================================================================================
FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003 Commission file number 1-106
----------------- -----
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
----------------------- -----------
LYNCH INTERACTIVE CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 06-1458056
-------- ----------
State of other jurisdiction (I.R.S. Employer
incorporation or organization Identification No.)
401 Theodore Fremd Avenue, Rye, NY 10580
---------------------------------- -----
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (914) 921-8821
--------------
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange
------------------- on which registered
-------------------
Common Stock, $.0001 American Stock Exchange
Securities registered pursuant to section 12(g) of the Act: None
----
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 Act of 1934 during the
preceding 12 months (or for such shorter period that the Registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes X No
Indicate by mark if disclosure of delinquent filers pursuant to Item 405 of
Regulations S-K is not contained herein, and will not be contained, to the best
of the Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K, or any amendment to
this Form 10-K. [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act) Yes
---
No X
----- -
The aggregate market value of voting stock held by non-affiliates of the
Registrant as of June 30, 2003 (based upon the closing price of the Registrant's
Common Stock on the American Stock Exchange of $24.01 per share) was $50.8
million. (In determining this figure, the Registrant has assumed that all of the
Registrant's directors and officers are affiliates. This assumption shall not be
deemed conclusive for any other purpose.)
The number of outstanding shares of the Registrant's Common Stock was 2,774,651
as of March 25, 2004.
================================================================================
DOCUMENTS INCORPORATED BY REFERENCE:
Part III: Certain portions of Registrant's Proxy Statement for the 2004 Annual
Meeting of Shareholders.
FORWARD LOOKING INFORMATION
- ---------------------------
This Form 10-K contains certain forward looking information, including without
limitation Item 1-I.A "Regulatory Environment" and possible changes thereto and
"Competition," Item 1.-I.B "Cable Television," Item 1-I.C "Personal
Communications and other Wireless Services," including without limitation the
risks described, "Impairment of Assets," and "Risk Management, Safety and
Insurance," Item 7. "Management's Discussion and Analysis of Financial Condition
and Results of Operations," including without limitation Liquidity and Capital
Resources, and Market Risk. It should be recognized that such information
contains estimates or forecasts based upon various assumptions, including the
matters, risks, and cautionary statements referred to therein, as well as
meeting the Registrant's internal performance assumptions regarding expected
operating performance and the expected performance of the economy and financial
markets as it impacts Registrant's businesses. As a result, such information is
subject to uncertainties, risks and inaccuracies, which could be material.
PART I
ITEM 1. BUSINESS
- ----------------
Lynch Interactive Corporation ("Interactive" or the "Company") was incorporated
in 1996 under the laws of the State of Delaware. On September 1, 1999,
Interactive was spun off by Lynch Corporation to its shareholders (the "Spin
Off") and became a public company. Prior to the Spin Off, Interactive had no
significant assets, liabilities or operations. As a successor to certain
businesses of Lynch Corporation, Interactive, at that time, became a diversified
holding company with subsidiaries primarily engaged in multimedia and
transportation services. In January 2002, Interactive spun off its interest in
The Morgan Group, Inc. ("Morgan"), its only services subsidiary, via a tax-free
dividend to its shareholders. Interactive's executive offices are located at 401
Theodore Fremd Avenue, Rye, New York 10580-1430. Its telephone number is
914-921-8821.
Interactive's business development strategy is to expand its existing operations
through internal growth and acquisitions. It may also, from time to time,
consider the acquisition of other assets or businesses that are not related to
its present businesses. The Company currently operates in one business segment,
multimedia, which consists of telecommunications, security, cable television and
broadcasting. As used herein, Interactive includes subsidiaries.
I. MULTIMEDIA OPERATIONS
- --------------------------
Wireline Telecommunications
- ---------------------------
Operations. Interactive conducts its telecommunications operations through
- -----------
subsidiary companies. The telecommunications group has been expanded through the
selective acquisition of local exchange telephone companies serving rural areas
and by offering additional services such as Internet service, alarm services,
long distance service and competitive local exchange carrier service. From 1989
through 2003, Interactive has acquired fourteen telephone companies, four of
which have indirect minority ownership of 2% to 19%, whose operations range in
size from approximately 800 to over 10,000 access lines. The Company's telephone
operations are located in Iowa, Kansas, Michigan, New Hampshire, New Mexico, New
York, North Dakota, Utah and Wisconsin. Our service areas are largely
residential and not densely populated. As of December 31, 2003, total access
lines were 53,145, 100% of which are served by digital switches.
In March 2004, the Company signed an agreement to acquire California-Oregon
Telecommunications Company ("Cal-Ore") located in Dorris, California. Cal-Ore's
subsidiary Cal-Ore Telephone Company is the incumbent service provider for a
rural area of about 850 square miles along the Northern California border with
Oregon with approximately 2,500 access lines. Cal-Ore's other businesses include
an Internet service provider, Competitive Local Exchange Carrier ("CLEC") that
is planning to provide services in the surrounding area and interests in certain
cellular partnerships. The acquisition price is $21.2 million, subject to
certain closing adjustments. The acquisition is subject to certain conditions
including the approval by the California Public Utilities Commission and other
regulatory authorities.
The principal business of Interactive's telephone companies is to provide
telecommunications services. These services fall into three major categories:
Local network services. We provide telephone wireline access services to
residential and non-residential customers in our service areas. We provide our
local network customers a number of calling features including call forwarding,
conference calling, caller identification, voicemail and call waiting. We offer
packages of telecommunications services.
-2-
These packages permit customers to bundle their basic telephone line with their
choice of enhanced services, or to customize a set of selected enhanced features
that fit their specific needs.
Network access services. We provide network access services to long distance
carriers and other carriers in connection with the use of our facilities to
originate and terminate interstate and intrastate telephone calls. Such services
are generally offered on a month-to-month basis and the service is billed on a
minutes-of-use basis. Access charges to long distance carriers and other
customers are based on access rates filed with the FCC for interstate services
and with the respective state regulatory agency for intrastate services.
Other Business. Interactive also provides non-regulated telephone-related
services, including Internet access service and long distance resale service in
certain of its telephone service (and adjacent) areas. Interactive also provides
and intends to provide more local telephone and other telecommunications service
outside certain of its franchise areas by establishing CLEC operations in
certain nearby areas. In selected areas, Interactive provides security
installation and monitoring services to homes and businesses and cable
television services ("CATV").
We expect future growth in telephone operations to be derived from the
acquisition of additional telephone companies, from providing service to new
customers or additional services to existing customers, from upgrading existing
customers to higher grades of service, and from new service offerings.
The following table summarizes certain information regarding Interactive's
multimedia operations:
Years Ended December 31,
2001 2002 2003
---------------------------------
Telecommunications operations
Access lines (a) ........................ 53,964 53,963 53,145
% Residential ......................... 74% 74% 73%
% Business ............................ 26% 26% 27%
Internet subscribers .................... 22,373 21,395 19,640
Security customers ...................... 5,597 6,500 6,712
Cable subscribers ....................... 2,934 2,831 2,731
Total Multimedia Revenues
Telephone operations
Local service .......................... 14% 15% 14%
Network access ......................... 58% 59% 60%
------ ------ ------
Total telephone operations ........... 72% 74% 74%
------ ------ ------
Other businesses ........................ 28% 26% 26%
------ ------ ------
Total multimedia revenues ............ 100% 100% 100%
====== ====== ======
(a) An "access line" is a telecommunications circuit between the customer's
establishment and the central switching
office.
(b) Other Businesses includes Internet, security, PCS, CLEC, CATV and other
non-regulated revenues.
Telephone Acquisitions. Interactive pursues an active program of acquiring
- ------------------------
operating telephone companies. From January 1, 1989 through December 31, 2003,
Interactive acquired fourteen telephone companies serving a total of
approximately 45,600 access lines, at the time of these acquisitions, for an
aggregate consideration totaling approximately $153.6 million. Such acquisitions
are summarized in the following table:
Number of Number of
Access Access
Year of Lines Lines Ownership
Acquisition Yr. of Acq. 12/31/03 Percentage
----------------------------------------------------------
Western New Mexico Telephone Co. ....... 1989 4,200 6,974 83.1
Inter-Community Telephone Co. .......... 1991 2,550(a) 2,746 100.0
Cuba City Telephone Co. &
Belmont Telephone Co. ................ 1991 2,200 2,699 81.0
Bretton Woods Telephone Co. ............ 1993 250 855 100.0
JBN Telephone Co. ...................... 1993 2,300(b) 2,697 98.0
Haviland Telephone Co. ................. 1994 3,800 3,815 100.0
Dunkirk & Fredonia Telephone Co. .......
& Cassadaga Telephone Co. ............ 1996 11,100 12,412 100.0
-3-
Number of Number of
Access Access
Year of Lines Lines Ownership
Continued Acquisition Yr. of Acq. 12/31/03 Percentage
---------------------------------------------------------
Upper Peninsula Telephone Co. .......... 1997 6,200 7,252 100.0
Central Scott Telephone Co. ............ 1999 6,000 6,209 100.0
Central Utah Telephone Co./Skyline
Telephone Company/Bear Lake
Telephone Company .................... 2001 7,000 7,486 100.0
(a) Includes 1,350 access lines acquired in 1996.
(b) Includes 354 access lines acquired in 1996.
Interactive continually evaluates acquisition opportunities targeting domestic
rural telephone companies with a strong market position, good growth potential
and predictable cash flow. In addition, Interactive generally seeks companies
with excellent local management already in place who will remain active with
their company. Recently, certain large telephone companies have offered certain
of their rural telephone exchanges for sale, often on a statewide or larger area
basis. Interactive has and in the future may, bid on such groups of exchanges.
Telephone holding companies and others actively compete for the acquisition of
telephone companies and such acquisitions are subject to the consent or approval
of regulatory agencies in most states. While management believes it will be
successful in making additional acquisitions, any acquisition program is subject
to various risks, including being able to find and complete acquisitions at an
attractive price and being able to integrate and operate successfully any
acquisition made.
Related Services and Investments. Affiliates of twelve of Interactive's
- -----------------------------------
telephone companies now offer Internet access service. At December 31, 2003,
Internet access customers totaled 19,184 compared to 20,939 at December 31,
2002. Affiliates of four of Interactive's telephone companies now offer long
distance service, and affiliates of two of Interactive's telephone companies now
offers CLEC services.
An affiliate of Dunkirk & Fredonia Telephone Company ("DFT") provides CLEC
service on a resale basis in neighboring Dunkirk, New York, certain areas of the
Buffalo, New York, and two other western New York counties. Some of DFT's CLEC
services are now being provided via an "unbundled network elements platform", or
UNEP, which allows for increased margins over a resale CLEC business model. In
addition, facilities-based services are continuing to be evaluated for DFT's
CLEC business. Giant Communications also provides CLEC services to selected
areas in Northeast Kansas.
