sec document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K/A
AMENDMENT NO. 2
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2004
-----------------
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission file number 1-15097
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LYNCH INTERACTIVE CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 06-1458056
-------- ----------
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
401 Theodore Fremd Avenue
Rye, New York 10580
(Address of principal executive offices) (Zip code)
(914) 921-8821
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of each Exchange on which Registered
------------------- -----------------------------------------
Common Stock, $.0001 par value 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 Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-20). Yes / / No / X /
The aggregate market value of voting stock held by non-affiliates of the
Registrant as of June 30, 2004 (based upon the closing price of the Registrant's
Common Stock on the American Stock Exchange of $34.54 per share) was $72.0
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 2,752,251
as of July 25, 2005.
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EXPLANATORY NOTE
This Report on Form 10-K/A amends Lynch Interactive's Annual Report on Form 10-K
for the year ended December 31, 2004, initially filed with the Securities and
Exchange Commission on April 1, 2005 as amended by Form 10-K/A, filed with the
Securities and Exchange Commission on May 2, 2005. This Form 10-K/A includes
Part I, Item 1, Business; Part I, Item 7, Management's Discussion and Analysis
of Financial Conditions and Results of Operations; and the Company's Financial
Statements and Financial Statement Schedules. The Company has revised its
business description to expand several sections, add captions to more easily
locate certain information and add a paragraph discussing government contracts.
Additionally, the Company has re-named the non-GAAP financial measure, "EBITDA
from operations" as "Adjusted Operating Profit" and has provided a
reconciliation to net income. The Company has also revised its disclosure to
indicate that management uses Adjusted Operating Profit as an indicator of
operating performance and that it believes this non-GAAP financial measure
provides useful information to investors.
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. In its first day of trading, Interactive
closed at $28.00 (adjusted for stock splits). 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. Interactive spun off its ownership interest in Sunshine
PCS to its shareholders in 2001 and its 63% interest in the Morgan Group, Inc.
to its shareholders in 2002. 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.
LYNCH INTERACTIVE CORPORATION TO CONSIDER DELISTING, AND GOING TO WHAT WALL
STREET REFERS TO AS "PINK SHEETS", AND OTHERS REFER TO AS "GOING DARK"
The Company's Board of Directors has voted to include in our proxy statement for
the 2005 annual meeting a proposal that the shareholders give the Board of
Directors authority to execute a "going dark" transaction, pursuant to which the
company would reduce its number of shareholders of record below 300 through a
reverse split and then delist from the American Stock Exchange, thereby
suspending its reporting obligations under the Securities Exchange Act of 1934.
If this transaction is consummated, the Company's common stock would be quoted,
if at all, in the "pink sheets". We point out that not withstanding trading
volumes, the Company currently intends voluntarily to disseminate press
releases, quarterly financial statements, and audited annual financial
statements to its stockholders and the investment community generally.
The principal reason for considering this step is the cost required to comply
with section 404 of the Sarbanes-Oxley Act of 2002. While the Company is
committed to having in place and consistently improving those controls necessary
to generate reliable financial statements, the documentation and testing process
required by section 404 of Sarbanes-Oxley will likely impose considerable costs
and a staffing strain on the Company and its subsidiaries unless the standards
are revised for smaller companies. The Company believes it is appropriate to
consider ways to mitigate these significant burdens.
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. Since
1989, Interactive has acquired fourteen telephone companies, four of which have
indirect minority ownership of 2% to 19%, whose operations range in size from
approximately 900 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, 2004, total lines,
including both access and DSL, were 54,901, 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
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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. In March 2005, the administrative law judge for the
California Public Utilities Commission issued a proposed opinion approving the
transaction subject to various conditions. The Company is reviewing the opinion,
which remains subject to the approval of the Commission.
PRINCIPAL PRODUCTS AND SERVICES. 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. 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 Federal Communications
Commission ("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").
PRODUCT STATUS. The Company is always trying to roll out new services based on
technological advances. 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. Interactive is currently exploring how to best incorporate Voice over
Internet Protocol ("VoIP") into its business model.
The following table summarizes certain information regarding Interactive's
multimedia operations:
Years Ended December 31,
2002 2003 2004
------------- ---------- ----------
TELECOMMUNICATIONS OPERATIONS
Access lines (a) 53,963 52,517 50,803
DSL Lines 1,466 2,709 4,098
------------ ----------- ----------
Total access lines 55,429 55,226 54,901
% Residential 74% 73% 76%
% Business 26% 27% 24%
Internet subscribers (including DSL) 21,890 20,853 20,240
Security customers 6,500 6,712 6,667
Cable subscribers 2,831 2,731 3,630
TOTAL MULTIMEDIA REVENUES
Local service 14% 14% 13%
Network access 61% 62% 63%
Other businesses 24% 24% 25%
------------ ----------- ----------
Total multimedia revenues 100% 100% 100%
============ =========== ==========
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(a) An "access line" is a telecommunications circuit between the customer's
establishment and the central switching office.
(b) Other Businesses includes Internet, security, CLEC, CATV and other
non-regulated revenues.
TELEPHONE ACQUISITIONS. Interactive pursues an active program of acquiring
operating telephone companies. Since 1989, 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 YR. LINES OWNERSHIP
ACQUISITION OF ACQ. 12/31/04 PERCENTAGE
-----------------------------------------------------------------------------------------------------------
Western New Mexico Telephone Co. 1989 4,200 6,906 83.1(c)
Inter-Community Telephone Co. 1991 2,550(a) 2,569 100.0
Cuba City Telephone Co. &
Belmont Telephone Co. 1991 2,200 2,629 81.0
Bretton Woods Telephone Co. 1993 250 908 100.0
JBN Telephone Co. 1993 2,300(b) 2,653 98.0
Haviland Telephone Co. 1994 3,800 3,705 100.0
Dunkirk & Fredonia Telephone Co.
& Cassadaga Telephone Co. 1996 11,100 11,682 100.0
Upper Peninsula Telephone Co. 1997 6,200 6,641 100.0
Central Scott Telephone Co. 1999 6,000 5,837 100.0
Central Utah Telephone Co./Skyline
Telephone Company/Bear Lake
Telephone Company 2001 7.000 7,273 100.0
(a) Includes 1,350 access lines acquired in 1996.
(b) Includes 354 access lines acquired in 1996.
(c) Does not include a 36% interest in a company that owns the 16.9%
minority interest. The Company is in the process of acquiring the
remaining 64% interest subject to final negotiations. Closing is
expected by the second quarter of 2005.
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. At times, 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, 2004,
Internet access customers totaled 20,240 compared to 20,853 at December 31,
2003. Interactive companies have increased DSL service offset by a decrease in
dial up service. Affiliates of six 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
Buffalo, New York, and two other western New York counties. Some of DFT's CLEC
services are being provided via an unbundled network elements platform (UNE-P),
which allows for increased margins over a resale CLEC business model. In
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addition, DFT is in position with network functions and agreements to begin
offering services through their own facilities. 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 2,400 subscribers.
Central Telcom Services, LLC, a 100% owned subsidiary of the Company based in
Fairview, Utah, acquired certain cable television assets in February 2004 and
has entered into an agreement in January 2005 to acquire a cable television
system located in nearby counties. The acquisition closed in March 2005, after
completion of necessary regulatory approvals and other steps. The acquisition
expanded Lynch Interactive's existing customer base by 2,411 cable subscribers
and positions the company to promote additional services to its customer base.
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 6,667 alarm customers. As part of Company's effort to reduce debt
and or monetize certain assets, it is considering selling a portion of its alarm
accounts.
A subsidiary of Inter-Community Telephone Company in North Dakota, and Western
New Mexico Telephone Company in New Mexico have filed with their respective
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 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 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.
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INTERCARRIER COMPENSATION REFORM. The FCC released a Further Notice of Proposed
Rulemaking ("FNPRM") on March 3, 2005 to examine all aspects of intercarrier
compensation including access charges, reciprocal compensation, transport and
transiting services, as well as, various network interconnection issues.
Currently, the rate for intercarrier compensation depends on the type of traffic
at issue, the types of carriers involved, and the end points of the
communication. Many believe these rate differentials create both opportunities
for regulatory arbitrage and incentives for inefficient investment and
deployment decisions. The intent of this proceeding is to replace the existing
patchwork of intercarrier compensation rules with a unified approach.
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.
On February 25, 2005, the FCC adopted measures addressing the minimum
requirements for a telecommunications carrier to be designated as an eligible
telecommunications carrier ("ETC") and thus be eligible to receive federal USF.
All of Interactive's companies are already designated as ETCs. New carriers
seeking ETC designation must now:
o Provide a five-year plan demonstrating how high-cost universal service
support will be used to improve its coverage, service quality or
capacity throughout the service area for which it seeks designation.
o Demonstrate its ability to remain functional in emergency situations.
o Demonstrate that it will satisfy consumer protection and service
quality standards.
o Offer local usage plans comparable to those offered by the incumbent
local exchange carrier ("ILEC") in the areas for which it seeks
designation.
o Acknowledge that it may be required to provide equal access, if all
other ETCs in the designated service area relinquish their
designations.
