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 MARCH 31, 1998
------------------------------------
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 (I.R.S. Employer Identification No.)
incorporation or organization)
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 (336) 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 April 24,
1998 was 37,234,993.
VANGUARD CELLULAR SYSTEMS, INC. AND SUBSIDIARIES
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets - I-1
March 31, 1998 and December 31, 1997.
Condensed Consolidated Statements of Operations - I-2
Three months ended March 31, 1998 and 1997.
Condensed Consolidated Statements of Cash Flows - I-3
Three months ended March 31, 1998 and 1997.
Notes to Condensed Consolidated Financial Statements I-4
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations I-13
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)
March 31, December 31,
- -------------------------------------------------------------------------------------------------------------------------------
ASSETS 1998 1997
- -------------------------------------------------------------------------------------------------------------------------------
(UNAUDITED) (See note)
CURRENT ASSETS:
Cash $ 7,079 $ 2,487
Accounts receivable, net of allowances for doubtful accounts of $8,649 and $8,184 52,542 54,340
Cellular telephone inventories 16,598 18,826
Deferred income taxes, current 45,002 43,139
Prepaid expenses 4,043 3,620
- --------------------------------------------------------------------------------------------------------------------------------
Total current assets 125,264 122,412
- --------------------------------------------------------------------------------------------------------------------------------
INVESTMENTS 308,277 307,718
PROPERTY AND EQUIPMENT, net of accumulated depreciation of $181,212
and $166,230 377,201 371,343
NON-CURRENT DEFERRED INCOME TAXES 11,690 9,447
Other Assets, net of accumulated amortization of $8,026 and $10,701 13,662 17,041
- --------------------------------------------------------------------------------------------------------------------------------
Total assets $ 836,094 $ 827,961
- --------------------------------------------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
- --------------------------------------------------------------------------------------------------------------------------------
CURRENT LIABILITIES: Accounts payable and accrued expenses $ 48,119 $ 58,084
LONG-TERM DEBT 827,841 768,967
- --------------------------------------------------------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY (DEFICIT):
Preferred stock - $.01 par value, 1,000 shares authorized, no shares issued - -
Common stock, Class A - $.01 par value, 250,000 shares authorized,
and 37,232 and 38,308 shares outstanding 372 383
Common stock, Class B - $.01 par value, 30,000 shares authorized, no shares issued - -
Additional capital in excess of par value 213,895 221,624
Net unrealized holding loss (1,524) -
Accumulated deficit (252,609) (221,097)
- --------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity (deficit) (39,866) 910
- --------------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity (deficit) $ 836,094 $ 827,961
- --------------------------------------------------------------------------------------------------------------------------------
THE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS ARE AN
INTEGRAL PART OF THESE BALANCE SHEETS.
NOTE: THE BALANCE SHEET AT DECEMBER 31, 1997 HAS BEEN DERIVED FROM THE AUDITED
FINANCIAL STATEMENTS AT THAT DATE.
I-1
VANGUARD CELLULAR SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 1998 AND 1997
(Amounts in thousands, except per share data)
- ------------------------------------------------------------------------------------------------------------------------------------
1998 1997
- ------------------------------------------------------------------------------------------------------------------------------------
(UNAUDITED) (Unaudited)
Revenues:
Service revenue $ 89,980 $ 75,109
Cellular telephone equipment revenue 7,641 4,754
Other 338 452
- ------------------------------------------------------------------------------------------------------------------------------------
97,959 80,315
- ------------------------------------------------------------------------------------------------------------------------------------
Costs and Expenses:
Cost of service 7,413 7,869
Cost of cellular telephone equipment 10,664 8,643
General and administrative 27,386 23,275
Marketing and selling 18,656 14,494
Depreciation and amortization 22,098 15,152
- ------------------------------------------------------------------------------------------------------------------------------------
86,217 69,433
- ------------------------------------------------------------------------------------------------------------------------------------
Income From Operations 11,742 10,882
Interest Expense (15,683) (12,401)
Net Losses from Unconsolidated Investments (14,566) (2,396)
Other, net 288 143
- -----------------------------------------------------------------------------------------------------------------------------------
Net Loss Before Income Taxes and Extraordinary Item (18,219) (3,772)
Income Tax Benefit 1,461 4,000
- -----------------------------------------------------------------------------------------------------------------------------------
Net Income (Loss) Before Extraordinary Item (16,758) 228
Extraordinary Loss on Extinguishment of Debt, net of Tax Benefit of $2,645 (3,971) -
- -----------------------------------------------------------------------------------------------------------------------------------
Net Income (Loss) $ (20,729) $ 228
- -----------------------------------------------------------------------------------------------------------------------------------
Net Income (Loss) Per Common Share:
Basic $ (0.55) $ 0.01
Diluted $ (0.55) $ 0.01
- -----------------------------------------------------------------------------------------------------------------------------------
Common Shares Used in Computing Per Share Amounts:
Basic 37,844 40,824
Diluted 37,844 40,881
- -----------------------------------------------------------------------------------------------------------------------------------
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 THREE MONTHS ENDED MARCH 31, 1998 AND 1997
(Dollar amounts in thousands)
- -----------------------------------------------------------------------------------------------------------------------------------
1998 1997
- -----------------------------------------------------------------------------------------------------------------------------------
(Unaudited) (Unaudited)
Cash flows from operating activities:
Net income (loss) $ (20,729) $ 228
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Depreciation and amortization 22,098 14,952
Amortization of deferred debt issuance costs 334 471
Net losses from unconsolidated investments 14,566 2,396
Net loss on dispositions 7 189
Income tax benefit (4,106) (4,020)
