares and
entered into a five-year management consulting agreement to provide operational
and marketing support in exchange for 300,000 shares of Geotek common stock per
year. Geotek is a telecommunications company that is developing a wireless
communications network in certain metropolitan markets in the United States
based on its FHMA digital technology. Its common stock is traded on the NASDAQ
National Market System. In September 1995, the Company purchased for $5.0
million in cash 531,463 shares of convertible preferred stock of Geotek with a
stated value of $9.408 per share. On September 15, 1996, the Company allowed the
initial series of options to expire unexercised, and as a result, all other
options and the management consulting agreement also expired.
Capital Expenditures. As of December 1996, the Company had $391.3 million
of property and equipment in service. The Company historically has incurred
capital expenditures primarily based upon capacity needs in its existing markets
resulting from continued subscriber growth. In order to increase geographic
coverage and provide for additional portable usage the Company intends to
increase the number of sites and add additional capacity to existing sites. As a
result of this accelerated network buildout and the continued growth of the
Company's subscriber base, capital expenditures were $130.8 million during 1996.
During 1997, the Company plans to continue this accelerated buildout. Capital
expenditures for 1997 are estimated to be approximately $120 million and are
expected to be funded primarily through internally generated funds.
Approximately $90 million of those capital expenditures will be for cellular
network equipment, and the remainder will be primarily for rental telephones and
computer equipment.
On November 4, 1996, the Company's Board of Directors authorized the
repurchase of up to 2,500,000 shares of its Class A Common Stock from time to
time in open market or other transactions. As of December 31, 1996 the Company
had repurchased 255,000 shares at an average price per share of approximately
$17.00. Through March 31, 1997, the Company had repurchased 320,000 additional
shares at an average price per share of approximately $14.85.
Income Taxes. The Company accounts for income taxes in accordance with
Statement of Financial Accounting Standards No. 109--"Accounting for Income
Taxes." This standard requires, among other things, the recognition of future
tax benefits, measured by enacted tax rates, attributable to deductible
temporary differences between financial statement and income tax bases of assets
and liabilities and to tax NOLs, to the extent that realization of such benefits
is more likely than not. Prior to 1996, the Company incurred significant
financial reporting and tax losses primarily as a result of substantial
depreciation, amortization and interest expenses associated with acquiring and
developing its cellular markets and substantial marketing and other operating
costs associated with building its subscriber base. Although substantial net
deferred income tax assets were generated, these assets and the associated
income were not recognized for financial reporting purposes and a valuation
allowance equal to the unrecognized asset was established. Management's
assessment was that the Company's historical operating results did not make
future profitability certain enough for it to recognize any part of the asset
and related income.
Since inception, the Company has steadily increased its subscriber base and
improved its revenues and operating results at rates consistent with
management's annual internal forecasts. See "Item 6. Selected Financial Data."
The Company achieved profitability in 1996 for financial reporting purposes, and
management expects improvements in operating results in 1997 and future periods.
Although the Company's ongoing operations have generated Federal taxable losses
since inception,
26
it expects taxable income in future periods. There can be no assurance that the
Company will achieve improvements in its results of operations. See the "Safe
Harbor" statement below for a description of certain risks and uncertainties
that may affect the Company. Because of these risks and uncertainties,
management concluded that forecasts could be made with enough certainty to
recognize net deferred income tax assets only over a relatively short-term
period. Therefore, the Company recognized only $5.0 million of
its $104.2 million of its net deferred income tax assets at
December 31, 1996 and maintained a valuation allowance for the
remainder of the Company's $99.2 million of net deferred
income tax assets. The Company will continue to assess the recognition of
additional net deferred tax assets based on its ongoing evaluation of its actual
performance and ability to estimate future performance.
For Federal income tax reporting purposes, the Company had net operating
loss carryforwards of approximately $315 million at December 31, 1996. These
losses may be used to reduce future taxable income, if any, and expire through
2010. The primary differences between the accumulated deficit for financial
reporting purposes and the income tax loss carryforwards relate to the
differences in the treatment of certain deferred cellular license acquisition
costs, certain gains on dispositions of cellular interests, partnership losses,
depreciation methods, estimated useful lives and compensation earned under stock
compensation plans. These carryforwards may be subject to annual limitation in
the future in accordance with the Tax Reform Act of 1986 and the ability to use
these carryforwards could be significantly impacted by a future "change in
control" of the Company. The limitations, if any, arising from such future
"change in control" cannot be known at this time. See Note 6 to the Company's
Consolidated Financial Statements for further information regarding the
Company's income tax status.
General. Although no assurance can be given that such will be the case, the
Company believes that its internally generated funds and available borrowing
capacity under the Credit Facility will be sufficient during the next several
years to complete its planned network expansion, to fund debt service, to
provide flexibility, to repurchase shares, to pursue acquisitions and other
business opportunities that might arise in the future, and to meet working
capital and general corporate needs. The Company also may issue additional
shares of Class A Common Stock.
Inflation
The Company believes that inflation affects its business no more than it
generally affects other similar businesses.
"Safe Harbor" Statement under Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended:
Except for the historical information presented, the matters disclosed in
this release include forward-looking statements. These statements represent the
Company's judgment on the future and are subject to risks and uncertainties that
could cause actual results to differ materially. Such factors include, without
limitation: (i) the substantial leverage of the Company which may adversely
affect the Company's ability to finance its future operations, to compete
effectively against better capitalized competitors and to withstand downturns in
its business or the economy generally; (ii) a change in economic conditions in
the markets served by the Company which could effect demand for cellular
services; (iii) greater than anticipated competition from PCS and ESMR companies
that provide services and features in addition to those currently provided by
cellular companies, and the risk that the Company will not be able to provide
such services and features or that it will not be able to do so on a timely or
profitable basis; (iv) technological developments that make the Company's
existing analog networks and planned digital networks uncompetitive or obsolete
such as the risk that the Company's choice of Time Division Multiple Access
("TDMA") as its digital technology leaves it at a competitive disadvantage if
other digital technologies, including Code Division Multiple Access ("CDMA"),
ultimately provide substantial advantages over TDMA or analog technology and
competitive pressures force the Company to implement CDMA or another digital
technology at substantially increased cost; and (v) higher than anticipated
costs due to unauthorized use of its networks and the development and
implementation of measures to curtail such fraudulent use. See the Company's
Form 8-K dated March 31, 1997 and the Company's subsequent filings and reports
with the Securities and Exchange Commission for a further description of these
risks.
Item 8. Financial Statements and Supplementary Data
The consolidated financial statements and notes to consolidated financial
statements of the Registrant and its subsidiaries are included in this Form 10-K
following the Index to Financial Statements and Schedules. In addition,
Financial Statements of the Registrant's 50% or less owned significant
subsidiaries are included.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
27
PART III
Item 10. Directors and Executive Officers of the Registrant
Information with respect to directors appearing under the heading,
"Election of Directors" in the Registrant's proxy statement for the Annual
Meeting of Shareholders to be held May 15, 1997, is incorporated herein by
reference. Other information with respect to executive officers is contained in
Part I -- Item 4 (a) Executive Officers of the Registrant.
Item 11. Executive Compensation
Information with respect to executive compensation appearing under the
heading "Executive Compensation" in the Registrant's proxy statement for the
Annual Meeting of Shareholders to be held May 15, 1997, is incorporated herein
by reference.
Item 12. Securities Ownership of Certain Beneficial Owners and Management
Information with respect to securities ownership of certain beneficial
owners and management appearing under the headings "Voting Securities
Outstanding" and "Security Ownership of Management" in the Registrant's proxy
statement for the Annual Meeting of Shareholders to be held May 15, 1997, is
incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions
Information with respect to certain transactions appearing under the
heading "Certain Transactions" in the Registrant's proxy statement for the
Annual Meeting of Shareholders to be held May 15, 1997, is incorporated herein
by reference.
28
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a)(1) and (2) Financial Statements and Financial Statement Schedules. The financial statements and supplemental schedules
listed in the accompanying Index to Financial Statements and Schedules are filed as a part of this report.
(3) Exhibits. Exhibits to this report are listed in the accompanying Index to Exhibits.
(b) Reports on Form 8-K. There were no reports filed on Form 8-K during the fourth quarter of 1996.
29
SIGNATURES
Pursuant to the requirements of the Section 13 and 15(d) of the Securities
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
VANGUARD CELLULAR SYSTEMS, INC.
By: /s/ HAYNES G. GRIFFIN
Haynes G. Griffin
Chairman of the Board of Directors
and Co-Chief Executive Officer
Date: March 31, 1997
Pursuant to the requirements of the Securities and Exchange Act of 1934,
this report has been signed by the following persons on behalf of the registrant
and in the capacities and on the dates indicated.
Signature Title Date
/s/ HAYNES G. GRIFFIN Chairman of the Board of Directors, Co-Chief March 31, 1997
Haynes G. Griffin Executive Officer
/s/ STEPHEN R. LEEOLOU President, Co-Chief Executive Officer, Director March 31, 1997
Stephen R. Leeolou
/s/ STUART S. RICHARDSON Vice Chairman of the Board of Directors March 31, 1997
Stuart S. Richardson
/s/ L. RICHARDSON PREYER, JR. Vice Chairman of the Board of Directors March 31, 1997
L. Richardson Preyer, Jr.
/s/ STEPHEN L. HOLCOMBE Chief Financial Officer (Principal accounting March 31, 1997
Stephen L. Holcombe and principal financial officer)
/s/ F. COOPER BRANTLEY Director March 31, 1997
F. Cooper Brantley
/s/ DORIS R. BRAY Director March 31, 1997
Doris R. Bray
/s/ ROBERT M. DEMICHELE Director March 31, 1997
Robert M. DeMichele
/s/ L. RICHARDSON PREYER, SR. Director March 31, 1997
L. Richardson Preyer, Sr.
/s/ ROBERT A. SILVERBERG Director March 31, 1997
Robert A. Silverberg
30
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
Page
Vanguard Cellular Systems, Inc. and Subsidiaries
Consolidated Balance Sheets, December 31, 1996 and 1995.............................................................. F-2
Consolidated Statements of Operations for the Years ended December 31, 1996, 1995 and 1994........................... F-3
Consolidated Statements of Changes in Shareholders' Equity for the Years ended
December 31, 1996, 1995 and 1994.................................................................................. F-4
Consolidated Statements of Cash Flows for the Years ended December 31, 1996, 1995 and 1994........................... F-5
Notes to Consolidated Financial Statements........................................................................... F-6
Report of Independent Public Accountants............................................................................. F-22
Schedule I -- Condensed Financial Information of the Registrant...................................................... F-23
Schedule II -- Valuation and Qualifying Accounts..................................................................... F-27
Financial Statements of Certain Significant 50% or less Owned Subsidiaries............................................. F-28
All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are not
required under the related instructions or are inapplicable and therefore have
been omitted.
F-1
VANGUARD CELLULAR SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollar amounts in thousands)
December 31,
1996 1995
Assets
CURRENT ASSETS:
Cash.............................................................................................. $ 11,180 $ 8,085
Accounts receivable, net of allowances for doubtful accounts of $4,617 and $5,823................. 29,907 31,270
Cellular telephone inventories.................................................................... 15,921 8,957
Deferred income tax asset......................................................................... 2,149 --
Prepaid expenses.................................................................................. 2,057 1,498
Total current assets........................................................................... 61,214 49,810
INVESTMENTS......................................................................................... 333,371 306,760
PROPERTY AND EQUIPMENT, at cost:
Land.............................................................................................. 2,432 1,997
Buildings......................................................................................... 584 536
Cellular telephones held for rental............................................................... 30,040 18,814
Cellular telephone systems........................................................................ 295,376 221,281
Office furniture and equipment.................................................................... 62,866 45,222
391,298 287,850
Less -- Accumulated depreciation.................................................................. 119,470 94,057
271,828 193,793
Construction in progress.......................................................................... 41,972 31,413
313,800 225,206
OTHER ASSETS, net of accumulated amortization of $6,965 and $3,390.................................. 22,196 14,801
Total assets................................................................................... $ 730,581 $ 596,577
Liabilities and Shareholders' Equity
CURRENT LIABILITIES:
Accounts payable and accrued expenses............................................................. $ 65,497 $ 43,147
Customer deposits................................................................................. 1,679 1,666
Total current liabilities...................................................................... 67,176 44,813
LONG-TERM DEBT...................................................................................... 629,954 522,143
MINORITY INTERESTS.................................................................................. -- 573
COMMITMENTS AND CONTINGENCIES (Note 5)
SHAREHOLDERS' EQUITY:
Preferred stock -- $.01 par value, 1,000,000 shares authorized, no shares issued.................. -- --
Common stock, Class A -- $.01 par value, 250,000,000 shares authorized, and 41,084,522 and
41,312,053 shares issued and outstanding....................................................... 411 413
Common stock, Class B -- $.01 par value, 30,000,000 shares authorized, no shares issued........... -- --
Additional capital in excess of par value......................................................... 237,640 238,662
Net unrealized holding loss....................................................................... (14,570) (16,395)
Accumulated deficit............................................................................... (190,030) (193,632)
Total shareholders' equity..................................................................... 33,451 29,048
Total liabilities and shareholders' equity..................................................... $ 730,581 $ 596,577
The accompanying notes to consolidated financial statements are an integral part
of these balance sheets.
F-2
VANGUARD CELLULAR SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollar amounts in thousands, except per share data)
For the Years Ended December 31,
1996 1995 1994
REVENUE:
Service revenue..................................................................... $282,694 $217,440 $146,417
Cellular telephone equipment revenue................................................ 15,120 15,647 18,529
Other............................................................................... 4,240 2,984 3,055
302,054 236,071 168,001
COSTS AND EXPENSES:
Cost of service..................................................................... 31,678 27,043 21,008
Cost of cellular telephone equipment................................................ 25,372 25,605 29,933
General and administrative.......................................................... 80,057 60,489 44,019
Marketing and selling............................................................... 62,384 54,906 37,102
Depreciation and amortization....................................................... 48,635 36,170 24,073
248,126 204,213 156,135
INCOME FROM OPERATIONS................................................................ 53,928 31,858 11,866
NET GAINS (LOSSES) ON DISPOSITIONS.................................................... 6,716 1,787 (339)
INTEREST EXPENSE...................................................................... (46,199) (38,293) (22,126)
EQUITY IN EARNINGS (LOSSES) OF UNCONSOLIDATED AFFILIATES.............................. (13,816) (2,261) 206
OTHER, net............................................................................ 1,680 (101) (3,399)
INCOME (LOSS) BEFORE INCOME TAXES..................................................... 2,309 (7,010) (13,792)
INCOME TAX BENEFIT.................................................................... 4,109 -- --
INCOME (LOSS) BEFORE MINORITY INTERESTS............................................... 6,418 (7,010) (13,792)
MINORITY INTERESTS.................................................................... 31 (3) (153)
NET INCOME (LOSS) BEFORE EXTRAORDINARY ITEM........................................... 6,449 (7,013) (13,945)
EXTRAORDINARY LOSS ON EXTINGUISHMENT OF DEBT.......................................... -- -- (8,402)
NET INCOME (LOSS)..................................................................... $ 6,449 $ (7,013) $(22,347)
NET INCOME (LOSS) PER SHARE BEFORE EXTRAORDINARY ITEM................................. $ 0.16 $ (0.17) $ (0.36)
PER SHARE EFFECT OF EXTRAORDINARY ITEM................................................ -- -- (0.22)
NET INCOME (LOSS) PER SHARE........................................................... $ 0.16 $ (0.17) $ (0.58)
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING................................ 41,320 41,100 38,628
The accompanying notes to consolidated financial statements are an integral part
of these statements.
F-3
VANGUARD CELLULAR SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(Dollar amounts in thousands)
For the Years Ended December 31, 1994, 1995 and 1996
Additional
Common Stock Capital in Total
Class A Excess of Net Unrealized Accumulated Shareholders'
Shares Amount Par Value Holding Loss Deficit Equity
BALANCE, January 1, 1994...................... 38,398,080 $384 $ 185,786 $ -- $(164,272) $ 21,898
Shares issued upon exercise of stock
options..................................... 210,719 2 1,061 -- -- 1,063
Shares issued for cash........................ 28,576 -- 499 -- -- 499
Shares issued in exchange for cellular
interests................................... 1,891,959 19 47,385 -- -- 47,404
Net unrealized holding loss................... -- -- -- (9,310) -- (9,310)
Net loss...................................... -- -- -- -- (22,347) (22,347)
BALANCE, December 31, 1994.................... 40,529,334 405 234,731 (9,310) (186,619) 39,207
Shares issued upon exercise of stock
options..................................... 755,906 8 3,294 -- -- 3,302
Shares issued for cash........................ 26,813 -- 637 -- -- 637
Net unrealized holding loss................... -- -- -- (7,085) -- (7,085)
Net loss...................................... -- -- -- -- (7,013) (7,013)
BALANCE, December 31, 1995.................... 41,312,053 413 238,662 (16,395) (193,632) 29,048
Shares issued upon exercise of stock
options..................................... 27,190 -- 448 -- -- 448
Shares issued for cash........................ 279 -- 6 -- -- 6
Shares repurchased and retired................ (255,000) (2) (1,476) -- (2,847) (4,325)
Net unrealized holding gain................... -- -- -- 1,825 -- 1,825
Net income.................................... -- -- -- -- 6,449 6,449
BALANCE, December 31, 1996.................... 41,084,522 $411 $ 237,640 $(14,570) $(190,030) $ 33,451
The accompanying notes to consolidated financial statements are an integral part
of these statements.
F-4
VANGUARD CELLULAR SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollar amounts in thousands)
For the Years Ended December 31,
1996 1995 1994
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)................................................................. $ 6,449 $ (7,013) $ (22,347)
Adjustments to reconcile net income (loss) to net cash provided by operating
activities:
Depreciation and amortization.................................................. 48,635 36,170 24,073
Amortization of deferred financing costs....................................... 1,587 1,322 1,334
Equity in losses (earnings) of unconsolidated affiliates....................... 13,816 2,261 (206)
Amortization of bond investment discount....................................... (714) -- --
Minority interests............................................................. (31) 3 153
Net (gains) losses on dispositions............................................. (6,716) (1,787) 339
Deferred income tax benefit.................................................... (5,000) -- --
Extraordinary loss on extinguishment of debt................................... -- -- 8,402
Stock received for management consulting services.............................. (2,087) (2,436) (2,496)
Changes in current items:
Accounts receivable, net..................................................... 1,363 (8,250) (8,974)
Cellular telephone inventories............................................... (6,964) 1,649 (5,744)
Accounts payable and accrued expenses........................................ 10,614 8,363 7,223
Other, net................................................................... (537) (321) 494
Net cash provided by operating activities.................................... 60,415 29,961 2,251
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment............................................... (119,077) (136,149) (51,017)
Proceeds from dispositions of property and equipment.............................. 540 380 109
Payments for acquisition of investments........................................... (38,790) (69,908) (54,813)
Proceeds from dispositions of investments......................................... 4,644 1,413 446
Capital contributions to unconsolidated cellular entities......................... (221) (318) (651)
Net cash used in investing activities........................................ (152,904) (204,582) (105,926)
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments of long-term debt.............................................. (193,007) -- (334,006)
Repurchase of common stock........................................................ (4,325) -- --
Net proceeds from issuance of common stock........................................ 454 3,939 1,415
Proceeds of long-term debt........................................................ 300,802 173,494 444,500
Debt issuance costs............................................................... (6,914) (124) (11,180)
Increase in other assets.......................................................... (1,426) (348) (407)
Net cash provided by financing activities.................................... 95,584 176,961 100,322
NET INCREASE (DECREASE) IN CASH..................................................... 3,095 2,340 (3,353)
CASH, beginning of year............................................................. 8,085 5,745 9,098
CASH, end of year................................................................... $ 11,180 $ 8,085 $ 5,745
SUPPLEMENTAL DISCLOSURE OF CASH PAID DURING THE YEAR FOR:
INTEREST, net of amounts capitalized.............................................. $ 42,579 $ 32,597 $ 21,914
INCOME TAXES...................................................................... 891 -- --
The accompanying notes to consolidated financial statements are an integral part
of these statements.