The FCC added that these same requirements are applicable to ETCs previously
designated by the commission, and these carriers must submit evidence by October
1, 2006, showing compliance. The FCC encourages states that have jurisdiction
over ETC designations to adopt these requirements.
The FCC adopted the Rural Task Force ("RTF") order related to USF for rural
carriers in May 2001 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. On June 28, 2004, the FCC referred the issue of what modifications
are needed for rural carriers for a post-RTF USF mechanism to a Federal-State
Joint Board on Universal Service after June 2006.
The federal and state USF mechanisms, including that which the Company receives,
are subject to considerable scrutiny and possible modification by the FCC. 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.
VOICE OVER INTERNET PROTOCOL. 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
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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 or wireless broadband
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.
Competition in our specific wireline telecommunications markets is becoming more
significant in the areas closest to larger towns or metropolitan areas. 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. The total number of competitors is difficult to
estimate since many of the companies do not have a local presence but, instead
compete for services via the internet using Vo IP or wireless operations.
As a result of the 1996 Act, FCC and state regulatory authority initiatives and
judicial decisions aimed at increasing competition, certain telecommunications
providers have attempted to bypass local exchange carriers 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 reduce regulations and introduce more
competition among providers of local services. In addition, regulatory
authorities in certain states, such as New York, have taken steps to promote
competition in local telephone exchange service by requiring certain companies
to offer wholesale rates to resellers. To date, no substantial impact has been
seen on Interactive's telephone subsidiaries, which do not consider this a
significant near-term competitive threat due to the limited number of
high-volume customers they serve.
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
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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.
Based upon a multiple of twelve times broadcast cash flow, plus cash, less debt,
Interactive estimates its value in these stations at almost $16 million as
compared to the net book value of these investments of a negative $0.6 million.
It is not assured that the results of these stations will continue at the
current level or that they could be sold at twelve 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 cable television 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 Services
("DBS") 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.
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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.
OTHER
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. During 2004,
the Company received a cash distribution from Sunshine equal to $.83 per share
and on March 25, 2005, Sunshine was quoted at $.12 per share on bulletin board
market.
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. In a February 2005 FCC auction for
similar spectrum, the price per MHz of population was materially lower than the
price paid by Interactive for this spectrum. Accordingly, at December 31, 2004,
Interactive recorded a $0.3 million impairment of this investment, which is
included in amortization expense.
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 committed to donate 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. In a February 2005 FCC
auction for similar spectrum, the price per MHz of population was materially
lower than the price paid by Interactive for this spectrum. Accordingly, at
December 31, 2004, Interactive recorded a $0.4 million impairment of this
investment, which is included in amortization expense.
10
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 of
68,470.
RSA CELLULAR INTERESTS. Interactive owns 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 $2.9 million in 2004 on a combined basis and the combined book
value of these entities was $6.3 million at December 31, 2004. Interactive's
proportional share of these operations combined revenues, EBITDA and operating
profits were $3.9 million, $1.9 million and $1.6 million respectively, for the
year ended December 31, 2004, and we received $0.7 million in cash
distributions, net of cash paid to minority interests, from these investments in
2004. An additional $0.9 million was received from these investments in the
first quarter of 2005. 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 $1.1 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.
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. 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.
11
In July 2004, Lynch 3G participated in the Auction for 24 GHz Spectrum and was
high bidder for two licenses, Buffalo - Niagara, NY and Davenport, IA - Moline,
IL, for a total cost of $49,000.
In February 2005, Lynch 3G participated in Auction 58 for PCS Spectrum and was
high bidder for two licenses, Marquette, MI and Klamath Falls, OR, for a total
cost of $0.5 million.
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.
MORGAN GROUP HOLDING COMPANY. 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.
II. OTHER INFORMATION
PATENTS, LICENSES, FRANCHISES. 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) FCC licenses to
operate point-to-point microwave systems; (4) licenses held by partnerships and
corporations in which certain of Interactive's subsidiaries own minority
interests to operate cellular telephone systems covering various service areas
in New Mexico and North Dakota, (5) Giant Communications' 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.
COMPLIANCE. 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.
SEASONALITY. No portion of the business of Interactive is regarded as seasonal.
While Interactive's New Hampshire and Michigan operations usage varies during
the year due to tourism and vacation homes in their areas, this is not material
for Interactive's telephone operations as a whole.
DEPENDENCE ON CUSTOMERS. 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 which are
referred to as interexchange carriers (IXCs). Bankruptcy of a significant IXC or
of several IXCs in the same period could have a material adverse effect on
Interactive. Interactive cannot predict which, if any, IXCs may go bankrupt in
the future.
12
GOVERNMENT CONTRACTS. Interactive provides service to the government under
tariff or special contract. Interactive's government contracts are not
significant and it would not adversely impact its operations if those contracts
were eliminated.
EMPLOYEES. Interactive had a total of 356 employees at December 31, 2004,
including 6 corporate employees and the remainder responsible for providing
rural telephone services, compared to 349 employees at December 31, 2003.
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 Offices and Positions Held Age
Mario J. Gabelli Chairman and Chief Executive Officer of Lynch 62
Interactive since December 2004 (and also from
September 1999 to December 2002) and Vice
Chairman and Chief Executive Officer from
December 2002 to December 2004. He is also
Chairman, Chief Executive 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 GGCP,
Inc., a private company.
Robert E. Dolan Chief Financial Officer (since January 2004); 53
Chief Financial Officer 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 47
2003); Vice President-Regulatory Affairs
(2002-2003); Director of Revenue Requirements of
Western New Mexico Telephone Company, Inc. (since
1992).
John A. Cole Vice President-Corporate Development, Secretary 54
and General Counsel (since December 2004);
Counsel at LeBoeuf, Lamb, Greene & MacRae, LLP
(1994 to 2004).
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.
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.
13
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 the current reporting period,
Interactive (and its predecessor corporation) 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 dependent 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. The Company
expects to recover settlements from MCI in 2005.
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 Act
("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. Due to the nature of the Company's regulated
telephone operations, revenues and operating expenses are relatively stable
period to period.
o Local Revenues - The number of access lines is the primary driver of
local network access revenues. In addition, the ratio of business to
residential lines, 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 All of our RLECs participate in the National Exchange Carrier
Association ("NECA") access pools. 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 nine cost-based
carriers directly correlate to the rate-of-return on regulated net
investment earned by the NECA access pools plus the amount of
14
regulated operating expenses including taxes. The revenues of the
Company's five average schedule subsidiaries correlate to usage based
measurements such as access lines, interstate minutes-of-use, and the
number and mileage of different types of circuits. The average
schedule formulas are 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 certain 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 it is
providing the long distance service to the end user customer as the
toll provider. For unaffiliated IXCs who contract with Interactive for
billing services, the Company provides billing services and receives
an administrative handling fee.
The following are material opportunities, challenges and risks that
Interactive's executives are currently focused on, as well as actions that are
being taken to address the concerns:
o Universal Service Reform: Efforts to modify universal service
mechanisms are currently underway at the FCC. In June 2004, the FCC
asked the Federal-State Joint Board on Universal Service ("Joint
Board") to review the rules relating to the high-cost universal
service support mechanisms for rural carriers and to determine the
appropriate rural mechanism to succeed the five-year plan adopted in
the RURAL TASK FORCE ORDER. In particular, the FCC asked the Joint
Board to make recommendations on a long-term universal service plan
that ensures that support is specific, predictable, and sufficient to
preserve and advance universal service. The FCC asked the Joint Board
to ensure that its recommendations are consistent with the goal of
ensuring that consumers in rural, insular, and high-cost areas have
access to telecommunications and information services at rates that
are affordable and reasonably comparable to rates charged for similar
services in urban areas. The FCC also asked the Joint Board to
consider how support can be effectively targeted to rural telephone
companies serving the highest cost areas, while protecting against
excessive fund growth. In conducting its review, the Joint Board is
supposed to take into account the significant distinctions among rural
carriers, and between rural and non-rural carriers and consider all
options for determining appropriate universal service support. The
Company participated with the RLEC industry in comments to the FCC
regarding the potential impact to customers and RLECs in rural
America. Total USF support payments are material to the Company'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. VoIP traffic currently does not pay access charges or
contribute to universal service. The FCC has several proceedings
underway to determine whether VoIP traffic should contribute for the
use of the network and contribute to USF. The Company is participating
in the RLEC industry efforts to have VoIP traffic contribute for use
of the underlying network on which the VoIP call travels. To offset
revenue losses from traditional voice services, Interactive is
installing more broadband services and is exploring how to best
incorporate VoIP into its business model.
15
o Intrastate revenue at our Michigan telephone company could be
substantially reduced in the future due to a state requirement to
expand the local calling area. The Company intends to file with the
state commission recover some or all of the revenue deficiency,
however, there is no assurance that it will be successful.