Giant Communications (formerly CLR Video, L.L.C.), a 98% owned subsidiary of
Interactive, is a provider of cable television in northeast Kansas with
approximately 2,600 subscribers.
DFT Security Systems, Inc. (which is 63.6% owned by Interactive), another
affiliate of DFT, acquired American Alarm Company in December 2001. DFT Security
Systems provides alarm services to western New York, including the Buffalo area,
and now serves 6,712 alarm customers.
Affiliates of Inter-Community Telephone Company in North Dakota, and Western New
Mexico Telephone Company in New Mexico have filed with the state regulatory
commissions to provide CLEC services in those states. Final plans to offer CLEC
service in areas adjacent to Interactive's telephone operations in those states
have not been completed.
There is no assurance that Interactive can successfully develop these businesses
or that these new or expanded businesses can be made profitable within a
reasonable period of time. Such businesses, in particular any CLEC business,
would be expected to operate at losses initially and for a period of time.
Regulatory Environment. Operating telephone companies are regulated by state
- ------------------------
regulatory agencies with respect to intrastate telecommunications services and
the Federal Communications Commission ("FCC") with respect to interstate
telecommunications services.
Telecommunications Act of 1996. In recent years, various aspects of federal and
state telephone regulation have been subject to re-examination and on-going
modification. In February 1996, the Telecommunications Act of 1996 (the "1996
Act"), which is the most substantial revision of communications regulations
since the 1930's, became law. The 1996 Act is intended generally to allow
telephone, cable, broadcast and other telecommunications providers to compete in
each other's businesses, while loosening regulation of those businesses. Among
other things, the 1996 Act (i) allows major long distance telephone companies
and cable television companies to provide local exchange telephone service; (ii)
allows new local telephone service providers to connect into existing local
telephone exchange networks and purchase services at wholesale rates for resale;
(iii) provides for a commitment to universal service for high-cost, rural
-4-
areas and authorizes state regulatory commissions to consider their status on
certain competition issues; (iv) allows the Regional Bell Operating Companies to
offer long distance telephone service and enter the alarm services and
electronic publishing businesses; (v) removes rate regulation over non-basic
cable service; and (vi) increases the number of television stations that can be
owned by one party. The 1996 Act had dual goals of fostering local and
intrastate competition while ensuring universal service to rural America.
National Exchange Carrier Association. For interstate services, Interactive's
telephone subsidiaries participate in the National Exchange Carrier Association
("NECA") common line and traffic sensitive tariffs and access revenue pools.
Where applicable, Interactive's subsidiaries also participate in similar pooling
arrangements approved by state regulatory authorities for intrastate services.
Such interstate and intrastate arrangements are intended to compensate local
exchange carriers ("LECs"), such as Interactive's operating telephone companies,
for the costs, including a fair rate-of-return, of facilities furnished in
originating and terminating interstate and intrastate long distance services.
In addition to access pool participation, certain of Interactive's subsidiaries
are compensated for their intrastate costs through billing and keeping
intrastate access charge revenues (without participating in an access pool).
Intrastate access charge revenues are based on intrastate access rates filed
with the state regulatory agency.
Universal Service Fund. The FCC has completed numerous regulatory proceedings
required to implement the 1996 Act. For certain issues, the FCC bifurcated the
proceedings between price-cap and rate-of-return companies or in the case of the
Universal Service Fund ("USF") mechanisms between rural and non-rural companies.
All of Interactive's telephone subsidiaries are rural, rate-of-return companies
for interstate regulatory purposes. Rate-of-return companies receive support
based on their costs while price cap companies receive support based on the
prices of communications services. USF is intended, among other things, to
provide special support funds to high cost rural LECs so that they can provide
affordable services to their customers, notwithstanding their high cost due to
low population density.
In May 2001, the FCC adopted an order related to USF for rural carriers that
mandates the continued use of actual embedded costs as the basis for USF support
for rural carriers through June 2006. In such order, the FCC emphasized that it
would provide predictability, certainty and stability to rural LECs for five
years, so as to allow rural carriers to continue to provide supported
telecommunications services at affordable rates to American consumers. We
anticipate that the FCC will open a proceeding related to USF for rural carriers
to consider modifications needed for the USF mechanisms after June 2006 (see
"Uncertain Future of USF" below).
Uncertain Future of USF. The federal and state USF mechanisms, including that
which the Company receives, are subject to considerable scrutiny and possible
modification by the FCC. In November 2002 the FCC requested that the
Federal-State Joint Board on Universal Service (Joint Board) review certain of
the FCC rules relating to the high-cost universal service support mechanisms to
ensure that the dual goals of preserving universal service and fostering
competition continue to be fulfilled. In February 2004, the Joint Board released
its Recommended Decision concerning the process for designation of eligible
telecommunications carriers (ETCs) (i.e., non-rural carriers that are entitled
to USF support) and the FCC's rules regarding high-cost universal service
support. The Joint Board recommended that the FCC adopt permissive federal
guidelines for states to consider in proceedings to designate ETCs. As more ETCs
are designated, and due to political and economic pressure not to increase the
overall size of the USF, it is likely that rural carriers such as our telephone
companies will receive less support.
The Joint Board also recommended that the FCC limit the scope of high-cost
support to one primary line in an effort to reduce the total size of the USF
mechanisms. Limiting USF support to only one primary line could result in a
significant decrease in the Company's USF revenues depending on the methodology
the FCC adopts. The Joint Board recommended that the FCC seek comment on three
different proposals as a means of preventing or mitigating reductions in the USF
support available to rural carriers.
In conjunction with these measures, the Joint Board recommended that high-cost
support in areas served by rural carriers be capped on a per-line basis where a
competitive carrier is designated as an ETC, and adjusted annually by an index
factor. The Joint Board declined to recommend that the FCC modify the basis of
support (i.e. the methodology used to calculate support) in study areas with
multiple ETCs. Instead, they recommended that the Joint Board and Commission
consider possible modifications to the basis of support as part of an overall
review of the high-cost support mechanisms for rural and non-rural carriers. The
FCC will consider the Joint Board's recommendation and comments of other
interested parties, including the RLEC industry, and make a final decision in
the coming months. It is not possible to predict what modifications the FCC may
adopt regarding USF, the timing of such modifications or the impact of those
modifications on the Company.
Effect on USF of Regional Bell Operating Company ("RBOC") Sales of Access Lines.
SBC and Verizon have announced their intention to sell some of their more rural
access lines. SBC intends to sell approximately 650,000 access lines in Michigan
and Texas. Verizon announced plans to sell lines in upstate New York and Hawaii.
In addition,
-5-
Citizens Communications announced it has engaged J.P. Morgan Securities and
Morgan Stanley as its financial advisors following their December 2003
announcement that they were reviewing strategic alternatives.
The buyers of these access lines will be limited to receive the amount of USF
which the seller was receiving prior to the sale unless they invest a
significant amount for capital expenditures for network infrastructure or unless
the FCC provides a waiver of these rules. Although it is not possible to predict
whether the buyers will substantially invest in these properties or whether the
FCC will grant waivers, if either of these circumstances occurs, Interactive
could be adversely effected due to the additional pressure on USF.
Voice Over Internet Protocol ("VoIP"). Interactive's local exchange carrier
telephone operations do not have significant wireline competition at the present
time. However, wireless usage and VoIP is continuing to increase across the
nation, including in the areas served by Interactive, which could have
substantial detrimental impact on future revenues and create additional
uncertainty for the Company. It is not possible to predict the extent these
complimentary or substitutable services might impact Interactive's revenues.
Because of the rural nature of their operations and related low population
density, Interactive's rural LEC subsidiaries are primarily high cost
operations, which receive substantial Federal and state support. However, the
regulatory environment for LEC operations has begun to change. VoIP usage is
increasing as both a transport facility to haul traffic between switching
centers, as well as the means to serve the end user customer's voice telephone
needs. As a transport facility, it is expected to decrease the overall cost of
transport in the long run. Interactive is analyzing if VoIP could be utilized
for transport in a cost effective manner in the most rural portions of the
nation, such as those served by the Company.
The Interexchange carriers (IXCs) would like to have access minutes that are
transported over VoIP exempt from paying access charges. If the IXCs were
exempted from paying access charges on traffic transported over VoIP, it would
have a significant detrimental impact to the Company's access charge revenues.
While the FCC has initially determined that computer-to-computer VoIP traffic
should not be considered a telecommunications service, it is not possible to
predict the FCC's actions regarding the transport issue since the FCC has not
issued a decision on this matter. The FCC has opened a more comprehensive
proceeding to determine the extent VoIP should be subject to regulation.
In addition to transport, companies are increasing the use of VoIP in providing
voice services to the end user. The VoIP end user traffic requires the use of a
broadband service, such as DSL or cable, in order to receive the low price (or
free) VoIP voice service. Since DSL cannot be purchased from the ILEC without
the customer first purchasing a traditional local access line service, the ILEC
still receives the DSL and the local service revenue as long, as the end user
purchases the DSL from the ILEC. Obviously, if the end user purchases the
broadband service from a competitor, such as a cable company, the ILEC loses all
revenue associated with the customer switching to VoIP. Of greater concern is
the fact that the Company loses the access charge revenue associated with
intrastate calls that previously were provided through the Company's switched
network. It is not possible to determine the potential lost revenue from calls
that are handled by VoIP rather than the public switched network. This is very
similar to revenue losses due to wireless usage where minutes of use are being
removed from the Company's switching platform to the wireless carrier's switch
thus reducing the Company's access revenues.
Competition. Competition in the telecommunications industry is increasing.
- ------------
Although all of Interactive's current telephone companies have historically been
monopoly wireline providers in their respective area for local telephone
exchange service, except to a very limited extent in Iowa, the regulatory
landscape has begun to change and we now experience competition from long
distance carriers, from cable companies and internet service providers with
respect to internet access and potentially in the future from cable telephony,
and from wireless carriers. Competition may result in a greater loss of access
lines and minutes of use and the conversion of retail lines to wholesale lines,
which negatively affects revenues and margins from those lines. Competition also
puts pressure on the prices we are able to charge for some services,
particularly for some non-residential services.
As a result of the 1996 Act, FCC and state regulatory authority initiatives and
judicial decisions, competition has been introduced into certain areas of the
toll network wherein certain providers are attempting to bypass local exchange
facilities to connect directly with high-volume toll customers. For example, in
the last few years, the States of New Mexico, New York, Michigan, Wisconsin and
Kansas passed or amended telecommunications bills intended to introduce more
competition among providers of local services and reduce regulation. Regulatory
authorities in certain states, including New York, have taken steps to promote
competition in local telephone exchange service, by requiring certain companies
to offer wholesale rates to resellers. A substantial impact is yet to be seen on
Interactive's telephone companies. Interactive's subsidiaries do not expect
bypass to pose a significant near-term competitive threat due to a limited
number of high-volume customers they serve.