F-5
VANGUARD CELLULAR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 -- ORGANIZATION
Vanguard Cellular Systems, Inc. ("Vanguard") (a North Carolina corporation)
through its only direct subsidiary, Vanguard Cellular Financial Corp. ("VCFC"),
is a provider of cellular telephone service to various markets in the eastern
United States. The majority of Vanguard's operations are conducted in the
Mid-Atlantic SuperSystem covering areas of Pennsylvania, New York and New
Jersey. The primary activities of Vanguard, VCFC, its wholly owned subsidiaries
and its majority owned cellular entities (collectively referred to as the
Company) include acquiring interests in entities that have been granted
nonwireline Federal Communications Commission ("FCC") permits to construct or
authorizations to operate cellular telephone systems, and constructing and
operating cellular telephone systems.
All of the Company's cellular entities operate under the trade name of
CellularONE(Register mark), which is the trade name many nonwireline carriers
have adopted to provide uniformity throughout the industry. The trade name is
owned by a partnership in which the Company holds a minority ownership interest.
Vanguard is a holding company which is the 100% shareholder of VCFC. This
organization was created to structurally subordinate Vanguard's $200 million in
Senior Debentures to VCFC's Credit Facility. (See Note 4 -- Long-Term Financing
Arrangements.)
Note 2 -- SIGNIFICANT ACCOUNTING AND REPORTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of Vanguard,
VCFC, its wholly owned subsidiaries and the entities in which it has a majority
ownership interest. Investments in which the Company exercises significant
influence but does not exercise control through majority ownership have been
accounted for using the equity method of accounting. Investments in which the
Company does not exercise significant influence or control through majority
ownership have been accounted for using the cost method of accounting. All
significant intercompany accounts and transactions have been eliminated.
Use of Estimates
The preparation of these consolidated financial statements and footnote
disclosures required the use of certain estimates by management in determining
the Company's financial position and results of operations. Actual results could
differ from those estimates.
Cellular Telephone Inventories
Inventories, consisting primarily of cellular telephones held for resale,
are valued at the lower of first-in, first-out (FIFO) cost or market.
Investments
Investments in Cellular Entities -- Investments in cellular entities
consist of the costs incurred to acquire FCC licenses or interests in entities
that have been awarded FCC licenses to provide cellular service net of the
Company's share of the fair value of the net assets acquired, payments of other
acquisition related expenses and capital contributions to unconsolidated
cellular entities. The Company's investment in consolidated cellular entities is
being amortized over forty years. Exchanges of minority ownership interests in
cellular entities are recorded based on the fair value of the ownership
interests acquired.
Investments in Noncellular Entities -- Investments in noncellular entities
consist of the Company's investments in International Wireless Communications
Holdings, Inc. ("IWC"), Inter(Bullet)Act Systems, Incorporated
("Inter(Bullet)Act") and Geotek Communications, Inc. ("Geotek"). The investments
in IWC and Inter(Bullet)Act are recorded using the equity method. The investment
in Geotek common stock is considered to be "available for sale" under the
provisions of Statement of Financial Accounting Standards No. 115, "Accounting
for Certain Investments in Debt and Equity Securities." Accordingly, the
Company's investment in the common stock of Geotek is recorded at its fair value
and the investment in other securities of Geotek is recorded at cost.
F-6
VANGUARD CELLULAR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Note 2 -- SIGNIFICANT ACCOUNTING AND REPORTING POLICIES -- Continued
The Company recognizes, only to the extent of its investment, its pro rata
share of the net income or losses generated by the unconsolidated cellular and
noncellular entities carried on the equity method of accounting.
Property and Equipment
Property and equipment are recorded at cost. Depreciation is calculated on
a straight-line basis for financial reporting purposes over the following
estimated useful lives:
Buildings............................................................................... 20 years
Cellular telephones held for rental..................................................... 3 years
Cellular telephone systems.............................................................. 7-20 years
Office furniture and equipment.......................................................... 3-10 years
At December 31, 1996 and 1995, construction in progress was composed
primarily of the cost of uncompleted additions to the Company's cellular
telephone systems in majority owned cellular markets. The Company capitalized
interest costs of $1.3 million, $1.3 million and $684,000 in 1996, 1995 and
1994, respectively, as part of the cost of cellular telephone systems.
Maintenance, repairs and minor renewals are charged to operations as
incurred. Gains or losses at the time of disposition of property and equipment
are reflected in the statements of operations currently.
Cellular telephones are rented to certain customers generally with a
contract for a minimum stipulated length of service. Such customers have the
option to purchase the cellular telephone at any time during the term of the
agreement.
Long-Lived Assets
In accordance with Statement of Financial Accounting Standards ("SFAS") No.
121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of, the Company reviews for the impairment of long-lived
assets and certain identifiable intangibles whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Under SFAS No. 121, an impairment loss would be recognized when
estimated future cash flows expected to result from the use of the asset and its
eventual disposition is less than its carrying amount. No such impairment losses
have been identified by the Company.
Other Assets
Other assets include deferred financing costs which are being amortized
over the period of the related agreements. Amortization of $1.6 million, $1.3
million and $1.3 million has been included in interest expense in each of the
accompanying December 31, 1996, 1995 and 1994 Statements of Operations,
respectively. In addition, payments related to agreements not to compete in
certain cellular markets are being amortized over the period of the related
agreements. As of December 31, 1995, these agreements had been fully amortized.
Amortization expense relating to these agreements of $40,000 and $160,000 has
been included in the accompanying December 31, 1995 and 1994 Statements of
Operations, respectively. Other assets also include $8.2 million allocated to
the acquired customer bases in connection with the acquisitions of the Logan, WV
(WV-6) RSA in August 1996, the Union, PA (PA-8) RSA in January 1995, and the
Binghamton, NY and Elmira, NY MSAs in December 1994. The customer bases are
being amortized over a four-year period and accordingly amortization of $1.8
million and $1.7 million has been included in the accompanying December 31, 1996
and 1995 Statements of Operations, respectively.
Revenue Recognition
Service revenue is recognized at the time cellular services are provided
and service fees related to prebilled services are not recognized until earned.
Cellular telephone equipment revenues consist primarily of sales of cellular
telephones to subscribers and are recognized at the time equipment is delivered
to the subscriber.
F-7
VANGUARD CELLULAR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Note 2 -- SIGNIFICANT ACCOUNTING AND REPORTING POLICIES -- Continued
Income Taxes
The Company accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes", which requires the use of the "asset and
liability method" of accounting for income taxes. Accordingly, deferred tax
liabilities and assets are determined based on the difference between the
financial statement and tax bases of assets and liabilities, using enacted tax
rates in effect for the year in which the differences are expected to reverse.
Net Income (Loss) per Share
Net income (loss) per share is computed based upon the weighted average
number of common shares outstanding during the year. Stock options have not been
included in the calculation of net income per share for 1996 as their effect
would not be significant, and have not been included in the calculation of net
loss per share for 1995 and 1994 as their effect would be antidilutive.
In February 1997, SFAS No. 128, "Earnings Per Share" was issued. SFAS No.
128 requires presentation of basic earnings per share and diluted earnings per
share and supersedes or amends all previous earnings per share presentation
requirements. Basic earnings per share will be based on income available to
common shareholders divided by the weighted average number of common shares
outstanding. Diluted earnings per share is also based on income available to
common shareholders divided by the sum of the weighted average number of common
shares outstanding and all diluted potential common shares. SFAS No. 128 is
effective for fiscal years ending after December 15, 1997. Earlier adoption is
not allowed and the Company has not determined the impact on its future earnings
per share presentations.
Statements of Cash Flows
Additional required disclosures of noncash investing and financing
activities for the years ended December 31, 1996, 1995 and 1994 are as follows:
The Company acquired ownership interests in certain cellular entities and
other investments for cash and noncash consideration, as follows (in thousands):
1996 1995 1994
Fair value of investments acquired........................................... $ 57,272 $ 79,710 $105,742
Fair value of noncash consideration given up:
Cellular licenses and interests............................................ 16,395 7,366 882
Issuance of common stock................................................... -- -- 47,551
Stock received for management consulting services............................ 2,087 2,436 2,496
18,482 9,802 50,929
Cash acquisitions of investments............................................. $ 38,790 $ 69,908 $ 54,813
The Company acquired property and equipment for cash and noncash
consideration, as follows:
Cash......................................................................... $119,077 $136,149 $ 51,017
Increase (decrease) in accounts payable...................................... 11,728 (6,255) 11,615
$130,805 $129,894 $ 62,632
F-8
VANGUARD CELLULAR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Note 3 -- INVESTMENTS
Investments consist of the following as of December 31, 1996 and 1995 (in
thousands).
1996 1995
Investments in cellular entities:
Consolidated entities:
License cost......................................................................... $300,780 $272,708
Accumulated amortization............................................................. (36,113) (29,546)
264,667 243,162
Entities carried on the equity method:
Cost................................................................................. 10,193 10,193
Accumulated share of earnings........................................................ 2,056 177
12,249 10,370
Entities carried on the cost method..................................................... 9,993 14,262
286,909 267,794
Investments in noncellular entities:
Entities carried on the equity method:
Cost................................................................................. 23,823 17,258
Accumulated share of losses.......................................................... (18,239) (2,545)
5,584 14,713
Investments carried as "available for sale":
Cost................................................................................. 37,736 35,648
Net unrealized holding losses........................................................ (14,570) (16,395)
23,166 19,253
Investment in debentures:
At par............................................................................... 18,000 --
Discount............................................................................. (8,389) --
9,611 --
Other equity investments, at cost....................................................... 8,101 5,000
46,462 38,966
$333,371 $306,760
Investments in Cellular Entities
The Company continues to expand its ownership of cellular markets through
strategic acquisitions. The Company's significant activity relating to its
cellular investments is discussed below.
In April 1994, the Company completed the acquisition of the Altoona, PA MSA
and the Chambersburg, PA (PA-10) RSA, which are contiguous to its Mid-Atlantic
SuperSystem in exchange for $4.4 million in cash, the exchange of Hagerstown, MD
cellular market and the Company's minority ownership interest in one cellular
market.
The Company purchased in October 1994, for $6.9 million in cash and $3.3
million in the Company's Class A common stock, the Washington, ME (ME-4) RSA and
three of the four counties of the Mason, WV (WV-1) RSA. The Maine RSA is
approximately 40 miles north of the Portland, ME MSA, which is already operated
by the Company. The West Virginia RSA is contiguous to the Company's Charleston,
WV MSA.
In December 1994, the Company purchased the Binghamton, NY MSA and the
Elmira, NY MSA for a purchase price consisting of 1,766,674 shares of the
Company's Class A common stock and $6.1 million in cash. These markets are
contiguous to the Company's Mid-Atlantic SuperSystem.
F-9
VANGUARD CELLULAR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Note 3 -- INVESTMENTS -- Continued
In January 1995, the Company purchased the Union, PA (PA-8) RSA for a cash
price of $51.3 million. The PA-8 RSA lies in the center of the Company's
Mid-Atlantic SuperSystem and is an operational cellular system. Pro forma
consolidated results of operations, as if the acquisition of the Union, PA RSA
had occurred January 1, 1994, are as follows (in thousands, except per share
data):
Years Ended
December 31,
1995 1994
Revenue................................................................................... $236,578 $173,735
Net loss before extraordinary item........................................................ (7,254) (18,155)
Net loss.................................................................................. (7,254) (26,557)
Net loss per share before extraordinary item.............................................. (0.18) (0.47)
Net loss per share........................................................................ (0.18) (0.69)
In December 1995, the Company completed the acquisition of the remaining
13.24% ownership interests in the Harrisburg, PA MSA in exchange for ownership
interests in cellular markets outside its regional metro-clusters and $2.9
million in cash.
In August 1996, the Company acquired the Logan, WV RSA ("WV-6 RSA") for a
cash purchase price of $16.7 million. The WV-6 RSA is contiguous to the
Company's West Virginia markets and its operations are managed as part of its
West Virginia metro-cluster. Pro forma results of operations, as if the
acquisitions of the WV-6 RSA had occurred January 1, 1995 are as follows (in
thousands, except per share data):
Years Ended
December 31,
1996 1995
Revenue................................................................................... $304,196 $239,412
Net income (loss)......................................................................... 4,774 (8,790)
Net income (loss) per share............................................................... 0.12 (0.21)
In the third quarter of 1996, the Company acquired the remaining portions
of the State College, PA and Williamsport, PA MSA's and the PA-10 East RSA in
exchange for $2.8 million in cash. These markets are now 100% owned by the
Company.
In October 1996, the Company exchanged certain cellular properties for four
cellular markets contiguous to its Ohio Valley SuperSystem. In this transaction,
the Company received four markets, OH-9 RSA, OH-10 RSA (excluding Perry and
Hocking counties), Parkersburg-Marietta, WV-OH MSA, and the remaining county in
the WV-1 RSA, in exchange for the Company's Orange County, NY cellular market
and ownership interests in several minority owned cellular markets. The Company
surrendered 324,000 POPs in Orange County and 76,000 POPs in minority owned
markets, and added 542,000 POPs to the Ohio Valley SuperSystem. This transaction
was treated principally as an exchange of similar productive assets and,
therefore, the cellular markets received have been recorded at the historical
cost of the Orange County, NY cellular market, increased for the fair value of
the additional minority ownership interests given up.
Cellular Entities on the Equity Method
The Company holds an investment in a joint venture known as Eastern North
Carolina Cellular Joint Venture ("ENCCJV"), owned 50% by the Company, created to
acquire, own and operate various cellular markets located primarily in eastern
North Carolina. The underlying net assets of the joint venture consist
principally of its investment in the FCC licenses in the Wilmington, NC and
Jacksonville, NC MSA cellular markets. The Company recognized $1.9 million,
$284,000 and $206,000 as its proportionate share of the ENCCJV earnings during
the years ended December 31, 1996, 1995 and 1994, respectively.
F-10
VANGUARD CELLULAR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Note 3 -- INVESTMENTS -- Continued
Cellular Entities on the Cost Method
The investment balance of approximately $10.0 million at December 31, 1996
represents the Company's investment in approximately 40 cellular markets with
ownership interests ranging from 0.30% to 5.09%. The Company holds these
ownership interests for investment purposes.
Noncellular Investments
International Wireless Communications Holdings, Inc. and Foreign Investments
The Company owns approximately 36% of the outstanding stock of IWC and has
invested an aggregate of $13.8 million. IWC is a development stage Company
specializing in securing, building and operating wireless businesses other than
cellular telephone systems primarily in Asia and Latin America.
During 1996, IWC completed the sale of 14% Senior Secured Discount Notes
due 2001, which have been exchanged for identical notes registered with the
Securities and Exchange Commission ("SEC"), and warrants to purchase shares of
IWC common stock. IWC received approximately $100 million in net proceeds from
this financing which will be used to fund existing projects and the exploration
of other opportunities. As existing and new projects are in the network buildout
phase, the losses of IWC are expected to grow significantly in future years. The
Company records its proportionate share of these losses under the equity method
of accounting. During 1995 and 1996, the Company recognized an amount of losses
on the equity method from IWC that is equal to the Company's equity investment
in IWC. As a result, the Company has suspended the recognition of losses
attributable to IWC until such time that the equity method income is available
to offset the Company's share of IWC's future losses.
Subsequent to December 31, 1996, the Company entered into a stock purchase
agreement to purchase from an unrelated third party 7% of the outstanding shares
of Star Digitel Limited ("SDL"), a Hong Kong company whose principal business
activities relate to the provision and development of cellular
telecommunications services in the People's Republic of China. Pursuant to the
stock purchase agreement, the Company's purchase of such shares will occur in
two closings, which are subject to the satisfaction of certain conditions, for
an aggregate cash consideration of $8.4 million. IWC also recently acquired and
maintains a 40% ownership interest in SDL.
Inter(Bullet)Act Systems, Incorporated.
As of December 31, 1996, the Company had invested $10.0 million in
Inter(Bullet)Act for an ownership interest of approximately 26%.
Inter(Bullet)Act is a development stage Company that provides consumer product
manufacturers and retailers (currently supermarkets) the ability to offer
targeted promotions to retail customers at the point of entry of a retail outlet
through an interactive multi-media system utilizing ATM-like terminals.
During 1996, Inter(Bullet)Act completed the sale of 142,000 units ("Units")
of 14% Senior Discount Notes due 2003, which have been exchanged for identical
notes registered with the SEC and warrants to purchase shares of common stock at
$.01 per share. The Company purchased for $12.0 million a total of 18,000 Units
consisting of $18.0 million principal amount at maturity of these 14% Senior
Discount Notes and warrants to purchase 132,012 shares of common stock. At
issuance, the Company allocated, based upon the estimated fair values, $8.9
million and $3.1 million to the debentures and warrants purchased by the
Company, respectively. The shares issuable upon the exercise of these warrants
currently represent approximately 2% of Inter(Bullet)Act's outstanding common
stock. In addition, an existing warrant held by the Company was restructured
whereby the Company has the right to acquire at any time prior to May 5, 2005 an
aggregate of 900,113 shares of common stock for $23.50 per share, which shares
presently represent approximately 10% of the outstanding common stock of
Inter(Bullet)Act.
Inter(Bullet)Act has incurred net losses since its inception.
Inter(Bullet)Act received approximately $91 million in net proceeds from the
above financing which will be used to accelerate the roll-out of its systems in
retail supermarkets and, as a result, the net losses incurred by
Inter(Bullet)Act are expected to grow significantly in future years. The Company
records its proportionate share
F-11
VANGUARD CELLULAR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Note 3 -- INVESTMENTS -- Continued
of these losses under the equity method of accounting. The Company anticipates
that during 1997 its cumulative proportionate share of Inter(Bullet)Act losses
will exceed the remaining portion of its investment in Inter(Bullet)Act.
Accordingly the Company will suspend the recognition of losses attributable to
Inter(Bullet)Act until such time that the equity method income is available to
offset the Company's share of Inter(Bullet)Act's future losses.
In addition to the current ownership held by the Company certain officers,
directors and entities affiliated with certain directors of the Company maintain
an additional 27% ownership interest in Inter(Bullet)Act. The aggregate amount
of losses recognized on the equity method of accounting for IWC and
Inter(Bullet)Act are $15.7 million and $2.5 million during 1996 and 1995,
respectively.
Geotek Communications, Inc.
In 1994, the Company purchased from Geotek 2.5 million shares of Geotek
common stock for $30 million and received a series of options to purchase
additional shares and entered into a management consulting agreement to provide
operational and marketing support in exchange for 300,000 shares of Geotek
common stock per year. The investment in Geotek common shares is presented in
the above table and is accounted for as "available for sale" pursuant to SFAS
No. 115. As such, the investment is recorded as its market value, and a net
unrealized holding loss of $14.6 million has been recorded as a component of
shareholders' equity as of December 31, 1996. In September 1995, the Company
purchased for $5.0 million in cash 531,463 shares of convertible preferred stock
of Geotek with a stated value of $9.408 per share. The preferred stock
investment is accounted for at cost and is included in Other Equity Investments
in the above table. The stock options previously granted to the Company by
Geotek in 1994 have all expired unexercised. The expiration of the options also
resulted in the termination of the management agreement.
Under the management agreement, the Company earned and recorded as revenue
approximately 201,370 shares with an aggregate value of $2.1 million in 1996,
approximately 300,000 shares with an aggregate value of $2.4 million in 1995 and
approximately 250,000 shares with an aggregate value of $2.5 million in 1994.
The Company currently owns less than 5% of Geotek's outstanding common stock.
Financial Information of Equity Method Investees
Combined financial position and operating results of the Company's equity
method investees, ENCCJV, IWC and Inter(Bullet)Act as well as certain
significant investees of IWC, for the last three years are as follows (in
thousands):
1996 (1) 1995 (2) 1994 (3)
Current assets.................................................................. $161,974 $ 30,040 $ 14,367
Non-current assets.............................................................. 238,507 119,528 52,530
Current liabilities............................................................. 48,397 19,318 6,462
Non-current liabilities......................................................... 254,073 2,701 353
Redeemable convertible preferred stock.......................................... 103,021 98,845 19,578
Minority interest............................................................... 7,360 335 294
Revenues........................................................................ 29,583 14,050 9,386
Gross profit.................................................................... 2,769 10,418 7,265
Loss from operations............................................................ (54,386) (12,787) (2,773)
Net loss........................................................................ (71,730) (15,081) (3,327)
Information for each investee is summarized from the available financial
information for each entity and is presented only for the years in which the
Company maintained an investment.
