UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(MARK ONE)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1997
--------------------------------------
or
[ ] TRANSITION REPORT PURSUANT TO SECTION A3 OR 15(d) OF THE
SECURITIES AND 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 (I.R.S. Employer
or organization) Identification No.)
2002 Pisgah Church Road, Suite 300
Greensboro, North Carolina 27455-3314
- ----------------------------------- --------------
(Address of principal executive (Zip Code)
offices)
Registrant's telephone number, including area code (910) 282-3690
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 ___.
The number of shares outstanding of the issuer's common stock as of October 9,
1997 was 40,282,265.
VANGUARD CELLULAR SYSTEMS, INC. AND SUBSIDIARIES
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets - I-1
September 30, 1997 and December 31, 1996.
Condensed Consolidated Statements of Operations - I-2
Three months and nine months ended September 30, 1997
and 1996.
Condensed Consolidated Statements of Cash Flows - I-3
Nine months ended September 30, 1997 and 1996.
Notes to Condensed Consolidated Financial I-4
Statements
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations I-11
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K II-1
SIGNATURES II-2
Item 1. FINANCIAL STATEMENTS
VANGUARD CELLULAR SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except per share data)
September 30, December 31,
- -----------------------------------------------------------------------------------------------------------------
ASSETS 1997 1996
- -----------------------------------------------------------------------------------------------------------------
(Substantially all pledged on long-term debt) (Unaudited) (See note)
Current Assets:
Cash $ 3,517 $ 11,180
Accounts receivable, net of allowances for doubtful accounts of $6,516
and $4,617 61,681 29,907
Cellular telephone inventories 17,056 15,921
Deferred income tax asset 5,596 2,149
Prepaid expenses 3,254 2,057
- -----------------------------------------------------------------------------------------------------------------
Total current assets 91,104 61,214
- -----------------------------------------------------------------------------------------------------------------
Investments 324,151 333,371
Property and Equipment, net of accumulated depreciation of $154,170 and
$119,470 367,382 313,800
Other Assets, net of accumulated amortization of $10,033 and $6,965 23,923 22,196
- -----------------------------------------------------------------------------------------------------------------
Total assets $ 806,560 $ 730,581
- -----------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
- -----------------------------------------------------------------------------------------------------------------
Current liabilities:
Current portion of long term debt 18,413 $ -
Accounts payable and accrued expenses 53,083 65,497
Customer deposits 1,244 1,679
- -----------------------------------------------------------------------------------------------------------------
Total current liabilities 72,740 67,176
- -----------------------------------------------------------------------------------------------------------------
Long-Term Debt 718,550 629,954
- -----------------------------------------------------------------------------------------------------------------
Commitments and Contingencies
Shareholders' Equity:
Preferred stock - $.01 par value, 1,000 shares authorized, no shares
issued -- --
Common stock, Class A - $.01 par value, 250,000 shares authorized,
40,281 and 41,085 shares issued and outstanding 403 411
Common stock, Class B - $.01 par value, 30,000 shares authorized,
no shares issued -- --
Additional capital in excess of par value 232,951 237,640
Net unrealized holding losses (23,918) (14,570)
Accumulated deficit (194,166) (190,030)
- -----------------------------------------------------------------------------------------------------------------
Total shareholders' equity 15,270 33,451
- -----------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 806,560 $ 730,581
- -----------------------------------------------------------------------------------------------------------------
The accompanying notes to condensed consolidated financial statements are an
integral part of these balance sheets.
Note: The balance sheet at December 31, 1996 has been derived from the
audited financial statements at that data.