Extraordinary loss on extinguishment of debt 6,618 -
Changes in current items:
Accounts receivable, net 1,798 128
Cellular telephone inventories 2,228 1,849
Accounts payable and accrued expenses (7,317) (3,339)
Other, net (60) (2,063)
- -----------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 15,437 10,791
- -----------------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Purchases of property and equipment (29,046) (34,432)
Proceeds from dispositions of property and equipment 501 51
Payments for acquisition of investments (16,232) (31)
Capital contributions to unconsolidated entities (2,312) -
- -----------------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (47,089) (34,412)
- -----------------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Principal payments of long-term debt (594,130) (4,002)
Repurchase of common stock (18,565) (4,754)
Net proceeds from issuance of common stock 42 -
Proceeds of long-term debt 653,000 25,000
Debt issuance cost (4,106) -
Decrease (increase) in other assets 3 (156)
- -----------------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 36,244 16,088
- -----------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash 4,592 (7,533)
Cash, beginning of period 2,487 11,180
- -----------------------------------------------------------------------------------------------------------------------------------
Cash, end of period $ 7,079 $ 3,647
- -----------------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DISCLOSURE OF INTEREST PAID $ 11,515 $ 7,184
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
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(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 three month period ended March 31, 1998
are not necessarily indicative of the results that may be expected for the year
ending December 31, 1998. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Company's 1997 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
Investments consist of the following (in thousands):
MARCH 31, DECEMBER 31,
1998 1997
--------------- ------------
INVESTMENTS IN DOMESTIC CELLULAR ENTITIES:
Consolidated entities:
License cost $ 302,695 $ 297,142
Accumulated amortization (45,591) (43,696)
----------------- ---------------
257,104 253,446
--------------- -------------
Entities carried on the equity method:
Cost 10,193 10,193
Accumulated share of earnings 1,635 1,960
--------------- -------------
11,828 12,153
--------------- --------------
Entities carried on the cost method 9,551 9,592
--------------- -------------
278,483 275,191
--------------- -------------
INVESTMENTS IN OTHER ENTITIES:
Entities carried on the equity method:
Investment in equity securities 54,197 40,794
Debentures, net of discount of $5,901 and $6,449 12,099 11,551
Loans 4,045 4,045
Accumulated share of losses (49,001) (33,842)
---------------- -------------
21,340 22,548
--------------- -------------
Investments carried as "available for sale":
Cost 37,736 37,736
Net unrealized holding losses (34,282) (32,757)
----------------- ---------------
3,454 4,979
--------------- -------------
Other investments, at cost 5,000 5,000
--------------- -------------
29,794 32,527
--------------- -------------
$ 308,277 $ 307,718
=============== =============
INVESTMENTS IN DOMESTIC CELLULAR ENTITIES
In March 1998, the Company entered into an agreement to sell for $160
million in cash its Myrtle Beach, SC RSA market and related operations. This
transaction is expected to close in the third quarter of 1998. Additionally, the
Company is pursuing various alternatives for divesting of its Florida
metro-cluster and other non-core cellular properties in which it owns minority
interests.
The Company holds a 50% investment in a joint venture known as Eastern
North Carolina Cellular Joint Venture ("ENCCJV"), 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. In February 1998, the Company entered into an agreement to
sell for $30 million in cash its ownership interest in the ENCCJV. This
transaction is expected to close in the third quarter of 1998.
I-5
The Company also explores, on an ongoing basis, possible acquisitions of
companies that will facilitate new service offerings to its customers, such as
paging and Internet access. The Company entered into an agreement in December,
1997 to purchase NationPage, a leading regional paging provider in Pennsylvania
and New York, for approximately $28.5 million in cash.
In the first quarter of 1998, the Company participated in the FCC's Local
Multipoint Distribution Service ("LMDS") auction, which concluded on March 25,
1998. The Company was the high bidder for 22 LMDS Basic Trading Area ("BTA")
licenses, with an aggregate bid of $8.9 million. As of March 31, 1998, the
Company had $5.3 million on deposit with the FCC, and anticipates that in June
or July 1998, the FCC will call for payment of the remaining $3.6 million and
will issue the licenses.
LMDS frequencies may be used for a variety of technologies, including
traditional wireless telephony, competitive local exchange service, broadband
data transmissions, including Internet, video and others. The Company is
studying these applications and presently plans to focus primarily on
traditional wireless telephony and broadband data transmission. There is no
assurance that these are the applications the Company will implement, or when it
will implement these or other applications.
NONCELLULAR INVESTMENTS
INTERNATIONAL WIRELESS COMMUNICATIONS HOLDINGS, INC. AND FOREIGN INVESTMENTS
At March 31, 1998, the Company owned approximately 29% of the outstanding
stock of International Wireless Communications Holdings, Inc. ("IWC") and has
invested an aggregate of $25.5 million. IWC is a development stage company
specializing in securing, building and operating wireless businesses, primarily
in Asia and Latin America. 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 suspended the recognition of
losses attributable to IWC until such time that the equity method income became
available to offset the Company's share of IWC's future losses or the Company
makes further investments in IWC. In March 1998, the Company invested an
additional $10.3 million in IWC. Accordingly, during the first quarter of 1998
the Company recognized losses equal to the amount of this additional investment.
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, which are subject to the satisfaction of certain conditions, for
an aggregate cash consideration of $8.4 million. Through March 31, 1998, the
Company has funded $5.1 million of
I-6
the $8.4 million share purchase price and invested an additional $1.5 million,
including payment of a $700,000 capital call in the first quarter of 1998. IWC
acquired and maintains a 40% ownership interest in SDL. The Company accounts
for its investment using the equity method of accounting. In addition, the
Company has guaranteed obligations of SDL totaling $14.1 million, which includes
guarantees of $7.2 million on behalf of IWC. If the Company must eventually fund
these guarantees, the funding will be in the form of loans to SDL.