(1) Includes information for ENCCJV, Inter(Bullet)Act, IWC and two of IWC's
investees for which the Company's attributable indirect ownership was
determined to be significant.
(2) Includes information for ENCCJV, IWC and Inter(Bullet)Act.
(3) Includes information for ENCCJV only.
F-12
VANGUARD CELLULAR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Note 4 -- LONG-TERM FINANCING ARRANGEMENTS
The Company's long-term financing arrangements consist primarily of a $675
million Credit Facility and $200 million of Senior Debentures due 2006. The
Credit Facility is senior to the Senior Debentures through the use of structured
subordination whereby Vanguard is the borrower on the Senior Debentures and
VCFC, Vanguard's only direct subsidiary, is the primary obligor on the Credit
Facility.
Long-term debt consists of the following as of December 31, 1996 and 1995
(in thousands):
1996 1995
Debt of VCFC:
Borrowings under the Credit Facility:
Term Loan............................................................................ $325,000 $325,000
Revolving Loan....................................................................... 105,000 197,000
Other Long-Term Debt.................................................................... 137 143
430,137 522,143
Debt of Vanguard:
Senior Debentures due 2006, net of unamortized discount of $183......................... 199,817 --
$629,954 $522,143
The future maturities of the principal amount outstanding of all long-term
financing arrangements at December 31, 1996 were as follows (in thousands):
1997...................................................................................... $ --
1998...................................................................................... 24,512
1999...................................................................................... 40,625
2000...................................................................................... 48,750
2001...................................................................................... 65,000
Thereafter................................................................................ 451,250
$630,137
Credit Facility of VCFC
In December 1994, the Company completed the closing of a $675 million
credit facility, pursuant to an Amended and Restated Loan Agreement (the "Credit
Facility"), with various lenders led by The Toronto-Dominion Bank and The Bank
of New York.
The Credit Facility is available to provide the Company with additional
financial and operating flexibility and enable it to pursue business
opportunities that may arise in the future. The Credit Facility refinanced the
Company's then existing $390 million credit facility. In connection with the
refinancing, the Company recorded an extraordinary loss of $8.4 million ($0.22
per share) in 1994, which represented the write-off of all unamortized deferred
financing costs related to the refinanced facility.
The Credit Facility consists of a "Term Loan" and a "Revolving Loan." The
Term Loan, in the amount of $325 million, was used to repay the Company's
borrowings under the prior credit facility. The Revolving Loan, in the amount of
up to $350 million, is available for capital expenditures, to make acquisitions
of and investments in cellular and other wireless communication interests, and
for other general corporate purposes. As of December 31, 1996, $105 million had
been borrowed under the Revolving Loan and the terms of these agreements limit
additional available borrowing during the first quarter of 1997 to $54.0
million.
The outstanding amount of the Term Loan as of March 30, 1998 is to be
repaid in increasing quarterly installments commencing on March 31, 1998 and
terminating at the maturity date of December 31, 2003. The quarterly installment
payments begin at 1.875% of the outstanding principal amount at March 30, 1998
and gradually increase to 5.625% at March 31, 2003. The available borrowings
under the Revolving Loan shall be reduced on a quarterly basis also commencing
on
F-13
VANGUARD CELLULAR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Note 4 -- LONG-TERM FINANCING ARRANGEMENTS -- Continued
March 31, 1998 and terminating on December 31, 2003. The quarterly reduction
begins at 1.875% of the Revolving Loan commitment at March 30, 1998 and
gradually increases to 5.625% on March 31, 2003. The outstanding borrowings
under the Term Loan are due and the Revolving Loan commitment is reduced
quarterly as follows:
Percentage of
Outstanding Loans
1997............................................................................... --%
1998............................................................................... 7.5
1999............................................................................... 12.5
2000............................................................................... 15.0
2001............................................................................... 20.0
2002............................................................................... 22.5
2003............................................................................... 22.5
100.0%
The Term Loan and the Revolving Loan bear interest at a rate equal to the
Company's choice of the Prime Rate or Eurodollar Rate plus an applicable margin
based upon a leverage ratio for the most recent fiscal quarter. The ranges for
this applicable margin are 0.0% to 0.5% for the Prime Rate and 1.0% to 1.75% for
the Eurodollar Rate. As of December 31, 1996 the leverage ratio, which is
computed as the ratio of Total Debt (as defined) to Adjusted Cash Flow (as
defined), was at such a level as to cause the applicable margins on the
borrowings to be 0.0% and 1.125% per annum for the Prime Rate and Eurodollar
Rate, respectively. At December 31, 1996, the Company's effective interest rate
on its outstanding borrowings was 7.65%.
As security for borrowings under the Credit Facility, VCFC has pledged
substantially all of its tangible and intangible assets and future cash flows.
Among other restrictions, the credit facility restricts the payment of cash
dividends, limits the use of borrowings, limits the creation of additional
long-term indebtedness and requires the maintenance of certain financial ratios.
The requirements of the Credit Facility were established in relation to
projected capital needs and projected results of operations and cash flow. These
requirements generally were designed to require continued improvement in
operating performance such that its cash flow would be sufficient to continue
servicing the debt as repayments are required. VCFC is in compliance with all
loan covenants.
Senior Debentures of Vanguard
On April 10, 1996, Vanguard issued $200 million aggregate principal amount
of 9 3/8% Senior Debentures due 2006 (the "Debentures") through an underwritten
public offering. The Debentures were issued at a price to the public of 99.901
for a yield of 9.384%. The net proceeds from the sale of the Debentures of
approximately $194.8 million were used to reduce borrowings under the Revolving
Loan portion of the Credit Facility and pay approximately $844,000 of expenses
in connection with an amendment to the Credit Facility. The Credit Facility was
amended to permit issuance of the Debentures and to require the structural
subordination of the Debentures by making VCFC the primary obligor of the Credit
Facility and all liabilities of the Company (other than the Debentures) and the
owner of all stock and partnership interests of the Company's operating
subsidiaries. The Debentures mature in 2006 and are redeemable at the Company's
option, in whole or in part, at any time on or after April 15, 2001. There are
no mandatory sinking fund payments for the Debentures. Interest is payable
semi-annually. Upon a Change of Control Triggering Event (as defined in the
Indenture for the Debentures), the Company will be required to make an offer to
purchase the Debentures at a purchase price equal to 101% of the principal
amount thereof plus accrued and unpaid interest, if any, to the date of
purchase.
The Debentures require that the Company limit, among other things, the
incurrence of additional indebtedness, the payment of dividends or the
repurchase of Capital Stock, certain distributions and transfers, and certain
asset sales.
F-14
VANGUARD CELLULAR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Note 4 -- LONG-TERM FINANCING ARRANGEMENTS -- Continued
Interest Rate Protection Agreements
The Company maintains interest rate swaps and interest rate caps which
provide protection against interest rate risk. At December 31, 1996 the Company
had interest rate cap agreements in place covering a notional amount of $100
million. The interest rate cap agreements provide protection to the extent that
LIBOR exceeds the strike level through the expiration date as follows (in
thousands):
Strike Level Notional Amount Expiration Date
9.00% 50,000 December 1997
9.75 50,000 December 1997
$ 100,000
The total cost of these interest rate cap agreements of $412,500 has been
recorded in other assets in the accompanying consolidated balance sheet and is
being amortized over the lives of the agreements as a component of interest
expense.
Additionally, the Company maintains interest rate swap agreements that fix
the LIBOR interest rate at 6.01% on a notional amount of $50 million through
July 1997. Under these swap agreements, the Company benefits if LIBOR interest
rates increase above the fixed rates and incurs additional interest expense if
rates remain below the fixed rates. Any amounts received or paid under these
agreements are reflected as interest expense over the period covered.
On December 9, 1996, the Company entered into two 10 year reverse interest
rate swaps with notional amounts totaling $75 million. The reverse swaps
effectively convert $75 million of the Debentures into floating rate debt with
interest payable at the six month LIBOR rate plus 3.1%. Simultaneous with this
transaction, the Company purchased an interest rate cap that limits the total
interest on the $75 million to 10% for the first three years should interest
rates rise. The rate for the first six month period is 8.64% or .735% below the
coupon rate on the Debentures.
The effect of interest rate protection agreements on the operating results
of the Company was to increase interest expense by $464,000, $82,000, and
$95,000 in 1996, 1995 and 1994, respectively. The Company does not hold or issue
financial instruments for trading purposes.
Subsequent to December 31, 1996 the Company entered into additional
interest rate protection agreements. The Company purchased interest rate cap
agreements covering a notional amount of $50 million, having a strike level of
7.5% and having an expiration date of February 1999. The total cost of these
agreements was $141,700. Additionally, the Company entered into two 9 year
reverse interest rate swaps with notional amounts totaling $25 million. The
reverse swaps effectively convert $25 million of the Debentures into floating
rate debt with interest payable at the six-month LIBOR rate plus 2.61%.
Simultaneously with this transaction, the Company purchased an interest rate cap
that limits the total interest on the $25 million to 10% for the first three
years. The rate for the first six month period will be set on April 11, 1997
Note 5 -- COMMITMENTS AND CONTINGENCIES
Operating Leases
The Company leases office space, furniture, equipment, vehicles and land
under noncancelable operating leases expiring through 2019. As of December 31,
1996, the future minimum rental payments under these lease agreements having an
initial or remaining term in excess of one year were as follows (in thousands):
1997...................................................................................... $ 10,623
1998...................................................................................... 10,014
1999...................................................................................... 9,379
2000...................................................................................... 8,913
2001...................................................................................... 8,176
Thereafter................................................................................ 69,705
$116,810
F-15
VANGUARD CELLULAR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Note 5 -- COMMITMENTS AND CONTINGENCIES -- Continued
Rent expense under operating leases was $9.3 million, $6.6 million, and
$4.2 million for the years ended December 31, 1996, 1995 and 1994, respectively.
Construction and Capital Commitments
Capital expenditures for 1997 are estimated to be approximately $120
million for the Company, and are expected to be funded primarily with internally
generated funds.
Note 6 -- INCOME TAXES
Deferred income taxes are provided for the temporary differences between
the financial reporting and tax basis of the Company's assets and liabilities.
The components of net deferred income taxes as of December 31, 1996 and 1995
were as follows (in thousands):
1996 1995
Deferred income tax assets:
Net operating loss carryforwards........................................................ $129,979 $126,684
Property and equipment.................................................................. -- 13,157
Alternative minimum tax credits......................................................... 891 --
Other liabilities and reserves.......................................................... 3,659 811
Valuation allowance..................................................................... (99,215) (81,388)
Total deferred income tax assets................................................... 35,314 59,264
Deferred income tax liabilities:
Investments and other intangibles....................................................... (29,070) (59,264)
Property and equipment.................................................................. (1,244) --
Total deferred income tax liabilities.............................................. (30,314) (59,264)
Net deferred income taxes................................................................. $ 5,000 $ --
The above amounts have been classified in the consolidated balance sheet as
follows (in thousands):
As of December
31
1996 1995
Deferred income tax assets:
Current.......................................................................... $2,149 $ --
Non-current, included in Other Assets............................................ 2,851 --
$5,000 $ --
Prior to 1996, the Company incurred significant financial reporting and tax
losses primarily as a result of substantial depreciation, amortization and
interest expenses associated with acquiring and developing its cellular markets
and substantial marketing and other operating costs associated with building its
subscriber base. Although substantial net deferred income tax assets were
generated during these periods, a valuation allowance was established because in
management's assessment the historical operating results made it uncertain
whether the net deferred income tax assets would be realized.
Since inception, the Company has steadily increased its subscriber base and
improved its revenues and operating results at rates consistent with
management's annual internal forecasts. For example, its reported operating
results have improved from an $8.1 million loss from operations in 1992 to $53.9
million of income from operations in 1996. Similarly, pretax results (before
extraordinary items) reflect earnings of $2.3 million in 1996 compared to losses
of $7.0 million and $13.9 million in 1995 and 1994, respectively. Improvements
in the Company's reported taxable income have generally lagged the financial
reporting results; however, this gap is expected to narrow in future periods as
a result of management tax planning and the expected timing of capital
expenditures.
F-16
VANGUARD CELLULAR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Note 6 -- INCOME TAXES -- Continued
The Company achieved profitability in 1996 for financial reporting
purposes, and management expects improvements in operating results in 1997 and
future periods. Although the Company's ongoing operations have generated Federal
taxable losses since inception, it expects taxable income in 1997 and future
periods. The Company's ability to achieve these expected future financial
reporting and income tax results is dependent on numerous factors, including
general economic conditions, the level of competition from PCS and other service
providers and other factors beyond management's control. Therefore, there can be
no assurance that the Company will achieve improvements in its results of
operations.
In assessing the realizability of the Company's net deferred income tax
assets at December 31, 1996, management considered its historical operating
trends in relation to management expectations of those results, forecasts of
future taxable income and the risks and uncertainties discussed above. Because
of these risks and uncertainties, management concluded that forecasts could be
made with enough certainty to recognize net deferred income tax assets only over
a relatively short-term period. Based upon this analysis, management concluded
that it is "more likely than not" that $5.0 million of its $104.2 million of net
deferred income tax assets at December 31,1996 will be realized. A valuation
allowance of $99.2 million has been provided for the remainder of the Company's
net deferred income tax assets. The Company will continue to assess the
recognition of additional net deferred income tax assets based on its ongoing
evaluation of its actual performance and ability to estimate future performance.
The unrecognized portion of the Company's net deferred income tax assets at
December 31, 1996 includes deferred income tax assets totaling $41.5 million
relating to the net unrealized holding loss on the investment in Geotek and to
additional income tax deductions arising from restricted stock bonuses, stock
options and stock purchase warrants. To the extent the tax benefit of these
amounts is realized in future years, the benefit will be recorded as a direct
addition to shareholders' equity.
The Company's 1996 income tax benefit of $4.1 million includes a current
provision of $891,000 for Federal alternative minimum taxes offset by the
deferred income tax benefit discussed above. In 1995 and 1994, the Company
reported no Federal income tax provision because of the reported losses for
financial reporting and income tax purposes. State income tax planning
strategies have been implemented such that no state income tax provision has
been required for any period.
A reconciliation between income taxes computed at the statutory Federal
rate of 35% and the reported income tax benefit is as follows (in thousands):
December 31,
1996 1995 1994
Amount at statutory Federal rate..................................... $ 808 $(2,454) $(4,827)
Net benefit of tax planning strategies............................... (20,814) (9,877) --
Other................................................................ (2,748) 2,779 1,275
Change in valuation allowance........................................ 18,645 9,552 3,552
Income tax benefit................................................... $ (4,109) $ -- $ --
In 1996 and 1995, the Company executed certain tax planning strategies that
had the effect of increasing the total net deferred income tax assets. These
transactions generally resulted in the current utilization of net operating loss
carryforwards in exchange for the creation of income tax basis that will be
deductible in future periods. The realizability of these additional net deferred
tax amounts was evaluated by the Company in the manner discussed above.
The net unrealized holding losses on the investment in Geotek and the
additional income tax deductions arising from the exercise of stock options
created additional net deferred income tax assets of $10.4 million in 1995. The
1996 change in the unrealized holding loss reduced net deferred income tax
assets by $818,000. The valuation allowance has been adjusted to fully offset
these changes in the net deferred income tax asset.
For Federal income tax reporting purposes, the Company had net operating
loss carryforwards of approximately $315 million at December 31, 1996. These
losses may be used to reduce future taxable income, if any, and expire through
2010.
F-17
VANGUARD CELLULAR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Note 6 -- INCOME TAXES -- Continued
The primary differences between the accumulated deficit for financial reporting
purposes and the income tax loss carryforwards relate to the differences in the
treatment of certain deferred cellular license acquisition costs, certain gains
on dispositions of cellular interests, partnership losses, depreciation methods,
estimated useful lives and compensation earned under the stock compensation
plan. These carryforwards may be subject to annual limitation in the future in
accordance with the Tax Reform Act of 1986 and the ability to use these
carryforwards could be significantly impacted by a future "change of control" of
the Company. The limitations, if any, arising from such future "change in
control" cannot be known at this time.
Note 7 -- CAPITAL STOCK
Common Stock
In July 1994, the Board of Directors declared a 3 for 2 stock split of the
Company's Class A common stock which was effected in the form of a dividend paid
to shareholders of record on August 24, 1994 with cash paid for resultant
fractional shares. The effect of the split has been retroactively applied to all
Class A common stock and per share amounts disclosed in the accompanying
financial statements and footnotes.
Acquisition of Cellular Interests
The Company has registered 4,500,000 shares of its Class A common stock and
3,000,000 shares of its Class B common stock. The shares may be offered in
connection with the acquisition of entities which have received or may receive
an authorization or license from the FCC to provide cellular service. Through
December 31, 1996, 2,707,957 of these registered shares of Class A common stock
have been issued in conjunction with the acquisition of cellular markets.
Stock Compensation Plans
During 1994, the Board adopted the 1994 Long-Term Incentive Plan (the 1994
Plan). Under the provisions of the 1994 Plan, the Company may grant up to
3,000,000 shares of the Company's Class A common stock to officers, directors
and key employees in the form of nonqualified stock options, incentive stock
options, stock appreciation rights, unrestricted stock, restricted stock and
performance shares. All stock options must require exercise prices of not less
than the fair market value of the Company's Class A common stock on the date of
the grant, except that certain incentive stock options must require exercise
prices of not less than 110% of fair market value of the Company's Class A
common stock on the date of the grant. Options granted under the 1994 Plan may
not have a term greater than ten years from the date of grant and are not
transferable except upon death. As of December 31, 1996, 21,575 shares were
available for future grants.
Upon adoption of the 1994 Plan, the Company's previously adopted stock
option and stock compensation plans were terminated. Options granted and
outstanding under these previous plans are still exercisable, but no further
grants may be made under these plans.
Restricted Stock Bonuses
During 1987, the Board granted restricted stock bonuses for a total of
3,469,554 shares of Class A common stock (i) to three key officers for 1,077,768
shares each and (ii) to a director and a key employee for an aggregate of
236,250 shares. In the event of a change in control of the Company prior to
December 31, 1998, the participants will be reimbursed for certain individual
income tax payments, as defined, on the shares vesting after February 1991. As
of December 31, 1996, all of the shares have vested.
Stock Options
Under the terms of the Company's previous and current stock compensation
plans, the Board has granted incentive stock options and nonqualified stock
options requiring exercise prices approximating the fair market value of the
Company's Class A common stock on the date of the grant.
In January 1997, the Board of Directors authorized the cancellation of
certain options with higher exercise prices and the reissuance of fewer options
at a lower exercise price. Options for 896,000 shares with exercise prices
ranging from $24.75 to
F-18
VANGUARD CELLULAR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Note 7 -- CAPITAL STOCK -- Continued
25.125 were canceled and new options for 717,200 shares with an exercise price
of $15.69 were issued. In addition, options for 1,403,750 shares with an
exercise price ranging from $21.50 and $21.625 were canceled and new options for
1,263,375 shares with an exercise price of $15.69 were issued. The exercise
price for all of these new options reflects the fair market value at the time of
issuance.
Stock option activity under the plans was as follows:
Number of Shares Weighted Average
Under Option Exercise Price
Balance, January 1, 1994..................................................... 2,862,425 $11.41
Granted...................................................................... 1,140,743 20.73
Exercised.................................................................... (210,719) 5.05
Forfeited.................................................................... (15,332) 15.47
Balance, December 31, 1994................................................... 3,777,117 14.57
Granted...................................................................... 907,500 25.12
Exercised.................................................................... (760,765) 4.36
Forfeited.................................................................... (20,750) 19.06
Balance, December 31, 1995................................................... 3,903,102 18.96
Granted...................................................................... 1,331,925 18.40
Exercised.................................................................... (27,190) 16.56
Forfeited.................................................................... (6,450) 24.57
Balance, December 31, 1996................................................... 5,201,387 $18.82
Of the total options outstanding at December 31, 1996, 2,871,637 have an
exercise price in the range of $13.17 and $19.25 with a weighted-average
exercise price of $15.58 and a weighted-average contractual life of 6.6 years.