I-1
VANGUARD CELLULAR SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share data)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
- --------------------------------------------------------------------------------------------------------------
1997 1996 1997 1996
- --------------------------------------------------------------------------------------------------------------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
Revenues:
Service revenue $ 94,704 $ 75,305 $ 258,161 $ 208,068
Cellular telephone equipment revenue 6,320 3,297 16,421 9,877
Other 293 1,021 1,198 3,316
- --------------------------------------------------------------------------------------------------------------
101,317 79,623 275,780 221,261
- --------------------------------------------------------------------------------------------------------------
Costs and Expenses:
Cost of service 9,118 6,425 24,987 23,837
Cost of cellular telephone equipment 10,201 6,369 28,100 16,475
General and administrative 26,638 20,529 75,142 57,073
Marketing and selling 18,355 15,747 53,034 43,047
Depreciation and amortization 17,086 12,953 48,223 34,496
- --------------------------------------------------------------------------------------------------------------
81,398 62,023 229,486 174,928
- --------------------------------------------------------------------------------------------------------------
Income From Operations 19,919 17,600 46,294 46,333
Net Gain (Loss) on Dispositions (1,032) 2,426 (3,468) 1,796
Interest Expense (15,227) (12,147) (41,852) (33,868)
Equity in Losses of Unconsolidated Affiliates (3,513) (5,476) (9,796) (5,083)
Other, net 921 490 2,192 1,072
- -------------------------------------------------------------------------------------------------------------
Income (Loss) Before Taxes 1,068 2,893 (6,630) 10,250
Income Tax Benefit - - 8,000 -
- -------------------------------------------------------------------------------------------------------------
Income Before Minority Interests 1,068 2,893 1,370 10,250
Minority Interests - (5) - 31
- -------------------------------------------------------------------------------------------------------------
Net Income $ 1,068 $ 2,888 $ 1,370 $ 10,281
- -------------------------------------------------------------------------------------------------------------
Net Income Per Share $ 0.03 $ 0.07 $ 0.03 $ 0.25
- -------------------------------------------------------------------------------------------------------------
Weighted Average Number of Common
Shares Outstanding 40,280 41,339 40,466 41,325
- -------------------------------------------------------------------------------------------------------------
The accompanying notes to condensed consolidated financial statements are an
integral part of these statements.
I-2
VANGUARD CELLULAR SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
(Dollar amounts in thousands)
- -----------------------------------------------------------------------------------------
1997 1996
- -----------------------------------------------------------------------------------------
(Unaudited) (Unaudited)
Cash flows from operating activities:
Net income $ 1,370 $ 10,281
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 48,223 34,496
Amortization of deferred debt issuance costs 1,448 1,302
Equity method loss of unconsolidated entities 9,797 5,083
Amortization of bond investment discount (1,425) (288)
Minority interests - (31)
Net (gain) loss on dispositions 3,468 (1,796)
Deferred income tax benefit (8,000) -
Noncash compensation for management consulting services - (2,193)
Changes in current items:
Accounts receivable, net (31,774) 489
Cellular telephone inventories (1,135) (2,790)
Accounts payable and accrued expenses 6,257 7,105
Other, net (1,632) (799)
- ------------------------------------------------------------------------------------------
Net cash provided by operating activities 26,597 50,859
- ------------------------------------------------------------------------------------------
Cash flows from investing activities:
Purchases of property and equipment (116,807) (84,701)
Proceeds from dispositions of Cellular Interests - 4,644
Proceeds from dispositions of property and equipment 78 518
Payments for acquisition of investments (13,542) (36,718)
Capital contributions to unconsolidated cellular entities (538) (221)
- ------------------------------------------------------------------------------------------
Net cash used in investing activities (130,809) (116,478)
- ------------------------------------------------------------------------------------------
Cash flows from financing activities:
Principal payments of long-term debt (11,006) (193,004)
Repurchase of common stock (10,257) -
Net proceeds from issuance of common stock 54 448
Proceeds of long-term debt 118,000 263,802
Debt issuance cost - (6,909)
Increase in other assets (242) (1,298)
- ----------------------------------------------------------------------------------------
Net cash provided by financing activities 96,549 63,039
- ----------------------------------------------------------------------------------------
Net decrease in cash (7,663) (2,580)
Cash, beginning of period 11,180 8,085
- ----------------------------------------------------------------------------------------
Cash, end of period $ 3,517 $ 5,505
- ----------------------------------------------------------------------------------------
SUPPLEMENTAL DISCLOSURE OF INTEREST PAID $ 34,694 $ 27,354
SUPPLEMENTAL DISCLOSURE OF INCOME TAXES PAID 20 -
- ----------------------------------------------------------------------------------------
The accompanying notes to condensed consolidated financial statements are an
integral part of these statements.
I-3
VANGUARD CELLULAR SYSTEMS, INC. AND SUBSIDIARIES
(Unaudited)
Note 1: Basis of Presentation
The accompanying condensed consolidated financial statements of Vanguard
Cellular Systems, Inc. and Subsidiaries (the Company) have been prepared without
audit pursuant to Rule 10-01 of Regulation S-X of the Securities and Exchange
Commission ("SEC"). Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the nine month period ended September 30,
1997 are not necessarily indicative of the results that may be expected for the
year ending December 31, 1997. For further information, refer to the
consolidated financial statements and footnotes thereto included in the
Company's 1996 annual report on Form 10-K and Form 10-K/A.