-6-
Other Telecommunication Services.
- ---------------------------------
Sunshine PCS Corporation. On December 31, 2003, Sunshine PCS Corporation
- ---------------------------
("Sunshine") completed the sale of its three C-Block personal communications
services licenses to Cingular Wireless LLC ("Cingular") for $13,750,000 in cash.
The licenses, which are for the provision of C-Block personal communications
services in the Florida cities of Tallahassee, Panama City and Ocala,
represented substantially all of the assets of Sunshine. In related
transactions, Sunshine used a portion of the sales proceeds to acquire all of
its preferred stock and warrants held by Interactive for an aggregate amount of
$7,587,000 (the "Preferred Stock and Warrant Repurchase") and all of its
outstanding Class B Common Stock for an aggregate amount of $613,862 (the "Class
B Stock Repurchase"). Interactive's cash investment in Sunshine and its
predecessor companies, beginning in 1993, was a cumulative $21.9 million. In
1997 and in 1999, Interactive recorded impairment losses of $7.0 million and
$15.4 million, respectively, which included the impairment of interest the
Company capitalized on these investments during the development of the licenses.
Following the Preferred Stock and Warrant Repurchase and the Class B Stock
Repurchase, Interactive owns 294,117 shares of Sunshine's Class A Common Stock,
representing 6.4% of all outstanding Class A Shares of Sunshine.
Las Cruces, NM PCS License. Another subsidiary of Interactive, Lynch PCS
- ------------------------------
Corporation G ("LPCSG") holds a 10 MHz PCS license for the Basic Trading Area
(BTA) covering Las Cruces, New Mexico. Las Cruces is the principal city in the
BTA, which covers a population of approximately 249,902 (as of the 2000 census).
In April 2002, LPCSG completed a build-out of the licensed area sufficient to
meet the FCC requirement that it provide service coverage to at least
one-quarter of the population in this BTA.
Logan, UT PCS License. As part of the acquisition of Central Utah Telephone
- ----------------------- Company by Interactive in June 2001, Interactive
acquired Central Telecom Services, LLC, a related entity that now owns a 10 MHz
PCS license in the Logan, Utah, BTA, which has a population of approximately
102,702 (as of 2000 census). Similar to LPCSG, Central Telecom Services has
completed a build-out sufficient to meet the FCC requirement that service
coverage be available to at least one-quarter of the population in this BTA. In
respect of the traditions of many staff members and former owners, Interactive
donated 20% of the net profits (as defined in the donation letter) from any sale
of the Logan license to the Church of Jesus Christ of Latter Day Saints.
Iowa PCS Licenses. Central Scott has a 10 MHz PCS License for its wireline
- -------------------
territory covering a population of 11,470. Central Scott is also an
approximately 14% minority owner of an entity that has a 10 MHz PCS license for
portions of Clinton and Jackson Counties in Iowa, with a total population at
December 31, 2002 of 68,470, of which Interactive's proportionate share is
9,781.
RSA Cellular Interests. At December 31, 2003, Interactive owned minority
- -------------------------
interests in certain entities that provide wireless cellular telephone service
in two Rural Service Areas ("RSAs") in New Mexico and two RSA's in North Dakota,
covering areas with a total population of approximately 163,000. Equity in
earnings from these two operations was $2.0 million in 2003 on a combined basis
and the combined book value of these entities was $4.6 million at December 31,
2003. Interactive's proportional share of these operations combined revenues,
EBITDA and operating profits were $2.8 million, $1.4 million and $1.1 million
respectively, for the year ended December 31, 2003, and we received $0.9 million
in cash distributions, net of cash paid to minority interests, from these
investments in 2003. The difference between EBITDA and operating profit is
depreciation of plant and equipment. EBITDA is presented because it is a widely
accepted financial indicator of value and ability to incur and service debt in
this industry. The Company utilizes the EBITDA metric for valuing potential
acquisitions. EBITDA is not a substitute for operating profit, in accordance
with generally accepted accounting principles. The entities have no debt and
Interactive's proportional share of their cash equivalents is $1.0 million.
Other Interests in Wireless Licenses. In 1997, LPCSG entered into an agreement
- --------------------------------------
with Bal/Rivgam LLC (in which an affiliate of the CEO has a 49.9% equity
interest), which won licenses in the FCC's Wireless Communications Services
("WCS") Auction in 1997, to receive a fee equal to 5% of the realized net
profits of Bal/Rivgam (after an assumed cost of capital), in return for
providing bidding and certain other services to Bal/Rivgam. Bal/Rivgam holds 5
WCS licenses covering a population of approximately 42 million with an aggregate
cost of $0.7 million and certain Local Multipoint Distribution Services ("LMDS")
licenses. Betapage Communications, L.L.C., in which Interactive has a 49.9%
equity interest, was a winning bidder in the FCC auction for 929 MHz paging
licenses, which was conducted in 2000. Betapage won 24 paging licenses covering
a population of 76.7 million at a cost of approximately $77,000. Interactive
also has the right to receive a fee equal to 20% of the realized net profits of
Betapage (after an assumed cost of capital).
Another subsidiary of Interactive is a 49.9% owner of PTPMS Communications,
L.L.C. ("PTPMS"), which was a winning bidder in the FCC auction of licenses for
fixed point-to-point microwave services, which was conducted in 2000. PTPMS won
22 licenses covering a population of 27.6 million for an aggregate cost of $1.5
million. Interactive's subsidiary has loaned PTPMS approximately $1.4 million.
-7-
Interactive's subsidiary also has the right to receive a fee equal to 20% of the
realized net profits of PTPMS (after an assumed cost of capital).
Another subsidiary of Interactive is a 49.9% owner of PTPMS Communications II,
L.L.C ("PTPMS II"), which was a winning bidder in the FCC auction of licenses
for 700 MHz Guard Band spectrum for wireless data transmission and wireless
Internet services, which was conducted in 2000. PTPMS II won three licenses
covering a population of 6.4 million in BTAs including the cities of Buffalo,
NY, Des Moines-Quad-Cities, IA and El Paso, TX, at an aggregate cost of
approximately $6.3 million. Interactive has loaned PTPMS II approximately $6.1
million, $5.0 million of which was loaned in 2001. Interactive's subsidiary has
the right to receive a fee equal to 20% of the realized net profits of PTPMS II
(after an assumed cost of capital). In a FCC auction conducted in September 2002
for similar spectrum, called the Lower 700 MHz Band Auction, the price per MHz
of population was materially lower than the price paid by PTPMS II in 2000.
Accordingly, during 2002, Interactive provided a reserve for impairment for its
investment in PTPMS II of $5.5 million.
Another subsidiary of Interactive, Lynch 3G Communications Corporation,
participated in the Lower 700 MHz auction conducted in August 2002. Lynch 3G won
eight 12 MHz licenses in the following areas: Reno, NV; Santa Barbara, CA; Des
Moines, IA; Quad Cities area of Davenport and Bettendorf, IA and Rock Island and
Moline, IL; Las Cruces, NM; Elmira, NY; and two RSAs in the western part of New
Mexico. The total population covered by these licenses is approximately 1.7
million. Lynch 3G paid $1.1 million for these licenses.
In June 2003, Lynch 3G participated in a re-auction of Lower 700 MHz spectrum
that was not licensed in the August 2002 auction and won four 12 MHz licenses in
the following areas: Dubuque, IA, Gogebic, MI, San Juan, NM and Chautauqua, NY.
The total population covered by these licenses is approximately 1.1 million.
Lynch 3G paid $620,000 for these licenses.
Interactive expects to continue to participate in the spectrum auctions being
conducted by the FCC in order to have the flexibility to accommodate present and
future needs of existing and future customers as well as establish high
bandwidth opportunities.
In addition to the build out requirements for PCS licenses, FCC rules impose
build-out requirements for WCS, LMDS, paging licenses, point-to-point microwave
services and the licenses granted in 700 MHz (guard band) and Lower 700 MHz
spectrum. There are also substantial restrictions on the transfer of control of
licensed spectrum.
There are many risks relating to PCS and other FCC wireless licenses including
without limitation, the high cost of PCS and certain other licenses, the fact
that it involves start-up businesses, raising the substantial funds required to
pay for the licenses and the build out, determining the best way to develop the
licenses and which technology to utilize, the small size and limited resources
of companies compared to other potential competitors, existing and changing
regulatory requirements, additional auctions of wireless telecommunications
spectrum and actually building out and operating new businesses profitably in a
highly competitive environment (including already established cellular telephone
operators and other new PCS licensees). There can be no assurance that any
licenses granted to entities in which subsidiaries of Interactive have
interests, can be successfully sold or financed or developed, thereby allowing
Interactive's subsidiaries to recover their debt and equity investments.
Other Multimedia Services
- -------------------------
Broadcasting
- ------------
Station WHBF-TV - Lynch Entertainment, L.L.C. ("Lynch Entertainment I"), a
wholly-owned subsidiary of Interactive, and Lombardo Communications, Inc.,
wholly-owned by Philip J. Lombardo, are the general partners of Coronet
Communications Company ("Coronet"). Lynch Entertainment I has a 20% interest in
Coronet and Lombardo Communications, Inc. has an 80% interest. In addition, on
the sale of the stations, Interactive is entitled to an additional fee of 5% of
the Capital Proceeds (as defined). Coronet owns a CBS-affiliated television
station WHBF-TV serving Rock Island and Moline, Illinois and Davenport and
Bettendorf, Iowa.
Station WOI-TV - Lynch Entertainment Corporation II ("LEC-II"), a wholly-owned
subsidiary of Interactive, owns 49% of the outstanding common shares of Capital
Communications Corporation which owns Station WOI-TV ("Capital") and convertible
preferred stock, which when converted, would bring LEC-II's common share
ownership to 50%. WOI-TV is an ABC affiliate and serves the Ames/Des Moines,
Iowa market. Lombardo Communications, Inc. II, controlled by Philip J. Lombardo,
has the remaining share interest in Capital.
The Company's investments in broadcasting investments are carried on the equity
basis and do not materially impact our current operating results.
-8-
Based upon a multiple of fourteen times broadcast cash flow, plus cash, less
debt, Interactive estimates its value in these stations at almost $11 million as
compared to the net book value of these investments of a negative $0.8 million.
It is not assured that the results of these stations will continue at the
current level or that they could be sold at fourteen times cash flow.
Operations. Revenues of a local television station depend to some extent upon
- -----------
its relationship with an affiliated television network. In general, the
affiliation contracts of WHBF-TV and WOI-TV with CBS and ABC, respectively,
provide that the network will offer to the affiliated station the programs it
generates, and the affiliated station will transmit a number of hours of network
programming each month. The programs transmitted by the affiliated station
generally include advertising originated by the network, for which the network
is compensated by its advertisers.