1,907,484 of those options are exercisable at December 31, 1996. 2,314,750 of
the total outstanding options at December 31, 1996 have an exercise price in the
range of $21.50 and $25.13 with a weighted-average exercise price of $22.94 and
a weighted-average contractual life of 8.2 years. 10,000 of those options are
exercisable at December 31, 1996. The remaining 15,000 options have an exercise
price of $2.22 and a one year remaining contractual life. All of those options
are exercisable at December 31, 1996.
In October 1995, SFAS No. 123, "Accounting for Stock-Based Compensation"
was issued. SFAS No. 123 is effective for fiscal years beginning after December
15, 1995. SFAS No. 123 encourages companies to adopt the fair value method for
compensation expense recognition related to employee stock options. Existing
accounting requirements of Accounting Principles Board Opinion No. 25 ("APB No.
25") use the intrinsic value method in determining compensation expense which
represents the excess of the market price of the stock over the exercise price
on the measurement date. The Company elected to remain under the APB No. 25
rules for stock options, and is required to provide pro forma disclosures of
what net income and earnings per share would have been had the Company adopted
the new fair value method for recognition purposes. The following information is
presented as if the Company had adopted SFAS No. 123 and restated its results
(in thousands, except per share data):
1996 1995
Net income (loss):
As reported........................................................ $6,449 $ (7,013)
Pro forma.......................................................... $ 163 $(11,056)
Net income (loss) per share:
As reported........................................................ $ 0.16 $ (0.17)
Pro forma.......................................................... $ -- $ (0.27)
For the above information, the fair value of each option grant was
estimated on the date of grant using the Black-Scholes option pricing model with
the following assumptions used for grants in fiscal 1996 and 1995, respectively:
risk free rates of
F-19
VANGUARD CELLULAR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Note 7 -- CAPITAL STOCK -- Continued
6.0% to 6.6% and 6.5% to 7.4%, expected volatility of 35% and 30%, and expected
lives of 7 years in both years. The weighted-average grant date fair value of
options granted during 1996 and 1995 was $9.19 and $12.45, respectively.
Because the SFAS No. 123 method of accounting has not been applied to
options granted prior to January 1, 1995, the above pro forma amounts may not be
representative of the compensation costs to be expected in future years.
Shares Reserved for Issuance
At December 31, 1996, 5,222,962 shares of the Company's Class A common
stock are reserved for exercise and grant under the Company's stock compensation
plans. In addition, 1,792,043 shares of Class A common stock and 3,000,000
shares of Class B common stock are reserved for issuance in conjunction with the
acquisition of cellular interests discussed above.
Share Repurchase
On November 11, 1996, the Company's Board of Directors authorized the
repurchase of up to 2,500,000 shares of its Class A Common Stock from time to
time in open market or other transactions. As of December 31, 1996 the Company
had repurchased 255,000 shares of its Class A Common Stock at an average price
of approximately $17.00.
Note 8 -- ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses were composed of the following at
December 31, 1996 and 1995 (in thousands):
1996 1995
Accounts payable............................................................................ $42,775 $25,451
Accrued expenses:
Interest.................................................................................. 6,279 4,631
Payroll and commissions................................................................... 10,449 7,880
Other..................................................................................... 5,994 5,185
$65,497 $43,147
Note 9 -- DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value
of each category of financial instruments for which it is practicable to
estimate that value:
Cellular entities carried on the cost method -- The fair value of these
instruments is estimated based upon recent transactions from this portfolio.
Investment in Geotek -- The fair value of publicly-traded securities is
based upon quoted market price. The fair value of the remaining securities
approximates the carrying value.
Inter(Bullet)Act debentures and warrants -- The fair value of the combined
investment in Inter(Bullet)Act debentures and warrants is based upon the quoted
market price.
Interest rate protection agreements -- The fair value of interest rate cap
and swap agreements is based on quoted market prices as if the agreements were
entered into on the measurement date.
Borrowings under Credit Facility -- The fair value of the borrowings under
the VCFC Credit Facility approximates the carrying value.
Vanguard Senior Debentures -- The fair value of the Vanguard Senior
Debentures is based upon quoted market price.
F-20
VANGUARD CELLULAR SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Note 9 -- DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS -- Continued
The estimated fair values of the Company's financial assets (liabilities)
are summarized as follows (in thousands):
December 31, 1996 December 31, 1995
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
Cellular entities carried on the cost method................... $ 9,993 $ 21,038 $ 13,853 $ 24,300
Investment in Geotek........................................... 28,166 28,166 24,253 24,253
Inter(Bullet)Act debentures and warrants....................... 12,712 9,000 -- --
Interest rate protection agreements............................ 137 (2,114) 380 (400)
Borrowings under Credit Facility............................... (430,000) (430,000) (522,000) (522,000)
Senior Debentures of Vanguard.................................. (199,817) (202,000) -- --
Note 10 -- QUARTERLY INFORMATION (UNAUDITED; IN THOUSANDS EXCEPT PER SHARE
AMOUNTS)
1996 Quarters First Second Third Fourth Total
Revenue............................................................... $66,017 $75,621 $79,623 $80,793 $302,054
Income from operations................................................ 11,872 16,861 17,600 7,595 53,928
Net income (loss)..................................................... 2,621 4,772 2,888 (3,832) 6,449
Net income (loss) per share........................................... 0.06 0.12 0.07 (0.09) 0.16
1995 Quarters First Second Third Fourth Total
Revenue............................................................... $49,817 $58,754 $62,704 $64,796 $236,071
Income from operations................................................ 1,963 7,928 13,805 8,162 31,858
Net income (loss)..................................................... (7,157) (1,327) 3,291 (1,820) (7,013)
Net income (loss) per share........................................... (0.18) (0.03) 0.08 (0.04) (0.17)
F-21
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Vanguard Cellular Systems, Inc.:
We have audited the accompanying consolidated balance sheets of Vanguard
Cellular Systems, Inc. (a North Carolina corporation) and subsidiaries as of
December 31, 1996 and 1995, and the related consolidated statements of
operations, changes in shareholders' equity and cash flows for each of the three
years in the period ended December 31, 1996. These financial statements and
schedules are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements 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 financial statements referred to above present fairly,
in all material respects, the financial position of Vanguard Cellular Systems,
Inc. and subsidiaries as of December 31, 1996 and 1995, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1996, in conformity with generally accepted accounting principles.
Our audit was made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedules listed in the index to
consolidated financial statements and schedules are presented for purposes of
complying with the Securities and Exchange Commission's rules and are not part
of the basic financial statements. The schedules have been subjected to the
auditing procedures applied in the audit of the basic financial statements and,
in our opinion, fairly state in all material respects the financial data
required to be set forth therein in relation to the basic financial statements
taken as a whole.
ARTHUR ANDERSEN LLP
Greensboro, North Carolina,
February 26, 1997.
F-22
VANGUARD CELLULAR SYSTEMS, INC.
SCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
CONDENSED PARENT COMPANY BALANCE SHEETS
(Dollar amounts in thousands)
December 31, December 31,
1996 1995
ASSETS
Cash............................................................................................. $ 586 $ --
Investments...................................................................................... 230,970 29,048
Other Assets, net of accumulated amortization of $450............................................ 5,552 --
Total assets.............................................................................. $ 237,108 $ 29,048
LIABILITIES AND SHAREHOLDERS' EQUITY
Accrued interest................................................................................. $ 3,840 $ --
Long-Term Debt, net of discount of $183.......................................................... 199,817 --
Total liabilities......................................................................... 203,657 --
Shareholders' Equity:
Preferred stock -- $.01 par value, 1,000,000 shares authorized, no shares issued............... -- --
Common stock, Class A -- $.01 par value, 250,000,000 shares authorized, 41,084,522 and
41,312,053 shares issued and outstanding.................................................... 411 413
Common stock, Class B -- $.01 par value, 30,000,000 shares authorized, no shares issued........ -- --
Additional capital in excess of par value...................................................... 237,640 238,662
Net unrealized holding loss.................................................................... (14,570) (16,395)
Accumulated deficit............................................................................ (190,030) (193,632)
Total shareholders' equity................................................................ 33,451 29,048
Total liabilities and shareholders' equity................................................ $ 237,108 $ 29,048
The accompanying notes to condensed parent company financial statements are an
integral part of these balance sheets.
F-23
VANGUARD CELLULAR SYSTEMS, INC.
SCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
CONDENSED PARENT COMPANY STATEMENTS OF OPERATIONS
(Dollar amounts in thousands)
For the years ended December
31,
1996 1995 1994
Interest expense............................................................................ $(13,940) $ -- $ --
Equity in earnings (losses) of Vanguard Cellular Financial Corp............................. 20,389 (7,013) (22,347)
Net income (loss)........................................................................... $ 6,449 $(7,013) $(22,347)
The accompanying notes to condensed parent company financial statements are an
integral part of these statements.
F-24
VANGUARD CELLULAR SYSTEMS, INC.
SCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
CONDENSED STATEMENTS OF CASH FLOWS
(Dollar amounts in thousands)
For the years ended December 31,
1996 1995 1994
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss).................................................................... $ 6,449 $(7,013) $ (22,347)
Adjustments to reconcile net loss to net cash used in operating activities:
Amortization of deferred debt issuance costs...................................... 450 -- --
Equity in earnings (losses) of Vanguard Cellular Financial Corp................... (20,389) (7,013) 22,347
Amortization of bond investment discount 15 -- --
Change in accrued interest........................................................ 3,840 -- --
Net cash used in operating activities........................................... (9,635) -- --
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from dividends of investee.................................................. 13,960 (3,939) (1,415)
Investment in Vanguard Cellular Financial Corp....................................... (193,668) (3,939) (1,415)
Net cash used in investing activities........................................... (179,708) (3,939) (1,415)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of common stock........................................... 454 3,939 1,415
Repurchase of stock.................................................................. (4,325) -- --
Proceeds of long-term debt........................................................... 199,802 -- --
Debt issuance costs.................................................................. (6,002) -- --
Net cash provided by financing activities....................................... 189,929 3,939 1,415
NET INCREASE IN CASH................................................................... 586 -- --
CASH, BEGINNING OF YEAR................................................................ -- -- --
CASH, END OF YEAR...................................................................... $ 586 $-- $ --
The accompanying notes to condensed parent company financial statements are an
integral part of these statements.
F-25
VANGUARD CELLULAR SYSTEMS, INC.
SCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
NOTES TO CONDENSED FINANCIAL STATEMENTS
1. PRESENTATION
These condensed financial statements have been prepared pursuant to the
rules and regulations of the Securities and Exchange Commission. Certain
information and note disclosures normally included in annual financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to those rules and regulations, although
the Company believes that the disclosures made are adequate to make the
information presented not misleading.
2. ORGANIZATION
Vanguard Cellular Systems, Inc. ("Vanguard") is a holding company which is
the 100% shareholder of Vanguard Cellular Financial Corp. ("VCFC"). This
organization was created in April 1996 to structurally subordinate Vanguard's
$200 million in Senior Debentures to VCFC's Credit Facility. Prior to that time,
operations of the Company were conducted by Vanguard. For purposes of this
condensed financial information, the reorganization has been treated in a manner
similar to a pooling-of-interests. As a result, this condensed financial
information has been prepared as if Vanguard were a holding company in all
periods.
3. LONG-TERM DEBT
On April 10, 1996, Vanguard issued $200 million aggregate principal amount
of 9 3/8% Senior Debentures due 2006 (the "Debentures") through an underwritten
public offering. The Debentures were issued at a price to the public of 99.901
for a yield of 9.384%. The net proceeds from the sale of the Debentures of
approximately $194.8 million were contributed to VCFC primarily to reduce
borrowings under the VCFC Credit Facility and were used by Vanguard to pay other
expenses. The VCFC Credit Facility was amended to permit issuance of the
Debentures and require the structural subordination of the Debentures by making
VCFC the primary obligor of the Credit Facility and all liabilities of Vanguard
(other than the Debentures) and the owner of all stock and partnership interests
of Vanguard's operating subsidiaries. The Debentures mature in 2006 and are
redeemable at Vanguard's option, in whole or in part, at any time on or after
April 15, 2001. There are no mandatory sinking fund payments for the Debentures.
Interest is payable semi-annually. Upon a Change of Control Triggering Event (as
defined in the Indenture for the Debentures), Vanguard will be required to make
an offer to purchase the Debentures at a purchase price equal to 101% of the
principal amount thereof plus accrued and unpaid interest, if any, to the date
of purchase.
The Debentures require that Vanguard and its subsidiaries limit, among
other things, the incurrence of additional indebtedness, the payments of
dividends or the repurchase of Capital Stock, certain distributions and
transfers, and certain asset sales.
4. SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR ADDITIONAL DISCLOSURES.
F-26
VANGUARD CELLULAR SYSTEMS, INC. AND SUBSIDIARIES
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1994, 1995 and 1996
(Dollar amounts in thousands)
Balance Provision
at charged to
beginning costs and
of period expenses Deductions(1) Other(2)
Allowance for doubtful accounts:
Year ended December 31, 1994................................... $ 1,771 $3,059 $(2,134) $ 65
Year ended December 31, 1995................................... 2,761 6,166 (3,154) 50
Year ended December 31, 1996................................... 5,823 5,860 (7,113) 47
Balance at
end of
period
Allowance for doubtful accounts:
Year ended December 31, 1994................................... $2,761
Year ended December 31, 1995................................... 5,823
Year ended December 31, 1996................................... 4,617
(1) Accounts written off during the period.
(2) Represents allowance for doubtful accounts for entities acquired during the
period.
F-27
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE BOARD OF DIRECTORS OF
INTER(Bullet)ACT SYSTEMS, INCORPORATED AND SUBSIDIARY:
We have audited the accompanying consolidated balance sheets of
Inter(Bullet)Act Systems, Incorporated (a North Carolina corporation in the
development stage) and Subsidiary as of September 28, 1996 and September 30,
1995, and the related consolidated statements of operations, stockholders'
equity (deficit) and cash flows for each of the three fiscal years in the period
ended September 28, 1996 and for the period from inception (February 25, 1993)
to September 28, 1996. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements 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 financial statements referred to above present fairly,
in all material respects, the financial position of Inter(Bullet)Act Systems,
Incorporated and Subsidiary as of September 28, 1996 and September 30, 1995, and
the results of their operations and their cash flows for each of the three
fiscal years ended September 28, 1996 and for the period from inception
(February 25, 1993) to September 28, 1996, in conformity with generally accepted
accounting principles.
ARTHUR ANDERSEN LLP
Melville, New York,
November 18, 1996.
F-28
INTER(Bullet)ACT SYSTEMS, INCORPORATED AND SUBSIDIARY
(A Development Stage Company)
CONSOLIDATED BALANCE SHEETS
September 28, September 30,
1996 1995
Assets
CURRENT ASSETS:
Cash and cash equivalents................................................................... $ 93,479,584 $ 65,676
Accounts receivable, net of allowance for doubtful accounts of $10,000 and $3,550,
respectively............................................................................. 243,848 62,302
Prepaid expenses and other.................................................................. 253,885 82,914
Notes receivable from stockholders (Note 4)................................................. -- 70,474
Accrued interest receivable................................................................. -- 12,984
Total current assets................................................................... 93,977,317 294,350
PROPERTY AND EQUIPMENT, net (Note 3).......................................................... 9,858,111 1,776,912
OTHER ASSETS:
Bond issuance costs, net of accumulated amortization of $67,422 and $0, respectively (Note
2)....................................................................................... 3,723,656 --
Deposits.................................................................................... 35,000 37,275
Organization costs, net of accumulated amortization of $28,158 and $20,300, respectively.... 11,132 18,990
Patents, licenses and trademarks, net of accumulated amortization of $24,202 and $2,972,
respectively (Note 2).................................................................... 126,175 18,228
Other intangibles, net of accumulated amortization of $8,836 and $2,301, respectively....... 25,677 32,212
Total other assets..................................................................... 3,921,640 106,705
Total assets........................................................................... $ 107,757,068 $ 2,177,967
Liabilities and Stockholders' Equity (Deficit)
CURRENT LIABILITIES:
Current portion of long-term debt........................................................... $ 67,709 $ --
Accounts payable............................................................................ 1,285,919 408,784
Accrued expenses............................................................................ 509,119 345,939
Deferred revenue............................................................................ 229,023 21,712
Note payable (Note 12)...................................................................... 50,000 --
Notes payable to related party (Note 5)..................................................... -- 200,000
Notes payable to stockholders-current portion (Note 6)...................................... -- 70,474
Total current liabilities.............................................................. 2,141,770 1,046,909
NOTES PAYABLE TO STOCKHOLDERS (Note 6)........................................................ 236,500 1,971,130
LONG-TERM DEBT, net of discount (Note 7)...................................................... 72,922,617 --
OTHER LONG-TERM LIABILITIES................................................................... 58,124 70,247
Total liabilities...................................................................... 75,359,011 3,088,286
COMMITMENTS AND CONTINGENCIES (Note 17)
COMMON STOCK PURCHASE WARRANTS (Note 8)....................................................... 24,463,760 --
STOCKHOLDERS' EQUITY (DEFICIT:)
Common stock, no par value; 20,000,000 shares authorized; 7,668,555 and 3,930,900 shares
issued and outstanding, respectively..................................................... 27,651,071 7,253,965
Additional paid-in capital.................................................................. 768,000 --
Deferred compensation (Note 10)............................................................. (761,600) --
Deficit accumulated during the development stage............................................ (19,723,174) (8,164,284)
Total stockholders' equity (deficit)................................................... 7,934,297 (910,319)
Total liabilities and stockholders' equity (deficit)................................... $ 107,757,068 $ 2,177,967
The accompanying notes are an integral part of these consolidated balance
sheets.
F-29
INTER(Bullet)ACT SYSTEMS, INCORPORATED AND SUBSIDIARY
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF OPERATIONS
For the For the For the
Year Ended Year Ended Year Ended
September 28, 1996 September 30, 1995 September 30, 1994
Gross sales.................................. $ 492,439 $ 254,714 $ 6,573
Less: Retailer reimbursements................ (286,980) (144,475) (3,812)
Net sales.............................. 205,459 110,239 2,761
Direct operating expenses.................... 2,694,320 842,025 262,389
Gross deficit................................ (2,488,861) (731,786) (259,628)
Selling, general and administrative
expenses................................... (6,440,468) (3,504,751) (1,975,313)
Depreciation and amortization................ (821,105) (190,748) (31,604)
Loss from operations......................... (9,750,434) (4,427,285) (2,266,545)
Interest expense............................. (2,743,436) (187,249) (87,808)
Interest and dividend income................. 1,009,160 34,565 8,630
Other income (expense), net.................. (74,180) 54,247 2,213
Net loss.............................. $(11,558,890) $ (4,525,722) $ (2,343,510)
PER SHARE INFORMATION:
Net loss per share (Note 2)........... $ (1.91) $ (1.27) $ (0.83)
Weighted average common shares
outstanding........................ 6,038,070 3,555,904 2,830,307
For the Period from
February 25, 1993
(Date of Inception)
to September 28,
1996
Gross sales.................................. $ 764,326
Less: Retailer reimbursements................ (435,267)
Net sales.............................. 329,059
Direct operating expenses.................... 3,802,083
Gross deficit................................ (3,473,024)
Selling, general and administrative
expenses................................... (13,215,294)
Depreciation and amortization................ (1,050,998)
Loss from operations......................... (17,739,316)
Interest expense............................. (3,018,493)
Interest and dividend income................. 1,052,355
Other income (expense), net.................. (17,720)
Net loss.............................. $ (19,723,174)
PER SHARE INFORMATION:
Net loss per share (Note 2)...........
Weighted average common shares
outstanding........................
The accompanying notes are an integral part of these consolidated statements.