The consolidated financial statements include the accounts of the Company, its
wholly owned subsidiaries and entities in which the Company holds a majority
ownership interest. Investments in entities 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. Ownership
interests in entities in which the Company does not exercise significant
influence and does not control through majority ownership and for which there is
no readily determinable fair value have been accounted for using the cost method
of accounting. Ownership interests in entities in which the Company does not
control through majority ownership and does not exercise significant influence
and for which there is a readily determinable fair value have been accounted for
as available for sale pursuant to the requirements of Statement of Financial
Accounting Standards No. 115, "Accounting for Certain Investments in Debt and
Equity Securities". All significant intercompany accounts and transactions have
been eliminated.
I-4
Note 2: Investments
September 30, December 31,
1997 1996
------------- -------------
Investments in domestic cellular entities:
Consolidated entities
License cost 301,780 300,780
Accumulated amortization (41,799) (36,113)
----------- -----------
259,981 264,667
---------- -----------
Entities carried on the equity method
Cost 10,193 10,193
Accumulated share of earnings 1,693 2,056
----------- ------------
11,886 12,249
----------- ------------
Entities carried on the cost method 9,910 9,993
----------- ------------
281,777 286,909
---------- -----------
Investments in other entities:
Entities carried on the equity method
Cost 40,193 26,924
Accumulated share of losses (27,673) (18,239)
------------ ------------
12,520 8,685
----------- ------------
Investments carried as "available for sale"
Cost 37,736 37,736
Net unrealized holding losses (23,918) (14,570)
----------- -----------
13,818 23,166
Investment in debentures
At par 18,000 18,000
Discount (6,964) (8,389)
----------- ------------
11,036 9,611
----------- -------------
Other investments, at cost 5,000 5,000
----------- ------------
42,374 46,462
----------- ------------
$ 324,151 $ 333,371
=========== ============
Domestic Cellular Entities
The Company continues to expand its ownership of cellular markets through
strategic acquisitions. 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 cellular acquisition.
I-5
Other Investments
International Wireless Communications Holdings, Inc. and Foreign Investments
The Company owns approximately 36% of the outstanding stock of International
Wireless Communications Holdings, Inc. ("IWC") and has invested an aggregate of
$13.8 million. 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. The Company records its
proportionate share of these losses under the equity method of accounting.
During 1996 and 1995, the Company recognized an amount of losses on the equity
method from IWC that was 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 equity method income is available to offset the
Company's share of IWC's future losses or until such time that the Company makes
additional financial commitments to IWC. During the third quarter of 1997, the
Company committed to fund a credit facility for the benefit of IWC. This
commitment is subject to the equity method and the Company recorded $966,000
in losses, which represents the entire amount of the commitment.
During the first quarter of 1997, 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, one of which has occurred, and 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. Through September 30, 1997, the Company has invested $5.1 million in SDL.
The Company accounts for its investment using the equity method of accounting.
During the third quarter of 1997, the Company guaranteed portions of two loans
acquired by SDL. The Company's guarantee is for a total of $4.3 million.
In August, 1997, the Company entered into an agreement to purchase from an
unrelated third party a 6% indirect ownership interest in Pakistan Mobile
Communications, Ltd. ("PMCL"), a Company whose principal business activity is
operating a nationwide cellular telecommunications system in Pakistan. Pursuant
to the agreement, the Company purchased this ownership interest for $7.1 million
in cash. Simultaneous with the closing of this transaction, IWC purchased a 20%
indirect ownership interest in PMCL for $22.0 million under substantially the
same terms as the Company. In addition, the Company advanced to a subsidiary
of IWC $2.9 million to fund a portion of its investment in PMCL. The Company
accounts for its investment using the equity method of accounting.
Inter (bullet) Act Systems, Incorporated
As of September 30, 1997, the Company had invested approximately $10.0 million
in Inter (bullet) Act common stock for an ownership interest of approximately
26%. Inter (bullet) Act is a development stage
I-6
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.
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.
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%
SeniorDiscount Notes and warrants to purchase 169,722 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.
The Company records its proportionate share of the losses of Inter (bullet)
Act under the modified equity method of accounting. As of September 30, 1997
the Company has a remaining investment in Inter (bullet) Act of $11.8 million.
Financial Information of Equity Method Investees
Combined financial position and operating results of the Company's equity method
investees, IWC, Inter (bullet) Act, and its Eastern North Carolina Joint Venture
for the first nine months of 1997 and 1996 are as follows (in thousands):
1997 1996
---------- --------
Revenues.............................................$ 15,181 $12,846
Gross profit......................................... 5,090 7,857
Loss from operations................................. (71,506) (22,174)
Net Loss............................................. (94,210) (25,594)
I-7
Information for each investee is summarized from the available financial
information for each entity.