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. Accordingly,
the amounts for Morgan are reflected on a one-line basis in the consolidated
financial statements as "to be distributed to shareholders."
YEAR 2004 COMPARED TO 2003
The following is a breakdown of revenues and operating costs and expenses for
2004 and 2003 (in thousands):
-------------------------- Increase
2004 2003 (Decrease)
-------------------------------------------
(Unaudited)
Revenues:
Local access $ 11,851 $ 11,836 $ 15
Interstate access 39,644 37,686 1,958
Intrastate access 15,263 15,352 (89)
Other business 21,036 20,518 518
----------- ------------- ---------------
Total 87,794 85,392 2,402
----------- ------------- ---------------
Operating Cost and Expense:
Cost of revenue, excluding depreciation 29,992 29,460 532
General and administrative costs at
operations 13,800 12,693 1,107
Corporate office expenses 6,401 4,529 1,872
Depreciation and amortization 21,870 20,282 1,588
----------- ------------- ---------------
Total 72,063 66,964 5,099
----------- ------------- ---------------
Operating profit $ 15,731 $ 18,428 $ (2,697)
=========== ============= ===============
Total revenues in 2004 increased $2.4 million, or 2.8%, to $87.8 million
compared to $85.4 million in 2003. Local access revenue increased by $15,000 in
2004 resulting from the sale of additional features and rate increases,
partially offset by a 3.3% decrease in access lines. The decrease in access
lines is due to the increase in cell phone usage and reduction in dial-up
internet service. Interstate access revenue increased $2.0 million in 2004
primarily due to infrastructure development undertaken in 2002 and 2003, which
entitled the Company to increased network access and USF support primarily at
the Haviland Telephone Company in Kansas. Such increase was partially offset by
the loss of a telecommunications transport contract in Utah and by a one-time
NECA adjustment to our reported rate base, which reduced revenue. Intrastate
network access revenue decreased $0.1 million as increases resulting from the
infrastructure development in Haviland were offset by an increase in local
dial-up access to the internet at our Michigan telephone company. Other business
revenues increased $0.5 million due to increased DSL penetration, the sale of
telecommunications equipment to an Iowa school district, revenues from a small
cable company in Utah that the Company acquired in February 2004, and partially
offset by lower revenues in the Company's security operation.
Total costs and expenses increased by $5.1 million to $72.1 million in 2004.
Costs of revenue increased $0.5 million, or 1.8%, due to additional operating
costs related to the infrastructure development in Haviland, costs related to
the sale of equipment to the Iowa school district, costs generated by the cable
television operation acquired in February 2004 and partially offset by cost
savings in the Company's security operation. General and administrative costs
incurred at the operations increased $1.1 million primarily due to increased
staffing, increased audit and consulting costs resulting from Sarbanes-Oxley
implementation, increased advertising, and higher professional fees offset by a
$0.1 million decrease in consulting fees relating to the Kansas Commission audit
incurred in 2003. Corporate office expenses increased $1.9 million resulting
16
from $3.2 million of legal costs incurred defending the False Claims Act
litigation in 2004, partially offset by the absence in 2004 of a $1.6 million
management incentive accrual recorded in 2003. Depreciation and amortization
increased $1.6 million including an increase of $0.5 million in depreciation and
$1.1 million of amortization expense. The increase in depreciation was primarily
as a result of the infrastructure development at Haviland, as well as a
regulatory approved change in depreciable lives, which resulted in increased
depreciation expense at our Michigan telephone company. The increase in
amortization resulted from the Company's 2004 annual test of goodwill and other
indefinite life intangible assets for impairment in accordance with SFAS No.142.
Interactive recorded a $0.7 million impairment of its investments in certain
10MHz PCS licenses in Las Cruces, NM and Logan, UT. Such impairment was based on
a February 2005 FCC auction of similar spectrum in which the price per MHz of
population was materially lower than the price Interactive paid for such
spectrum. In addition, $0.5 million of goodwill was considered to be impaired
and was written off in amortization expense.
As a result of the above, operating profit in 2004 decreased by $2.7 million to
$15.7 million compared to 2003.
ADJUSTED OPERATING PROFIT
Adjusted operating profit is used by our management as a supplemental financial
measure to evaluate the operating performance of our business that, when viewed
with our GAAP results and the accompanying reconciliations, we believe provides
a more complete understanding of factors and trends affecting our business than
the GAAP results alone. We also regularly communicate our adjusted operating
profit to the public through our earnings releases because it is the financial
measure commonly used by analysts that cover the telecommunications industry and
our investor base to evaluate our operating performance. In addition, we
routinely use adjusted operating profit as a metric for valuing potential
acquisitions. We understand that analysts and investors regularly rely on
non-GAAP financial measures, such as adjusted operating profit, to provide a
financial measure by which to compare a company's assessment of its operating
performance against that of other companies in the same industry. This non-GAAP
financial measure is helpful in more clearly reflecting the sales of our
products and services, as well as highlighting trends in our core business that
may not otherwise be apparent when relying solely on GAAP financial measures,
because this non-GAAP financial measure eliminates from earnings financial items
that have less bearing on our performance.
Interactive's management believes strongly in growing intrinsic value as a
long-term prescription for managing an enterprises health. Our local management
teams run their respective businesses as stand-alone, entrepreneurial units. We
believe that adjusted operating profit is the clearest indicator of the cash
flow generating ability and long-term health of such units. We value potential
acquisitions on the same basis.
The term "adjusted operating profit" as used in this Form 10-K/A refers to, for
any period, net income (loss) before all components of "Other income (expense)"
(consisting of investment income, interest expense, equity in earnings of
affiliates, gains and losses on disposition of or impairment of assets), income
taxes, depreciation, amortization, minority interests and income or loss from
discontinued operations.
Set forth below are descriptions of the financial items that have been excluded
from net income (loss) to calculate adjusted operating profit and the material
limitations associated with using this non-GAAP financial measure as compared to
the use of the most directly comparable GAAP financial measure:
o The amount of interest expense we incur is significant and reduces the
amount of funds otherwise available to use in our business and,
therefore, is important for investors to consider. However, management
does not consider the amount of interest expense when evaluating our
core operating performance.
o Investment income is considered to be similar to interest expense.
Although it is important for investors to consider, management does
not consider the amount of investment income when evaluating our core
operating performance.
17
o Management does not consider income tax expense when considering the
profitability of our core operations. Nevertheless, the amount of
taxes we are required to pay reduces the amount of funds otherwise
available for use in our business and thus may be useful for an
investor to consider.
o Depreciation and amortization are important for investors to consider,
even though they are non-cash charges, because they represent
generally the wear and tear on our property, plant and equipment,
which produce our revenue. We do not believe these charges are
indicative of our core operating performance.
o Income from equity investments relates to our proportionate share of
income or loss from the entities in which we hold minority interests.
We do not control these entities and, as such, do not believe the
income we receive from such entities is indicative of our core
operating performance.
o Minority interest in (income) loss of subsidiaries relates to our
minority investors' proportionate share of income or losses in our
non-wholly owned subsidiaries, which generated non-cash charges to our
operating results. Operating results attributable to these minority
investors' investments do not necessarily result in any actual benefit
or detriment to us and, therefore, we believe it would be more helpful
for an investor to exclude such items as being more reflective of our
core operating performance.
o Gain or losses on the disposition of assets or impairment of
investments may increase or decrease the cash available to us and thus
may be important for an investor to consider. We are not in the
business of acquiring or disposing of assets and, therefore, the
effect of the dispositions of assets may not be comparable from
year-to-year. We believe such gains or losses recorded on the
disposition of an asset do not reflect the core operating performance
of our business.
Management compensates for the above-described limitations of using a non-GAAP
financial measure by using this non-GAAP financial measure only to supplement
our GAAP results to provide a more complete understanding of the factors and
trends affecting our business. Adjusted operating profit should not be
considered to be a substitute for net income or (loss) as an indicator of the
Company's operating performance.
The following table provides the components of Adjusted Operating Profit and
reconciles it to net income:
--------------------------- Increase
2004 2003 (Decrease)
--------------------------- ---------
Adjusted operating profit from: $ 44,002 $ 43,239 $ 763
Operating units
Corporate expense:
False Claims Act litigation
and SOX consulting (3,501) (24) (3,477)
Bonus accrual -- (1,600) 1,600
Other (2,900) (2,905) 5
-------- -------- --------
Total corporate expenses (6,401) (4,529) (1,872)
-------- -------- --------
Adjusted operating profit $ 37,601 $ 38,710 $ (1,109)
======== ======== ========
RECONCILIATION TO NET INCOME:
Adjusted operating profit $ 37,601 $ 38,710 $ (1,109)
Depreciation and amortization (21,870) (20,282) (1,588)
Investment income 1,289 1,120 169
Interest expense (11,204) (11,864) 660
Equity in income of affiliates 3,564 2,280 1,284
Gains/ losses/ impairments, net 185 3,919 (3,734)
Income tax (3,078) (4,968) 1,890
Minority interests (2,021) (1,525) (496)
-------- -------- --------
Net income $ 4,466 $ 7,390 $ (2,924)
======== ======== ========
18
OTHER INCOME (EXPENSE)
In 2004, investment income increased by $0.2 million primarily due to an
increase in CoBank patronage refunds offset by a reduction in interest income
due to lower interest rates.