F-30
INTER(Bullet)ACT SYSTEMS, INCORPORATED AND SUBSIDIARY
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
From February 25, 1993 (Date of Inception) To September 28, 1996
Deficit
Accumulated
Additional During the
Common Stock Paid-in Deferred Development
Shares Amount Capital Compensation Stage
April 1993, the Company issued 816,902
shares of common stock to Clearing
Systems, Inc. for certain technological
information and processes. Consideration
for the shares, after assumption of
certain liabilities, was approximately
$.012 per share (Note 9).................. 816,902 $ 10,000 $ -- $ -- $ --
April 1993, the Company issued 1,898,592
shares to various stockholders in exchange
for cash and notes payable to the Company
valued at approximately $1.016 per
share..................................... 1,898,592 1,929,526 -- -- --
April 1993, the Company issued 101,406
shares to three stockholders in
consideration for investment services and
notes payable to the Company valued at
approximately $1.016 per share............ 101,406 103,059 -- -- --
Net loss for the period..................... -- -- -- -- (1,295,052 )
BALANCE AT SEPTEMBER 30, 1993............... 2,816,900 2,042,585 -- -- (1,295,052 )
August 1994, return of capital to
stockholders............................ -- (371,130) -- -- --
Issuance of common stock.................. 100,000 500,000 -- -- --
Forfeiture of common stock (Note 18)...... (10,000) -- -- -- --
Issuance of previously forfeited common
stock (Note 18)......................... 10,000 50,000 -- -- --
Net loss for the year..................... -- -- -- -- (2,343,510 )
BALANCE AT SEPTEMBER 30, 1994............... 2,916,900 2,221,455 -- -- (3,638,562 )
Issuance of common stock.................. 632,000 3,172,510 -- -- --
Forfeiture of common stock (Note 18)...... (18,000) (140,000) -- -- --
Issuance of common stock (Note 16)........ 400,000 2,000,000 -- -- --
Net loss for the year..................... -- -- -- -- (4,525,722 )
BALANCE AT SEPTEMBER 30, 1995............... 3,930,900 7,253,965 -- -- (8,164,284 )
Issuance of common stock.................. 3,319,338 18,256,359 -- -- --
Conversion of $1.6 million of debt to
common stock (Note 6)................... 319,993 1,599,965 -- -- --
Conversion of accrued interest to common
stock (Note 6).......................... 12,356 67,958 -- -- --
Conversion of notes payable to
stockholders and related accrued
interest to common stock (Note 6)....... 75,968 417,824 -- -- --
Issuance of common stock in payment of
consulting fees (Note 17)............... 10,000 55,000 -- -- --
Deferred Compensation related to stock
options granted......................... -- -- 768,000 (768,000) --
Amortization of deferred compensation..... -- -- -- 6,400 --
Net loss for the year..................... -- -- -- -- (11,558,890 )
BALANCE AT SEPTEMBER 28, 1996............... 7,668,555 $27,651,071 $768,000 $ (761,600) $(19,723,174)
Total
Stockholders'
Equity (Deficit)
April 1993, the Company issued 816,902
shares of common stock to Clearing
Systems, Inc. for certain technological
information and processes. Consideration
for the shares, after assumption of
certain liabilities, was approximately
$.012 per share (Note 9).................. $ 10,000
April 1993, the Company issued 1,898,592
shares to various stockholders in exchange
for cash and notes payable to the Company
valued at approximately $1.016 per
share..................................... 1,929,526
April 1993, the Company issued 101,406
shares to three stockholders in
consideration for investment services and
notes payable to the Company valued at
approximately $1.016 per share............ 103,059
Net loss for the period..................... (1,295,052)
BALANCE AT SEPTEMBER 30, 1993............... 747,533
August 1994, return of capital to
stockholders............................ (371,130)
Issuance of common stock.................. 500,000
Forfeiture of common stock (Note 18)...... --
Issuance of previously forfeited common
stock (Note 18)......................... 50,000
Net loss for the year..................... (2,343,510)
BALANCE AT SEPTEMBER 30, 1994............... (1,417,107)
Issuance of common stock.................. 3,172,510
Forfeiture of common stock (Note 18)...... (140,000)
Issuance of common stock (Note 16)........ 2,000,000
Net loss for the year..................... (4,525,722)
BALANCE AT SEPTEMBER 30, 1995............... (910,319)
Issuance of common stock.................. 18,256,359
Conversion of $1.6 million of debt to
common stock (Note 6)................... 1,599,965
Conversion of accrued interest to common
stock (Note 6).......................... 67,958
Conversion of notes payable to
stockholders and related accrued
interest to common stock (Note 6)....... 417,824
Issuance of common stock in payment of
consulting fees (Note 17)............... 55,000
Deferred Compensation related to stock
options granted......................... --
Amortization of deferred compensation..... 6,400
Net loss for the year..................... (11,558,890)
BALANCE AT SEPTEMBER 28, 1996............... $ 7,934,297
The accompanying notes are an integral part of these consolidated statements.
F-31
INTER(Bullet)ACT SYSTEMS, INCORPORATED AND SUBSIDIARY
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the For the For the
Year Ended Year Ended Year Ended
September 28, 1996 September 30, 1995 September 30, 1994
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................. $(11,558,890) $ (4,525,722) $ (2,343,510)
Adjustments to reconcile net loss to net
cash used in operating activities --
Issuance of convertible note payable to
related party in payment of royalties
(Note 17)............................. 375,000 -- --
Non-cash interest on discounted bonds... 2,626,161 -- --
Amortization of deferred compensation... 6,400 -- --
Depreciation and amortization........... 821,105 190,748 31,604
Loss on asset disposal.................. 74,268 10,463 --
Issuance of note payable to settle
litigation (Note 12).................. 50,000 -- --
Acquired research and development
expenses.............................. -- -- --
Expiration of acquired prepaid
expenses.............................. -- -- --
Stock issued in payment of investment
service fees.......................... -- -- --
Increase in accounts receivable and
accrued interest receivable........... (168,562) (59,218) (7,468)
Increase in prepaid expenses and
other................................. (115,971) (74,843) 32,649
Increase in other assets................ (126,902) (39,775) (6,886)
Increase in accounts payable............ 877,135 370,244 (51,584)
Increase in accrued expenses............ 277,832 216,916 78,216
Increase in deferred revenue............ 207,311 21,712 --
(Decrease) increase in other long-term
liabilities........................... (12,123) 70,247 --
Net cash used in operating
activities......................... (6,667,236) (3,819,228) (2,266,979)
CASH FLOWS FROM INVESTING ACTIVITIES:
Organization costs incurred............... -- -- --
Patents and licensing agreements.......... -- -- --
Purchases of property and equipment....... (743,274) (337,368) (266,893)
Increase in product equipment in process
of manufacturing........................ (1,615,526) (451,770) --
Cost of manufacturing of product and test
equipment............................... (6,379,833) (912,995) --
Proceeds from sale of property and
equipment............................... 56,908 -- --
Net cash used in investing
activities......................... (8,681,725) (1,702,133) (266,893)
For the Period from
February 25, 1993
(Date of Inception)
to September 28, 1996
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................. $ (19,723,174)
Adjustments to reconcile net loss to net
cash used in operating activities --
Issuance of convertible note payable to
related party in payment of royalties
(Note 17)............................. 375,000
Non-cash interest on discounted bonds... 2,626,161
Amortization of deferred compensation... 6,400
Depreciation and amortization........... 1,050,998
Loss on asset disposal.................. 84,731
Issuance of note payable to settle
litigation (Note 12).................. 50,000
Acquired research and development
expenses.............................. 611,471
Expiration of acquired prepaid
expenses.............................. 30,000
Stock issued in payment of investment
service fees.......................... 32,582
Increase in accounts receivable and
accrued interest receivable........... (243,848)
Increase in prepaid expenses and
other................................. (198,790)
Increase in other assets................ (186,690)
Increase in accounts payable............ 1,285,919
Increase in accrued expenses............ 623,771
Increase in deferred revenue............ 229,023
(Decrease) increase in other long-term
liabilities........................... 58,124
Net cash used in operating
activities......................... (13,288,322)
CASH FLOWS FROM INVESTING ACTIVITIES:
Organization costs incurred............... (39,290)
Patents and licensing agreements.......... (18,700)
Purchases of property and equipment....... (1,362,144)
Increase in product equipment in process
of manufacturing........................ (2,067,296)
Cost of manufacturing of product and test
equipment............................... (7,292,828)
Proceeds from sale of property and
equipment............................... 56,908
Net cash used in investing
activities......................... (10,723,350)
F-32
INTER(Bullet)ACT SYSTEMS, INCORPORATED AND SUBSIDIARY
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
For the For the For the
Year Ended Year Ended Year Ended
September 28, 1996 September 30, 1995 September 30, 1994
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of convertible notes not
converted to equity..................... (35) -- --
Proceeds from private placement (Note 1).. 94,655,780 -- --
Payment of bond issuance costs............ (3,791,078) -- --
Repayment of notes payable to related
party................................... (200,000) -- --
Payment of notes payable.................. -- -- (3,368)
Proceeds from repayment of notes
receivable from stockholders............ 70,474 -- --
Proceeds from notes payable to related
party................................... -- 200,000 --
Proceeds from notes payable to
stockholders............................ -- 148,362 912,112
Repayment of long-term debt............... (19,657) -- --
Payment of assumed liabilities............ -- -- --
Repayment of convertible notes payable to
related parties......................... (138,500) -- --
Proceeds from common stock issuance, net
of forfeitures.......................... 18,256,359 5,032,510 550,000
Repayment of notes payable to
stockholders............................ (70,474) -- --
Repayment of accounts receivable from
stockholders............................ -- -- 1,051,560
Net cash provided by financing
activities......................... 108,762,869 5,380,872 2,510,304
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS............................... 93,413,908 (140,489) (23,568)
CASH AND CASH EQUIVALENTS AT BEGINNING OF
YEAR...................................... 65,676 206,165 229,733
CASH AND CASH EQUIVALENTS AT END OF YEAR.... $ 93,479,584 $ 65,676 $ 206,165
SUPPLEMENTAL DISCLOSURE OF NON-CASH
ACTIVITIES:
Conversion of debt to common stock (Note
6)...................................... $ 1,599,965 $ -- $ --
Conversion of accrued interest to common
stock (Note 6).......................... $ 67,958 $ -- $ --
Conversion of notes payable to
stockholders and related accrued
interest to common stock (Note 6)....... $ 417,824 $ -- $ --
Issuance of common stock in payment of
consulting fees (Note 17)............... $ 55,000 $ -- $ --
Deferred compensation related to stock
options granted......................... $ 768,000 $ -- $ --
Capital lease obligations incurred........ $ 259,224 $ -- $ --
For the Period from
February 25, 1993
(Date of Inception)
to September 28, 1996
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of convertible notes not
converted to equity..................... (35)
Proceeds from private placement (Note 1).. 94,655,780
Payment of bond issuance costs............ (3,791,078)
Repayment of notes payable to related
party................................... (200,000)
Payment of notes payable.................. (4,575)
Proceeds from repayment of notes
receivable from stockholders............ 70,474
Proceeds from notes payable to related
party................................... 200,000
Proceeds from notes payable to
stockholders............................ 1,060,474
Repayment of long-term debt............... (19,657)
Payment of assumed liabilities............ (40,000)
Repayment of convertible notes payable to
related parties......................... (138,500)
Proceeds from common stock issuance, net
of forfeitures.......................... 24,717,287
Repayment of notes payable to
stockholders............................ (70,474)
Repayment of accounts receivable from
stockholders............................ 1,051,560
Net cash provided by financing
activities......................... 117,491,256
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS............................... 93,479,584
CASH AND CASH EQUIVALENTS AT BEGINNING OF
YEAR...................................... --
CASH AND CASH EQUIVALENTS AT END OF YEAR.... $ 93,479,584
SUPPLEMENTAL DISCLOSURE OF NON-CASH
ACTIVITIES:
Conversion of debt to common stock (Note
6)...................................... $ 1,599,965
Conversion of accrued interest to common
stock (Note 6).......................... $ 67,958
Conversion of notes payable to
stockholders and related accrued
interest to common stock (Note 6)....... $ 417,824
Issuance of common stock in payment of
consulting fees (Note 17)............... $ 55,000
Deferred compensation related to stock
options granted......................... $ 768,000
Capital lease obligations incurred........ $ 259,224
The accompanying notes are an integral part of these consolidated statements.
F-33
INTER(Bullet)ACT SYSTEMS, INCORPORATED AND SUBSIDIARY
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 28, 1996, SEPTEMBER 30, 1995 and SEPTEMBER 30, 1994
1. ORGANIZATION
Inter(Bullet)Act Systems, Incorporated and Subsidiary (together, the
"Company") develops, owns and operates proprietary electronic marketing systems
("IPN") that are designed to give consumer products manufacturers (the
"Manufacturers") and retailers the ability to influence the purchasing behavior
of consumers moments before shopping begins and to track and analyze individual
consumer purchasing behavior on an ongoing basis. The Company's current
commercial product offering utilizes interactive "touch-screen" terminals inside
the entrance of retail supermarkets that issue individually targeted, and
immediately usable, coupons and other promotional incentives based on each
consumer's cumulative purchasing history. Since its formation in 1993, the
Company has focused its system development and commercialization efforts
primarily in the retail supermarket industry. Although it has been tested in
commercial and noncommercial environments, the IPN is in the early stages of
implementation and is subject to the risks inherent in the commercialization of
new products. The Company has limited experience in installing and operating
substantial numbers of IPN terminals and has encountered technical
implementation problems as it installs IPN terminals on a greater scale, which
have delayed a substantial number of the Company's scheduled IPN installations.
There can be no assurance that these or other problems associated with new
product commercialization will not continue to occur. As the Company continues
to install terminals on a greater scale, there are likely to be other technical
implementation problems, some of which may be material. The continuing
occurrence of difficulities in installing and operating a large number of
terminals could have a material adverse effect on the Company's prospects,
operating results and financial condition.
The Company was incorporated on February 25, 1993 and issued common stock
to stockholders of CSI (Note 9) on April 14, 1993 and to fifteen additional
stockholders on April 16, 1993. Activities from the date of inception to
September 28, 1996 have been directed primarily to raising capital, developing
the software and cabinetry for placement of interactive terminals and network
equipment in stores, test marketing the service, advertising and promoting the
services offered and performing administrative functions.
From inception to September 28, 1996, the Company has had minimal revenues
and there is no assurance that the product which has been developed will achieve
success in the marketplace. The success of future operations will be dependent
primarily upon the acceptance of the Company's flagship product. The Company may
require additional capital subsequent to September 30, 1997 to fund its planned
expansion or to address liquidity needs caused by shortfalls in revenue. If
additional funds are raised through debt financing, such financing will increase
the financial leverage of the Company and earnings would be reduced by the
associated interest expense. Furthermore, if the product gains market
acceptance, there is no assurance that the Company will generate sufficient
revenues to recognize a profit or that other products will not be developed by
other companies that will render the Company's product obsolete.
Since inception, the Company has incurred recurring losses and experienced
negative operating cash flow. Through July 1996, the Company relied primarily on
equity financing to fund its operations. In October 1995, the Company approved
an offering of its common stock at $5.50 per share. In connection with this
offering, the Company issued warrants to the investors in the offering to
purchase an aggregate of 323,217 additional common shares. Investors in this
offering have purchased common shares for net proceeds in the amount of
approximately $18.1 million. Holders of convertible notes in the principal
amount of approximately $1,600,000 converted both principal and one-half of
accrued interest ($67,958) to shares of the Company's common stock and the
Company has revised the payment terms of certain commitments (Note 17) and
exchanged notes payable to stockholders (Note 6) and accrued interest thereon
for equity in the amount of $417,824.
In August 1996, the Company, through a private placement offering
memorandum ("Private Placement"), issued 142,000 units, each consisting of a 14%
senior discount note due 2003 with a principal amount at maturity of $1,000 and
one warrant to purchase 7.334 shares of common stock of the Company at $.01 per
share. However, if the Company has not completed an initial public offering by
September 30, 1997, each warrant that has not been exercised will entitle the
respective holder to purchase 9.429 shares of the Company's common stock at $.01
per share. Net proceeds of this offering were approximately $94.7 million
(before deducting costs of the offering of approximately $3.8 million). In the
opinion of the Company's management, the impact of the equity and debt raised
and the debt and commitments restructured will provide the Company with the
liquidity and capital resources to fund its operations through the end of fiscal
1997. However, the
F-34
INTER(Bullet)ACT SYSTEMS, INCORPORATED AND SUBSIDIARY
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
1. ORGANIZATION -- Continued
Company may require additional capital prior to December 31, 1997 to fund its
planned expansion and to address any liquidity needs caused by shortfalls in
revenue.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The financial statements include the consolidated accounts of the Company
and its wholly-owned subsidiary, Network Licensing, Inc. ("NLI"). All
significant intercompany accounts and transactions have been eliminated.
Fiscal Year
The Company's 1996 and 1995 fiscal years ended on the Saturday closest to
September 30. Fiscal 1994 ended on September 30, 1994. The financial statements
for fiscal 1996, 1995 and 1994 each contain activity for fifty-two weeks.
Revenue Recognition
The Company recognizes revenue as coupons are redeemed at terminals. Brand
manufacturers pay a fee to the Company for each redemption. The fee is composed
of 1) a retailer processing fee, 2) a redemption fee and 3) the face value of
the coupon. The Company in turn passes through both the retailer processing fee,
which is included in direct operating expenses, and the face value of the coupon
to the retailer, while retaining the redemption fee. The Company records as net
sales the redemption fee and the retailer processing fee paid by the
manufacturers. Certain manufacturers pay the Company in advance for a portion of
anticipated redemptions, and these amounts are recorded as deferred revenue
until earned through redemptions.
Cash and Cash Equivalents
Cash equivalents, which at September 28, 1996 were primarily comprised of
money market funds and overnight repurchase agreements, are stated at cost,
which approximates market value. Highly liquid investments with maturities of
three months or less are considered cash equivalents for purposes of the balance
sheets and statements of cash flows.
Accounts Receivable -- Allowance Method
The Company uses the allowance method to account for uncollectable accounts
receivable. The accounts receivable of the Company at September 28, 1996 and
September 30, 1995 consist of receivables accumulated during the test marketing
stage of the enterprise.
Product Equipment in Process of Manufacturing
The Company's product equipment in process of manufacturing consists of
components and spare parts used in the manufacturing of interactive terminals
and network equipment, and the assembly of store servers. Upon installation of
interactive terminals and network equipment, and store servers, accumulated
incurred costs (consisting of direct materials, direct labor and overhead
directly attributable to the manufacturing of these items) are capitalized as
product equipment and depreciated accordingly. Spare parts are expensed to
repairs and maintenance as they are used. Subsequent to the sale of the
Company's product equipment manufacturing function (Note 11), the Company will
purchase finished product equipment from an unrelated third party. The Company
will continue to own certain components and spare parts for use in repairs and
maintenance.
Property and Equipment
Property and equipment is recorded at cost. Depreciation and amortization
are determined using the straight-line method and are based on estimated useful
lives of assets and improvements of five to ten years for both book and income
tax
F-35
INTER(Bullet)ACT SYSTEMS, INCORPORATED AND SUBSIDIARY
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- Continued
purposes. Depreciation and amortization expense for fiscal years 1996, 1995 and
1994 and for the period from February 25, 1993 (Date of Inception) to September
28, 1996 was $785,482, $179,175, $22,500 and $989,802, respectively.
Research and Development Costs
Research and development costs incurred by the Company are included in
selling, general and administrative expenses. Such costs for fiscal 1996, 1995
and 1994, and for the period from February 25, 1993 (Date of Inception) to
September 28, 1996 were $799,645, $622,862, $350,130 and $2,384,108 (Note 9),
respectively.
Bond Issuance Costs
Bond issuance costs incurred by the Company are costs associated with the
Private Placement (Note 1) and are being amortized over seven years using the
effective interest method. Amortization of these costs is included in interest
expense and was $67,422 for fiscal 1996.
Organization Costs
Organization costs, principally legal fees, have been deferred and are
being amortized over five years using the straight-line method. Amortization
expense for fiscal 1996, 1995 and 1994, and for the period from February 25,
1993 (Date of Inception) to September 28, 1996 was $7,858, $7,858, $7,858 and
$28,158, respectively.
Patents, Licenses and Trademarks
Legal fees incurred for the improvement and protection of the Company's
patents, licenses and trademarks have been deferred and are being amortized over
fifteen years or the remaining life of the patent, license or trademark,
whichever is less, using the straight-line method. Amortization expense for
fiscal 1996, 1995 and 1994, and for the period from February 25, 1993 (Date of
Inception) to September 28, 1996 was $21,230, $1,414, $1,246 and $24,202,
respectively.