During 1997, the Company acquired a 12% equity interest in International
Wireless Communications Pakistan Ltd. ("IWCPL") for $7.0 million which has
subsequently been reduced to approximately 10%. Additionally, IWC's 100% owned
subsidiary, Pakistan Wireless Holdings, Inc. ("PWH"), owns a 34% equity interest
in IWCPL, thereby increasing the Company's total direct and indirect ownership
interest in IWCPL to approximately 20%. IWCPL owns approximately 59% of the
equity in Pakistan Mobile Communications (Pvt) Ltd., a Pakistan company that
owns and operates the cellular license in Pakistan. Through March 31, 1998, the
Company has invested $9.9 million in IWCPL, including $1.6 million invested
during the first quarter of 1998, and has provided $3.0 million in debt
financing. The Company records its proportionate share of the losses of IWCPL
under the equity method of accounting.
INTER*ACT SYSTEMS, INCORPORATED.
As of March 31, 1998, the Company had invested $10.0 million in Inter*Act
Systems, Inc. ("Inter*Act") common stock for an ownership interest of
approximately 26%. Inter*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*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. Effective September 30, 1997 and in accordance with the
warrant agreement, the shares of common stock eligible to be purchased with the
warrants held by the Company increased from 132,012 to 169,722. The shares
issuable upon the exercise of these warrants currently represent approximately
2% of Inter*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*Act.
Inter*Act has incurred net losses since its inception. Inter*Act received
approximately $91 million in net proceeds from the above financing which are
being used to accelerate the roll-out of its systems in retail supermarkets and,
as a result, the net losses incurred by Inter*Act are expected to grow
significantly in future years. The Company records its proportionate share of
I-7
these losses under the equity method of accounting. The Company's equity and
warrant investment was reduced to zero through the recognition of equity method
losses during 1997. However, the Company will continue to recognize equity
method losses related to its investment in bonds until such investment is
reduced to zero.
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*Act.
GEOTEK COMMUNICATIONS, INC.
In 1994, the Company purchased from Geotek Communications, Inc. ("Geotek")
2.5 million shares of Geotek common stock for $30 million. Geotek is a
telecommunications company that is developing a wireless communications network
using its FHMA (R) digital technology Under a management agreement, the Company
earned and recorded as revenue approximately 201,370 shares with an aggregate
value of $2.1 million in 1996, and approximately 300,000 shares with an
aggregate value of $2.4 million in 1995. The Company currently owns less than 5%
of Geotek's outstanding common stock.
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. During 1997,
the Geotek common stock price, as quoted on the NASDAQ National Market System,
declined from $7.13 per share at December 31, 1996 to $1.53 per share at
December 31, 1997. Based on Geotek's historical performance, including the
significant decline in the market value of Geotek's common stock, the Company's
management made the determination that the decline in Geotek's common stock
price during 1997 was other than temporary and, accordingly, recognized an
unrealized holding loss of $32.7 million in the fourth quarter of 1997 to adjust
the Company's investment in Geotek common stock to its market value at December
31, 1997. During the first quarter of 1998, Geotek common stock price declined
to $1.02 per share. Management assessed the decline to be temporary and recorded
an unrealized holding loss of $1.5 million as a component of comprehensive
income for the three months ended March 31, 1998. 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.
I-8
FINANCIAL INFORMATION OF EQUITY METHOD INVESTEES
Combined financial position and operating results of the Company's equity
method investees, ENCCJV, IWC, and Inter*Act, as well as certain significant
investees of IWC, for the first three months of 1998 and 1997 are as follows (in
thousands):
1998 1997
------------ ----------
Revenues. ................. $13, 319 $ 4,276
Gross profit .............. 2,342 408
Loss from operations. ..... (65,913) (15,786)
Net loss. ................. (91,101) (22,733)
- -------------------
Information for each investee is summarized from the available financial
information for each entity and is presented only for the periods in which the
Company maintained an investment.
I-9
NOTE 3 -- LONG-TERM FINANCING ARRANGEMENTS
In February 1998, the Company completed the closing of an amendment to the
1994 Credit Facility, increasing the facility to $1.0 billion pursuant to the
Third Amended and Restated Facility A Loan Agreement (Facility A Loan) and the
Facility B Loan Agreement (Facility B Loan) (collectively, the 1998 Loan
Agreements), with various lenders led by The Bank of New York , The
Toronto-Dominion Bank, and NationsBank of Texas, N.A. In addition, the Company
has $200 million of Senior Debentures due 2006. The credit facility is senior to
the Senior Debentures through the use of structured subordination whereby
Vanguard Cellular Systems, Inc. ("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 March 31, 1998 and December
31, 1997 (in thousands):
March 31, December 31,
1998 1997
------------- ------------
Debt of VCFC:
Borrowings under the 1998 Loan Agreements:
Facility A Loan ............................... $ 628,000 $ --
Facility B Loan................................ -- --
Borrowings under the 1994 Credit Facility:
Term Loan .................................... -- 325,000
Revolving Loan ............................... -- 244,000
Other Long-Term Debt ............................ -- 130
------------- ------------
628,000 569,130
Debt of Vanguard:
Senior Debentures due 2006, net of unamortized
discount of $159 and $163 .................... 199,841 199,837
------------- ------------
$ 827,841 $ 768,967
CREDIT FACILITY OF VCFC
The Facility A and Facility B Loans are 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 Facility A Loan
consists of a $750 million senior secured reducing revolving credit facility
which allows for the issuance of up to $25 million of standby letters of credit.