Note 3: Long-Term Debt
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
Vanguard Cellular Financial Corp. ("VCFC"), Vanguard's only direct subsidiary,
is the primary obligor on the Credit Facility.
Long-term debt consists of the following as of September 30, 1997 and December
31, 1996 (in thousands):
September 30, December 31,
1997 1996
------------- -----------
Debt of VCFC:
Borrowings under the Credit Facility:
Term Loan..........................................$325,000 $325,000
Revolving Loan..................................... 212,000 105,000
Other Long-Term Debt................................. 131 137
------- --------
537,131 430,137
Less Current Portion............................... 18,413 -
------- --------
518,718 430,137
Debt of Vanguard:
Senior Debentures due 2006, net of unamortized
discount of $168 and $183 ........................ 199,832 199,817
------- --------
$718,550 $629,954
======== =========
Credit Facility of VCFC. 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 September 30, 1997, $212 million had been borrowed under the Revolving Loan
and the terms of these agreements limit additional available borrowing during
the fourth quarter of 1997 to $93.7 million. See "Item 2. Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Liquidity and Capital Resources" for further information.
I-8
Interest Rate Protection. The Company maintains interest rate swaps and interest
rate caps which provide protection against interest rate risk. At September 30,
1997 the Company had interest rate cap agreements in place covering a notional
amount of $225 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
7.50 50,000 February 1999
7.50 50,000 February 1999
8.00 25,000 August 1999
--------
$ 225,000
The cost of these interest rate cap agreements of $556,650 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.
Subsequent to September 30, 1997 the Company purchased four additional interest
rate caps, one with an 8.5% strike level covering a $100 million notional amount
which expires November, 2002 and one with a 7.5% strike level covering a $75
million notional amount also expiring in November, 2002. The remaining two caps
maintain a 9.5% strike level covering a $100 million notional amount each and
both expire October, 2002.
Subsequent to September 30, 1997, the Company entered into an interest rate
swap agreement that fixes the LIBOR interest rate at 6.10% on a notional
amount of $50 million through October, 2002. Under this swap agreement, the
Company benefits if LIBOR interest rates increase above the fixed rate and
incurs additional interest expense if rates remain below the fixed rate. Any
amounts received or paid under this agreement 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
I-9
rates rise. The all-in-rate for the first six month period ending April 15, 1997
was 8.64% or .735% below the coupon rate on the Debentures. The all-in-rate for
the six month period ending October 15, 1997 is 9.1% or .275% below the coupon
rate on the Debentures. Additionally, during the first quarter of 1997, 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 all-in-rate for the first six month period
is 8.61% or .765% below the coupon rate on the Debentures.
The effect of interest rate protection agreements on the operating results of
the Company was to decrease interest expense in the third quarter of 1997 by
$7,000 and increase interest expense by $102,000 in the same period in 1996, and
in the nine month period ending September 30, 1997 and 1996, interest expense
decreased $5,000 and increased $477,000, respectively. The Company does not hold
or issue financial instruments for trading purposes.
- -----------------------------------------------------------------------------
Note 4: Capital Stock
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. During the six months ended June 30, 1997, the Company repurchased
820,000 additional shares at an average price per share of approximately $12.50.
Subsequent to September 30, 1997 and through November 13, 1997, the Company
repurchased 1,021,300 shares at an average price of approximately $14.00 per
share.
In January 1997, the Compensation Committee of 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 2,299,750
shares with exercise prices ranging from $21.50 to $25.125 were canceled and new
options for 1,980,575 shares with an exercise price of $15.69 were issued (the
"January 1997 Options"). The exercise price for all of these new options
reflected the fair market value at the time of issuance. In April 1997, the
Compensation Committee authorized the amendment of certain options, nearly all
of which were January 1997 Options, to lower the exercise price to $10.00, the
fair market value at that time.
I-10
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following is a summary of the Company's ownership interests in cellular
markets in which the Company's ownership interests exceeded 20% at September 30,
1997 and 1996. This table does not include any ownership interests that were
contracted for at these dates.