Net Loss Per Share
Net loss per share was computed by dividing net loss by the weighted
average number of common shares outstanding during the respective years. Fully
diluted net loss per common share has not been presented since the inclusion of
the impact of stock options and warrants outstanding (Notes 8, 10, 14, 15 and
16) would be antidilutive.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Recently Issued Accounting Standards
During March 1995, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
of". This statement establishes financial accounting and reporting standards for
the impairment of long-lived assets, certain identifiable intangibles and
goodwill related to those assets to be held and used, and for long-lived assets
and certain identifiable intangibles to be disposed of. This statement is
effective for financial statements for fiscal years beginning after December 15,
1995, although earlier application is encouraged. It is the Company's policy to
account for these assets at the lower of amortized cost or fair value. As part
of an ongoing review of the valuation and amortization of such assets,
management assesses the carrying value of such assets on a continuing basis. If
this review indicates that the assets will not be recoverable as determined by a
nondiscounted cash flow analysis over the remaining amortization period, the
carrying value of these
F-36
INTER(Bullet)ACT SYSTEMS, INCORPORATED AND SUBSIDIARY
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- Continued
assets would be reduced to their estimated fair market values. The Company does
not expect the impact of the adoption of this pronouncement to be material.
During October 1995, the Financial Accounting Standards Board issued SFAS
No. 123, "Accounting for Stock-Based Compensation". This statement establishes
financial accounting and reporting standards for stock-based employee
compensation plans. SFAS No. 123 encourages entities to adopt a fair value based
method of accounting for stock compensation plans. However, SFAS No. 123 also
permits the Company to continue to measure compensation costs under pre-existing
accounting pronouncements. If the fair value based method of accounting is not
adopted, SFAS No. 123 requires pro forma disclosures of net income (loss) and
net income (loss) per common share in the notes to consolidated financial
statements. The accounting requirements of SFAS No. 123 are effective for
transactions entered into in fiscal years that begin after December 15, 1995,
though they may be adopted on issuance. The disclosure requirements of SFAS No.
123 are effective for financial statements for fiscal years beginning after
December 15, 1995, or for an earlier fiscal year for which SFAS No. 123 is
initially adopted for recognizing compensation cost. The Company will adopt the
provisions of the SFAS No. 123 in fiscal 1997 by providing the pro forma
disclosure.
Reclassifications
Certain prior year financial statement amounts have been reclassified to
conform with the current year presentation.
3. PROPERTY AND EQUIPMENT, NET
Property and equipment consists of the following as of September 28, 1996
and September 30, 1995:
1996 1995
PRODUCT EQUIPMENT:
Store interactive terminals and network equipment............................................... $5,293,904 $ 652,032
Store interactive terminals and network equipment components.................................... 1,802,462 353,866
7,096,366 1,005,898
Less: Accumulated depreciation.................................................................. (753,295) (123,795)
6,343,071 882,103
OFFICE AND COMPUTER EQUIPMENT, VEHICLES AND LEASEHOLD IMPROVEMENTS:
Office equipment................................................................................ 78,016 42,432
Computer equipment.............................................................................. 1,106,705 352,225
Furniture and fixtures.......................................................................... 175,854 115,536
Vehicles........................................................................................ 278,559 --
Leasehold improvements.......................................................................... 13,084 10,089
1,652,218 520,282
Less: Accumulated depreciation and amortization................................................. (204,474) (77,243)
1,447,744 443,039
PRODUCT EQUIPMENT IN PROCESS OF MANUFACTURING..................................................... 2,067,296 451,770
$9,858,111 $1,776,912
4. NOTES RECEIVABLE FROM STOCKHOLDERS
The Company had notes receivable from three stockholders in the amount of
$70,474, bearing interest at 4.5%. Both principal and interest were due in full
on July 15, 1996 and, accordingly, are classified as current assets in the
accompanying consolidated balance sheet at September 30, 1995. These notes were
repaid during fiscal 1996.
F-37
INTER(Bullet)ACT SYSTEMS, INCORPORATED AND SUBSIDIARY
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
5. NOTES PAYABLE TO RELATED PARTY
At September 30, 1995, the Company had two notes payable to a company which
is significantly owned by stockholders of the Company, each in the amount of
$100,000 and bearing interest at 15%. Both notes were repaid during fiscal 1996.
6. NOTES PAYABLE TO STOCKHOLDERS
Notes payable to stockholders consists of the following:
September 28, September 30,
1996 1995
Notes payable to related parties relating to agreement with Clearing
Systems, Inc. (Note 17)............................................... $ 236,500 $ --
Notes payable to stockholders bearing interest at 8.5%, convertible to
common stock at conversion price of $5.00 per share, interest accruing
monthly, maturing on February 1, 1998 (a)............................. -- 1,600,000
Notes payable to stockholders bearing interest at 4.5%, both principal
and interest due on July 15, 1996 (b)................................. -- 70,474
Notes payable to stockholders bearing interest at prime (6.75% at
September 30, 1995) plus 2%, principal and interest due in eight equal
quarterly installment beginning on July 1, 1997 and due in full on
March 1, 1999 (c)..................................................... -- 371,130
236,500 2,041,604
Less: Current portion................................................... -- 70,474
$ 236,500 $ 1,971,130
(a) Effective February 1, 1995, the Company executed revised and amended
convertible notes payable to stockholders of $1,600,000 which extended the
terms of notes payable which were due on February 1, 1995 and May 1, 1995,
respectively, to February 1, 1998, with interest at 8.5% to be paid annually
beginning on February 1, 1996. In February 1996, the Company secured
agreements for holders of the convertible notes in the aggregate principal
amount of $1,600,000 (less cash paid in the amount of $35 for notes not
converted to common stock due to fractional shares) to convert their
principal balances to shares of the Company's common stock at $5.00 per
share, to convert fifty percent of the accrued interest thereon ($67,958) to
shares of the Company's common stock at $5.50 per share and to receive the
remaining fifty percent of the accrued interest thereon in cash.
(b) These notes were payable to certain stockholders of the Company for amounts
advanced to the Company on behalf of these other stockholders in order for
them to purchase common stock. These notes and the related amounts due from
other stockholders were repaid during fiscal 1996.
(c) Effective May 31, 1996, notes payable to stockholders with a principal
amount of $371,130 and related accrued interest of $46,694 were exchanged
for 75,968 shares of the Company's common stock at $5.50 per share.
7. LONG-TERM DEBT
September 28, September 30,
1996 1995
Bonds payable (a)....................................................... $ 72,750,759 $ --
Capital lease obligations (b)........................................... 239,567 --
72,990,326 --
Less: Current portion of long-term debt................................. 67,709 --
$ 72,922,617 $ --
F-38
INTER(Bullet)ACT SYSTEMS, INCORPORATED AND SUBSIDIARY
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
7. LONG-TERM DEBT -- Continued
(a) In the Private Placement (Note 1), the Company issued 142,000 units, each
consisting of a 14% senior discount note due 2003 with a principal amount
at maturity of $1,000 and one warrant to purchase 7.334 shares of common
stock of the Company at $.01 per share. However, if the Company has not
completed an initial public offering by September 30, 1997, each warrant
that has not been exercised will entitle the respective holder to purchase
9.429 shares of the Company's common stock at $.01 per share. The proceeds
of $94.7 million were allocated by the Company to the value of the warrants
($24.5 million -- Note 8) and to the discounted notes ($70.2 million).
No cash interest will be payable on the notes prior to February 1, 2000.
The notes will accrue cash interest at a rate of 14% per annum, commencing
on August 1, 1999, payable semi-annually on February 1 and August 1 of each
year commencing on February 1, 2000. The debt discount related to the
difference between the face value of the notes ($142 million) and the
proceeds of the Private Placement ($94.7 million) is being accreted over
the period to February 1, 2000. The debt discount related to the portion of
the Private Placement allocated to the value of the warrants ($24.5
million) is being accreted over the full term of the notes to August 1,
2003. Interest expense on the notes, including the accretion of debt
discount, is being recognized at a constant rate of interest over the life
of the notes. Discount accretion of $2,558,739 has been recognized as
interest expense during the year ended September 28, 1996.
The Company had agreed to use its best efforts to have a registration
statement with respect to the senior discount notes issued as part of the
Private Placement declared effective by the Securities and Exchange
Commission as promptly as practicable after the filing thereof. Since no
registration statement had been declared effective within 120 days of the
issue date of the Private Placement, approximately $1,000 of cash interest
is being accrued daily and will be payable on February 1, 1997 with respect
to the senior discount notes.
(b) The Company has leased certain vehicles and other assets under capital
leases. The following is a schedule by years of future minimum lease
payments under capital leases together with the present value of the net
minimum lease payments as of September 28, 1996:
Fiscal Year:
1997......................................................................... $ 91,849
1998......................................................................... 87,674
1999......................................................................... 58,406
2000......................................................................... 54,231
2001......................................................................... 8,861
Total minimum lease payments.................................................. 301,021
Less: Executory costs......................................................... 18,309
Net minimum lease payments.................................................... 282,712
Less: Amount representing interest............................................ 43,145
Present value of net minimum lease payments................................... $239,567
8. COMMON STOCK PURCHASE WARRANTS
Each warrant issued in the Private Placement (Notes 1 and 7(a)), when
exercisable, will entitle the holder thereof to purchase 7.334 shares of common
stock at an exercise price of $.01 per share; provided, however, that if by
September 30, 1997, the Company has not completed an initial public offering,
each warrant that has not theretofore been exercised will thereafter entitle the
holder thereof to purchase 9.429 shares of common stock. These warrants will be
exercisable on or after the earliest to occur of (i) August 1, 2000, (ii) a
change of control, (iii) (a) 90 days after the closing of an initial public
offering or (b) upon the closing of the initial public offering but only in
respect of warrants required to be exercised to permit the holders thereof to
sell shares in the initial public offering, (iv) a consolidation, merger or
purchase of assets involving the Company or any of its subsidiaries that results
in the common stock of the Company becoming subject to registration, (v) an
extraordinary cash dividend or (vi) the voluntary or involuntary dissolution,
liquidation or winding up of the affairs of the Company. The number of shares of
the common stock for which a warrant is exercisable is subject to adjustment
upon the occurrence of certain events.
F-39
INTER(Bullet)ACT SYSTEMS, INCORPORATED AND SUBSIDIARY
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
8. COMMON STOCK PURCHASE WARRANTS -- Continued
Holders of warrants (or common stock issued in respect thereof) will be
entitled to include the common stock issued or issuable upon the exercise of the
warrants (the "Underlying Common Stock") in a registration statement whenever
the Company or any shareholder proposes to effect a public equity offering with
respect to capital stock of the Company (other than redeemable stock), except to
the extent the managing underwriter for such offering determines that such
registration and sale would materially adversely affect the price, timing or
distribution of the shares to be sold in such public equity offering. Following
the occurrence of an initial public offering, holders of warrants and Underlying
Common Stock representing not less than 25% of all the outstanding warrants and
Underlying Common Stock, taken together, will have the right, on one occasion,
to require the Company to register such securities pursuant to an effective
registration statement.
In the event that a public market does not exist for the common stock on
August 1, 2001 (the "Triggering Date"), the Company will be required, at its
option, to (i) make an offer to purchase, for cash at fair market value, all
outstanding warrants and underlying common stock issued or (ii) take all
necessary action to cause all of the Underlying Common Stock issued or issuable
to be publicly registered within 120 days of the Triggering Date.
Management of the Company believes, based on independent third party
valuations, that the value of the Company's common stock at the date of the
issuance of these warrants was $23.50 per share and, accordingly, has allocated
$24,463,760 of the proceeds of the Private Placement to the value of these
warrants based on 142,000 units consisting of warrants to purchase 7.334 shares
of common stock per unit with an exercise price of $.01 per share. This amount
is classified between liabilities and stockholders' equity (deficit) in the
accompanying consolidated balance sheet as of September 28, 1996. The equal,
offsetting amount has been included as additional debt discount subject to
accretion as described in Note 7(a).
9. ACQUISITION
On April 14, 1993, Interactive Networks Incorporated ("INI") entered into
an agreement with Clearing Systems, Inc. ("CSI"), a Delaware corporation,
whereby 816,902 shares of INI stock were exchanged for certain assets and
assumption of certain liabilities of CSI. The assets acquired by INI included
the following:
Cash.......................................................................... $ 449
Deposit on cabinetry for interactive terminals and network equipment.......... 14,500
Prepayment of lease on facilities............................................. 30,000
Communication equipmen........................................................ 8,060
Accounts receivable........................................................... 95
Purchased technology, research and development................................ 611,471
664,575
Liabilities of CSI that were assumed by INI are as follows:
Demand note payable to members of the Investors Group....................... 610,000
Accounts payable............................................................ 40,000
Note payable -- communication equipment..................................... 4,575
654,575
Consideration for the 816,902 shares of common stock issued................... $ 10,000
The market value of the acquired technology, research and development of
$611,471 was expensed during the period ending September 30, 1993. The Company
has incurred additional research and development costs redesigning and refining
the technology and systems acquired from CSI, as indicated in Note 2.
10. DEFERRED COMPENSATION
In September 1996, the Company issued options to purchase 48,000 shares of
common stock at an exercise price of $7.50 per share under the 1996 Nonqualified
Stock Option Plan (Note 15), which was an exercise price below the fair market
F-40
INTER(Bullet)ACT SYSTEMS, INCORPORATED AND SUBSIDIARY
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
10. DEFERRED COMPENSATION -- Continued
value of the Company's common stock on the date of grant. Accordingly, the
Company has recorded a deferred compensation charge of $768,000, which will be
amortized ratably over the five year vesting period of the related options.
Through September 28, 1996, $6,400 of this amount has been amortized.
11. SALE AND OUTSOURCING OF MANUFACTURING FUNCTION
On September 9, 1996, the Company sold its manufacturing operations to
Coleman Resources Corporation ("Coleman Resources") for approximately $2.6
million and entered into a supply agreement whereby Coleman Resources is to
fulfill the Company's anticipated requirements for terminals for the next three
years with fixed pricing for the first 5,000 terminals. No material gain or loss
was realized in this transaction.
12. LITIGATION SETTLEMENT
During the year ended September 28, 1996, the Company settled a lawsuit
which was commenced in July 1996. This settlement requires the Company to pay an
aggregate of $400,000 by January 1997, $350,000 of which was paid on August 7,
1996. The remaining $50,000 is reflected as a note payable in the accompanying
consolidated balance sheet as of September 28, 1996. The cost of the settlement
has been charged to operations during the year ended September 28, 1996.
13. INCOME TAXES
The Company accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes", which requires the use of the "asset and
liability method" of accounting for income taxes. Accordingly, deferred tax
liabilities and assets are determined based on the difference between the
financial statement and tax bases of assets and liabilities, using enacted tax
rates in effect for the year in which the differences are expected to reverse.
Temporary differences relating primarily to utilization of net operating loss
("NOL") carryforwards of approximately $18.2 million resulted in a deferred tax
asset of approximately $7.5 million. The deferred tax asset has been reduced by
an equal, offsetting valuation allowance of approximately $7.5 million due to
both the uncertainty of future income and limitations on the use of the NOL
carryforwards due to changes in control resulting from equity transactions.
Accordingly, no net deferred tax asset is recorded at September 28, 1996 or
September 30, 1995. The net operating loss carryforwards, as well as research
and development credits, which can be applied against future taxable income and
income taxes, expire in years through 2011.
14. 1994 STOCK COMPENSATION PLAN
In April 1994, the Company adopted the 1994 Stock Compensation Plan (the
"Plan"), which authorizes a committee named by the Board of Directors to grant
options to purchase up to 200,000 shares of the Company's common stock to
officers, founders, key employees and directors of the Company at exercise
prices not less than the fair market value of the stock at the date of grant.
During fiscal 1995, the number of shares eligible to be granted was increased to
430,000. Options granted may be either qualified incentive stock options under
the Internal Revenue Code of 1986, as amended, or nonqualified stock options.
The Plan will expire on April 19, 2004. An aggregate of 125,900 shares remain
available for future grant under this plan.
In April 1994, the Company granted qualified options to purchase 25,000
shares of the Company's common stock at an exercise price of $1.86 per share
(which, in the opinion of management, represented the fair market value of such
stock at the date of grant) to an officer of the Company. These options vest
over a five year period beginning with the end of this officer's second year of
employment with the Company (August 1995). At September 28, 1996, none of these
options were exercised and 12,500 were exercisable.
In August 1994, the Company granted nonqualified stock options to purchase
a total of 18,000 shares of common stock at $5.00 per share. Of these options,
16,000 were granted to nonemployee directors of the Company and 2,000 were
granted to employee directors of the Company. At September 28, 1996, none of
these options were exercised and all were exercisable.
F-41
INTER(Bullet)ACT SYSTEMS, INCORPORATED AND SUBSIDIARY
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
14. 1994 STOCK COMPENSATION PLAN -- Continued
During the year ended September 30, 1995, the Company granted qualified
options to purchase a total of 45,000 shares of common stock, of which options
to purchase 15,000 shares were canceled in February 1996 concurrent with the
issuance of 7,500 nonqualified stock options, at $5.00 per share. These options
were granted to certain officers of the Company. At September 28, 1996, none of
the remaining options were exercised and 6,000 were exercisable.
Additionally, during the year ended September 30, 1995, the Company granted
qualified options to purchase a total of 96,000 shares of common stock, of which
options to purchase 28,000 shares were canceled. The exercise price for these
options (net of the 28,000 options canceled) is $5.00 for 33,000 options and
$5.50 for 35,000 options. These options were granted to certain key employees of
the Company. At September 28, 1996, none of these options were exercised and
6,600 were exercisable.
In March 1995, the Company granted nonqualified stock options to purchase a
total of 60,600 shares of common stock at $5.00 per share to certain nonemployee
directors of the Company. At September 28, 1996, none of these options were
exercised and all were exercisable.
In April 1995, the Company granted nonqualified stock options to purchase a
total of 30,000 shares of common stock at $5.00 per share. These options were
granted to certain consultants of the Company. At September 28, 1996, none of
these options were exercised and all were exercisable.
During the year ended September 28, 1996, the Company granted qualified
options to purchase a total of 65,000 shares of common stock at $5.50 per share.
These options were granted to certain employees of the Company, as well as an
employee of Vanguard. At September 28, 1996, none of these shares were exercised
and 12,000 were exercisable.
Management of the Company believes, based on independent third party
valuations, that the options issued under the 1994 Stock Compensation Plan were
issued at exercise prices which represented the fair market value of the
Company's common stock at the dates of grant.
15. 1996 NONQUALIFIED STOCK OPTION PLAN
On June 14, 1996, the Company adopted the 1996 Nonqualified Stock Option
Plan, which provides for the issuance of shares of common stock to key
employees, consultants and directors pursuant to nonqualified stock options. All
options must be granted at an exercise price not less than $5.50 per share. The
aggregate number of shares of common stock that may be issued pursuant to the
plan may not exceed 600,000 shares of common stock, subject to adjustment on the
occurrence of certain events affecting the Company's capitalization. As of
September 28, 1996, 496,000 options had been granted at an exercise price of
$5.50 per share and 48,000 options had been granted at an exercise price of
$7.50 per share. Management of the Company believes, based on independent third
party valuations, that the options granted at $5.50 per share were granted at
fair market value and that the options granted at $7.50 per share were granted
when the fair market value of common stock was $23.50 per share, resulting in a
deferred compensation charge (Note 10). These options vest annually over five
years from the date of grant with the exception of 129,400 options, which became
immediately exercisable.
16. ISSUANCE OF WARRANTS WITH SHARES
In May 1995, the Company issued 400,000 shares of common stock to an
investor at $5 per share. In addition, with the issuance of these shares, the
Company also issued to the same investor a warrant (the "Vanguard Warrant") to
purchase up to an additional 400,000 shares of the Company's common stock at the
agreed-upon fair market value of such stock at the time of exercise. This
warrant agreement contains an anti-dilution clause which provides for
adjustments to the number of shares eligible to be purchased to maintain the
number of shares at approximately 10.3% of the Company's outstanding common
stock. The warrant expires on the earlier of (i) May 5, 2005 or (ii) the
consummation of an initial public offering by the Company. The terms of the
Vanguard Warrant were restructured immediately prior to the consummation of the
private placement transaction (Note 1) to provide that Vanguard has the right to
buy 900,113 shares at any time before May 5, 2005 at $23.50 per share, which was
in the opinion of management, the fair market value of the related common stock
at the date of
F-42
INTER(Bullet)ACT SYSTEMS, INCORPORATED AND SUBSIDIARY
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
16. ISSUANCE OF WARRANTS WITH SHARES -- Continued
restructuring. The restructured Vanguard Warrant also provides that Vanguard may
pay the exercise price either in cash or, if the fair market value of the common
stock at the time of exercise is greater than the exercise price, by
surrendering any unexercised portion of the Vanguard Warrant and receiving the
number of shares equal to (i) the excess of fair market value per share at the
time of exercise over the exercise price per share multiplied by (ii) the number
of shares surrendered.