The Facility B Loan consists of a $250 million 364-day revolving credit facility
which may be extended for an additional 364-day period upon the approval of the
lenders or converted to a term loan according to the terms and subject to
certain conditions of the Facility B Loan Agreement.
Borrowings under the 1998 Loan Agreements 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 0.25% for the Prime Rate and 0.5%
to 1.5% for the Eurodollar Rate. Based on the leverage ratio, computed
I-10
as the ratio of Total Debt (as defined) to Adjusted Cash Flow (as defined), as
of March 31, 1998, the Company's applicable margins on borrowings under the 1998
Loan Agreements are 0.00% and 1.25% per annum for the first quarter of 1998 for
the Prime Rate and Eurodollar Rate, respectively. Upon the occurrence of an
event of default as defined in the 1998 Loan Agreements, the applicable margin
added to both the Eurodollar Rate and the Prime Rate becomes 2.0%.
Upon closing of the 1998 Loan Agreements, the Company paid fees of
approximately $4 million to the lenders. These fees and other costs incurred in
the refinancing have been recorded as a long-term asset in the first quarter of
1998 and will be amortized over the lives of the agreements. Remaining
unamortized deferred financing costs of $6.6 million related to the 1994 Credit
Facility have been expensed in the first quarter of 1998 and are reported on the
income statement as an extraordinary item. The extraordinary item recorded in
the first quarter of 1998, net of a related income tax benefit of $2.6 million,
totaled $4.0 million or 0.11 per share on a basic and diluted basis.
INTEREST RATE PROTECTION AGREEMENTS
The Company maintains interest rate swaps and interest rate caps which
provide protection against interest rate risk. At March 31, 1998 the Company had
interest rate cap agreements in place covering a notional amount of $500
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
- ----------------------------------------------------------
7.5% $50,000 February, 1999
7.5 50,000 February, 1999
8.0 25,000 August, 1999
9.5 100,000 October, 2002
9.5 100,000 October, 2002
8.5 100,000 November, 2002
7.5 75,000 November, 2002
-----------
$ 500,000
=======
The total cost of the interest rate cap agreements in place at March 31,
1998 of $1.6 million 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, at March 31, 1998 the Company maintains interest rate swap
agreements that fix the LIBOR interest rate at 6.10% on a notional amount of $50
million through October 2002 and at 5.62% on a notional amount of $100 million
through January 2003. 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.
I-11
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 Company's average effective interest rate under these agreements
during the first quarter of 1998 was 8.94%, or 0.44% below the coupon rate for
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 rate on the $25 million to 10%
for the first three years of the 9 year agreement. The Company's average
effective interest rate under those agreements during the first quarter of 1998
was 8.46%, which is 0.92% below the coupon rate for the Debentures.
The effect of interest rate protection agreements on the operating results
of the Company was to increase interest expense by $28,000 in the first quarter
of 1998 and decrease interest expense by $42,000 in the same period last year.
NOTE 4 -- CAPITAL STOCK AND COMPREHENSIVE INCOME
Through February 1998, the Company's Board of Directors authorized the
repurchase of up to 7,500,000 shares of its Class A Common Stock from time to
time in open market or other transactions. As of December 31, 1997, the Company
had repurchased 3,065,000 shares of its Class A Common Stock at an average price
of approximately $13.00 per share. As of March 31, 1998, the Company had
repurchased an additional 1,080,000 shares at an average price of approximately
$17.00 per share. In June 1997, the Financial Accounting Standards Board issued
SFAS No. 130 "Reporting Comprehensive Income." SFAS No. 130 establishes
standards for reporting and display of comprehensive income and its components
in a full set of general-purpose financial statements. The Company adopted SFAS
No. 130 on January 1, 1998. For the three months ended March 31, 1998 and 1997,
total comprehensive loss of the Company was $22.3 million and $21.3 million,
respectively.
I-12
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 March 31,
1998 and 1997. This table does not include any ownership interests that were
contracted for these at dates.
MARCH 31,
---------------------------
CELLULAR MARKETS 1998 1997
- ---------------- ---- ----
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
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 100.0 100.0
Ross, OH (OH-9 RSA) 100.0 100.0
Perry, OH (OH-10 South RSA) 100.0 100.0
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
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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.
THREE MONTHS ENDED MARCH 31, 1998 AND 1997
Service revenue in the first quarter of 1998 rose 20% to $90.0 million from
$75.1 million in the first quarter of 1997. This increase was primarily the
result of a 127,000 or 24% increase in the number of subscribers in
majority-owned markets to approximately 667,000 at the end of the first quarter
of 1998, as compared to approximately 540,000 in the same period in 1997.
Penetration, computed as a percentage of the Company's subscribers to total POPs
in majority owned cellular markets, increased to 8.8% in the first quarter of
1998 from 7.1 % 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. Churn, the monthly rate of customer deactivations
expressed as a percentage of the subscriber base, decreased to 1.8% in the first
quarter of 1998 from 2.1% in the first quarter of 1997.
Service revenue attributable to the Company's own subscribers (local
revenue) increased 20% during the first quarter of 1998 to $78.7 million as
compared to $65.7 million in the first quarter of 1997. Average monthly local
revenue per subscriber declined 4% to $40 in the first quarter of 1998 compared
to $42 in the same period last 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
21% to $11.3 million in the first quarter of 1998 as compared to $9.4 million in
the prior year. This increase was the result of increased usage partially offset
by continued reductions in daily access and usage rates. The reduced rates
affect the Company as both a provider and a purchaser of roaming services. Local
revenue combined with roaming revenue resulted in overall average monthly
revenue per subscriber for the quarter of $46, a decline of 4% from $48 in the
prior year period.