Interest expense decreased by $0.7 million in 2004 compared to 2003 due
primarily to lower outstanding borrowings partially offset by higher interest
rates.
Equity in earnings of affiliates in 2004 increased $1.3 million compared to 2003
due to higher earnings at the Company's New Mexico cellular investments (RSA 3
and 5).
INCOME TAX PROVISION
The income tax provision includes federal, as well as state and local taxes. The
tax provision for the 2004 and 2003, represent effective tax rates of 36.8% and
35.8%, respectively. The difference between these effective rates and the
federal statutory rate is principally due to state income taxes, including the
effect of earnings attributable to different state jurisdictions. In addition,
in December 2004 Interactive reversed certain tax reserves that were no longer
required.
MINORITY INTERESTS
Minority interests decreased earnings by $2.0 million in 2004, as compared to
$1.6 million in 2003. The change was due to higher earnings from the Company's
New Mexico cellular investments.
NET INCOME
Net income in 2004, was $4.5 million, or $1.61 per share (basic and diluted),
compared to a net income last year of $7.4 million, or $2.64 per share (basic
and diluted). The Company has no dilutive instruments outstanding.
19
YEAR 2003 COMPARED TO 2002
The following is a breakdown of revenues and operating costs and expenses for
2003 and 2002:
--------------------- Increase
2003 2002 (Decrease)
---------------------------------
(Unaudited)
Revenues:
Local access $ 11,836 $ 11,890 (54)
Interstate access 37,686 34,830 2,856
Intrastate access 15,352 16,723 (1,371)
Other business 20,518 20,782 (264)
-------- -------- ----
Total 85,392 84,225 1,167
-------- -------- ----
Operating Cost and Expense:
Cost of revenue, excluding depreciation, 29,460 29,020 440
General and administrative costs at
operations 12,693 13,285 (592)
Corporate office expenses 4,529 3,334 1,195
Depreciation and amortization 20,282 19,353 929
-------- -------- ----
Total 66,964 64,992 1,972
-------- -------- ----
Operating profit $ 18,428 $ 19,233 (805)
======== ======== ====
Total revenues in 2003 increased $1.2 million, or 1.4%, to $85.4 million
compared to $84.2 million in 2002. Local access revenue decreased by $54,000 in
2003 compared to 2002 as a 2.7% 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 $2.9 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 $0.3 million in 2003
compared to 2002. The sale of a wireless equipment operation in upstate New York
with 2002 revenues of $0.8 million was offset by a $0.6 million increase due to
additional subscribers in 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.
20
Total costs and expenses increased by $2.0 million to $67.0 million in 2003.
Cost of revenue increased $0.4 million, or 1.5%, due to additional operating
costs related to the infrastructure development in Haviland, additional
bandwidth and system maintenance costs in 2003, and a $0.8 million reduction in
costs due to the sale of a wireless business in upstate New York in late 2002.
General and administrative costs at the operations decreased $0.6 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. 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.
ADJUSTED OPERATING PROFIT
The following table provides the components of Adjusted Operating Profit and
reconciles it to net income:
---------------------- Increase
2003 2002 (Decrease)
---------------------- ------------
Adjusted operating profit from:
Operating units $ 43,239 $ 41,920 $ 1,319
Corporate expense:
False Claims Act litigation
and SOX consulting (24) (515) 491
Bonus accrual (1,600) (463) (1,137)
Other (2,905) (2,356) (549)
-------- -------- --------
Total corporate expenses (4,529) (3,334) (1,195)
-------- -------- --------
Adjusted operating profit $ 38,710 $ 38,586 $ 124
======== ======== ========
Reconciliation to net income:
Adjusted operating profit $ 38,710 $ 38,586 $ 124
Depreciation and amortization (20,282) (19,353) (929)
Investment income 1,120 1,765 (645)
Interest expense (11,864) (13,031) 1,167
Equity in income of affiliates 2,280 1,938 342
Gains/losses/impairments, net 3,919 (514) 4,433
Income tax (4,968) (3,924) (1,044)
Minority Interests (1,525) (1,706) 181
-------- -------- --------
Loss from Morgan (discontinued) - (1,888) 1,888
Net income $ 7,390 $ 1,873 $ 5,517
======== ======== ========
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.
21
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.
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.
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY
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
opportunities, including spectrum licenses. The Parent Company receives cash to
meet its obligations primarily through management fees charged to its
22
subsidiaries, a tax sharing agreement with its subsidiaries, usage of a line of
credit facility, and has obtained additional liquidity by refinancing certain
subsidiary debt. In addition, the Parent Company considers various alternative
long-term financing sources: debt, equity, or sale of investments and other
assets.
The Parent Company's short-term line of credit facility, which expires August
31, 2005, has a maximum availability totaling $5.0 million, $3.8 million of
which was available at December 31, 2004. The Company is pursuing various
financing alternatives including a replacement for its current line of credit
with a larger business base renewal of the line of credit, refinancing
substantially all or individual pieces of its currently outstanding debt, and
sale of certain investments. The Company expects to obtain an additional line of
credit in the next year. While it is management's belief that the Company will
have adequate resources to fund operations over the next twelve months, there
can be no assurance that the Company will obtain financing on terms acceptable
to management. The obtaining of a replacement line of credit is a critical
element of the Company's financing strategy.
The Company's RLECs and other businesses need cash to fund their current
operations, as well as future long-term growth initiatives. Each RLEC and other
business finances its cash needs with cash generated from operations, by
utilizing existing borrowing capacity or by entering into new long-term debt
agreements. New business acquisitions are generally financed with a combination
of new long-term debt, secured by the acquired assets, as well as cash from the
Parent. While management expects that both Parent and the operating subsidiaries
will be able to obtain adequate financing resources to enable the Company to
meet its obligations, there is no assurance that such can be readily obtained or
at reasonable costs. The Company is obligated under long-term debt provisions
and lease agreements to make certain cash payments over the term of the
agreements. The following table summarizes, as of December 31, 2004 for the
periods shown, these contractual obligations and certain other financing
commitments from banks and other financial institutions that provide liquidity:
Payments Due by Period
(In thousands)
Less than
Total 1 year 1 - 3 years 4 - 5 years After 5 years
----------------------------------------------------------------------------
Long-term debt (a) $168,966 $ 14,364 $ 66,085 $ 35,966 $ 52,551
Operating leases 1,343 283 503 248 309
Notes payable to banks 4,793 4,793 -- -- --
Guarantees 3,750 -- 3,750 -- --
----------------------------------------------------------------------------
Total contractual cash obligations
and commitments $178,852 $ 19,440 $ 70,338 $ 36,214 $ 52,860
============================================================================
(a) Does not include interest payments on debt.
23
A subsidiary of the Company has guaranteed $3.8 million of an equity investees'
total debt of $10.1 million. The guarantee is in effect for the duration of the
loan which expires on December 31, 2005 and would be payable if the equity
investee fails to make such payment in accordance with the terms of the loan.
At December 31, 2004, total debt (including notes payable to banks) was $173.8
million, a decrease of $5.5 million from December 31, 2003. At December 31,
2004, there was $106.5 million of fixed interest rate debt outstanding averaging
7.0% and $67.2 million of variable interest rate debt averaging 5.3%. The debt
at fixed interest rates includes $39.0 million of subordinated notes at interest
rates averaging 9.5% issued to sellers as part of acquisitions. The long-term
debt facilities at certain subsidiaries are secured by substantially all of such
subsidiaries assets, while at other subsidiaries it is secured by the common
stock of such subsidiaries. In addition, the debt facilities contain certain
covenants restricting distribution to Lynch Interactive. At December 31, 2003
and 2004, substantially all of the subsidiaries' net assets are restricted.
Interactive has a high degree of financial leverage. As of December 31, 2004,
the ratio of total debt to equity was 5.0 to 1. Certain subsidiaries also have
high debt to equity ratios. Management believes that it is currently more
beneficial to hold excess cash at certain of our subsidiaries rather than
utilizing the cash to pay-down existing credit facilities.
As of December 31, 2004, Interactive had current assets of $39.4 million and
current liabilities of $35.5 million resulting in a working capital surplus of
$3.9 million compared to a surplus of $7.2 million at December 31, 2003. This
$3.3 million reduction in the surplus was primarily due to the receipt in 2004
of a $2.4 million federal income tax refund included in the December 31,2003
balance sheet. In 2004, net cash provided by operations of $27.8 million was
used to invest in plant and equipment, to invest in cable assets and to repay
debt.
SOURCES AND USES OF CASH
Cash at December 31, 2004, was $27.2 million, an increase of $0.7 million
compared to 2003. In 2004, net cash provided by operations of $27.3 million was
used to invest in plant and equipment, to invest in cable assets and repay debt.