The affiliation contract has historically provided that the network will pay to
the affiliated station an amount which is determined by negotiation, based upon
the market size and rating of the affiliated station. Recently, however, the
networks have begun in some instances to charge affiliated stations for certain
programming. Typically, the affiliated station also makes available a certain
number of hours each month for network transmission without compensation to the
local station, and the network makes available to the affiliated station certain
programs, which will be broadcast without advertising, usually public
information programs. Some network programs also include "slots" of time in
which the local station is permitted to sell spot advertising for its own
account. The affiliate is permitted to sell advertising spots preceding,
following, and sometimes during network programs.
A network affiliation is important to a local station because network programs,
in general, have higher viewer ratings than non-network programs and help to
establish a solid audience base and acceptance within the market for the local
station. Because network programming often enhances a station's audience
ratings, a network-affiliated station is often able to charge higher prices for
its own advertising time. In addition to revenues derived from broadcasting
network programs, local television stations derive revenues from the sale of
advertising time for spot advertisements, which vary from 10 seconds to 120
seconds in length, and from the sale of program sponsorship to national and
local advertisers. Advertising contracts are generally short in duration and may
be canceled upon two-weeks notice. WHBF-TV and WOI-TV are represented by a
national firm for the sale of spot advertising to national customers, but have
local sales personnel covering the service area in which each is located.
National representatives are compensated by a commission based on net
advertising revenues from national customers.
Competition. WHBF-TV and WOI-TV compete for revenues with local television and
- ------------
radio stations, cable television, and other advertising media, such as
newspapers, magazines, billboards and direct mail. Generally, television
stations such as WHBF-TV and WOI-TV do not compete with stations in other
markets.
Other sources of competition include community antenna television ("CATV")
systems, which carry television broadcast signals by wire or cable to
subscribers who pay a fee for this service. CATV systems retransmit programming
originated by broadcasters, as well as providing additional programming that is
not originated on, or transmitted from, conventional broadcasting stations.
Direct broadcast are satellites providing local to local video services to a
growing percentage of the population in the United States. In addition, some
alternative media operators provide for a fee and, on a subscription basis,
programming that is not a part of regular television service. Additional program
services are provided by low-power television stations as well.
Federal Regulation. Television broadcasting is subject to the jurisdiction of
- -------------------
the FCC under the Communications Act of 1934, as amended (the "Communications
Act"). The Communications Act, and/or the FCC's rules, among other things, (i)
prohibit the assignment of a broadcast license or the transfer of control of a
corporation holding a license without the prior approval of the FCC; (ii)
prohibit the common ownership of a television station and a daily newspaper in
the same market; (iii) restrict the total number of broadcast licenses which can
be held by a single entity or individual or entity with attributable interests
in the stations and prohibits such individuals and entities from operating or
having attributable interests in most types of stations in the same service area
(loosened in the 1996 Act); and (iv) limit foreign ownership of FCC licenses
under certain circumstances. In June 2003, the FCC adopted substantial rule
changes that relax many of the prohibitions on the ownership of broadcast
licenses. Currently, however, these rule changes are being challenged in federal
court. In calculating media ownership interests, The Company's interests may be
aggregated under certain circumstances with certain other interests of Mr. Mario
J. Gabelli, Chairman and Chief Executive Officer of the Company, and certain of
his affiliates.
Television licenses are issued for terms of eight years and are renewable for
terms of eight years. The current licenses for WHBF-TV and WOI-TV expire on
December 1, 2005 and February 1, 2006, respectively.
-9-
II. OTHER INFORMATION
- ----------------------
While Interactive holds licenses of various types, Interactive does not believe
they are critical to its overall operations, except for (1) the
television-broadcasting licenses of WHBF-TV and WOI-TV; (2) Interactive's
telephone subsidiaries' franchise certificates to provide local-exchange
telephone service within their service areas; (3) Western New Mexico Telephone
Company's FCC licenses to operate point-to-point microwave systems; (4) licenses
held by partnerships and corporations in which Western New Mexico Telephone
Company and Inter-Community Telephone Company own minority interests to operate
cellular telephone systems covering areas in New Mexico and North Dakota, (5)
Giant Communication's franchises to provide cable television service within its
service areas and (6) personal communications services and other wireless
communication licenses held by companies in which Interactive's subsidiaries
have investments, including the PCS licenses for Las Cruces, New Mexico, Logan,
Utah, and portions of Iowa as described above in more detail.
The capital expenditures, earnings and competitive position of Interactive have
not been materially affected by compliance with current federal, state, and
local laws and regulations relating to the protection of the environment;
however, Interactive cannot predict the effect of future laws and regulations.
No portion of the business of Interactive is regarded as seasonal.
Interactive does not believe that its multimedia business is dependent on any
single customer of local telephone service. Most local exchange carriers,
including Interactive's, received a significant amount of revenues in the form
of access fees from long distance companies.
Interactive had a total of 349 employees at December 31, 2003, compared to 369
employees at December 31, 2002.
III. EXECUTIVE OFFICERS OF THE REGISTRANT
- -----------------------------------------
Pursuant to General Instruction G (3) of Form 10-K, the following list of
executive officers of the Registrant is included in Part 1 of this Annual Report
on Form 10-K in lieu of being included in the Proxy Statement for the 2004
Annual Meeting of Shareholders. Such list sets forth the names and ages of all
executive officers of the Registrant indicating all positions and offices with
the Registrant held by each such person and each such person's principal
occupations or employment during the past five years.
Name Officers and Positions Held Age
---- --------------------------- ---
Mario J. Gabelli Vice Chairman since December 2002 and Chief Executive Officer since 61
September 1999. From September 1999 to December 2002, Mr. Gabelli
served as our Chairman. He is also the Vice Chairman (and from 1986 to
August 2001 Chairman and Chief Executive Officer) of Lynch Corporation;
Chairman, Chief Executive Officer, Chief Investment Officer and a
director of Gabelli Asset Management Inc. and its predecessors (since
November 1976) (and in connection with those responsibilities, he
serves as director or trustee and/or an officer of registered
investment companies managed by subsidiaries of Gabelli Asset
Management); and Chairman and Chief Executive Officer of Gabelli Group
Capital Partners, Inc., a private company.
Robert E. Dolan Chief Financial Officer (since January 2004); Chief Financial Officer 52
and Controller from September 1999 to January 2004; Chief Financial
Officer (1992-2000) and Controller (1990-2000) of Lynch Corporation.
Evelyn C. Jerden Senior Vice President-Operations (since September 2003); Vice 46
President-Regulatory Affairs (2002-2003); Director of Revenue
Requirements of Western New Mexico Telephone Company, Inc. (since 1992).
John Fikre Vice President--Corporate Development, General Counsel and Secretary 39
(since August 2001); Associate, Willkie Farr & Gallagher (1994-2001).
The executive officers of the Registrant are elected annually by the Board of
Directors at its meeting in May and hold office until the organizational meeting
in the next subsequent year and until their respective successors are chosen and
qualified.
-10-
ITEM 2. PROPERTIES
- ------------------
Interactive leases approximately 3,300 square feet of office space from an
affiliate of its Chairman for its executive offices in Rye, New York. The lease
expires at the end of 2007.
Western New Mexico Telephone Company owns a total of 16.9 acres at 15 sites
located in southwestern New Mexico. Its principal operating facilities are
located in Silver City, where Western owns one building comprising a total of
6,480 square feet housing its administrative offices and certain storage
facilities and another building comprising 216 square feet, which houses core
network equipment. In Cliff, New Mexico, Western owns five buildings with a
total of 14,055 square feet in which are located additional offices and storage
facilities, as well as a vehicle shop, a fabrication shop, and central office
switching equipment. Smaller facilities, used mainly for storage and for housing
central office switching equipment, with a total of 9,984 square feet, are
located in Lordsburg, Reserve, Magdalena and five other localities in New
Mexico. In addition, Western leases 1.28 acres on which it has constructed four
microwave towers and a 120 square-foot equipment building. Western has the use
of 46 other sites under permits or easements at which it has installed various
equipment either in small company-owned buildings (totaling 2,403 square feet)
or under protective cover. Western also owns 3,757 miles of copper cable and 494
miles of fiber optic cable running through rights-of-way within its 15,000
square mile service area. All of these properties are encumbered under mortgages
held by the Rural Utilities Service ("RUS") and the National Bank for
Co-Operatives ("Co-Bank").
Inter-Community Telephone Company owns 12 acres of land at 10 sites. Its main
office at Nome, ND, contains 4,326 square feet of office and storage space. In
addition, it has 4,400 square feet of garage space and 5,035 square feet
utilized for its switching facilities. Inter-Community has 2,028 miles of copper
cable and 226 miles of fiber optic cable. All of these properties are encumbered
under mortgages held by Co-Bank.
Cuba City Telephone Company is located in a 3,800 square foot brick building on
0.4 of an acre of land. The building serves as the central office, commercial
office, and garage for vehicle and material storage. The company also owns a
cement block storage building of 1,490 square feet on 0.1 of an acre. In
Madison, Wisconsin, Cuba City leases 900 square feet for administrative
headquarters and financial functions. Belmont Telephone Company is located in a
cement block building of 800 square feet on .5 acre of land in Belmont,
Wisconsin. The building houses the central office equipment for Belmont. The
companies own a combined total of 302 miles of copper cable and 51 miles of
fiber optic cable. All of Cuba City and Belmont's properties described above are
encumbered under first mortgages held by the RUS and Rural Telephone Bank,
respectively, and second mortgages held by Co-Bank.
J.B.N. Telephone Company owns a total of approximately 2.25 acres at fifteen
sites located in northeast Kansas. Its administrative and commercial office
consisting of 7,000 square feet is located in Holton, Kansas and a 3,000 square
feet garage warehouse facility is located in Wetmore, Kansas. In addition,
J.B.N. owns thirteen smaller facilities housing central office switching
equipment and over 1,207 miles of copper cable and 206 miles of fiber optic
cable. All of these properties are encumbered under mortgages held by the RUS.
Giant Communications, LLC (formerly CLR Video) has its headquarters in Holton,
Kansas, leased from J.B.N. Telephone Company. It also owns one small parcel of
land and leases 13 small sites, which it uses for its cable receiving and
transmission equipment. All of these properties are encumbered under a mortgage
to Co-Bank. Also, see under Item 1.I.B. Cable Television.
Haviland Telephone Company owns a total of approximately 3.9 acres at 20 sites
located in south central Kansas. Its administrative and commercial office
consisting of 4,450 square feet is located in Haviland, Kansas. In addition,
Haviland owns 19 smaller facilities housing garage, warehouse, and central
office switching equipment and over 1,503 miles of copper cable and 529 miles of
fiber optic cable. All of these properties are encumbered under a mortgage held
by the RUS.