September 30,
CELLULAR MARKETS 1997 1996
- ---------------- ---- ----
MID-ATLANTIC SUPERSYSTEM:
Allentown, PA/NJ 100.0% 100.0%
Wilkes-Barre/Scranton, PA 100.0 100.0
Harrisburg, PA 100.0 100.0
Lancaster, PA 100.0 100.0
York, PA 100.0 100.0
Reading, PA 100.0 100.0
Altoona, PA 100.0 100.0
State College, PA 100.0 100.0
Williamsport, PA 100.0 100.0
Union, PA (PA-8 RSA) 100.0 100.0
Chambersburg, PA (PA-10 East RSA) 100.0 100.0
Lebanon, PA (PA-12 RSA) 100.0 100.0
Mifflin, PA (PA-11 RSA) 100.0 100.0
Wayne, PA (PA-5 RSA) 100.0 100.0
Orange County, NY -- 100.0
Binghamton, NY 100.0 100.0
Elmira, NY 100.0 100.0
NEW ENGLAND METRO-CLUSTER:
Portland, ME 100.0 100.0
Portsmouth, NH/ME 100.0 100.0
Bar Harbor, ME (ME-4 RSA) 100.0 100.0
FLORIDA METRO-CLUSTER:
Pensacola, FL 100.0 100.0
Fort Walton Beach, FL 100.0 100.0
WEST VIRGINIA METRO-CLUSTER:
Huntington, WV/KY/OH 100.0 100.0
Charleston, WV 100.0 100.0
Mason, WV (WV-1 RSA) 100.0 100.0
Logan, WV (WV-6 RSA) 100.0 100.0
Parkersburg-Marietta, WV/OH 100.0 --
Ross, OH (OH-9 RSA) 100.0 --
Perry, OH (OH-10 South RSA) 100.0 --
CAROLINAS METRO-CLUSTER:
Myrtle Beach, SC (SC-5 RSA) 100.0 100.0
Wilmington, NC 48.0 48.0
Jacksonville, NC 47.8 47.8
I-11
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 condensed consolidated financial statements, including the notes
thereto.
Three Months Ended September 30, 1997 and 1996
Service revenue in the third quarter of 1997 rose 26% to $94.7 million from
$75.3 million in the same period in 1996. This increase was primarily the result
of a 154,000 or 33% increase in the number of subscribers in majority-owned
markets to approximately 615,000 in the third quarter of 1997, as compared to
approximately 461,000 in the same period in 1996. Penetration, computed as a
percentage of the Company's subscribers to total POPs in majority owned cellular
markets, increased to 8.1% in the third quarter of 1997 from 6.3% in the same
period last year. 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. A
decrease in "churn" from 2.2% in the third quarter of 1996 to 1.9% in the third
quarter of 1997 contributed positively to the net increase in subscribers and
resulted in part from a renewed emphasis on customer service and a change in
billing procedures. 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 29% during the third quarter of 1997 to $78.0 million as compared to
$60.7 million in third quarter of 1996. This increase is a result of the
increase in subscribers discussed above. Average monthly Local Revenue per
subscriber declined 4% to $44 in the third quarter of 1997 compared to $45 in
the same period 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
14% to $16.7 million in the third quarter of 1997 as compared to $14.6 million
in the prior year period. This increase resulted from increased usage offset by
continued reductions in daily access and usage rates. The reduced rates affect
the Company both as a provider and purchaser of roaming services. Local Revenue
combined with roaming revenue resulted in overall average monthly revenue per
subscriber for the third quarter of 1997 of $53, a decline of 6% from $56 in the
prior year period.
Cost of service as a percentage of service revenue increased slightly from 9% to
10% during the third quarter of 1997 as compared to the same period in 1996. The
Company
I-12
expects cost of service as a percentage of service revenue to remain stable
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 1% of
service revenue in the third quarter of 1996 to less than 1% during the third
quarter of 1997. Cellular fraud is expected to be a significant industry issue
for the foreseeable future.
General and administrative expenses increased 30% or $6.1 million during the
third quarter of 1997 as compared to the same period in 1996. General and
administrative expenses as a percentage of service revenue increased from 27% in
the third quarter of 1996 to 28% in the third quarter of 1997. This increase is
due primarily to compensation expense resulting from increases in the Company's
employee base generally in the areas of technical services, customer operations,
and new product development. The Company does not anticipate significantly
expanding its employee base for the remainder of the year and believes that
general and administrative expenses will stabilize as a percentage of service
revenue over the remainder of the year.
Marketing and selling expenses increased 17% to $18.4 million during the third
quarter of 1997, compared to $15.7 million in the same period in 1996. As a
percentage of service revenue, these expenses decreased from 21% in the third
quarter of 1996 to 19% in the 1997 period. During the third quarter of 1997,
marketing and selling expenses including the net loss on cellular equipment
("Combined Marketing and Selling Expenses") increased to $22.2 million from
$18.8 million in the same period in 1996. Combined Marketing and Selling
Expenses per net subscriber addition decreased 9% to $635 in the third quarter
of 1997 from $697 during the third quarter of 1996 primarily as a result of the
decrease in churn. Net loss on cellular equipment increased from $3.1 million in
the third quarter of 1996 to $3.9 million in the third quarter of 1997, an
increase of $800,000. The Company continues to sell telephones at or below cost
for marketing purposes, and has become more aggressive with phone pricing in
response to competitive pressures. Combined Marketing and Selling Expenses per
gross subscriber addition decreased to $321 in the third quarter of 1997 from
$338 in the same period in 1996. While the Company has benefited 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 discontinued its agent relationship
with the Radio Shack chain, effective January 1, 1997.