Cost of service as a percentage of service revenue decreased to 8% during
the first quarter of 1998 from 10% during the same period in 1997. The Company
expects cost of service as a percentage of service revenue to remain in the 8%
to 10% range in the foreseeable future.
General and administrative expenses increased 18% or $4.1 million during
the first quarter of 1998 as compared to the same period in 1997 primarily as a
result of increased costs associated with higher levels of staffing in the
customer operations and technical service areas. General and administrative
expenses as a percentage of service revenue decreased slightly from 31% in the
first quarter of 1997 to 30% in the first quarter of 1998. General and
administrative expenses as a
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percentage of service revenue are expected to stabilize and then 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 29% to $18.7 million during the
first quarter of 1998, compared to $14.5 million in the same period in 1997 as a
result of increased advertising expense connected with the rollout of the
digital product in a significant portion of markets. As a percentage of service
revenue, these expenses increased from 19% in the first quarter of 1997 to 21%
in the first quarter of 1998. During the first quarter of 1998, marketing and
selling expenses including the net loss on cellular equipment ("Combined
Marketing and Selling Expenses") increased to $21.7 million from $18.4 million
in the first quarter of 1997. Combined Marketing and Selling Expenses per gross
subscriber addition increased to $383 in the first quarter of 1998 from $312 in
the same period last year.
Depreciation and amortization expense increased $6.9 million or 46% during
the first quarter of 1998 as compared to the same period in 1997. Property and
equipment placed in service since April 1, 1997 of approximately $117.7 million
accounted for much of this increase. Also contributing to the increase is the
Company's decision to change the depreciable lives of its rental phone assets
from 3 years to 1.5 years, which better reflects the useful life of this
equipment. In the first quarter of 1998, this change increased depreciation
expense by approximately $2.1 million, and will increase depreciation expense by
approximately $2.2 million in each of the remaining quarters in 1998.
Interest expense increased $3.3 million or 26% during the first quarter of
1998. This increase primarily resulted from an increase in average borrowings of
approximately $147.7 million, and to a lesser extent, an increase in the
interest rates charged.
Net losses from unconsolidated investments increased by $12.2 million with
$10.0 million of this increase resulting from an additional equity investment
the Company made in IWC in the first quarter of 1998. The remaining increase
resulted primarily from higher operating, amortization and interest expenses
incurred by Inter*Act Systems, Incorporated ("Inter*Act"). The Company continues
to recognize its share of the income and losses of its equity method investments
in Inter*Act and the Company's other equity method investees. See "Liquidity and
Capital Resources."
The Company recognized deferred income tax assets of $4.1 million and $4.0
million in the first quarter of 1998 and 1997, respectively. The Company has
entered into agreements to sell its Myrtle Beach, SC RSA market as well as its
interest in the Eastern North Carolina Cellular Joint Venture ("ENCCJV"). See
"Liquidity and Capital Resources". These sales transactions are expected to
generate substantial capital gains which will utilize an equivalent amount of
the Company's accumulated NOL's. Based on these anticipated gains, management
has assessed that it is more likely than not that a significant portion of the
Company's deferred income taxes are realizable, and, accordingly, the Company
has recognized a total of $56.7 million of net deferred income tax assets as of
March 31, 1998. See "Liquidity and Capital Resources -- Income Taxes."
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In the first quarter of 1998, the Company reported a net loss before
extraordinary item of $16.8 million or $0.44 per share as compared to net income
of $288,000 or $0.01 per share in the first quarter of 1997. This $17.0 million
decline in net income before extraordinary item is primarily attributable to
increases in losses from unconsolidated investments, depreciation expense, and
interest expense as discussed above.
In February 1998, the Company completed the closing of a $1 billion credit
facility which refinanced its existing $675 million facility. In connection with
this refinancing, the Company recorded an extraordinary loss of $4.0 million
($0.11 per basic and diluted common share) net of a $2.6 million tax benefit,
which represented the write-off of all unamortized deferred financing costs
related to the refinanced facility.
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. During the three months ended March 31, 1998 the
Company incurred approximately $29.0 million in capital expenditures as compared
to $34.4 million in the same period last year.
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, and although the Company anticipates that in 1999
EBITDA will be sufficient to cover property and equipment and debt service
requirements, the Company does not expect EBITDA to grow sufficiently to meet
both its property and equipment and debt service requirements during 1998. The
Company will rely on borrowings under its existing credit facility to meet any
short-falls. In the first quarter of 1998, the Company entered into agreements
to sell its Myrtle Beach, SC RSA market for approximately $160 million in cash
and its interest in the ENCCJV for approximately $30 million in cash. Both
transactions, which are subject to adjustment and are expected to close in the
third quarter of 1998, are subject to approval by regulatory authorities,
including the FCC. The Company is also pursuing opportunities to sell its
Pensacola and Fort Walton Beach, FL markets as well as minority interests in
other non-core cellular properties. The proceeds from these sales will be used
to pay down the Company's existing debt.
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
I-16
operating results and cash flows. EBITDA increased to $33.8 million in the first
quarter of 1998 from $26.0 million in the 1997 period and net cash provided by
operating activities as shown on the Statement of Cash Flows increased to $15.4
million in the first quarter of 1998 from $10.8 million in the 1997 period. Net
cash provided by operating activities in the first three months of 1998 reflects
a $3.3 million increase in interest expense and an increase in working capital
items of $74,000. Investing activities, primarily purchases of property and
equipment and acquisitions of investments, used net cash of $47.1 million and
$34.4 million in the first quarters of 1998 and 1997, respectively. Financing
activities provided net cash of $36.2 million and $16.1 million in the first
quarters of 1998 and 1997, respectively.