Dunkirk & Fredonia Telephone Company (including its subsidiaries) owns a total
of approximately 16 acres at six locations in western New York. Its host central
office switching equipment, administrative and commercial offices consisting of
18,297 square feet is located in Fredonia, New York. In addition, Dunkirk &
Fredonia owns five other properties, including a service garage, a paging tower
site, a small central office housing switching equipment, sales and service
center in Jamestown, New York, and one rental property in Ashville, New York.
Dunkirk & Fredonia also owns 357 miles of copper telephone cable and 79 miles of
fiber optic cable. All of these properties are encumbered under a mortgage held
by RUS.
Bretton Woods Telephone Co., Inc. leases approximately 2,800 square feet of
business office space and garage/storage space located in Bretton Woods, New
Hampshire. Bretton Woods Telephone owns a 444 square foot central office
-11-
building also located in Bretton Woods, New Hampshire that is built on leased
land. Bretton Woods Telephone has 28 miles of copper cable and 6 miles of fiber
optic cable.
Upper Peninsula Telephone Company owns a total of approximately 25 acres at 19
sites located principally in the Upper Peninsula of Michigan. Its host central
office switching equipment, administrative and commercial offices consisting of
11,200 square feet is located in Carney, Michigan. In addition, Upper Peninsula
owns 25 other smaller facilities housing garage, warehouse and central office
switching equipment and over 2,121 miles of copper cable and 157 miles of fiber
optic cable. All properties described herein are encumbered under mortgages held
by the RUS and Co-Bank.
Central Scott Telephone Company owns 3 acres of land at 5 sites. Its main office
in Eldridge, Iowa contains 3,104 square feet of office and 341 square feet of
storage space. In addition, it has 3,360 square feet of garage space and 2,183
square feet utilized for its switching facilities. Central Scott has 357 miles
of copper cable and 34 miles of fiber optic cable. All of these properties are
encumbered under mortgages held the First National Bank of Omaha.
Central Utah Telephone, Inc., and its subsidiaries own a total of 9.76 acres at
sixteen sites and have an additional 1.54 acres at fifteen sites, which are
under leases, permits or easements. These sites are located in the central,
northeastern and mid-western areas of Utah. Central Utah Telephone's principal
operating facilities are located in Fairview, Utah, where it owns a new
commercial office bldg. containing 14,400 square feet, a plant office and
central office building containing 5,200 square feet. In addition it has 720
square feet of office space, 2,455 square feet of warehouse space, 6,595 square
feet of vehicle maintenance facilities, 4,252 square feet of protective cover
and 3 rental homes. Central Utah Telephone owns smaller facilities used mainly
for housing central office switching equipment with a total of 9,405 square feet
in 25 various locations. In addition, Central Utah Telephone owns 897 miles of
copper cable and 199 miles of fiber optic cable running through rights-of-way
within its 6,867 square mile service area. All of Central Utah Telephone's
properties described herein are encumbered under mortgages held by the RUS and
CoBank.
It is Registrant's opinion that the facilities referred to above are in good
operating condition and suitable and adequate for present uses.
ITEM 3. LEGAL PROCEEDINGS
- --------------------------
Interactive and several other parties, including our Chief Executive Officer,
and Fortunet Communications, L.P., which was Sunshine PCS Corporation's
predecessor-in-interest, have been named as defendants in a lawsuit brought
under the so-called "qui tam" provisions of the Federal False Claims Act in the
United States District Court for the District of Columbia. The complaint was
filed under seal with the court on February 14, 2001. At the initiative of one
of the defendants, the seal was lifted on January 11, 2002. Under the False
Claims Act, a private plaintiff, termed a "relator," may file a civil action on
the U.S. government's behalf against another party for violation of the statute.
In return, the relator receives a statutory bounty from the government's
litigation proceeds if he is successful.
The relator in this lawsuit is R.C. Taylor III, an individual who, to the best
of our knowledge, has no relationship to any of the entities and affiliates that
have been named parties in this litigation. Indeed at the time of his filings,
and to the best of our knowledge, Mr. Taylor was a lawyer at Gardner, Carton &
Douglas. Thereafter, we believe he was a lawyer with Mintz, Levin, Cohn, Ferris,
Glovsky and Popeo. We do not know his current status. We issued a press release
dealing with this litigation on January 16, 2002.
The main allegation in the case is that the defendants participated in the
creation of "sham" bidding entities that allegedly defrauded the Federal
Treasury by improperly participating in certain Federal Communications
Commission spectrum auctions restricted to small businesses, as well as
obtaining bidding credits in other spectrum auctions allocated to "small" and
"very small" businesses. While the complaint seeks to recover an unspecified
amount of damages, which would be subject to mandatory trebling under the
statute, a document filed by the relator with the Court on February 24, 2004,
discloses an initial computation of damages of not less than $88 million
resulting from bidding credits awarded to the defendants in FCC auctions and
$120 million of unjust enrichment through the sale or assignment of licenses
obtained by the defendants in FCC auctions, in each prior to trebling.
Interactive strongly believes that this lawsuit is completely without merit and
that relator's initial damage computation is without basis, and intends to
defend the suit vigorously. The U.S. Department of Justice has notified the
court that it has declined to intervene in the case. Nevertheless, we cannot
predict the ultimate outcome of the litigation, nor can we predict the effect
that the lawsuit or its outcome will have on our business or plan of operation.
Interactive does not have any insurance to cover its cost of defending this
lawsuit, which will be material. Interactive does have a directors and officers
liability policy but the insurer has reserved its rights under the policy and,
as a result, any coverage to be provided to any director or officer of
Interactive in connection with a judgment rendered in this action is unclear at
this time.
-12-
Interactive was formally served with the complaint on July 10, 2002. On
September 19, 2002, Interactive filed two motions with the United States
District Court for the District of Columbia: a motion to dismiss the lawsuit and
a motion to transfer the action to the Southern District of New York. On
November 25, 2002, the relator filed an opposition reply to our motion to
dismiss and on December 5, 2002, Interactive filed a reply in support of its
motion to dismiss. On September 30, 2003, the Court granted our motion to
transfer the action to the Southern District of New York. A scheduling
conference was held on February 10, 2004, at which the judge approved a
scheduling order. Discovery has now commenced as the parties await a ruling on
the defendants' motion to dismiss the case.
Interactive first participated in FCC sponsored wireless auctions with the PCS
"C Block" Auction in 1995. In that auction, Interactive invested $22 million
into five separate partnerships that acquired 31 licenses. These partnerships
were eventually merged and, subsequently, returned 28 licenses under an FCC
sponsored restructuring program and, ultimately, became Sunshine PCS
Corporation. On December 31, 2003, Sunshine sold its three PCS licenses to
Cingular Wireless for $13.75 million in cash. As part of this sale, Interactive
received $7.2 million in exchange for all its preferred stock in Sunshine and
$0.4 million for its warrants, resulting in a pre-tax gain of $3.9 million. In
1997 and in 1999, Interactive recorded impairment losses of $7.0 million and
$15.4 million, respectively, which included the impairment of interest the
Company capitalized on these investments during the development of the licenses.
In addition to the litigation described above, Interactive is a party to routine
litigation incidental to its business. Based on information currently available,
Interactive believes that none of this ordinary routine litigation, either
individually or in the aggregate, will have a material effect on its financial
condition and results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------------------------------------------------------------
None in the fourth quarter of 2003.
PART II
-------
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
- --------------------------------------------------------------------------------
AND ISSUER PURCHASES OF EQUITY SECURITIES
-----------------------------------------
The Common Stock of Lynch Interactive Corporation is traded on the American
Stock Exchange under the symbol "LIC." The market price high and lows in
consolidated trading of the Common Stock for the last two years are as follows:
2003
Three Months Ended
March 31 June 30 September 30 December 31
-------- ------- ------------ -----------
High $ 28.00 $ 24.80 $ 27.75 $ 27.41
Low $ 21.50 $ 19.50 $ 23.95 $ 21.80
2002
Three Months Ended
March 31 June 30 September 30 December 31
-------- ------- ------------ -----------
High $ 70.50 $ 54.50 $ 31.58 $ 28.50
Low $ 39.00 $ 24.50 $ 24.50 $ 22.80
At March 25, 2004, Interactive had 837 shareholders of record and the closing
price of our Common Stock was $33.55.
Neither Interactive nor Lynch Corporation, the company from which Interactive
was spun off, has paid any cash dividends on its common stock since 1989.
Interactive does not expect to pay cash dividends on its common stock in the
foreseeable future. Interactive currently intends to retain its earnings, if
any, for use in its business. Current and future financings may limit or
prohibit the payment of dividends.
-13-
Issuer Purchases of Equity Securities
Total Number of Maximum Number of (or
Shares Purchased as Approximate Dollar Value)
Total Number of Part of Publicly of Shares that May Yet Be
Shares (or Units) Average Price Paid Announced Plans or Purchased Under the Plans
Period Purchased per Share (or Unit) Programs(1) or Programs(1)
------ --------- ------------------- ----------- --------------
10/1/03 to 10/31/03 -- -- -- 57,385
11/1/03 to 11/30/03 -- -- -- 57,385
12/1/03 to 12/31/03 2,200 22.27 2,200 55,185
-----------------------------------------------------------------------------------
Total 2,200 22.27 2,200
======================================================
(1) In September 1999, the Board of Interactive approved a stock repurchase
program providing for the purchase of up to 100,000 shares of Common Stock
in such manner, at such times and at such prices as the Chief Executive
Officer or his designee determines.