In 2003, net cash provided by operations of $29.1 million and $7.6 million
proceeds from the sale of Interactive's investment in Sunshine were used to
invest in plant and equipment and repay debt. In 2002, the Company used $7.6
million of restricted cash as part of the repurchase of $10.5 million of
convertible debt. In addition, in 2002, Interactive received $3.0 million of
cash proceeds for the sale of a minority interest in a cellular operation and
issued $7.1 million in long-term debt.
Capital expenditures were $16.5 million in 2004, $22.7 million in 2003, and
$23.8 million in 2002 which is predominantly spent at the RLECs and will be
included in their rate bases for rate setting purposes. Capital expenditures in
2005 are expected to be approximately $10 million, most of which will be added
to the RLEC rate bases.
24
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. The cash proceeds were used to repay amounts outstanding under the
$10 million credit facility. As part of this transaction, Interactive agreed to
provide an indemnification to Cingular for up to $8 million of losses that
Cingular might incur in the event of an adverse ruling in the False Claims Act
litigation (see Contingencies below) in which Interactive and Sunshine are
defendants. Management believes the probability that Cingular will incur such
losses is highly remote.
The Company has initiated an effort to monetize certain of its assets, including
selling a portion or all of its investment in certain of its operating entities
and equity investments. These initiatives may include the sale of certain
telephone operations where growth opportunities are not readily apparent. There
is no assurance that all or any part of this program can be effectuated on
acceptable terms.
Subsequent to the spin-off by Lynch Corporation, the Board of Directors of Lynch
Interactive Corporation authorized the purchase of up to 100,000 shares of
common stock. Through December 31, 2004, 67,000 shares had been purchased at an
average cost of $32.32 per share including 22,000 shares purchased in 2004 at an
average investment of $31.05 per share. Subsequent to year-end, an additional
5,700 shares have been acquired at an average investment of $31.53 per share.
President Bush's proposed Budget for Fiscal Year 2006 establishes the process
and terms to implement the dissolution of the Rural Telephone Bank ("RTB").
Under RTB's By-Laws, on dissolution, the holders of its Class B and Class C
stock would be paid the par value of their stock. As of December 31, 2004, the
total par value of RTB Class B and Class C stock at the Company's subsidiaries
was $11.3 million. The net book value and tax basis of this stock, at that date,
was $1.1 million. The dissolution of the RTB and payments to the stock holders
is subject to numerous approvals and actions, including Congressional approval
of President Bush's proposed Budget for Fiscal Year 2006 and actions by RTB's
Board of Directors. Therefore, the Company cannot predict whether, or when, such
payments will actually be made to the Company's subsidiaries.
Lynch Corporation, the Company's predecessor, has not paid any cash dividends on
its common stock since 1989. The Company has not paid any cash dividends since
its inception in 1999 and 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. Further financing may limit or
prohibit the payment of dividends.
CONTINGENCIES
FALSE CLAIMS ACT LITIGATION.
Interactive and several other parties, including Interactive's CEO, 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 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 FCC 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 case
prior to trebling. Later filings have increased this amount and the bidding
credits the defendants received were considerably less than the $88 million
amount reported.
25
Interactive strongly believes that this lawsuit is completely without merit and
that relator's initial damage computations are 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 costs 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.
Interactive was formally served with the complaint on July 10, 2002. On
September 19, 2002, the defendants 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; the defendants 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 time, the judge approved a
scheduling order and discovery commenced.
On July 28, 2004, the judge denied in part and granted in part the motion to
dismiss. Defendant bidding entities that did not win licenses were dismissed and
the "reverse" False Claims Act count was dismissed as redundant. Interactive and
its subsidiaries remain parties to the litigation.
In December 2004, the defendants filed a motion in the United States District
Court for the District of Columbia to compel the FCC to provide certain
information subpoenaed by them in order to enable them to conduct a defense.
This motion was denied in May 2005 and the defendants have filed a notice of
appeal with the United States Court of Appeals for the D.C. Circuit.
See also "Item 3. Legal Proceedings - History of Lynch's C-Block Activities"
above for a history of our involvement in Auction 5.
OTHER LITIGATION.
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.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of consolidated financial statements requires Interactive's
management to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses, and related disclosure of contingent
assets and liabilities. On an ongoing basis, Interactive evaluates its
estimates, including those related to revenue recognition, carrying value of its
investments in spectrum entities and long-lived assets, purchase price
allocations, and contingencies and litigation. Interactive bases its estimates
on historical experience and on various other assumptions that are believed to
be reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions. Interactive believes the
following critical accounting policies affect its more significant judgments and
estimates used in the preparation of its consolidated financial statements.
We believe that revenue from interstate access is based on critical accounting
estimates and judgment. Such revenue is derived from settlements with the
National Exchange Carrier Association ("NECA"). NECA was created by the FCC to
administer interstate access rates and revenue pooling on behalf of small local
exchange carriers who elect to participate in a pooling environment. Interstate
settlements are determined based on the various subsidiaries' cost of providing
interstate telecommunications service. Interactive recognizes interstate access
revenue as services are provided based on an estimate of the current year cost
of providing service. Estimated revenue is adjusted to actual upon the
completion of cost studies in the subsequent period.
26
Interactive's business development strategy is to expand its existing operations
through internal growth and acquisition. From 1989 through 2001, the Company has
acquired twelve telephone companies. Significant judgments and estimates are
required to allocate the purchase price of acquisitions to the fair value of
tangible assets acquired and identifiable intangible assets and liabilities
assumed. Any excess purchase price over the above fair values is allocated to
goodwill. Additional judgments and estimates are required to determine if
identified intangible assets have finite or indefinite lives.
Annually, the Company tests goodwill and other intangible assets with indefinite
lives for impairment. The Company screens for potential impairment by
determining fair value for each reporting unit. We estimate the fair value of
each reporting unit based on a number of subjective factors, including: (a)
appropriate weighting of valuation approaches (income approach, market approach
and comparable public company approach), (b) estimates of our future cost
structure, (c) discount rates for our estimated cash flows, (d) selection of
peer group companies for the public company approach, (e) required level of
working capital, (f) assumed terminal value and (g) time horizon of cash flow
forecasts.
We consider the estimate of fair value to be a critical accounting estimate
because (a) a potential goodwill impairment could have a material impact on our
financial position and results of operations and (b) the estimate is based on a
number of highly subjective judgments and assumptions, the most critical of
which is that the regulatory environment will continue in its current form. In
2004, $0.5 million of goodwill was considered impaired and was charged to income
as amortization expense.
Interactive tests its investments and other long-term non-regulated assets
annually whenever events or changes in circumstances indicate that the carrying
value of such assets may not be recoverable. Significant judgment is required to
determine if an impairment has occurred and whether such impairment is "other
than temporary." In 2004, Interactive recorded a $0.7 million impairment of its
investment in certain 10 MHz spectrum based on a materially lower price paid for
similar spectrum in a 2005 auction. In 2002, Interactive provided $5.5 million
for the impairment of an investment in wireless spectrum purchased in 2001,
based on a materially lower price paid for similar spectrum in 2002. In 2001, we
wrote down the investment in Spinnaker Industries to zero, based on our judgment
that the decline in the quoted value was "other than temporary."
The calculation of depreciation and amortization expense is based on the
estimated economic useful lives of the underlying property, plant and equipment
and intangible assets. Although Interactive believes it is unlikely that any
significant changes to the useful lives of its tangible or intangible assets
will occur in the near term, rapid changes in technology, the discontinuance of
accounting under SFAS No. 71 by the Company's wireline subsidiaries, or changes
in market conditions could result in revisions to such estimates that could
materially affect the carrying value of these assets and the Company's future
consolidated operating results.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board ("FASB") issued Financial
Interpretation No. 46, "Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51" (FIN 46) in January 2003 and revised it in
December 2003 (FIN 46R). FIN 46 requires certain variable interest entities to
be consolidated by the primary beneficiary of the entity if the equity investors
in the entity do not have the characteristics of a controlling financial
interest or do not have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support from other parties.
The provisions of FIN 46R were applicable for the first interim or annual period
ending after March 15, 2004 for both new and existing variable interest
entities. Certain less than 50% owned investments in limited liability
companies, which were considered to be variable interest entities, needed to be
consolidated as a result of the implementation of FIN 46. The effect of
consolidating such operations resulted in increasing intangible assets and
decreasing investments in and advances to affiliated companies by approximately
$2 million and had no other significant effect on the Company's consolidated
financial statements.
In November 2002, the Emerging Issues Task Force of the FASB reached a consensus
on EITF No. 00-21, "Accounting for Revenue Arrangements with Multiple
Deliverables" ("EITF No. 00-21"). EITF No. 00-21 addresses how to account for
arrangements that may involve multiple revenue-generating activities. The
Company adopted this guidance on January 1, 2003, which did not have a material
effect on our consolidated results of operations, consolidated financial
position or consolidated cash flows.