I-13
Management believes that, through increasing its own presence in the retail
marketplace, the Company has mitigated any effect on gross subscriber additions
which might have occurred as a result of the loss of the Radio Shack locations,
and 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 $4.1 million or 32% during the
third quarter of 1997 as compared to 1996. Property and equipment placed in
service since October 1, 1996 of approximately $138 million accounted for
substantially all of this increase.
Interest expense increased $3.1 million or 25% during the third quarter of 1997.
Substantially all of this increase resulted from an increase in average
borrowings of approximately $153 million.
Equity in losses of unconsolidated investments decreased by $2.0 million. This
decrease resulted primarily from the suspension of the Company's recognition of
losses attributable to its equity method investment in IWC. During the third
quarter of 1997, the Company committed to fund a credit facility for the
benefit of IWC. This commitment is subject to the equity method and the
Company recorded $966,000 in losses, which represents the entire amount of
the commitment. The Company continues to recognize its share of the income and
losses of its equity method investments in Inter (bullet) Act, Eastern North
Carolina Joint Venture, SDL, and PMCL. See "Liquidity and Capital Resources".
Net loss on dispositions increased by $3.5 million, substantially all of which
is related to the gain on disposition of the Company's cellular investment in
India recorded in the third quarter of 1996.
In the third quarter of 1997, the Company suspended recognition of
its deferred income tax assets. The Company may resume recognition of its
deferred tax assets in the future. The total recognized deferred income tax
asset as of September 30, 1997 is $13.0 million. Management concluded that it
is "more likely than not" that this portion of the Company's net deferred
income tax assets will be realized. This assessment considered the Company's
historical operating trends, short-term operating forecasts and certain other
factors. Prior to the fourth quarter of 1996, the Company concluded 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".
Net income for the third quarter was $1.1 million, or $0.03 per share, compared
with net income of $2.9 million, or $0.07 per share, reported for the same
period a year ago. The decline in net income in the third quarter resulted from
the $3.5 million negative change in Net Gain (Loss) on Dispositions from third
quarter 1996 to third quarter 1997, and the $3.1
I-14
million increase in interest expense, offset by the $2.3 million increase in
income from operations and the $2.0 million decrease in equity method losses.
Nine Months Ended September 30, 1997 and 1996
Service revenue in the first nine months of 1997 rose 24% to $258.2 million from
$208.1 million in the same period in 1996 primarily as a result of a 33%
increase in the number of subscribers served in the 1997 period. Churn declined
from 2.2% to 1.9%. Average monthly revenue per subscriber for the nine months
ended September 30, 1997 was $51, a decline of 7% from $55 in the prior year
period. Local Revenue increased 27% to $218.4 million during the first nine
months of 1997 as compared to $171.9 million in the same period last year.
Average monthly Local Revenue per subscriber declined 5% to $43 in the first
nine months of 1997 as compared to $46 in the 1996 period.
Cost of service as a percentage of service revenue decreased from 11% in the
first nine months of 1996 to 10% in the 1997 period primarily as a result of the
Company's continued effort to reduce the charges associated with roamer fraud.
General and administrative expenses increased 32% or $18.1 million during the
first nine months of 1997 as compared to the same period in 1996, and, as a
percentage of service revenue, increased from 27% in the 1996 period to 29% in
the 1997 period.
Marketing and selling expenses increased 23% to $53.0 million during the first
nine months of 1997, compared to $43.0 million in 1996. As a percentage of
service revenue, these expenses decreased slightly from 21% in the 1996 period
to 20% in the 1997 period. Combined Marketing and Selling Expenses per net
subscriber addition decreased 3% to $634 in the first nine months of 1997 from
$653 during the same period in 1996, primarily as a result of the decrease in
churn previously discussed. Combined Marketing and Selling Expenses per gross
subscriber addition increased to $329 in the first nine months of 1997 from
$312 in the same period in 1996.
Depreciation and amortization expenses increased $13.7 million or 40% during the
first nine months of 1997 as compared to 1996. Property and equipment placed in
service since October 1, 1996 of approximately $138 million accounted for
substantially all of this increase.