FINANCING AGREEMENTS. At December 31, 1997 the Company's long-term debt
consisted primarily of a $675 million credit facility (the "Credit Facility")
and $200 million of 9 3/8% Senior Debentures due 2006 (the "Debentures"). In
February 1998, the Company completed the closing of an amendment to the Credit
Facility, increasing the facility to $1.0 billion pursuant to the Third Amended
and Restated Facility A Loan Agreement (Facility A Loan) and the Facility B Loan
Agreement (Facility B Loan) (collectively, the 1998 Loan Agreements) with
various lenders led by The Bank of New York, The Toronto-Dominion Bank, and
NationsBank of Texas, N.A.
The Facility A and Facility B Loans are available to provide the Company
with additional financial and operating flexibility and to enable it to pursue
business opportunities that may arise in the future. The Facility A Loan,
consists of a $750 million senior secured reducing revolving credit facility
which allows for the issuance of up to $25 million of standby letters of credit.
The Facility B Loan consists of a $250 million 364-day revolving credit facility
which may be extended for an additional 364-day period upon the approval of the
lenders or converted to a term loan according to the terms and subject to
certain conditions of the Facility B Loan Agreement.
Borrowings under the 1998 Loan Agreements 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 0.25% for the Prime Rate and 0.5%
to 1.5% for the Eurodollar Rate. Based upon the leverage ratio, the applicable
margins for the first quarter of 1998 are 0.00% and 1.25% for the Prime Rate and
Eurodollar Rate, respectively.
The outstanding amount of the Facility A Loan as of September 30, 2000 is
to be repaid in increasing quarterly installments commencing on September 30,
2000 and terminating at the maturity date of December 31, 2005. The quarterly
installment payments begin at 2.5% of the outstanding principal amount at
September 30, 2000 and gradually increase to 6.875% of the outstanding principal
amount. The maturity date for borrowings under the Facility B Loan is February
18, 1999. However, at the Borrower's request and the Lenders' approval, as set
forth in the Facility B Loan Agreement, the maturity date of the Facility B Loan
may be extended to February 16, 2000. Under the terms and subject to certain
conditions of the Facility B Loan Agreement, the Company has the option to
convert the borrowings outstanding under the Facility B Loan as of the Facility
B maturity date to a term loan maturing on December 31, 2005. Upon
I-17
conversion to a term loan, the principal balance of the Facility B Loan
outstanding on September 30, 2000 shall be repaid in quarterly installments
commencing on September 30, 2000 and terminating at the maturity date of
December 31, 2005. The quarterly repayments begin at 2.5% of the outstanding
principal amount at September 30, 2000 and gradually increase to 6.875% of the
outstanding principal amount.
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 1998 Loan Agreements limit the payment of
cash dividends, limit the use of borrowings and the creation of additional
long-term indebtedness and require the maintenance of certain financial ratios.
The provisions of the 1998 Loan Agreements were established in relation to the
Company's projected capital needs, projected results of operations and cash
flow. These provisions 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 1998 Loan Agreements
and the Indenture.
Borrowings under the 1998 Loan Agreements are secured by the stock of
Vanguard Cellular Financial Corp. and Vanguard Cellular Operating Corp., direct
or indirect wholly owned subsidiaries of the Company. The Debentures are
unsecured obligations of the Company.
INVESTMENTS IN CELLULAR ENTITIES. 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. The Company also explores possible acquisitions of companies that
will facilitate new service offerings to its customer base, such as paging and
Internet access.
The Company has entered into an agreement to purchase NationPage, a leading
regional paging provider in Pennsylvania and New York, for approximately $28.5
million. The NationPage acquisition will minimize future paging service capacity
constraints and will be financed through borrowings under the 1998 Loan
Agreements.
In the first quarter of 1998, the Company participated in the FCC's Local
Multipoint Distribution Service ("LMDS") auction, which concluded on March 25,
1998. The Company was
I-18
the high bidder for 22 LMDS Basic Trading Area ("BTA") licenses, with an
aggregate bid of $8.9 million. As of March 31, 1998, the Company had $5.3
million on deposit with the FCC, and anticipates that in June or July 1998, the
FCC will call for payment of the remaining $3.6 million and will issue the
licenses.
LMDS frequencies may be used for a variety of technologies, including
traditional wireless telephony, competitive local exchange service, broadband
data transmissions, including Internet, video and others. The Company is
studying these applications and presently plans to focus primarily on
traditional wireless telephony and broadband data transmission. There is no
assurance that these are the applications the Company will implement, or when it
will implement these or other applications.
OTHER INVESTMENTS. At March 31, 1998, the Company owned approximately 29%
of the outstanding stock of IWC and has invested an aggregate of $25.5 million.
IWC is a development stage company specializing in securing, building and
operating wireless businesses, primarily in Asia and Latin America. 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 suspended the recognition of losses attributable to IWC
until such time that the equity method income became available to offset the
Company's share of IWC's future losses or the Company makes further investments
in IWC. In March 1998, the Company invested an additional $10.3 million in IWC.
Accordingly, during the first quarter of 1998 the Company recognized losses
equal to the amount of this additional investment.
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, which are subject to the satisfaction of certain conditions, for
an aggregate cash consideration of $8.4 million. Through March 31, 1998, the
Company has funded $5.1 million of the $8.4 million share purchase price and
invested an additional $1.5 million, including payment of a $700,000 capital
call in the first quarter of 1998. IWC acquired and maintains a 40% ownership
interest in SDL. The Company accounts for its investment using the equity method
of accounting. In addition, the Company has guaranteed obligations of SDL
totaling $14.1 million, which includes guarantees of $7.2 million on behalf of
IWC. If the Company must eventually fund these guarantees, the funding will be
in the form of loans to SDL.