-14-
ITEM 6. SELECTED FINANCIAL DATA
LYNCH INTERACTIVE CORPORATION
SELECTED FINANCIAL DATA
(In Thousands, Except Per Share Data)
Years Ended December 31, (a)(b)
------------------------------------------------------
1999 2000 2001 2002 2003
------------------------------------------------------
Revenues ............................................. $ 59,011 $ 66,983 $ 79,352 $ 86,304 $ 87,453
Operating profit(c) .................................. 12,299 15,331 19,985 19,233 18,428
Net financing activities (d) ......................... (8,789) (10,308) (11,074) (11,266) (10,744)
Equity in earnings of affiliates ..................... 1,585 2,594 1,456 1,938 2,280
Impairment of investment in Spinnaker Industries, Inc. -- -- (3,194) -- --
Reserve for impairment of investment in spectrum
license holders (e) ................................ (15,406) -- -- (5,479) --
Gain on sale of subsidiary stock and other
Assets ............................................. -- 4,187 -- 4,965 3,919
-------- -------- -------- -------- --------
Income (loss) before income taxes, minority
interests, extraordinary item and discontinued
operations of Morgan ............................... (10,311) 11,804 7,173 9,391 13,883
(Provision) benefit for income taxes ................. 2,478 (4,971) (3,454) (3,924) (4,968)
Minority interests ................................... (1,214) (1,802) (1,185) (1,706) (1,525)
-------- -------- -------- -------- --------
Income (loss) from continuing operations before
discontinued operations of
Morgan and Extraordinary item .................... (9,047) 5,031 2,534 3,761 7,390
Income (Loss) from operations of Morgan
distributed to shareholders (h) .................... (9) (2,666) (1,386) (1,888) --
Extraordinary item (f) .............................. (160) -- -- -- --
-------- -------- -------- -------- --------
Net income (loss) .................................. $ (9,216) $ 2,365 $ 1,148 $ 1,873 $ 7,390
======== ======== ======== ======== ========
Basic and diluted earnings
Per common share (g)
Income (loss) from continuing operations before
Extraordinary item and operations of Morgan ...... $ (3.21) $ 1.78 $ 0.90 $ 1.34 $ 2.65
Extraordinary item ................................. (0.06) -- -- -- --
Income (loss) from operations of Morgan
distributed to shareholders (h) .................. $ (0.00) $ (0.94) $ (0.49) $ (0.67) --
Net income (loss) .................................. $ (3.27) $ 0.84 $ 0.41 $ 0.67 $ 2.65
December 31, (a)
----------------------------------------------------------
1999 2000 2001 2002 2003
----------------------------------------------------------
Cash, securities and short-term investments $ 29,094 $ 26,900 $ 31,233 $ 23,356 $ 26,556
Total assets (j) ..................................... $ 221,705 $217,742 $256,350 $ 249,639 $252,186
Long-term debt ....................................... $ 164,736 $162,304 $193,202 $ 176,621 $175,783
Shareholders' equity (i) ............................. $ 20,211 $ 19,391 $ 24,517 $ 22,632 $ 29,887
(a) On September 1, 1999, Interactive was spun off to the Lynch Corporation
("Lynch") shareholders (the "Spin Off") and became a public company. Prior
to the Spin Off, Interactive had no significant assets, liabilities or
operations. The above financial data represented the consolidated accounts
of Interactive since September 1, 1999. Prior to September 1, 1999, the
financial data has been prepared using the historical basis of assets and
liabilities and historical results of operations of the multimedia and
services businesses and other assets and liabilities, which were
contributed to Interactive, on a combined basis. Accordingly, the results
for the year ended December 31, 1999, represent a combination of
consolidated and combined financial information for the respective periods.
As the historical financial information prior to September 1, 1999 herein
reflects periods during which the Company did not operate as an independent
public company, certain assumptions were made in preparing such financial
information. Such information, therefore, may not necessarily reflect the
results of operations, financial condition or cash flows of the Company in
the future or what they would have been had the Company been an independent
public company during the reporting periods. Morgan has been treated as a
discontinued operation for all periods presented.
-15-
(b) Includes results of Central Scott Telephone Company from July 16, 1999, and
Central Utah Telephone Company from June 23, 2001, their respective dates
of acquisition.
(c) Operating profit is sales and revenues less Multimedia cost of sales, and
selling and administrative expenses. Goodwill amortization was $2.2 million
in 1999, $2.5 million in 2000 and $2.8 million in 2001. On January 1, 2002,
the Company adopted the provisions of SFAS 142 and ceased amortizing
goodwill. (See note 1 in the accompanying financial statements.)
(d) Consists of investment income and interest expense.
(e) See Note 4 "Wireless Communications Services" in the Company's consolidated
financial statements.
(f) Loss from Early Extinguishment of Debt.
(g) Adjusted to reflect a 2 for 1 stock split which occurred on September 11,
2000.
(h) Net of income tax and minority interest.
(i) No cash dividends have been declared or paid during the 5-year period.
(j) Amounts do not include assets associated with The Morgan Group, Inc.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS
-------------
This discussion should be read together with the Consolidated Financial
Statements of Interactive and the notes thereto included elsewhere in this
Annual Report.
RESULTS OF OPERATIONS
- ---------------------
Overview
- --------
Interactive has grown primarily through the selective acquisition of rural local
exchange carriers (RLECs) and by offering additional services such as Internet
service, alarm services, long distance service and competitive local exchange
carrier (CLEC) service. From 1989 through 2003, Interactive acquired fourteen
telephone companies, four of which have indirect minority ownership of 2% to
19%, whose operations range in size from approximately 800 to over 10,000 access
lines. The Company's telephone operations are located in Iowa, Kansas, Michigan,
New Hampshire, New Mexico, New York, North Dakota, Utah and Wisconsin.
The telecommunications industry in general and the RLECS that comprise
Interactive's business face a number of economic or industry-wide issues and
challenges.
o Regulatory- The Telecommunications Act of 1996 and other federal and state
legislation and regulations have a significant impact on the industry and
on rural carriers in particular. Interactive's telephone companies are all
RLECs serving very high cost areas with a significant portion of their
revenues being derived from federal or state support mechanisms, which are
referred to as Universal Service Funds ("USF"). The revenues and margins of
our RLEC subsidiaries are largely dependant on the continuation of such
support mechanisms.
o Competition- The effects of competition from CLECs, wireless service, high
speed cable, Voice Over Internet Protocol ("VoIP") and other internet
providers is an industry-wide issue that is felt to varying degrees by our
rural telephone companies.
o The economy- Unemployment, building starts, business bankruptcies and the
overall health of the economy have a significant effect on demand for our
services.
o Telecommunication bankruptcies- Interactive's telephone companies have
significant, normal course of business receivables from interexchange
carriers, such as MCI or Global Crossings who filed for bankruptcy and, as
a result, have been written-off. Additional bankruptcies could have a
significant effect on our financial condition.
o Market challenges- Our phone companies are required to comply with
industry-wide initiatives such as local number portability and the
requirements of the Communications Assistance for Law Enforcement Acto
(CALEA) that are expensive to implement and that in some cases have limited
demand in our markets.
Interactive generates cash and earns telecommunications revenues primarily from
local network access, intrastate and interstate access revenue and from state
and federal USF support mechanisms.
-16-
o Local Revenues - The number of access lines is the primary driver of local
network access revenues. In addition, the ratio of business lines to
residential, as well as the number of features subscribed to by customers
are secondary drivers.
o Intrastate access revenues - Customer usage, primarily based on minutes of
use, and the number of access lines are the primary drivers of intrastate
access revenues since the Company's RLECs are on a "bill-and-keep" basis.
o Interstate access revenues depend upon whether the RLEC has elected to be
"cost-based" or has remained an "average schedule" carrier. The revenues of
our ten cost-based carriers directly correlate to their approved rate of
return on regulated net investment plus the amount of regulated operating
expenses including taxes. The revenues of the Company's four average
schedule subsidiaries correlate to usage based measurements such as access
lines, interstate minutes-of-use, the number and mileage of different types
of circuits, etc. The average schedule method is intended to be a proxy for
cost-based recovery.
o USF subsidies are primarily driven by investments in specific types of
infrastructure as well as the operating expenses and taxes of the Company.
Interstate and intrastate USF subsidies are included in the respective
interstate and intrastate access revenue captions in the breakdown of
revenue and operating expenses which follows.
o Other business revenue: Interactive's companies also provide non-regulated
telecommunications related services, including Internet access service,
wireless and long distance resale service, in certain of its telephone
service and adjacent areas. Interactive also provides and intends to
provide more local telephone and other telecommunications service outside
certain of its franchise areas by establishing CLEC operations in selected
nearby areas. In addition, certain of Interactive's companies have expanded
into cable and security businesses in the areas in which they operate.
o Long Distance revenues are only retained by the Company if we are providing
the long distance service to the end user customer as the toll provider.
For unaffiliated IXCs, we provide a billing service and receive an
administrative handling fee.
The following are the material opportunities, challenges and risks that
Interactive's executives are currently focused on and what actions are being
taken to address the concerns:
o Universal Service Reform: The Federal-State Joint Board on Universal
Service (Joint Board) issued a recommendation that the FCC modify the USF
support mechanisms for RLECs such as those owned by the Company. The
Company will participate with the RLEC industry to analyze the potential
impact of the Joint Board's recommendation and provide the FCC information
with the potential impact to customers and RLECs in rural America. Total
USF support payments are material to theCompany's financial results.
o Intercarrier Compensation and Access Charge Reform: The Company is actively
participating in the RLEC industry's efforts to determine how intercarrier
compensation and access charges should be modified without sustaining
revenue losses for RLECs.
o Loss of Access Revenues from VoIP and wireless usage: The Company is
experiencing revenue losses as usage transfers from landline service
provided by the Company's subsidiaries to either VoIP or wireless services.
The Company is trying to install more broadband service to offset revenue
losses from traditional voice services.
In January 2002, Interactive spun off its investment in Morgan, its only
services subsidiary, via a tax-free dividend to its shareholders of the stock of
Morgan Group Holding Co., a corporation that was initially formed to serve as a
holding company for Interactive's controlling interest in Morgan. Morgan Group
Holding Co. is now a public company. Accordingly, the amounts for Morgan are
reflected on a one-line basis in the consolidated financial statements as "to be
distributed to shareholders."
-17-
Year 2003 compared to 2002
- --------------------------
The following is a breakdown of revenues and operating expenses for the two
years ended December 31, 2003 and 2002:
Increase
2002 2003 (Decrease)
--------------------------------------
(in thousands)
Revenues:
Local access ..................... $ 12,315 $ 12,302 $ (13)
Interstate access .................. 34,403 37,030 2,627
Intrastate access .................. 16,776 15,388 (1,388)
-------- -------- --------
Total telephone .................. 63,494 64,720 1,226
Other businesses ................... 22,810 22,733 (77)
-------- -------- --------
86,304 87,453 1,149
-------- -------- --------
Operating expenses:
Plant costs ........................ 11,223 12,117 894
Customer operations ................ 4,428 4,495 67
Other telephone related (1) ........ 13,396 13,014 (382)
-------- -------- --------
Total telephone (excluding
depreciation and amortization) . 29,047 29,626 579
Other business (1) ................. 15,337 14,588 (749)
Unallocated corporate costs ........ 3,334 4,529 1,195
-------- -------- --------
Operating expenses (excluding
depreciation and amortization) 47,718 48,743 1,025
-------- -------- --------
EBITDA ............................... 38,586 38,710 124
Depreciation ....................... 17,890 19,524 1,634
Amortization ....................... 1,463 758 (705)
-------- -------- --------
Operating profit ..................... 19,233 18,428 (805)
Other income (expense) ............... (9,842) (4,545) 5,297
-------- -------- --------
Income before income taxes, minority
interests, and operations of Morgan 9,391 13,883 4,492
Provision for income taxes ........... (3,924) (4,968) (1,044)
Minority interests ................... (1,706) (1,525) 181
-------- -------- --------
Income before operations of Morgan ... $ 3,761 $ 7,390 $ 3,629
======== ======== ========
(1) General and administrative costs at operations in the Company's
Consolidated Statement of Operations includes $11,176 and $10,836 included
herein as Other Telephone Related and $2,133 and $986 included herein as
Other Business as of December 31, 2002 and 2003, respectively.