Interest expense increased $8.0 million or 24% during the 1997 period. This
increase primarily resulted from an increase in average borrowings of
approximately $135 million. Contributing to the increase in average borrowings
are a second quarter change in the Company's billing practices from billing
monthly access fees in advance to billing these fees in arrears resulting in
I-15
additional borrowings, and the Company's repurchase of 820,000 shares of its
common stock, and an increase in interest rates on $200 million of borrowings
represented by the Debentures.
Equity in losses of unconsolidated investments increased by $4.7 million during
the nine months ended September 30, 1997. This increase resulted primarily from
higher operating, amortization and interest expenses incurred by Inter (bullet)
Act, and was lessened by the suspension of the Company's recognition of losses
attributable to its equity method investment in IWC, as previously
discussed.
Net loss on dispositions increased $5.3 million. Substantially all of this
change is related to the gain on disposition recorded in the 1996 period as
discussed above, and the Company's adjustment of the value of its rental phone
assets in the 1997 period.
In the first two quarters of 1997, the Company recognized a deferred income
tax benefit of $8.0 million. In the third quarter of 1997, the Company
suspended recognition of its deferred income tax assets. As discussed above,
the Company may resume recognition of its deferred tax assets in the future.
See "Liquidity and Capital Resources - Income Taxes."
The Company reported net income of $1.4 million or $0.03 per share as compared
to $10.3 million or $0.25 per share for 1996. This $8.9 million decrease in net
income is substantially due to a $4.7 million increase in recognition of the
Company's proportionate share of losses of its unconsolidated subsidiaries,
depreciation expense, disposition losses, and an overall increase in operating
expenses, partially offset by recognition of deferred income tax assets of
approximately $8 million.
I-16
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, to provide for increased
portable usage, and to upgrade its cellular system for digital conversion and
the implementation of new services. 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. During the nine months ended September 30, 1997 the Company spent
approximately $13.5 million on acquisitions and incurred approximately $98.1
million in capital expenditures.
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
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. 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 $94.5 million during the third quarter of 1997 from
$80.8 million in the same period in 1996. Net cash provided by operating
activities as shown on the Statement of Cash Flows decreased to $26.6 million
in the first nine months of 1997 as compared to $50.9 million in the same
period in 1996 due to the change in billing procedures as discussed below. Net
cash provided by operating activities in the first nine months of 1997 reflects
a $7.3 million increase in interest expense, and a change in working capital
items of $32.3 million. Investing activities, primarily purchases of property
and equipment and acquisitions of investments, used net cash of $130.8 million
and $116.5 million in the first nine months of 1997 and 1996, respectively.
Financing activities provided net cash of $96.5 million and $63.0 million in
1997 and 1996, respectively.
I-17
Long-Term Debt. The Company's long-term debt consists primarily of a $675
million credit facility (the "Credit Facility") and $200 million of 93/8% senior
debentures (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
93/8% Senior Debentures due 2006 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 September 30, 1997, $537 million had
been borrowed under the Credit Facility, and the Company had available
borrowings, subject to certain limitations, under the Revolving Loan portion of
the Credit Facility of approximately $93.7 million.
Increased borrowings resulted from a second quarter change in the Company's
billing practices and were estimated to be approximately $16.0 million.
Historically, the Company billed subscriber access fees in advance. To reduce
customer confusion upon receipt of the first bill and to remain competitive, the
Company changed its billing policy and now bills access fees in arrears. This
change had no impact on the Company's revenue recognition, but did affect the
in-flow of cash from bill payments in the second quarter resulting in increased
borrowings. In addition, during the first six months of 1997 the Company
borrowed approximately $10.3 million to repurchase 820,000 shares of its common
stock at an average price per share of approximately $12.50.
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. As of
September 30, 1997, the current portion of long-term debt borrowed under the
Credit Facility was $18.4 million.
I-18
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 September 30, 1997, the applicable margins on the borrowings were
.25% and 1.5% 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 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 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 continues to expand its ownership of cellular markets
through strategic acquisitions. 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 cellular
acquisition.
International Wireless Communications Holdings, Inc. and Foreign Investments. As
of September 30, 1997, the Company had invested $13.8 million in International
Wireless
I-19
Communications 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 was 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 equity method income is available
to offset the Company's share of IWC's future losses or until such time that the
Company makes additional financial commitments to IWC. During the third quarter
of 1997, the Company committed to fund a credit facility for the benefit of
IWC. This commitment is subject to the equity method and the Company recorded
$966,000 in losses, which represents the entire amount of the commitment.
In the first quarter of 1997, 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, one of which has occurred, and 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. Through September 30, 1997, the Company has invested $5.1 million in SDL.