17. COMMITMENTS AND CONTINGENCIES
Agreement with CSI
Pursuant to an agreement with CSI, the Company was required to pay a
consulting fee to CSI of $375,000 in the form of an 8.5% convertible note
payable. Of this amount, the Company has paid $138,500 and $236,500, which is
convertible to common stock at $5.50 per share, is due December 28, 1998. The
$375,000 consulting fee is included in selling, general and administrative
expenses for the year ended September 28, 1996.
Consulting and Management Services Agreements with Vanguard Cellular Systems,
Inc. ("Vanguard")
The Company entered into a consulting agreement with Vanguard pursuant to
which an employee of Vanguard began to serve as Chief Operating Officer of the
Company and Vanguard provided other consulting services requested by the
Company. Pursuant to the agreement, the Company was to reimburse Vanguard for
its costs of providing such services and had recognized expense of approximately
$52,000 during fiscal 1996 until the consulting agreement was terminated and
replaced by a management services agreement dated June 17, 1996. The management
services agreement, which has a term expiring on June 17, 1998, provides that
Vanguard will be entitled to receive 10,000 shares of common stock annually
during the term of the agreement in return for its other consulting services to
the Company. In June 1996, 10,000 shares were issued to Vanguard pursuant to
this agreement and were recorded as a prepaid expense at the fair market value
of $5.50 per share at the date of issuance.
Commitments for Technology
The Company has commitments for use of technology for which it has agreed
to pay aggregated minimum fees of $23,000 per month through August 1, 1996 and
subsequently increasing to $33,000 per month. Future commitments are expected to
be paid at least through November 2003 and are subject to increases based upon
the amount of revenue generated from this technology. Aggregated technology
commitments charged to operations for fiscal 1996, 1995 and 1994 and for the
period from February 23, 1993 (Date of Inception) to September 28, 1996 were
$296,000, $265,465, $200,000 and $861,465, respectively, and are included in
selling, general and administrative expenses.
Lease Commitments
The Company is also obligated under noncancelable operating leases expiring
through fiscal year 2000, covering premises and equipment with minimum rentals
of:
Fiscal Year:
1997........................................................................ $264,644
1998........................................................................ 262,124
1999........................................................................ 274,215
2000........................................................................ 69,401
Rent expense of $221,143, $218,243, $93,817 and $573,492 was recognized for
fiscal 1996, 1995 and 1994 and for the period from February 25, 1993 (Date of
Inception) to September 28, 1996, respectively, and is included in selling,
general and administrative expenses.
F-43
INTER(Bullet)ACT SYSTEMS, INCORPORATED AND SUBSIDIARY
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
18. FORFEITURE OF SHARES
In September 1994, a stockholder agreed to forfeit 10,000 shares of the
Company's common stock for failure to fulfill an obligation to invest additional
capital in the Company. The forfeiture did not reduce the amount of the
stockholder's financial investment in the Company at that time, but did reduce
the number of shares issued to this individual. These shares were subsequently
reissued to two other individuals at $5.00 per share. In December 1994, the same
stockholder agreed to forfeit an additional 18,000 shares of the Company's
common stock for failure to fulfill an obligation to invest additional capital
in the Company. Upon this forfeiture, the investor's equity in the Company was
reduced in the total amount of $140,000, representing the value of 28,000 shares
of common stock at $5.00 per share.
F-44
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE PARTNERS OF
EASTERN NORTH CAROLINA CELLULAR JOINT VENTURE:
We have audited the accompanying consolidated balance sheets of Eastern
North Carolina Cellular Joint Venture (a Delaware partnership) And Subsidiaries
as of December 31, 1996 and 1995, and the related consolidated statements of
operations, changes in partners' capital, and cash flows for each of the three
years in the period ended December 31, 1996. These financial statements are the
responsibility of the Partnership's management. Our responsibility is to express
an opinion on these financial statements 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 financial statements referred to above present fairly,
in all material respects, the financial position of Eastern North Carolina
Cellular Joint Venture and subsidiaries as of December 31, 1996 and 1995, and
the results of their operations and their cash flows for each of the three years
in the period ended December 31, 1996 in conformity with generally accepted
accounting principles.
ARTHUR ANDERSEN
LLP
Atlanta, Georgia
March 17, 1997
F-45
EASTERN NORTH CAROLINA CELLULAR JOINT VENTURE
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND 1995
(IN THOUSANDS)
1996 1995
ASSETS
CURRENT ASSETS:
Cash.................................................................................................. $ 2 $ 1
Accounts receivable -- trade, net of allowance for doubtful accounts of $199 and $253................. 2,424 2,429
Inventories........................................................................................... 484 165
Deferred income tax assets............................................................................ 92 112
Other current assets.................................................................................. 277 188
Total Current Assets............................................................................. 3,279 2,895
PROPERTY AND EQUIPMENT, at cost:
Land.................................................................................................. 393 156
Building and towers................................................................................... 5,623 4,368
Equipment............................................................................................. 13,596 9,745
Furniture and fixtures................................................................................ 188 183
Assets under construction............................................................................. 771 2,106
20,571 16,558
Less accumulated depreciation......................................................................... 6,052 4,574
Net Property and Equipment....................................................................... 14,519 11,984
OTHER ASSETS, net:
FCC license, net of accumulated amortization of $6,884 and $5,813..................................... 35,802 36,864
Other................................................................................................. 4 5
Total Other Assets, Net.......................................................................... 35,806 36,869
Total Assets..................................................................................... $53,604 $51,748
LIABILITIES AND PARTNERS' CAPITAL
CURRENT LIABILITIES:
Accounts payable:
Construction and trade............................................................................. $ 439 $ 197
Affiliates......................................................................................... 314 --
Due to managing partner............................................................................... 5,119 5,714
Advance billings and customer deposits................................................................ 164 133
Federal income taxes payable.......................................................................... 188 268
Other accrued taxes................................................................................... 207 110
Other accrued liabilities............................................................................. 194 292
Total Current Liabilities........................................................................ 6,625 6,714
LONG-TERM OBLIGATIONS:
Postretirement benefit obligation..................................................................... 67 61
Other deferred credits................................................................................ 2 37
Deferred income tax liabilities....................................................................... 893 227
Total Long-Term Obligations...................................................................... 962 325
MINORITY INTERESTS...................................................................................... 435 335
PARTNERS' CAPITAL....................................................................................... 45,582 44,374
Total Liabilities and Partners' Capital.......................................................... $53,604 $51,748
The accompanying notes are an integral part of these consolidated balance
sheets.
F-46
EASTERN NORTH CAROLINA CELLULAR JOINT VENTURE
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995, AND 1994
(IN THOUSANDS)
1996 1995 1994
REVENUES AND SALES:
Service revenues............................................................................ $15,023 $12,975 $8,715
Equipment sales............................................................................. 605 583 447
Other revenue............................................................................... 604 382 225
Total revenues and sales............................................................... 16,232 13,940 9,387
OPERATING EXPENSES:
Cost of services............................................................................ 5,853 6,055 4,605
Cost of equipment sales..................................................................... 1,966 1,797 1,400
System, operations, and maintenance......................................................... 1,226 994 731
Area........................................................................................ 1,595 1,238 1,105
Depreciation and amortization............................................................... 2,663 2,095 1,836
Total Operating Expenses............................................................... 13,303 12,179 9,677
OPERATING INCOME.............................................................................. 2,929 1,761 (290)
OTHER INCOME, net............................................................................. -- -- 34
INTEREST EXPENSE, net......................................................................... (235) (180) (80)
NET INCOME (LOSS) BEFORE INCOME TAXES AND MINORITY INTERESTS.................................. 2,694 1,581 (336)
MINORITY INTERESTS............................................................................ 100 80 10
NET INCOME (LOSS) BEFORE INCOME TAXES......................................................... 2,594 1,501 (346)
PROVISION FOR INCOME TAXES.................................................................... 1,386 785 478
NET INCOME (LOSS)............................................................................. $ 1,208 $ 716 $ (824)
The accompanying notes are an integral part of these consolidated statements.
F-47
EASTERN NORTH CAROLINA CELLULAR JOINT VENTURE
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' CAPITAL
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995, AND 1994
(IN THOUSANDS)
GTE MOBILNET
OF EASTERN VANGUARD
NORTH NORTH CAROLINA CELLULAR
CAROLINA CELLULAR SYSTEMS,
INCORPORATED HOLDING CORP. INC. TOTAL
BALANCE, DECEMBER 31, 1993............................................ $22,241 $ -- $ 22,241 $44,482
Net loss for the year ended December 31, 1994....................... (412) -- (412 ) (824)
BALANCE, DECEMBER 31, 1994............................................ 21,829 -- 21,829 43,658
Net income for the year ended December 31, 1995..................... 358 -- 358 716
BALANCE, DECEMBER 31, 1995............................................ 22,187 -- 22,187 44,374
Transfer of partnership interests................................... -- 22,634 (22,634 ) --
Net income for the year ended December 31, 1996..................... 604 157 447 1,208
BALANCE, DECEMBER 31, 1996............................................ $22,791 $22,791 $ -- $45,582
The accompanying notes are an integral part of these consolidated statements.
F-48
EASTERN NORTH CAROLINA CELLULAR JOINT VENTURE
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995, AND 1994
1996 1995 1994
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)........................................................................... $ 1,208 $ 716 $ (824)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization............................................................ 2,663 2,095 1,836
Losses from property and equipment retirements........................................... 10 -- --
Deferred income tax expenses............................................................. 686 379 469
Increase in postretirement benefit obligation............................................ 6 4 4
Minority interests in earnings........................................................... 100 80 10
Changes in current assets and current liabilities:
Decrease (increase) in accounts receivable............................................. 5 (957) (729)
(Increase) decrease in inventories..................................................... (319) 297 (398)
Increase in other current assets....................................................... (88) (111) (77)
Increase (decrease) in accounts payable, net of capital expenditures................... 11 (73) 110
(Decrease) increase in other current liabilities....................................... (50) 291 147
Other, net............................................................................... (39) 37 7
Net cash provided by operating activities.............................................. 4,193 2,758 555
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures........................................................................ (3,597) (4,735) (2,522)
Purchase of minority interest............................................................... -- (146) --
Net cash used in investing activities.................................................. (3,597) (4,881) (2,522)
CASH FLOWS FROM FINANCING ACTIVITIES:
Change in due to managing partner........................................................... (595) 2,123 1,967
INCREASE IN CASH.............................................................................. 1 -- --
CASH AT BEGINNING OF YEAR..................................................................... 1 1 1
CASH AT END OF YEAR........................................................................... $ 2 $ 1 $ 1
SUPPLEMENTAL CASH FLOWS DISCLOSURES:
Cash payments for income taxes.............................................................. $ 791 $ 261 $ 7
The accompanying notes are an integral part of these consolidated statements.
F-49
EASTERN NORTH CAROLINA CELLULAR JOINT VENTURE
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1995
Note 1 -- ORGANIZATION AND MANAGEMENT
Eastern North Carolina Cellular Joint Venture (the "Joint Venture") was
formed on July 10, 1990 and operates in accordance with the provisions of the
Delaware Revised Uniform Limited Partnership Act. The Joint Venture provides
cellular telephone services in Onslow, Brunswick, and New Hanover Counties,
North Carolina.
The partners and their respective ownership percentages as of December 31,
1996 were as follows:
Managing General Partner:
GTE Mobilnet of Eastern North Carolina Incorporated............................................ 50%
General Partner:
North Carolina Cellular Holding Corp........................................................... 50%
Effective January 22, 1996, W&J Metronet, Inc. changed its name to GTE
Mobilnet of Eastern North Carolina Incorporated.
Effective September 27, 1996, Vanguard Cellular Systems, Inc. assigned its
interest in the Joint Venture to North Carolina Cellular Holding Corp. North
Carolina Cellular Holding Corp. is a subsidiary of Vanguard Cellular Systems,
Inc. Ownership percentages as of December 31, 1995 were as follows:
Managing General Partner:
W&J Metronet, Inc.............................................................................. 50%
General Partner:
Vanguard Cellular Systems, Inc................................................................. 50%
The Joint Venture's ownership interest in the Wilmington, North Carolina,
market was 95.6% as of December 31, 1996 and 1995. The Joint Venture's ownership
interest in the Jacksonville, North Carolina, market was 95.9% as of December
31, 1996 and 1995.
The managing partner is responsible for managing and operating the Joint
Venture. The partners make capital contributions to, share in the operating
results of, and receive distributions from the Joint Venture in accordance with
their respective ownership percentage.
Note 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The Joint Venture prepares its financial statements in accordance with
generally accepted accounting principles which require that management make
estimates and assumptions that affect reported amounts. Actual results could
differ from these estimates.
Certain prior year amounts have been reclassified to conform to the current
year presentation.
PRINCIPLES OF CONSOLIDATION
The accompanying financial statements include the accounts of the Joint
Venture and its majority-owned corporations and partnerships. All significant
intercompany balances and transactions have been eliminated in consolidation.
REVENUE RECOGNITION
The Joint Venture earns service revenues primarily by providing access to
the cellular network (access revenue) and for usage of the cellular network
(airtime and toll revenues). Access revenue is recognized when earned. Airtime
(including roaming) and toll revenues are recognized when the services are
rendered. Other service revenues are recognized after services are performed and
include activation and custom calling feature revenues. Equipment sales are
recognized upon delivery of the equipment to the customer.
F-50
EASTERN NORTH CAROLINA CELLULAR JOINT VENTURE
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- CONTINUED
Note 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- Continued
The Joint Venture also earned revenue by leasing its switch to an
affiliate. These revenues are based on a charge per part and are included in
other revenue. Refer to Note 4 for additional discussion of affiliated
transactions.
OPERATING EXPENSES
Operating expenses include expenses incurred directly by the Joint Venture,
as well as an allocation of area administrative expenses and other costs
incurred by the managing partner or its affiliates. Refer to Note 4 for
additional discussion of allocated and affiliated expenses.
CUSTOMER ACQUISITION COSTS
The Joint Venture defers certain customer acquisition costs for
approximately two weeks and recognizes these costs when the associated revenue
stream begins. These deferred costs were $169,000 and $49,000 at December 31,
1996 and 1995, respectively and are included in other current assets in the
accompanying balance sheets.
ADVERTISING COSTS
The Joint Venture expenses the cost of advertising as incurred. Advertising
expense was $375,000, $413,000, and $640,000 for 1996, 1995, and 1994,
respectively, and is included as a component of cost of services in the
accompanying statements of operations.
INTEREST EXPENSE, NET
The statements of operations reflect total interest expense, net of
interest expense capitalized during construction, less interest income.
1996 1995 1994
(IN THOUSANDS)
Interest expense............................................................ $(311) $(299) $ (95)
Interest capitalized........................................................ 40 115 12
Interest income............................................................. 36 4 3
Interest expense, net....................................................... $(235) $(180) $ (80)
Interest expense and income include charges to the Joint Venture and its
subsidiaries for funds advanced by the managing partner and credits to the Joint
Venture and its subsidiaries for funds advanced to the managing partner. The
interest rate on funds advanced to or from the Joint Venture is equivalent to
the managing partner's incremental borrowing rate, which fluctuated between
5.44% and 6.07% in 1996, 5.98% and 6.26% in 1995, and 3.32% and 5.47% in 1994.
INCOME TAXES
A provision for income taxes is recorded on the subsidiary corporations of
the Joint Venture relating to income of these corporations. The consolidated
financial statements also include certain partnerships for which, according to
the Internal Revenue Code and applicable state statutes, income and expenses are
not separately taxable to the partnerships, but rather accrue directly to the
partners. Accordingly, no provision for income taxes is made on such entities.
Deferred income taxes are recorded using enacted tax law and rates for the
years in which the taxes are expected to be paid. Deferred income taxes are
provided for items when there is a temporary difference in recording such items
for financial reporting and income tax reporting.
INVENTORIES
Inventories include cellular telephones, pagers, and accessories held for
sale and are valued at the lower of cost or market. Cost is determined using the
specific identification method. Inventories are net of reserves for
obsolescence.
F-51
EASTERN NORTH CAROLINA CELLULAR JOINT VENTURE
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- CONTINUED
Note 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- Continued
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. The Joint Venture records
depreciation using the straight-line method over the estimated useful lives of
the assets, which are primarily twenty years for buildings and towers, three to
ten years for cell and switching equipment, and three to five years for
furniture and fixtures and other equipment. When property is retired, the cost
of the property and the related accumulated depreciation are removed from the
balance sheet and any gain or loss on the transaction is included in income.
Assets under construction represent costs incurred for the construction of
cell sites and include, if applicable, capitalized interest. When these assets
are placed in service, the costs are recorded to the appropriate property and
equipment accounts and depreciation begins.
OTHER ASSETS, NET
Other assets, net, consist primarily of deferred FCC cellular license
costs, which represent the fair value of the cellular market ownership interest
contributed to the Joint Venture by the partners, which is being amortized over
forty years.
LONG-LIVED ASSETS
The Joint Venture periodically reviews the values assigned to long-lived
assets such as FCC cellular licenses, property and equipment, to determine
whether any impairments exist that are other than temporary. Management believes
that the long-lived assets in the accompanying balance sheets are appropriately
valued.
CREDIT RISK
The Joint Venture's accounts receivable subject the Joint Venture to credit
risk, as collateral is generally not required. The Joint Venture's risk of loss
is limited due to advance billings to certain customers for services and the
ability to terminate access on delinquent accounts. The concentration of credit
risk is mitigated by the large number of customers comprising the customer base.
The carrying amount of the Joint Venture's receivables approximates their fair
value.
SOURCES OF SUPPLIES
The Joint Venture relies on local telephone companies and other companies
to provide certain communication services. Although management feels alternative
telecommunications facilities could be found in a timely manner, any disruption
of these services could potentially have an adverse effect on operating results.
Although the Joint Venture attempts to maintain multiple vendors for each
required product, its inventory and equipment, which are important components of
its operations, are each currently acquired from only a few sources. If the
suppliers are unable to meet the Joint Venture's needs as it builds out its
network infrastructure and sells service and equipment, then delays and
increased costs in the expansion of the Joint Venture's network infrastructure
or losses of potential customers could result, which would adversely affect
operating results.
EMPLOYEE BENEFIT PLANS
The Company's employees participate in a defined benefit pension plan
administered by GTE Services Corporation (the "Service Corporation"), an
affiliate of the Joint Venture. The benefits paid under this plan are generally
based on years of credited service and average final earnings. The Service
Corporation funds the plan in accordance with minimum funding requirements of
employee benefit and tax laws.
Costs allocated to the Company for this plan were $4,000, $5,000, and
$1,000 in 1996, 1995, and 1994, respectively.
F-52
EASTERN NORTH CAROLINA CELLULAR JOINT VENTURE
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- CONTINUED
Note 3 -- COMMITMENTS AND CONTINGENCIES
LEASES
The Joint Venture leases office space and network sites under long-term
operating leases. These leases have options for renewal with provisions for
increased rent upon renewal. Rent expense for the years ended December 31, 1996,
1995, and 1994 was $288,000, $190,000, and $115,000, respectively, and is
included in cost of services, system, operations, and maintenance, and area
operating expenses in the accompanying statements of operations.
As of December 31, 1996, future minimum lease payments under noncancelable
operating leases with initial or remaining periods in excess of one year were as
follows:
(IN THOUSANDS)
1997.................................................................................. $ 243
1998.................................................................................. 221
1999.................................................................................. 215
2000.................................................................................. 210
2001.................................................................................. 106
Subsequent years...................................................................... 174
Total............................................................................... $1,169
CONTINGENCIES
The Joint Venture and managing partner face exposure from actual and
potential claims and legal proceedings arising in the normal course of business.
Although the ultimate outcome of these legal proceedings cannot be determined
with any certainty at this time, management believes that any liability
resulting from any pending matters will not have a material adverse effect on
the Joint Venture's financial position or results of operations.