Revenues:
- ---------
Local access revenue decreased by $13,000 in 2003 compared to 2002 as a 1.5%
decrease in the number of access lines, due primarily to additional DSL lines
sold, offset a 1% increase in the percentage of business lines, which typically
generate higher revenues, compared to residential access lines.
Interstate revenues increased $2.6 million in 2003 compared to 2002 primarily
due to the effect of infrastructure development, which entitled the Company to
increased USF support primarily at the Haviland Telephone Co. and Central Utah
Telephone Co. ("CUT"). In addition, interstate access revenue increased $0.8
million primarily due to the recovery in revenue of increased operating
expenditures, in accordance with our ratemaking structure, associated with the
increased infrastructure development. Under the rate of return model in which
these companies are regulated, further increases in revenue are expected in
2004, as the 2003 capital expenditures are fully recognized by the model.
Intrastate revenues decreased $1.4 million in 2003 compared to 2002 primarily
due to state initiatives in Kansas and New York. The Kansas initiative has been
fully recognized in the regulatory model, but additional revenue reductions are
expected in New York of approximately $0.1 million per year over the next four
years.
Other Business revenues, which include the Company's internet, CLEC, wireless,
long-distance, cable and security operations, decreased $0.1 million in 2003
compared to 2002. The sale of a wireless equipment operation in upstate New York
with 2002 revenues of $0.8 million more than offset a $0.6 million increase due
to additional subscribers in
-18-
the Company's 63.6% owned security business in upstate New York. In addition,
decreased revenue in long-distance resale and other lines of business offset an
increase of $0.6 million in the Company's CLEC operations in New York.
Operating and Other Expenses:
- -----------------------------
Total operating expenses, excluding depreciation and amortization, were $48.7
million in 2003, an increase of $1.0 million over the prior year. Plant costs,
which include all direct and indirect costs of operating and maintaining the
physical plant, increased $0.9 million, or 8%, due to various factors, including
additional bandwidth and system maintenance costs, in 2003 compared to 2002.
Customer operations, which include all costs of servicing existing customers and
obtaining new customers, were flat between the two years. Other telephone
related costs, including executive, administrative and plant overhead, operating
taxes and bad debt expense, decreased $0.4 million in 2003 compared to 2002,
primarily due to $0.9 million of bad debt expense in 2002 associated with the
bankruptcies of MCI/Worldcom and Global Crossings. Other business costs,
including costs of the security, cable, internet, wireless and CLEC businesses,
decreased $0.7 million. Such reduction includes a $0.8 million reduction in
costs due to the sale of a wireless business in upstate New York in late 2002,
partially offset by increased costs of the security, CLEC and internet
businesses due to the overall expansion of those businesses.
Unallocated corporate costs increased $1.2 million in 2003, primarily due to a
$1.2 million increase in the bonus accrual. The Company recorded a $1.6 million
accrual in 2003 in accordance with a shareholder approved management incentive
program compared to a $0.4 million bonus accrual in 2002. The gain on the sale
of the Sunshine Preferred Stock and warrants resulted in $0.8 million of such
increase to the bonus accrual.
Depreciation expense increased by $1.6 million in 2003, of which $0.8 million
was due to increased capital expenditures at one of our Kansas operations and
$0.3 million was due to revised depreciation rates that more accurately reflect
asset lives at our Michigan subsidiary. Amortization expense decreased by $0.7
million during 2003, as the Dunkirk & Fredonia security operation increased the
amortization period for its subscriber lists from three to ten years in the
fourth quarter of 2002.
As a result of the above, operating profit was $18.4 million in 2003, $0.8
million less than the $19.2 million recorded in 2002.
EBITDA
- ------
EBITDA represents the Company's earnings before interest, taxes, depreciation
and amortization. EBITDA is not intended to represent cash flows from operating
activities and should not be considered as an alternative to net income or loss
(as determined in conformity with generally accepted accounting principles), as
an indicator of the Company's operating performance or to cash flows as a
measure of liquidity. EBITDA from operations is presented herein because the
Company's chief operating decision maker evaluates and measures each business
unit's performance based on their EBITDA results. The Company believes that
EBITDA from operations is the most accurate indicator of the Company's results,
because it focuses on revenue and operating cost items driven by operating
managers' performance, and excludes non-recurring items and items largely
outside of operating managers' control. EBITDA from operations may not be
available for the Company's discretionary use as there are requirements to repay
debt, among other payments. EBITDA from operations as presented may not be
comparable to similarly titled measures reported by other companies since not
all companies necessarily calculate EBITDA from operations in an identical
manner, and therefore, is not necessarily an accurate measure of comparison
between companies. See the above table for a reconciliation of EBITDA to
Operating profit and to Income before income taxes, minority interests and
operations of Morgan.
Increase
2002 2003 (Decrease)
-----------------------------
(in thousands)
Telephone:
Revenues ..................................... $63,494 $64,720 $ 1,226
Operating expenses (excluding depreciation and
amortization) ............................ 29,047 29,626 579
------- ------- -------
34,447 35,094 647
Other business:
Revenues ..................................... 22,810 22,733 (77)
Operating expenses (excluding depreciation and
amortization) .............................. 15,337 14,588 (749)
------- ------- -------
7,473 8,145 672
------- ------- -------
-19-
Increase
2002 2003 (Decrease)
-----------------------------
(in thousands)
EBITDA from operations ......................... 41,920 43,239 1,319
Unallocated corporate costs .................... 3,334 4,529 1,195
------- ------- -------
EBITDA ......................................... $38,586 $38,710 $ 124
======= ======= =======
EBITDA (earnings before interest, taxes, depreciation and amortization) for the
year ended December 31, 2003 was $38.7 million, which was up slightly, $0.1
million, from the 2002 amount. EBITDA generated by operations grew $1.3 million,
or 3.1%, to $43.2 million from the previous year. Higher revenues and
essentially flat operating costs and expenses, excluding depreciation and
amortization, were the cause of the higher EBITDA. Corporate office expense
increased to $4.5 million from $3.3 million due to the $1.2 million increase in
incentive compensation that was determined under a formula that was approved by
the Company's shareholders in 2000.
Other Income (Expense)
- ----------------------
Investment income was $1.1 million in 2003 as compared to $1.8 million in 2002.
The decrease was attributed to absence of interest income associated with an
escrow account securing our previously outstanding convertible note which was
repaid in November 2002, interest on an IRS refund that was recorded in 2002,
lower realized gain on sales of marketable securities and lower patronage
capital income associated with our long term borrowings.
Interest expense was $11.9 million in 2003, as compared to $13.0 million in
2002, primarily due to the repayment in November 2002 of a $10 million
Convertible Note. The company recorded $0.7 million of interest expense
associated with the note in 2002. The remaining decrease was the result of lower
interest rates on the Company's variable rate borrowings. The Company is
considering converting a significant portion of its current variable interest
rate debt to fixed interest rate debt, which would increase interest expense in
the future, based on current interest rate levels.
On December 31, 2003, Sunshine sold its three PCS licenses to Cingular Wireless
for $13.75 million in cash. As part of this sale, Interactive received $7.2
million in exchange for all its preferred stock in Sunshine and $0.4 million for
its warrants, resulting in a pre-tax gain of $3.9 million. Interactive's cash
investment in Sunshine and its predecessor companies, beginning in 1995, was a
cumulative $21.9 million. In 1997 and in 1999, Interactive recorded impairment
losses of $7.0 million and $15.4 million, respectively, which included the
impairment of interest the Company capitalized on these investments during the
development of the licenses.
The Company has made loans to and has investments in PTPMS Communications II,
LLC, totaling $6.2 million. PTPMS II acquired wireless spectrum in an auction
conducted by the Federal Communications Commission in 2000 called the 700 MHz
Guard Band Auction. In a FCC auction conducted in September 2002 for similar
spectrum, called the Lower 700 MHz Band Auction, the price per MHz of population
was materially lower than the price paid by PTPMS II in 2000. Accordingly,
during 2002, Interactive provided for the impairment for its investment in PTPMS
II of $5.5 million ($3.6 net of income tax effects).
During 2002, the Company sold its interest in a cellular partnership in New
Mexico RSA # 1 (North) for $5.5 million resulting in a pre-tax gain of $5.0
million ($2.5 million net of income tax and minority interests effect).
Equity in earning of affiliates increased by $0.3 million in 2003 compared to
2002 due to higher revenues and earnings of our investments in cellular
telephone affiliates in New Mexico.
Income Tax Provision
- --------------------
The income tax provision includes federal, as well as state and local taxes. The
tax provision in 2003 and 2002, represent effective tax rates of 35.8% in 2003
and 41.8% in 2002. The differences from the federal statutory rate are primarily
due to the effects of state income taxes. In addition, in 2003, no state
provision was required on the gain on sale of the investment in Sunshine and the
Company reassessed certain tax accruals.
Minority Interests
- ------------------
Minority interests decreased earnings by $1.5 million in 2003 and $1.7 million
in 2002. The gain in 2002 from the sale of New Mexico RSA #1 (North) resulted in
a $0.5 million reduction in minority interests in 2003 when compared to 2002.
Such reduction in minority interests was offset by higher earnings in 2003 at
several of our less than 100% owned subsidiaries.
-20-
Income from Continuing Operations
- ---------------------------------
As a result of all of the above, income from continuing operations of $7.4
million in 2003, or $2.65 per share (basic and diluted), increased by $3.6
million from the $3.8 million, or $1.34 per share (basic and diluted), recorded
in 2002.
Year 2002 compared to 2001
- --------------------------
The acquisitions of CUT in June 2001 and the acquisition of a 63.6% interest in
American Alarm Company in November 2001 (referred to collectively as the "2001
Acquisitions") had a significant effect on the comparison of 2002 and 2001
revenues and operating costs. Both acquisitions were accounted for based on the
purchase method of accounting and the results of operations reflect these
acquisitions from the acquisition dates in 2001 compared with a full year in
2002. The following is a breakdown of our revenues and operating expenses for
the two years ended December 31, 2002 and 2001:
Increase Effect of
2001 2002 (Decrease) Acquisitions(1)
--------------------------------------------------
(in thousands)
Revenues:
Local access ........................ $ 10,817 $ 12,315 $ 1,498 $ 1,041
Interstate access ................... 29,542 34,403 4,861 2,746
Intrastate access ................... 16,649 16,776 127 1,290
-------- -------- -------- --------
Total telephone ................... 57,008 63,494 6,486 5,077
Other businesses .................... 22,344 22,810 466 2,963
-------- -------- -------- --------
79,352 86,304 6,952 8,040
-------- -------- -------- --------
Operating Expenses:
Plant costs ......................... 9,920 11,223 1,303 1,103
Customer operations ................. 4,583 4,428 (155) 163
Other telephone related (2) ......... 11,085 13,396 2,311 946
-------- -------- -------- --------
Total telephone (excluding ........ 25,588 29,047 3,459 2,212
depreciation and amortization)
Other business (2) .................. 12,490 15,337 2,847 2,171
Unallocated corporate costs .......... 3,006 3,334 328 --
-------- -------- -------- --------
Operating expenses (excluding
depreciation and amortization) .. 41,084 47,718 6,634 4,383
-------- -------- -------- --------
EBITDA ................................ 38,268 38,586 318 3,657
Depreciation ........................ 15,521 17,890 2,369 1,118
Amortization ........................ 2,762 1,463 (1,299) 1,255
-------- -------- -------- --------
Operating profit ...................... 19,985 19,233 (752) $ 1,284
========
Other income (expense) ................ (12,812) (9,842) 2,970
-------- -------- --------
Income before income taxes, minority
interests, and operations of Morgan 7,173 9,391 2,218
Provision for income taxes ............ (3,454) (3,924) (470)
Minority interests .................... (1,185) (1,706) (521)
-------- -------- --------
Income before operations of Morgan .... $ 2,534 $ 3,761 $ 1,227
======== ======== ========
(1) Represents management's estimate of the portion of the increase (decrease)
between 2001 and 2002 that was attributable to the inclusion of the results
of the 2001 Acquisitions for a full year in 2002 compared to a partial year
in 2001.