The Company accounts for its investment using the equity method of
accounting. During the third quarter of 1997, the Company guaranteed portions
of two loans acquired by SDL. The Company's guarantee is for the total of $4.3
million.
In August, 1997, the Company entered into an agreement to purchase from an
unrelated third party a 6% indirect ownership interest in Pakistan Mobile
Communications, Ltd. ("PMCL"), a Company whose principal business activity is
operating a nationwide cellular telecommunications system in Pakistan. Pursuant
to the agreement, the Company purchased this ownership interest for $7.1 million
in cash. Simultaneous with the closing of this transaction, IWC purchased a 20%
indirect ownership interest in PMCL for $22.0 million under substantially the
same terms as the Company. In addition, the Company advanced to a subsidiary
of IWC $2.9 million to fund a portion of its investment in PMCL. The Company
accounts for its investment using the equity method of accounting.
Inter (bullet) Act Systems, Incorporated. As of September 30, 1997, the Company
had invested approximately $10.0 million in Inter (bullet) Act Systems,
Incorporated ("Inter (bullet) Act") for an ownership interest of
I-20
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.
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 169,722 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 the losses of Inter (bullet) Act
under the modified equity method of accounting. As of September 30, 1997, the
Company has a remaining investment in Inter (bullet) Act of $11.8 million.
Capital Expenditures. As of September 30, 1997, the Company had $477.7 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 continues to
increase the number of sites and add additional capacity to existing sites as it
has done over the past few years. 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
continued this accelerated buildout to expand system coverage and capacity, and
to upgrade its cellular system for digital conversion and the
implementation of new services. Capital expenditures for 1997 are estimated to
be approximately $125 million and are expected to be funded primarily through
internally generated funds and
I-21
borrowed under the Credit Facility. 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. During the nine months
ended September 30, 1997, the Company incurred approximately $98.1 million in
capital expenditures.
Capital Stock. 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. During the six months ended June 30, 1997, the Company
repurchased 820,000 additional shares at an average price per share of
approximately $12.50. Subsequent to September 30, 1997 and through November 13,
1997, the Company repurchased 1,021,300 shares at an average price of
approximately $14.00 per share.
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. Although the Company's ongoing
operations have generated Federal taxable losses since inception, it expects
taxable income in future periods. There can be no assurance that the Company
will achieve these improvements. 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 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
I-22
income tax assets. In the first six months of 1997, the Company recognized an
additional $8.0 million of its net deferred income tax assets. No additional
portion of the net deferred income tax assets was recognized in the third
quarter of 1997. 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. See " Results
of Operations."
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.
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
report 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)
I-23
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; (v) higher than anticipated
costs due to unauthorized use of its networks and the development and
implementation of measures to curtail such fraudulent use; and (vi) greater than
anticipated losses attributable to its equity interests in other companies. 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.
I-24
Part II. OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The exhibits to this Form 10-Q are listed in the accompanying Index to
Exhibits.
(b) There have been no reports filed on Form 8-K during the period.
II-1
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has fully caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
VANGUARD CELLULAR SYSTEMS, INC.
Date: November 14, 1997 By: /s/ Stephen R. Leeolou
--------------------------
Stephen R. Leeolou
President
and
Co-Chief Executive Officer
Date: November 14, 1997 By: /s/ Stephen L. Holcombe
---------------------------
Stephen L. Holcombe
Executive Vice President
and
Chief Financial Officer
(principal accounting and
principal financial officer)
II-2
INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION
*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 2 to the
Registrant's Form 8- A/A dated July 25, 1995.
*4(b)(1) 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)(2) 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)(3) 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)(4) 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)(5) First Amendment to 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 July 31, 1996, filed as Exhibit 4(d)(5) to
the Registrant's Form 10-Q dated September 30, 1996 and confirmed
electronically as Exhibit 4(d)(5) to the Registrant's 10-Q/A dated
September 30, 1996.
*4(b)(6) Second Amendment to 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 October 9, 1996, filed as Exhibit 4(d)(6)
to the Registrant's Form 10-Q dated September 30, 1996 and
confirmed electronically as Exhibit 4(d)(6) to the
Registrant's 10-Q/A dated September 30, 1996.
*4(b)(7) Third Amendment to 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 March 31, 1997, filed as Exhibit 4(b)(7)
to the Registrant's Form 10-Q dated March 31, 1997.
*4(c)(1) 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(c)(2) 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.
11 Calculation of fully diluted earnings per share for the three
months and nine months ended September 30, 1997 and 1996.
27 Financial Data Schedule.
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* Incorporated by reference to the statement or report indicated.