During 1997, the Company acquired a 12% equity interest in International
Wireless Communications Pakistan Ltd. ("IWCPL") for $7.0 million which has
subsequently been reduced to approximately 10%. Additionally, IWC's 100% owned
subsidiary, Pakistan Wireless Holdings, Inc. ("PWH"), owns a 34% equity interest
in IWCPL, thereby increasing the Company's total direct and
I-19
indirect ownership interest in IWCPL to approximately 20%. IWCPL owns
approximately 59% of the equity in Pakistan Mobile Communications (Pvt) Ltd., a
Pakistan company that owns and operates the cellular license in Pakistan.
Through March 31, 1998, the Company has invested $9.9 million in IWCPL including
$1.6 million invested during the first quarter of 1998 and has provided $3.0
million in debt financing. The Company records its proportionate share of the
losses of IWCPL under the equity method of accounting.
As of March 31, 1998, the Company had invested $10.0 million in Inter*Act
common stock for an ownership interest of approximately 26%. Inter*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*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 (subsequently increased
to 169,722) 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*Act's
outstanding common stock. In addition, under a stock warrant agreement, 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*Act.
Inter*Act has incurred net losses since its inception. Inter*Act received
approximately $91 million in net proceeds from the above financing which are
being used to accelerate the roll-out of its systems in retail supermarkets and,
as a result, the net losses incurred by Inter*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's equity and
warrant investment was reduced to zero through the recognition of equity method
losses during 1997. However, Vanguard will continue to recognize equity method
losses related to its investment in bonds until such investment is reduced to
zero.
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*Act.
In 1994, the Company purchased from Geotek Communications, Inc. ("Geotek")
2.5 million shares of Geotek common stock for $30 million. Geotek is a
telecommunications Company that is developing a wireless communications network
using its FHMA (R) digital technology Under a management agreement, the Company
earned and recorded as revenue approximately 201,370 shares with an aggregate
value of $2.1 million in 1996, and approximately 300,000 shares with an
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aggregate value of $2.4 million in 1995. 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.
The Company currently owns less than 5% of Geotek's outstanding common stock.
CAPITAL EXPENDITURES. As of March 31, 1998, the Company had $504.0 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 it
has done over the past few years. During 1998, the Company plans to continue
this accelerated buildout. Capital expenditures for 1998 are estimated to be
approximately $105 to $110 million and are expected to be funded primarily
through internally generated funds and borrowing under the 1998 Loan Agreements.
Approximately $75.0 million of those capital expenditures will be for cellular
and paging network equipment, and the remainder will be primarily for rental
telephones and computer equipment. During the first quarter of 1998, the Company
incurred approximately $29.0 million in capital expenditures.
STOCK REPURCHASES. Through February 1998, the Company's Board of Directors
authorized the repurchase of up to 7,500,000 shares of its Class A Common Stock
from time to time in open market or other transactions. As of December 31, 1997,
the Company had repurchased 3,065,000 shares of its Class A Common Stock at an
average price of approximately $13.00 per share. As of March 31, 1998, the
Company had repurchased an additional 1,080,000 shares at an average price of
approximately $17.00 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 tax benefits 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 tax benefits.
Historically, the Company's strategy has been to enhance shareholder value
by investing in growth initiatives. These efforts have resulted in steadily
increasing levels of subscribers, revenues
I-21
and EBITDA; however, these initiatives in the form of market acquisitions,
capital expenditures, and expansion of the Company's sales and marketing and
customer service functions have resulted in significant interest, depreciation,
amortization and marketing costs. In addition, the Company has explored
strategic investment opportunities in international telecommunications ventures
and alternative lines of business, all of which are in the early development
stages and are generating significant losses to the Company. As a result,
although the Company achieved profitability in 1996 for financial reporting
purposes, the continued costs of its investment strategy prevented the Company
from generating profitable financial results in 1997.
During the fourth quarter of 1997, management revised its strategy from one
of growth and expansion to enhancing shareholder value through profitable
operations in its core cellular properties in Pennsylvania, West Virginia and
New England. This revised strategy incorporates dispositions of noncore cellular
and noncellular properties over the course of the next several years. As part of
this Board-approved strategy, in the first quarter of 1998, the Company entered
into agreements to dispose of its cellular properties in the Carolinas
Metrocluster, which include the Myrtle Beach RSA and ownership interests in the
ENCCJV. Additionally, the Company has begun active efforts to dispose of its
operations in Western Florida and anticipates reaching an agreement with a
potential buyer during 1998. Based on negotiated sales prices for the Myrtle
Beach cellular market and its ownership interests in ENCCJV, the Company expects
to generate capital gains approximating $140 million in 1998. Additionally, the
Company's anticipated sales price, based on recent transactions in the cellular
industry and the two transactions discussed above, for the disposition of its
Western Florida markets is expected to generate a substantial capital gain.
The gains to be generated on these transactions will utilize an equivalent
amount of the Company's accumulated NOLs. Based on these anticipated gains,
management has assessed that it is more likely than not that a significant
portion of the Company's deferred income tax assets are realizable. Accordingly,
the Company has recognized a total of $56.7 million of net deferred income tax
assets as of March 31, 1998. Of the amount recognized, $4.1 million was
recognized as a deferred income tax benefit in the first quarter of 1998, $42.7
million was recognized as a deferred income tax benefit in 1997, $5.0 million
was recognized as a deferred income tax benefit in 1996 and $4.9 million related
to acquired NOLs was recognized through a reduction in investments in domestic
cellular entities in 1997.
A valuation allowance of $36.5 million remains on certain deferred income
tax assets due to uncertainties as to when and whether these assets will be
realized in the future. To the extent that the income tax benefit of these
amounts is realized in future years, a significant portion of the benefit will
be recorded as a direct addition to shareholders' equity as these assets relate
to additional income tax deductions arising from restricted stock bonuses, stock
options and stock purchase warrants.