(2) General and administrative costs at operations in the Company's
Consolidated Statement of Operations includes $8,901 and $11,176 included
herein as Other Telephone Related and $1,425 and $2,133 included herein as
Other Business as of December 31, 2001 and 2002, respectively.
-21-
Revenues:
- ---------
Local access revenue increased by $1.5 million in 2002 compared to 2001, of
which the CUT acquisition resulted in $1.0 million of such increase. An
additional increase of $0.3 million resulted from a change in Michigan
regulatory rules that re-categorized a portion of intrastate access revenue to
local in 2002 and in future periods.
Interstate access revenue increased by $4.9 million in 2002 compared to 2001, of
which the CUT acquisition resulted in $2.7 million of such increase. The USF
support portion of interstate revenue increased $1.5 million resulting from the
effect of infrastructure development at several of our telephone companies,
which entitles such companies to additional USF support. In addition, interstate
access revenue increased $0.6 million primarily due to the recovery in revenue
of increased operating expenditures, in accordance with our ratemaking
structure, associated with the increased infrastructure development.
Intrastate access revenue increased by $0.1 million in 2002 compared to 2001.
Revenues in Michigan were down by $0.7 million resulting from a negotiated
structural change in the reporting of access minutes with the intrastate
carrier, including $0.3 million reclassification to local revenue (see above).
In addition, the continuing reductions in intrastate access minutes caused by
competition from other providers, primarily wireless, resulted in a $0.5 million
reduction in revenue. Such revenue reductions were offset by an increase of $1.3
million due to the effect of the CUT acquisition.
Other Business revenue in 2001 includes $2.8 million of one-time contingent fee
relating to administrative fee services that it had performed for an affiliate
in an auction for wireless spectrum. In 2002, other business revenues increased
$2.5 million in security operations, resulting from the acquisition of American
Alarm Company (63.6% owned) in November 2001 and $0.5 million due to the CUT
acquisition.
Operating and Other Expenses:
- -----------------------------
Operating expenses, excluding depreciation and amortization, were $47.7 million
in 2002, an increase of $6.6 million over the prior year, of which the 2001
Acquisitions accounted for $4.4 million of the increase. Excluding the effects
of the 2001 Acquisitions, plant costs and customer operations were flat between
the two years. Other telephone related costs increased $2.3 million in 2002
compared to 2001, of which $0.9 million was due to the CUT acquisition. In
addition, $0.9 million of bad debt expense was incurred in 2002 associated with
the bankruptcies of MCI/Worldcom and Global Crossings. Other business costs
increased $2.8 million of which $2.2 million was due to the 2001 Acquisitions.
Unallocated corporate costs increased $0.3 million to $3.3 million in 2002. The
increase resulted from a $0.4 million increase in the bonus accrual.
Approximately $0.6 million in legal costs incurred defending the "qui tam"
litigation in 2002, see Contingencies below, were offset by $0.7 million in
litigation costs incurred in 2001.
Depreciation expense increased $2.4 million, of which $1.1 million was due to
the 2001 Acquisitions and $1.1 million was due to increased infrastructure
development at several of the telephone companies. Amortization expense
decreased $1.3 million due to a $2.8 million reduction in the amortization of
goodwill, offset by an increase in the amortization of subscriber lists due
almost entirely to the American Alarm acquisition. In accordance with Financial
Accounting Standards ("SFAS") No. 142, Goodwill and Other Intangible Assets,
effective January 1, 2002, the Company no longer amortized goodwill and other
intangible assets, deemed to have indefinite lives. In November 2001, the
Company acquired American Alarm. At that time, $4.0 million of the acquisition
price was allocated to customer contracts, which for nine months of 2002 were
amortized over 3 years. During the fourth quarter of 2002, based on Company
specific experience, the amortization period was changed to 10 years. During
2002, the Company recorded $1.2 million of amortization expense associated with
these contracts.
As a result of the above, operating profit was $19.2 million in 2002, $0.8
million less than the $20.0 million recorded in 2001.
-22-
EBITDA
- ------
See the above table for a reconciliation of EBITDA to Operating profit and to
Income before income taxes, minority interest and operations of Morgan.
Increase Effect of
2001 2002 (Decrease) Acquisitions(1)
-----------------------------------------------
(in thousands)
Telephone:
Revenues ........................ $ 57,008 $ 63,494 $ 6,486 $ 5,077
Operating expenses (excluding
depreciation and amortization 25,588 29,047 3,459 2,212
-------- -------- -------- --------
31,420 34,447 3,027 2,865
Other business:
Revenues ........................ 22,344 22,810 466 2,963
Operating expenses (excluding
depreciation and amortization) 12,490 15,337 2,847 2,171
-------- -------- -------- --------
9,854 7,473 (2,381) 792
-------- -------- -------- --------
EBITDA from operations ............ 41,274 41,920 646 3,657
Unallocated corporate costs ....... 3,006 3,334 328 --
-------- -------- -------- --------
EBITDA ............................ $ 38,268 $ 38,586 $ 318 $ 3,657
======== ======== ======== ========
(1) Represents management's estimate of the portion of the increase
(decrease) between 2001 and 2002 that was attributable to the inclusion of the
results of the 2001 Acquisitions for a full year in 2002 compared to a partial
year in 2001.
EBITDA (earnings before interest, taxes, depreciation and amortization)
increased by $0.3 million to $38.6 million in 2002 when compared to 2001. EBITDA
from operations increased $0.6 million in 2002. The 2001 Acquisitions increased
EBITDA by $3.7 million, which was partially offset by the absence in 2002 of the
$2.8 million of one-time contingent fee revenue earned in 2001.
Other Income (Expense)
- ----------------------
The Company has made loans to and has investments in PTPMS Communications II,
LLC, totaling $6.2 million. PTPMS II acquired wireless spectrum in an auction
conducted by the Federal Communications Commission in 2000 called the 700 MHz
Guard Band Auction. In a FCC auction conducted in September 2002 for similar
spectrum called the Lower 700 MHz Band Auction, the price per MHz of population
was materially lower than the price paid by PTPMS II in 2000. Accordingly,
during 2002, Interactive provided for the impairment of its investment in PTPMS
II of $5.5 million ($3.6 net of income tax effects).
During 2002, the Company sold its interest in a cellular partnership in New
Mexico RSA # 1 (North) for $5.5 million resulting in a pre-tax gain of $5.0
million ($2.5 million net of income tax and minority interests effect).
In 2001, the Company provided a $3.2 million impairment loss to write down to
zero its investment in Spinnaker Industries Inc. On November 13, 2001, Spinnaker
announced that it had commenced voluntary proceedings under Chapter 11 of the
U.S. Bankruptcy Code for the purpose of facilitating and accelerating its
financial restructuring. In late March 2002, all assets of Spinnaker were sold
and equity holders received no value.
In 2002 investment income was down by $1.1 million from the previous year due to
lower levels of treasury rates, in which the Company invests the predominant
amount of its liquid assets. In addition, 2001's investment income included
approximately $1.0 million of gains in connection with the Company's investment
in Tremont Advisers, Inc. All of the Company's interest in Tremont was sold in
October 2001 when Tremont was acquired by Oppenheimer Funds, Inc. at a price of
$19.00 per share. Offsetting these 2001 gains, there was higher dividend income
in 2002 from the Company's ownership of bank stocks.
Interest expense decreased from 2001 to 2002 by $0.9 million due primarily to
reduced interest rates, lower levels of borrowings and the absence, in 2002, of
a collateral fee $0.6 million associated with a Put on the Company's convertible
debt outstanding. Offsetting these decreases, interest expense increased during
2002 from 2001 due to the full year effect of debt incurred for the acquisitions
of Central Utah and American Alarm. In November 2002, the Company
-23-
reacquired its Convertible Note issued to Cascade Investments LLC, there was
$0.7 million of interest expense and other costs associated with this note in
2002.
Income Tax Provision
- --------------------
The income tax provision includes federal as well as state and local taxes. The
tax provision in 2002 and 2001, represent effective tax rates of 41.8% and
48.2%, respectively. The differences from the federal statutory rate are
principally the effect of state income taxes, and in 2001 the amortization of
goodwill, which is not deductible for tax purposes.
Minority Interests
- ------------------
Minority interests decreased earnings by $1.7 million in 2002 and $1.2 million
in 2001. The change was principally due to minority interest associated with the
gain from the 2002 sale of New Mexico RSA 1 (North) offset by net losses at
American Alarm for which there is a 36.4% minority ownership.
Income From Continuing Operations
- ---------------------------------
The Company recorded income from continuing operations in 2002 of $3.8 million,
$1.34 per share (basic and diluted), as compared to income from continuing
operations in 2001 of $2.5 million, or $0.90 per share (basic and diluted). The
following were the significant causes of the variance: (1) the absence of the
administrative fee in 2002 reduced net income by $1.7 million, (2) the absence
of the reserve for impairment in Spinnaker increased net income by $2.1 million,
(3) the gain in 2002 on the sale of New Mexico RSA # 1 (North) increased net
income by $2.5 million, (4) the provision for impairment of spectrum license
holders reduced net income in 2002 by $3.6 million and (5) the amortization of
goodwill prior to the adoption by the Company of the non-amortization provision
SFAS 142 which decreased 2001 net income by $2.4 million.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
Cash Requirements
- -----------------
The debt at each of Interactive's subsidiary companies contains restrictions on
the amount of funds that can be transferred to their respective parent
companies. The Interactive parent company ("Parent Company") needs cash
primarily to pay corporate expenses, federal income taxes and to invest in new
opportuniti