Note 4 -- RELATED-PARTY TRANSACTIONS
The Joint Venture operates under a budget approved by the partners and
executed by the managing partner. Many management and administrative services
are performed by the Service Corporation and GTE Mobilnet Incorporated. Services
provided to the Joint Venture include support in major functional areas such as
accounting, information and cash management, human resources, legal, marketing,
billing, and technology planning. In accordance with a management agreement,
only area costs that are attributable to these support functions are included in
cost of services and area expense. In addition, billing and customer care costs
are allocated to the Joint Venture. Area costs, along with services provided by
the managing partner, are allocated to the Joint Venture Partnership based on
various factors specified by the management agreement with the Joint Venture.
Area costs allocated to the Joint Venture for these services were $1,184,000,
$863,000, and $721,000 in 1996, 1995, and 1994, respectively. Costs attributable
to the billing support and customer care function are allocated to the Joint
Venture based on customers. Costs allocated to the Joint Venture for billing
services and customer care costs were $350,000, $391,000, and $250,000 in 1996,
1995, and 1994, respectively.
Amounts paid by the Joint Venture to the Service Corporation for inventory
purchases amounted to $1,497,000, $1,463,000, and $1,340,000 in 1996, 1995, and
1994, respectively.
The managing partner either advances funds to or borrows funds from the
Joint Venture and its subsidiaries. Funds advanced to the Joint Venture are used
to cover construction and working capital requirements. The advances and
borrowings are netted and are reflected in due to managing partner in the
accompanying balance sheets. Interest is calculated on this balance as described
in Note 2.
The Joint Venture records revenue from an affiliate for use of its switch.
This revenue amounted to $209,000, $254,000, $217,000 in 1996, 1995, and 1994,
respectively. In September 1996, the affiliate discontinued its switch sharing
agreement with the Joint Venture.
F-53
EASTERN NORTH CAROLINA CELLULAR JOINT VENTURE
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- CONTINUED
Note 4 -- RELATED-PARTY TRANSACTIONS -- Continued
The Joint Venture makes payments to an affiliate of the managing partner
for construction of cell sites and other system property. The amounts
capitalized were $371,000 in 1996 and $10,000 in 1994, respectively, and are
included in assets under construction and other property and equipment. No such
payments were made in 1995.
The Joint Venture purchases roamer administration, advertising, and other
operating services from affiliates whose business is the provision of such
services. The managing partner believes the cost of these services to the Joint
Venture of $145,000, $154,000, and $102,000 in 1996, 1995, and 1994,
respectively, was equivalent to the cost charged by the affiliates to any of
their customers.
Note 5 -- INCOME TAXES
Deferred income taxes reflect the net tax effect of temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes as well as tax credit and
loss carryforwards. The significant components of the Joint Venture's deferred
tax assets (liabilities) at December 31, 1996 and 1995 were as follows:
1996 1995
(IN THOUSANDS)
Deferred tax assets:
Loss carryforwards....................................................................................... $ 414 $1,018
AMT credit carryforwards................................................................................. 667 407
Provision for bad debt................................................................................... 85 108
Postretirement and other benefits........................................................................ 29 27
Other.................................................................................................... 37 42
Total deferred tax assets........................................................................... 1,232 1,602
Valuation allowance...................................................................................... -- (166)
Net deferred tax assets............................................................................. 1,232 1,436
Deferred tax liabilities:
Accelerated depreciation................................................................................. 2,033 1,551
Net deferred tax liabilities........................................................................ 801 115
Deferred tax asset -- current.............................................................................. 92 112
Deferred tax liability -- noncurrent....................................................................... $ 893 $ 227
The federal net operating loss carryforwards expire from 2003 to 2009
unless utilized. All state net operating loss carryforwards were utilized as of
December 31, 1996. The alternative minimum tax ("AMT") credit carryforwards do
not expire. Prior to 1994, the Joint Venture provided a valuation allowance
against a significant portion of the existing deferred tax asset. Based on the
operating results from 1994 through 1996, the valuation allowance has been
reduced by $166,000, $365,000, and $37,000 in 1996, 1995, and 1994,
respectively, to $0 at December 31, 1996. Although realization is not assured,
management believes it is more likely than not that the related deferred tax
assets will be realized through future taxable earnings.
The provision for income taxes consists of the following:
1996 1995 1994
(IN THOUSANDS)
Current taxes................................................................ $ 866 $771 $ 46
Deferred taxes............................................................... 686 379 469
Reversal of valuation allowance.............................................. (166) (365) (37)
Provision for income taxes................................................... $1,386 $785 $478
F-54
EASTERN NORTH CAROLINA CELLULAR JOINT VENTURE
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- CONTINUED
Note 5 -- INCOME TAXES -- Continued
A reconciliation of the income tax provision computed at the statutory tax
rate to the Joint Venture's effective tax rate is as follows for the years ended
December 31, 1996, 1995, and 1994:
1996 1995 1994
Income tax provision (benefit) at the statutory rate...................... 35.0% 35.0% (35.0)%
FCC license amortization.................................................. 14.4 24.9 131.5
State income taxes, net of U.S. federal benefit........................... 8.1 5.0 9.4
Minority interests........................................................ 2.2 2.1 6.4
Other taxes............................................................... -- 4.8 34.6
Other, net................................................................ 0.1 4.8 2.0
Reduction in valuation allowance.......................................... (6.4) (24.3) (10.7)
Provision for income tax.................................................. 53.4% 52.3% 138.2%
F-55
INDEX TO EXHIBITS
Sequential
Page
Exhibit No. Description No.
* 3(a) Articles of Incorporation of Registrant as amended through July 25,
1995, filed as Exhibit 1 to the Registrant's Form 8-A/A dated July 25,
1995.
* 3(b) Bylaws of Registrant (compilation of July 25, 1995), filed as Exhibit 2
to the Registrant's Form 8-A/A dated July 25, 1995.
* 4(a) Specimen Common Stock Certificate, filed as Exhibit 4(a) to
the Registrant's Registration Statement on Form S-1 (File No.
33-18067).
* 4(b)(1) Amended and Restated Loan Agreement between the Registrant and various
lenders led by The Bank of New York and The oronto-Dominion Bank as
agents, dated as of December 23, 1994, filed as Exhibit 2(a) to the
Registrant's Current Report on Form 8-K dated as of December 23, 1994.
* 4(b)(2) Security Agreement between the Registrant and various lenders led by The
Bank of New York and The Toronto-Dominion Bank, as Secured Party, dated
as of December 23, 1994, filed as Exhibit 2(b) to the Registrant's
Current Report on Form 8-K dated as of December 23, 1994.
* 4(b)(3) Master Subsidiary Security Agreement between the Registrant, certain of
its subsidiaries and various lenders led by The Bank of New York and The
Toronto-Dominion Bank, as Secured Party, dated as of December 23, 1994,
filed as Exhibit 2(c) to the Registrant's Current Report on Form 8-K
dated as of December 23, 1994.
* 4(b)(4) Second Amended and Restated Loan Agreement between Vanguard Cellular
Operating Corp. and various lenders led by The Bank of New York and The
Toronto-Dominion Bank as agents, dated as of April 10, 1996, filed as
Exhibit 4(d)(1) to the Registrant's Form 10-Q/A dated March 31, 1996.
* 4(b)(5) VCOC Security Agreement between Vanguard Cellular Operating Corp. and
various lenders led by The Bank of New York and The Toronto-Dominion
Bank as Secured Party, dated as of April 10, 1996, filed as Exhibit
4(d)(2) to the Registrant's Form 10-Q/A dated March 31, 1996.
* 4(b)(6) Second Amended and Restated Master Subsidiary Security Agreement between
certain subsidiaries of the Registrant and various lenders led by The
Bank of New York and The Toronto-Dominion Bank, as Secured Party, dated
as of April 10, 1996, filed as Exhibit 4(d)(3) to the Registrant's Form
10-Q/A dated March 31, 1996.
* 4(b)(7) Assignment, Bill of Sale and Assumption Agreement by and between
Registrant and Vanguard Cellular Financial Corp., dated as of April 10,
1996, filed as Exhibit 4(d)(4) to the Registrant's Form 10-Q/A dated
March 31, 1996.
* 4(b)(8) Indenture dated as of April 1, 1996 between Registrant and The Bank of
New York as Trustee, filed as Exhibit 4(e)(1) to the Registrant's Form
10-Q/A dated March 31, 1996.
* 4(b)(9) First Supplemental Indenture, dated as of April 1, 1996 between
Registrant and The Bank of New York as Trustee, filed as Exhibit 4(e)(2)
to the Registrant's Form 10-Q/A dated March 31, 1996.
* 10(a)(1) Amended and Restated Stock Compensation Plan of the Registrant approved
April 22, 1987 by the Shareholders of the Registrant, with forms of
stock bonus and stock option agreements attached, filed as Exhibit 10
(a) to the Registrant's Registration Statement, on Form
S-1 (File No. 33-18067).
* 10(a)(2) Amendment to Amended and Restated Stock Compensation Plan of the
Registrant approved May 2, 1989 by the Shareholders of the Registrant,
filed as Exhibit 4(h)(2) to the Registrant's Quarterly Report on Form
10-Q for the quarter ended March 31, 1989.
Sequential
Page
Exhibit No. Description No.
* 10(a)(3) Form of Restricted Stock Bonus Agreements dated March 23, 1987 between
the Registrant and Stuart S. Richardson, Haynes G. Griffin, L.
Richardson Preyer, Jr., Stephen R. Leeolou and Stephen L. Holcombe, and
form of amendments dated October 12, 1987 to agreements with Messrs.
Richardson, Griffin, Preyer and Leeolou, filed as Exhibit 10(a)(3) to
the Registrant's Annual Report on Form 10-K for the fiscal year ended
December 31, 1988.
* 10(a)(4) Form of Restricted Stock Bonus Agreements dated October 12, 1987 between
the Registrant and Haynes G. Griffin, Stephen R. Leeolou and L.
Richardson Preyer, Jr., filed as Exhibit 10(a)(4) to the Registrant's
Annual Report on Form 10-K for the fiscal year ended December 31, 1988.
* 10(1)(5) Form of Amendment to Restricted Stock Bonus Plan Agreements dated as of
March 1, 1990 by and between Haynes G. Griffin, L. Richardson Preyer,
Jr., Stephen R. Leeolou, and Stephen L. Holcombe and the Registrant,
amending the Restricted Stock Bonus Plan Agreements dated as March 23,
1987, filed as Exhibit 10(a)(5) to the Registrant's Annual Report on
Form 10-K for the fiscal year ended December 31, 1990.
* 10(1)(6) Form of Amendment to Restricted Stock Bonus Plan Agreements dated as of
March 1, 1990 by and between Haynes G. Griffin, L. Richardson Preyer,
Jr. and Stephen R. Leeolou and the Registrant, amending the Restricted
Stock Bonus Plan Agreements dated as October 12, 1987, filed as Exhibit
10(a)(6) to the Registrant's Annual Report on Form 10-K for the fiscal
year ended December 31, 1990.
* 10(a)(7) Form of Second Amendment to Restricted Stock Bonus Plan Agreements dated
February 22, 1991 between the Registrant and Haynes G. Griffin, Stephen
R. Leeolou, and L. Richardson Preyer, Jr., amending the Restricted Stockx
Bonus Agreements dated October 12, 1987, filed as Exhibit 10(a)(7) to
the Registrant's Annual Report on Form 10-K for the fiscal year ended
December 31, 1990.
* 10(a)(8) Form of Third Amendment to Restricted Stock Bonus Plan Agreements dated
February 22, 1991 between the Registrant and Haynes G. Griffin, Stephen
R. Leeolou, L. Richardson Preyer, Jr., and Stephen L. Holcombe, amending
the Restricted Stock Bonus Agreements dated March 23, 1987, filed as
Exhibit 10(a)(8) to the Registrant's Annual Report on Form 10-K for the
fiscal year ended December 31, 1990.
* 10(a)(9) Form of Third Amendment to Restricted Stock Bonus Plan Agreement dated
February 22, 1991 between the Registrant and Stuart S. Richardson,
amending the Restricted Stock Bonus Plan Agreement dated March 23, 1987,
filed as Exhibit 10(a)(9) to the Registrant's Annual Report on Form 10-K
for the fiscal year ended December 31, 1990.
* 10(a)(10) Employment Agreement dated March 1, 1995 by and between the Registrant
and Haynes G. Griffin, filed as Exhibit 10(a)(10) to the Registrant's
Annual Report on Form 10-K for the fiscal year ended December 31, 1994.
* 10(a)(11) Employment Agreement dated March 1, 1995 by and between the Registrant
and L. Richardson Preyer, Jr., filed as Exhibit 10(a)(11) to the
Registrant's Annual Report on Form 10-K for the fiscal year ended
December 31, 1994.
* 10(a)(12) Employment Agreement dated March 1, 1995 by and between the Registrant
and Stephen R. Leeolou, filed as Exhibit 10(a)(12) to the Registrant's
Annual Report on Form 10-K for the fiscal year ended December 31, 1994.
* 10(a)(13) Executive Officer Long-Term Incentive Compensation Plan adopted October
1, 1990 by the Registrant, filed as Exhibit 10(a)(13) to the
Registrant's Annual Report on Form 10-K to the fiscal year ended
December 31, 1990.
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Exhibit No. Description No.
* 10(a)(14) Form on Nonqualified Option Agreements dated October 12, 1987 between
the Registrant and Stephen L. Holcombe, Ralph E. Hiskey, John F. Dille,
Jr., Charles T. Hagel, L. Richardson Preyer, Sr. and Robert A.
Silverberg, filed as Exhibit 10(a)(5) to the Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 1988.
* 10(a)(15) Nonqualified Option Agreements dated October 12, 1987 between the
Registrant and Robert M. DeMichele, John F. Dille, Jr., L. Richardson
Preyer, Sr., Robert A. Silverberg and Thomas I. Storrs, filed as Exhibit
10(a)(8) to the Registrant's Annual Report on Form 10-K for the fiscal
year ended December 31, 1988.
* 10(a)(16) Form of Incentive Stock Option Agreements dated March 3, 1988 between
the Registrant and Stephen L. Holcombe and Richard C. Rowlenson, filed
as Exhibit 10(a)(9) to the Registrant's Annual Report on Form 10-K for
the fiscal year ended December 31, 1988.
* 10(a)(17) Form of Incentive Stock Option Agreements dated June 23, 1988 between
the Registrant and Charles T. Hagel, Haynes G. Griffin, L. Richardson
Preyer, Jr., and Stephen R. Leeolou, filed as Exhibit 10(a)(10) to the
Registrant's Annual Report on Form 10-K for the fiscal year ended
December 31, 1988.
10(a)(18) Amended and restated 1994 Long-Term Incentive Plan, approved by the
Registrant's Board of Directors on February 26, 1997.
* 10(a)(19) Senior Management Severance Plan of the Registrant adopted
March 8, 1995, filed as Exhibit 10(a)(19) to the Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31, 1994.
* 10(a)(20) Form of Severance Agreement for Senior Management Employees of the
Registrant, filed as Exhibit 10(a)(20) to the Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 1994.
* 10(a)(21) Form of Incentive Stock Agreement dated March 7, 1995 between the
Registrant and Haynes G. Griffin, Steven L. Holcombe, Richard C.
Rowlenson and Stuart S. Richardson filed as Exhibit 10(a)(21) to the
Registrant's Quarterly Report on Form 10-Q for the quarterly period
ended March 31, 1995.
* 10(a)(22) Form of Nonqualified Option Agreement dated March 7, 1995 between the
Registrant and Haynes G. Griffin, Stephen R. Leeolou, L. Richardson
Preyer, Jr., Stephen L. Holcombe, Richard C. Rowlenson and Stuart S.
Richardson, filed as Exhibit 10(a)(22) to the Registrant's Quarterly
Report on Form 10-Q for the quarterly period ended March 31, 1995.
* 10(b))(1) Loan Agreement between the Registrant and various lenders led by The
Bank of New York and The Toronto-Dominion Bank as agents, dated as of
December 23, 1994, filed as Exhibit 2(a) to the Registrant's Current
Report on Form 8-K dated as of December 23, 1994.
* 10(b)(2) Security Agreement between the Registrant and various lenders led by The
Bank of New York and The Toronto-Dominion Bank, as Secured Party, dated
as of December 23, 1994, filed as Exhibit 2(b) to the Registrant's
Current Report on Form 8-K dated as of December 23, 1994.
* 10(b)(3) Master Subsidiary Security Agreement between the Registrant, certain of
its subsidiaries and various lenders led by The Bank of New York and The
Toronto-Dominion Bank, as Secured Party, dated as of December 23, 1994
filed as Exhibit 2(c) to the Registrant's Current Report on Form 8-K
dated as of December 23, 1994.
* 10(d))(1) 1989 Stock Option Plan of the Registrant approved by the Board of
Directors of the Registrant on December 21, 1989, and approved by
Shareholders at a meeting held on May 10, 1990, filed as Exhibit
10(h)(1) to the Registrant's Annual Report on Form 10-K for the fiscal
year ended December 31, 1989.
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Exhibit No. Description No.
* 10(d)(2) Form of Nonqualified Stock Option Agreements dated March 1, 1990 between
the Registrant and Haynes G. Griffin, L. Richardson Preyer, Jr., Stephen
R. Leeolou, Stephen L. Holcombe and Stuart S. Richardson, filed as
Exhibit 10(h)(2) to the Registrant's annual Report on Form 10-K for the
fiscal year ended December 31, 1989.
* 10(d)(3) Form of Incentive Stock Option Agreement dated March 1, 1990 between the
Registrant and Richard C. Rowlenson, filed as Exhibit 10(h)(2) to the
Registrant's Annual Report on Form 10-K for the fiscal year ended
December 31, 1989.
* 10(d)(4) Form of Incentive Stock Option Agreement dated July 30, 1990 between the
Registrant and Stephen L. Holcombe, Richard C. Rowlenson, Sunir Kochhar
and Timothy G. Biltz, filed as Exhibit 10(f)(4) to the Registrant's
Annual Report on Form 10-K for the fiscal year ended December 31, 1990.
* 10(d)(5) Stock Option Agreement dated November 28, 1990 between the Registrant
and Stuart Smith Richardson, filed as Exhibit 10(f)(5) to the
Registrant's Annual Report on Form 10-K for the fiscal year ended
December 31, 1990.
* 10(d)(6) Form of Stock Option Agreements dated November 28, 1990 between the
Registrant and Haynes G. Griffin, Stephen R. Leeolou, L. Richardson
Preyer, Jr. and Stephen L. Holcombe, filed as Exhibit 10(f)(6) to the
Registrant's Annual Report on Form 10-K for the fiscal year ended
December 31, 1990.
* 10(d)(7) Incentive Stock Option Agreements dated November 28, 1990 between the
Registrant and Richard C. Rowlenson, filed as Exhibit 10(f)(7) to the
Registrant's December 31, 1990.
* 10(e)(1) Joint Venture Agreement by and among W&J Metronet, Inc., Vanguard
Cellular Systems of Coastal Carolina, Inc., Providence Journal
Telecommunications and the Registrant dated as of January 19, 1990,
filed as Exhibit 10(j) to the Registrant's Registration Statement on
Form S-4 (File No. 33-35054).
* 10(e)(2) First Amendment and Assumption Agreement dated as of the 28th day of
December, 1990 to Joint Venture Agreement by and among W&J Metronet,
Inc., Vanguard Cellular Systems of Coastal Carolina, Inc., Providence
Journal Telecommunications and the Registrant dated as of January 19,
1990, filed as Exhibit 10(g)(2) to the Registrant's Annual Report on
Form 10-K for the fiscal year ended December 31, 1990.
* 10(f)(1) Stockholders Voting Agreement dated as of February 23, 1994, filed as
Exhibit 7 to Amendment 1 of Schedule 13D dated February 23, 1994 with
respect to the Common Stock of Geotek Communications,
10(g)(1) Nonqualified Deferred Compensation Plan with Form of Salary Reduction
Agreement.
11 Calculation of fully diluted net income per share for the years ended
December 31, 1996, 1995, and 1994.
22 Subsidiaries of the Registrant.
23 Consent of Arthur Andersen LLP
27 Financial Data Schedule.
* Incorporated by reference to the statement or report indicated.