27
In December 2003, the SEC issued Staff Accounting Bulletin ("SAB") No. 104,
"Revenue Recognition," which revises or rescinds certain sections of SAB No.
101, "Revenue Recognition," in order to make this interpretive guidance
consistent with current authoritative accounting and auditing guidance and SEC
rules and regulations. The changes noted in SAB No. 104 did not have a material
effect on the Company's consolidated results of operations, consolidated
financial position or consolidated cash flows.
In December 2004, the FASB issued SFAS No.153, "Exchanges of Nonmonetary
Assets", which eliminates the exception for nonmonetary exchanges of similar
productive assets and replaces it with a general exception for exchanges of
nonmonetary assets that do not have commercial substance. SFAS No.153 will be
effective for nonmonetary asset exchanges occurring in fiscal periods beginning
after June 15, 2005. The Company does not believe the adoption of SFAS No.153
will have a material impact on its consolidated financial statements.
In December 2004, the FASB issued SFAS No.123(R), "Share-Based Payment", which
establishes standards for transactions in which an entity exchanges its equity
instruments for goods or services. This standard requires a public entity to
measure the cost of employee services received in exchange for an award of
equity instruments based on the grant-date fair value of the award. This
eliminates the exception to account for such awards using the intrinsic method
previously allowable under APB Opinion No.25. SFAS No.123(R) will be effective
for interim or annual reporting periods beginning on or after June 15, 2005. The
Company is currently evaluating the impact of the adoption of SFAS No.123(R)
will have on its consolidated financial statements.
28
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as part of this Form 10-K/A Annual
Report:
Financial Statements:
Reports of Independent Registered Public Accounting Firms and the
following Financial Statements of the Company are included herein:
Consolidated Balance Sheets - December 31, 2003 and 2004 Consolidated
Statements of Operations - Years ended December 31, 2002, 2003 and
2004 Consolidated Statements of Shareholders' Equity - Years ended
December 31, 2002, 2003 and 2004 Consolidated Statements of Cash Flows
- Years ended December 31, 2002, 2003 and 2004 Notes to Consolidated
Financial Statements
Financial Statement Schedules:
Schedule I - Condensed Financial Information of Registrant
Schedule II - Valuation and Qualifying Accounts
All other schedules for which provision is made in the applicable accounting
regulation of the Securities and Exchange Commission are not required under the
related instructions, or are inapplicable, and therefore have been omitted.
(b) Exhibits: The following Exhibits listed in the Exhibit Index are
filed with this Form 10-K/A Annual Report:
31.1 Rule 13a-14(a) Certification of the Chief Executive Officer
31.2 Rule 13a-14(a) Certification of the Chief Financial Officer
32.1 Section 1350 Certification of the Chief Executive Officer
32.2 Section 1350 Certification of the Chief Financial Officer
29
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Lynch Interactive Corporation
Rye, New York
We have audited the accompanying consolidated balance sheets of
Lynch Interactive Corporation and subsidiaries (the "Company") as of December
31, 2004 and 2003, and the related consolidated statements of operations,
stockholders' equity, and cash flows for the years then ended. Our audit also
includes the 2004 financial statement schedules listed in the Index at Item
15(a) (2). These consolidated financial statements and financial statement
schedules are the responsibility of the Company's management. Our responsibility
is to express an opinion on these consolidated financial statements and
financial statement schedules based on our audits.
We conducted our audits in accordance with standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audits included consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present
fairly, in all material respects, the financial position of Lynch Interactive
Corporation and subsidiaries as of December 31, 2004 and 2003, and the results
of their operations and their cash flows for the years then ended, in conformity
with accounting principles generally accepted in the United States of America.
Also, in our opinion, such 2004 and 2003 financial statement schedules, when
considered in relation to the basic consolidated financial statements taken as a
whole, present fairly in all material respects the information set forth
therein.
/s/ DELOITTE & TOUCHE LLP
--------------------------
New York, New York
March 31, 2005
30
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders of Lynch Interactive Corporation
We have audited the accompanying consolidated statements of operations,
shareholders' equity, and cash flows of Lynch Interactive Corporation (the
"Company") and subsidiaries for the year ended December 31, 2002. Our audit also
included the 2002 financial statement schedules listed in the index at Item
15(a). These financial statements and schedules are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and schedules based on our audit. We did not audit the
following: the financial statements of Cuba City Telephone Exchange Company and
Belmont Telephone Company, indirect wholly-owned subsidiaries of Lynch
Interactive Corporation, which statements reflect total revenues of $2,117,000
for the year ended December 31, 2002; and the financial statements of Upper
Peninsula Telephone Company, an indirect wholly-owned subsidiary of Lynch
Interactive Corporation, which statements reflect total revenues of $10,986,000
for the year ended December 31, 2002. Those financial statements were audited by
other auditors whose reports have been furnished to us, and our opinion, insofar
as it relates to the amounts included in the consolidated financial statements
and financial statement schedules for Cuba City Telephone Exchange Company and
Belmont Telephone Company and Upper Peninsula Telephone Company, is based solely
on the reports of the other auditors.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit and the reports of
other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audit and the reports of other auditors, the
financial statements referred to above present fairly, in all material respects,
the consolidated results of operations and cash flows of Lynch Interactive
Corporation and subsidiaries for the year ended December 31, 2002, in conformity
with U.S. generally accepted accounting principles. Also, in our opinion, based
on our audit and the reports of other auditors, the related 2002 financial
statement schedules, when considered in relation to the basic financial
statements taken as a whole, present fairly in all material respects the
information set forth therein.
/s/ Ernst & Young LLP
----------------------
Stamford, Connecticut
March 14, 2003
31
LYNCH INTERACTIVE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
December 31,
------------------------
2003 2004
------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 26,556 $ 27,214
Receivables, less allowances of $262 and $260, respectively 8,183 8,225
Material and supplies 2,597 2,314
Prepaid expenses and other current assets 1,272 1,685
------------------------
Total current assets 38,608 39,438
Property, plant and equipment:
Land 840 983
Buildings and improvements 13,336 17,640
Machinery and equipment 213,939 216,429
------------------------
228,115 235,052
Accumulated depreciation (102,556) (114,724)
------------------------
125,559 120,328
Excess of cost over fair value of net assets acquired, net (goodwill) 60,580 60,042
Other intangibles 8,168 10,026
Investments in and advances to affiliated entities 7,223 12,340
Other assets 12,657 14,906
------------------------
Total assets $ 252,795 $ 257,080
========================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
32
LYNCH INTERACTIVE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
December 31,
----------------------------
2003 2004
----------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Notes payable to banks $ 3,456 $ 4,793
Trade accounts payable 5,336 4,326
Accrued interest payable 697 825
Accrued liabilities 8,732 11,238
Current maturities of long-term debt 13,162 14,364
----------------------------
Total current liabilities 31,383 35,546
Long-term debt 162,621 154,602
Deferred income taxes 15,517 17,549
Other liabilities 3,624 3,268
----------------------------
Total liabilities 213,145 210,965
Minority interests 9,763 11,543
Commitments and contingencies (Note 12)
Shareholders' equity
Common stock, $0.0001 par value-10,000,000
shares authorized; 2,824,766 issued; 2,779,951
and 2,757,951 outstanding -- --
Additional paid-in capital 21,406 21,406
Retained earnings 9,269 13,735
Accumulated other comprehensive income 686 1,588
Treasury stock, 44,815 and 66,815 shares, at cost (1,474) (2,157)
----------------------------
29,887 34,572
----------------------------
Total liabilities and shareholders' equity $ 252,795 $ 257,080
============================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
33
LYNCH INTERACTIVE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Years Ended December 31,
-----------------------------------------------
2002 2003 2004
-----------------------------------------------
Revenues $ 84,225 $ 85,392 $ 87,794
Operating costs:
Cost of revenue, excluding depreciation 29,020 29,460 29,992
General and administrative costs at operations 13,285 12,693 13,800
Unallocated corporate costs 3,334 4,529 6,401
Depreciation and amortization 19,353 20,282 21,870
-----------------------------------------------
Operating profit 19,233 18,428 15,731
Other income (expense):
Investment income 1,765 1,120 1,289
Interest expense (13,031) (11,864) (11,204)
Equity in earnings of affiliated companies 1,938 2,280 3,564
Impairment of investment in spectrum license holders (5,479) -- --
Gain on sale of investment in cellular partnership 4,965 -- --
Gain on sale of investments in Sunshine PCS -- 3,919 185
-----------------------------------------------
(9,842) (4,545) (6,166)
-----------------------------------------------
Income before income taxes, minority interests, and 9,391 13,883 9,565
operations of The Morgan Group, Inc. ("Morgan")
distributed to Shareholders
Provision for income taxes (3,924) (4,968) (3,078)
Minority interests (1,706) (1,525) (2,021)
-----------------------------------------------
Income from continuing operations before operations 3,761 7,390 4,466
of Morgan distributed to shareholders
Loss from operations of Morgan to be distributed to (1,888) -- --
shareholders net of income taxes of $0 and minority
interests of $868
-----------------------------------------------
Net income $ 1,873 $ 7,390 $ 4,466
===============================================
Basic and diluted weighted average shares outstanding 2,805 2,786 2,769
===============================================
Basic and diluted earnings (loss) per share:
Income before operations of Morgan to be distributed to $ 1.34 $ 2.65 $ 1.61
Shareholders
Loss from operations of Morgan distributed to (0.67) -- --
Shareholders
-----------------------------------------------
Net income per share $ 0.67 $ 2.65 $ 1.61
===============================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
34
LYNCH INTERACTIVE CORPORATION AND SUBSIDIAIRES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
Shares of Accumulated
Common Additional Other
Stock Out- Common Paid-in Retained Comprehensive Treasury
standing Stock Capital Earnings Income Stock Total
-------------------------------------------------------------------------------------------
Balance at December 31, 2001 2,820,051 $ 0 $ 21,406 $ 1,800 $ 1,542 $ (231) $ 24,517
Dividend of shares of Morgan Group -- -- -- (1,794) -- -- (1,794)
Holding Inc.