The transactions discussed above which will create the taxable income upon
which management based its deferred income tax asset recognition decisions have
been approved by the Company's Board of Directors and are represented by
definitive agreements among the parties to the
I-22
transactions; however, ultimate consummation of these transactions is dependent
on the parties reaching final agreement on terms and financing and the Company
obtaining standard regulatory approvals. There can be no assurance that these
transactions will be consummated.
For Federal income tax reporting purposes, the Company had net operating
loss carryforwards of approximately $323 million at December 31, 1997. These
losses may be used to reduce future taxable income, if any, and expire through
2012. 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 1998 Loan Agreements 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.
THE YEAR 2000 ISSUES
Many existing computer programs use only two digits to identify a year in
the date field. These programs were designed and developed without considering
the impact of the upcoming change in the century. If not corrected, many
computer applications could fail or create erroneous results by or at the Year
2000. The Year 2000 issue affects virtually all companies and organizations.
The Company has begun efforts to assess its Year 2000 compliance issues.
The assessment is expected to be completed and a detailed plan for addressing
Year 2000 issues finalized in the second quarter of 1998. Until the assessment
is completed, management is unable to determine the magnitude of effort and cost
that will be required to bring the Company's computer systems into compliance.
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
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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) 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; and (vi) greater than
anticipated losses attributable to its equity interests in other companies.
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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: May 4, 1998 By: /s/ Stephen R. Leeolou
------------------------------------
Stephen R. Leeolou
President and
Co-Chief Executive Officer
Date: May 4, 1998 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(b)(8) Third Amended and Restated Facility A Loan Agreement between
Vanguard Cellular Financial Corp. and various lenders led by
the Bank of New York, and The Toronto-Dominion Bank, and
NationsBank of Texas, N.A. as agents, dated February 20, 1998.
4(b)(9) Facility B Loan Agreement between Vanguard Cellular Financial
Corp. and various lenders led by The Bank of New York, and The
Toronto-Dominion Bank, and NationsBank of Texas, N.A. as
agents, dated February 20, 1998.
4(b)(10) Borrower Pledge Agreement between Vanguard Cellular Financial
Corp. and Toronto-Dominion (Texas), Inc. as collateral agent,
dated February 20, 1998.
4(b)(11) VCOC Guaranty between Vanguard Cellular Operating Corp. and
various lenders led by The Bank of New York, and The
Toronto-Dominion Bank, and NationsBank of Texas, N.A. as
Secured Parties, dated February 20, 1998.
4(b)(12) Vanguard Guaranty between Vanguard Cellular Operating Corp.
and various lenders led by the Bank of New York, and the
Toronto-Dominion Bank, and NationsBank of Texas, N.A. as
Secured Parties, dated February 20, 1998.
4(b)(13) Vanguard Pledge Agreement between Registrant and
Toronto-Dominion (Texas), Inc. as collateral agent, dated
February 20, 1998.
* 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 ended March 31, 1998 and 1997.
27 Financial Data Schedule.
- -----------------------
* Incorporated by reference to the statement or report indicated.
The following exhibits and schedules to the Third Amended and Restated
Facility A Loan Agreement filed as Exhibit 4(b)(8) hereto, have been omitted.
The Registrant hereby undertakes to furnish supplementally a copy of any such
omitted exhibit or schedule to the Commission upon request.
Exhibit A Form of Borrower Pledge Agreement
Exhibit B Form of Certificate of Financial Condition
Exhibit C-1 Form of Facility A Note
Exhibit C-2 Form of Swing Line Note
Exhibit D Form of Request for Advance
Exhibit E Form of VCOC Guaranty
Exhibit F Form of Vanguard Guaranty
Exhibit G Form of Vanguard Pledge Agreement
Exhibit H-1 Form of Borrower's Loan Certificate
Exhibit H-2 Form of Subsidiary Loan Certificate
Exhibit H-3 Form of Vanguard Loan Certificate
Exhibit I Form of Performance Certificate
Exhibit J Form of Assignment and Assumption Agreement
Exhibit K Form of Request for Issuance of Letter of Credit
Exhibit L Form of Request for Swing Line Advance
Schedule 1 Commitment Ratios
Schedule 2 Licenses
Schedule 3 Liens of Record as of the Agreement Date
Schedule 4 Subsidiaries
Schedule 5 Litigation
Schedule 6 Agreements with Affiliates
Schedule 7 Investments
The following exhibits and schedules to the Facility B Loan Agreement filed
as Exhibit 4(b)(9) hereto, have been omitted. The Registrant hereby undertakes
to furnish supplementally a copy of any such omitted exhibit or schedule to the
Commission upon request.
Exhibit A Form of Borrower Pledge Agreement
Exhibit B Form of Certificate of Financial Condition
Exhibit C Form of Facility B Note
Exhibit D Form of Request for Advance
Exhibit E Form of VCOC Guaranty
Exhibit F Form of Vanguard Guaranty
Exhibit G Form of Vanguard Pledge Agreement
Exhibit H-1 Form of Borrower's Loan Certificate
Exhibit H-2 Form of Subsidiary Loan Certificate
Exhibit H-3 Form of Vanguard Loan Certificate
Exhibit I Form of Performance Certificate
Exhibit J Form of Assignment and Assumption Agreement
Exhibit K Form of Term Conversion Notice
Exhibit L Form of Request for Extension
Schedule 1 Commitment Ratios
Schedule 2 Licenses
Schedule 3 Liens of Record as of the Agreement Date
Schedule 4 Subsidiaries
Schedule 5 Litigation
Schedule 6 Agreements with Affiliates
Schedule 7 Investments