Net income for the period -- -- -- 1,873 -- -- 1,873
Unrealized loss on available for -- -- -- -- (780) -- (780)
sale securities, net
Reclassification adjustment -- -- -- -- (228) -- (228)
-----------
Comprehensive income -- -- -- -- -- -- 865
-----------
Purchase of Treasury Stock (27,400) -- -- -- -- (956) (956)
-------------------------------------------------------------------------------------------
Balance at December 31, 2002 2,792,651 0 21,406 1,879 534 (1,187) 22,632
Net income for the period -- -- -- 7,390 -- -- 7,390
Unrealized gain on available for sale -- -- -- -- 322 -- 322
securities, net
Reclassification adjustment -- -- -- -- (170) -- (170)
-----------
Comprehensive income -- -- -- -- -- -- 7,542
-----------
Purchase of Treasury Stock (12,700) -- -- -- -- (287) (287)
-------------------------------------------------------------------------------------------
Balance at December 31, 2003 2,779,951 0 21,406 9,269 686 (1,474) 29,887
Net income for the period -- -- -- 4,466 -- -- 4,466
Unrealized gain on available for sale -- -- -- -- 902 -- 902
securities, net
Reclassification adjustment -- -- -- -- -- -- --
-----------
Comprehensive income 5,368
Purchase of Treasury Stock (22,000) -- -- -- -- (683) (683)
-------------------------------------------------------------------------------------------
Balance at December 31, 2004 2,757,951 $ 0 $ 21,406 $ 13,735 $ 1,588 $ (2,157) $ 34,572
===========================================================================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
35
LYNCH INTERACTIVE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
Years Ended December 31,
----------------------------------
2002 2003 2004
----------------------------------
OPERATING ACTIVITIES
Net income $ 1,873 $ 7,390 $ 4,466
Depreciation and amortization 19,353 20,282 21,870
Minority interests 1,706 1,525 2,021
Equity in earnings of affiliated companies (1,938) (2,280) (3,564)
Provision for impairment of investment in spectrum license holders 5,479 -- --
Gain on sale of investment in cellular partnership (4,965) -- --
Gain on sale of investment in Sunshine PCS -- (3,919) (185)
Gain on sale of securities (228) (171) --
Deferred income taxes 398 8,869 1,598
Non-cash items and changes in operating assets and liabilities from 1,888 -- --
operations of Morgan Group Holding Co. to be distributed to shareholders
Changes in operating assets and liabilities, net of effects of acquisitions:
Trade accounts receivable (increase) decrease 1,047 733 5
Trade accounts payable and accrued liabilities increase (decrease) 563 (4,219) 1,779
Other 328 893 (660)
----------------------------------
Net cash provided by operating activities 25,504 29,103 27,330
----------------------------------
INVESTING ACTIVITIES
Acquisitions (net of debt assumed and cash equivalents acquired) -- -- (377)
Capital expenditures (23,785) (22,740) (16,468)
Acquisition of subscriber lists (301) (372) (305)
Investment in affiliated companies -- -- (4,688)
Returns from spectrum partnerships 333 -- --
Acquisition of spectrum licenses (1,121) (617) (49)
Proceeds from sale of cellular partnership 2,958 -- --
Proceeds from sale of investment in Sunshine PCS -- 7,587 244
Proceeds from sale of securities 398 285 2
Distributions received from investments -- 1,500 1,229
Other 516 (382) 776
----------------------------------
Net cash used in investing activities (21,002) (14,739) (19,636)
----------------------------------
FINANCING ACTIVITIES
Issuance of long-term debt 7,087 11,772 5,973
Payments to reduce long-term debt (21,056) (12,610) (13,345)
Net borrowings (payments) related to lines of credit 2,546 (9,426) 1,337
Purchase of Treasury stock (956) (287) (683)
Other -- (613) (318)
----------------------------------
Net cash used in financing activities (12,379) (11,164) (7,036)
----------------------------------
Net increase (decrease) in cash and cash equivalents (7,877) 3,200 658
Cash and cash equivalents at beginning of year 31,233 23,356 26,556
----------------------------------
Cash and cash equivalents at end of year $ 23,356 $ 26,556 $ 27,214
==================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
36
LYNCH INTERACTIVE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
1. ACCOUNTING AND REPORTING POLICIES
ORGANIZATION
Lynch Interactive Corporation, (the "Company" or "Interactive") was formed on
September 1, 1999, when Lynch Corporation ("Lynch") distributed 100 percent of
the outstanding shares of common stock of Interactive, its wholly owned
subsidiary, to the then holders of record of Lynch's common stock ("Spin-Off"),
in the form of a tax-free distribution. As part of the Spin-Off, Interactive
received one million shares of common stock of Spinnaker Industries, Inc.
representing an approximately 13.6% equity ownership interest (and an
approximate 2.5% voting interest) and Interactive also assumed certain short
term and long term debt obligations of Lynch Corporation.
Interactive and Lynch have entered into certain agreements governing various
ongoing relationships, including the provision of support services and a tax
allocation agreement. The tax allocation agreement provides for the allocation
of tax attributes to each company as if it had actually filed with the
respective tax authority.
The Company's long term debt facilities contain covenants that restrict the
distribution of cash and other net assets between subsidiaries or to the parent
company.
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 of the stock of Morgan Group Holding Co., a corporation that was
initially formed to serve as a holding company for, among other business
purposes, Interactive's controlling interest in Morgan.
BASIS OF PRESENTATION
The accompanying consolidated financial statements represent the accounts of
Interactive and its majority owned subsidiaries which primarily consists of its
telephone (81%-100% owned), cable television (100% owned) and security (63.6%
owned from date of acquisition of American Alarm on November 30, 2001)
subsidiaries. All material intercompany transactions and balances have been
eliminated. Investments in affiliates in which the Company does not have a
majority voting control but has the ability to significantly influence financial
and operating policies are accounted for in accordance with the equity method.
The Company accounts for the following affiliated companies on the equity basis
of accounting:
o Coronet Communications Company (20% owned),
o Capital Communications Company, Inc. (49% of common equity owned and
100% of convertible preferred owned, when converted, equals 50% of all
equity),
o KMG Holdings Group, Inc. (37% owned from May 2004),
o Two cellular telephone providers in New Mexico, both 33% owned,
o Telecommunications operations in North Dakota, Iowa and New York (5%
to 14% owned through partnerships).
The Company's telephone subsidiaries are public utilities that are regulated by
both the Federal Communications Commission (FCC) and various state commissions.
These subsidiaries follow the accounting prescribed by the Uniform System of
Accounts of the FCC and the state commissions and Statement of Financial
Accounting Standards (SFAS) No. 71, "Accounting for the Effects of Certain Types
of Regulation." Where applicable, this accounting recognizes the economic
effects of rate regulation by recording costs and a return on investment as such
amounts are recovered through rates authorized by regulatory authorities.
37
USE OF ESTIMATES/RECLASSIFICATIONS
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that effect the amounts reported in
the financial statements and accompanying notes. Actual results could differ
from those estimates. Certain prior year amounts in the accompanying
consolidated financial statements have been reclassified to conform to current
year presentation.
CASH AND CASH EQUIVALENTS
Cash equivalents consist of highly liquid investment with a maturity of three
months or less when purchased.
MARKETABLE SECURITIES
Marketable securities, included in other assets, consist principally of publicly
traded common stocks. At December 31, 2003 and 2004, Interactive's investment in
marketable securities, which had carrying values of $2.5 million and $3.9
million, respectively, were entirely classified as available-for-sale. Such
carrying values include Interactive's 4.8% investment in Hector Communications
(AMEX:HCT) valued at $2.3 million and $3.6 million at December 31, 2003 and
2004, respectively. Available-for-sale securities are stated at fair value with
unrealized gains or losses included in equity as a component of comprehensive
income (loss). Unrealized (losses) gains on available-for-sale securities were
($1.3 million), ($0.4 million), and $1.4 million for the years ended December
31, 2002, 2003 and 2004, respectively and have been included in the Consolidated
Statements of Shareholder's Equity, as "Accumulated other comprehensive income."
The cost of marketable securities sold is determined on the specific
identification method. Realized gains included in investment income were $0.4
million, $0.3 million and $-- million for the years ended December 31, 2002,
2003 and 2004, respectively.
INVESTMENT INCOME - PATRONAGE
CoBank, from which the Company has loans totaling $51.9 million at December 31,
2004, is a cooperative, owned and controlled by its customers. Each customer
borrowing from the bank shares in the bank's net income through payment of
patronage refunds. Approximately 50% of patronage refunds are received in cash,
with the balance in CoBank stock. Patronage stock is redeemable at its face
value for cash when the related debt is paid off. Total patronage refunds were
$0.6 million, $0.4 million and $0.8 million in 2002, 2003 and 2004, respectively
and were included as investment income in the Company's statement of operations.
The Company cannot predict what patronage refunds might be in future years.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Cash and cash equivalents, trade accounts receivable, short-term borrowings,
trade accounts payable and accrued liabilities are carried at cost which
approximates fair value due to the short-term maturity of these instruments. The
carrying amount of the Company's borrowings under its revolving line of credit
approximates fair value, as the obligations bear interest at a floating rate.
The fair value of other long-term obligations approximates carrying value based
on borrowing rates for similar instruments.
ACCOUNTS RECEIVABLE
Accounts receivable are recorded at the invoiced amount and do not bear
interest. The allowance for doubtful accounts is the Company's best estimate of
the amount of probable credit losses in the Company's existing accounts
receivable. The Company establishes an allowance for doubtful accounts based
upon factors surrounding the credit risk of specific customers, historical
trends, and other information. Receivable balances are reviewed on an aged basis
38
and account balances are charged off against the allowance after all means of
collection have been exhausted and the potential for recovery is doubtful. Due
to dispersed geographic nature of the Company operations and residential nature
of its customers, no customer account for significant amount of Company's
receivable balances, other than from the National Exchange Carrier Association
discussed below.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are recorded at cost and include expenditures for
additions and major improvements and, for our regulated telephone companies,
include an allowance for funds used during construction (AFUDC). Maintenance and
repairs are charged to operations as incurred. Depreciation of telephone plant
is computed on the straight-line method using class or overall group rates
acceptable to regulatory authorities. Depreciation of non-telephone property is
computed on the straight-line method over the estimated useful lives of the
assets. Depreciable lives for the Company's telephone and non-telephone
properties, excluding land, range from 19 to 45 years for building, 3 to 50
years for machinery and equipment and 4 to 20 years for other assets. During
2003, a Michigan subsidiary revised its depreciation rates to more accurately
reflect asset lives. For income tax purposes, accelerated depreciation methods
are used.
When a portion of the Company's depreciable property, plant and equipment
relating to its telephone operations business is retired, the gross carrying
value of the assets, including cost of disposal and net of any salvage value, is
charged to accumulated depreciation, in accordance with regulated accounting
procedures.
The Company adopted SFAS No. 143 "Accounting for Asset Retirement obligations"
on January 1, 2003. This standard provides accounting guidance for legal
obligations associated with the retirement of long-lived assets that result from
the acquisition, construction or development and (or) normal operation of that
asset. According to the standard, the fair value of an asset retirement
obligation (ARO liability) should be recognized in the period in which (1) a
legal obligation to retire a long-lived asset exists and (2) the fair value of
the obligation based on retirement cost and settlement date is reasonably
estimable. In accordance with federal and state regulations, depreciation
expense for the Company's wireline operations has historically included an
additional provision for cost of removal. The additional cost of removal
provision does not meet the recognition and measurement principles of an asset
retirement obligation under SFAS No. 143. In connection with SFAS No. 143, $1.6
million and $1.7 million at December 31, 2003 and 2004, respectively, for cost
of removal has been classified as a regulatory liability included in long term
liabilities.
GOODWILL AND OTHER INTANGIBLE ASSETS
The Company tests goodwill and other intangible assets with indefinite lives for
impairment using the two-step process prescribed in SFAS No. 142 Goodwill and
Other Intangible Assets. The first step is a screen for potential impairment, in
which we determine the fair value for each reporting unit. We estimate the fair
value of each reporting unit based on a number of subjective factors, including:
(a) appropriate weighting of valuation approaches (income approach, market
approach and comparable public company approach), (b) estimates of our future
cost structure, (c) discount rates for our estimated cash flows, (d) selection
of peer group companies for the public company approach, (e) required level of
working capital, (f) assumed terminal value and (g) time horizon of cash flow
forecasts.
If such tests indicate potential impairment, then a second step measures the
amount of impairment, if any. The Company performed its annual impairment tests
of goodwill as of October 1, 2003 and 2004 and determined that there were no
impairments in 2003, but in 2004, $0.5 million of goodwill was considered
impaired and was charged to income as amortization expense.
In addition to goodwill, intangible assets with indefinite lives consist of
cellular licenses, with a carrying value of $3.3 million and $4.9 million at
December 31, 2003 and 2004 respectively. The increase in 2004 includes the $2.0
million effect of implementing FIN 46 in the first quarter of 2004 (See Recently
Issued Accounting Pronouncements). At December 31, 2004, Interactive recorded a
$0.7 million impairment of its investment in certain 10 MHz spectrum, which is
included in amortization expense. This impairment was based on a February 2005
FCC auction for similar spectrum in which the price per MHz of population was
materially lower than the price paid by Interactive for this spectrum.
39
The Company's subscriber lists are generally amortized over a 10 to 15-year
life. Subscriber lists had a gross value of $8.0 million and $7.9 million and
accumulated amortization of $3.2 million and $3.6 million at December 31, 2003
and 2004, respectively. Amortization expense was $1.5 million, $0.7 million, and
$0.6 million for the years ended December 31, 2002, 2003 and 2004 respectively
and is estimated to be between $0.6 and $0.9 million annually for the next five
years.
IMPAIRMENT OF LONG-LIVED ASSETS
Long-lived assets, such as property, plant, and equipment, and purchased
intangibles subject to amortization, are reviewed for impairment whenever events
or changes in circumstances indicate that the carrying amount of an asset may
not be recoverable. Recoverability of assets to be held and used is measured by
a comparison of the carrying amount of an asset to estimated undiscounted future
cash flows expected to be generated by the asset. If the carrying amount of an
asset exceeds its estimated future cash flows, an impairment charge is
recognized by the amount by which the carrying amount of the asset exceeds the
fair value of the asset. Assets to be disposed of are reported at the lower of
the carrying amount or fair value less costs to sell, and depreciation ceases.
REVENUES
Telephone service revenue is primarily derived from regulated local, intrastate
and interstate access services and is recognized as services are provided.
Revenues are based upon the Company's cost for providing services.
Local access revenue comes from providing local telephone exchange services and
is billed to local end users in advance in accordance with tariffs approved by
each state's Public Utilities Commission. Such advance billings are initially
deferred and recognized as revenue when earned.
Revenue that is billed in arrears includes nonrecurring intrastate and
interstate network access services, nonrecurring local services and long
distance services. The earned but unbilled portion of this revenue is recognized
as revenue in the period that the services are provided.
Revenue from intrastate access is based on tariffs approved by each state's
Public Utilities Commission. Revenue from interstate access is derived from
settlements with the National Exchange Carrier Association (NECA). NECA was
created by the FCC to administer interstate access rates and revenue pooling on
behalf of small local exchange carriers who elect to participate in a pooling
environment. Interstate settlements, including amounts received under Universal
Service Funds, are determined based on the Company's cost of providing
interstate telecommunications service, including investments in specific types
of infrastructure and operating expenses and taxes.
Other businesses revenues include the Company's internet, CLEC, wireless,
long-distance, cable and security operations all of which are recognized as
services are provided.
Alarm system installation revenues, sales revenues on equipment upgrades and
direct incremental costs of installations and sales are deferred for residential
customers with monitoring services contracts. Revenues from monitoring contracts
are recognized in the period such services are provided.
Deferred alarm system installation revenues are recognized over the expected
life of the monitoring contracts of the customer for residential and commercial
customers. Deferred costs in excess of deferred revenue are recognized over the
initial contract term, typically three years. To the extent deferred costs are
less than or equal to deferred revenues, such costs are recognized over the
estimated life of the customer.
EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per common share amounts are based on the average number
of common shares outstanding during each period, excluding the dilutive effects
of options, warrants, and convertible securities. Diluted earnings per share
reflect the effect, where dilutive, of options, warrants and convertible
securities, using the treasury stock and if converted methods as applicable.
40
COMPREHENSIVE INCOME
The Company follows the provisions of SFAS No. 130, "Reporting Comprehensive
Income" that requires unrealized gains or losses, net of tax, on the
Registrant's available-for-sale securities to be included as a separate
component of Shareholder Equity and in other comprehensive income (loss).
MINORITY INTEREST
The Company consolidates certain subsidiaries that are less than 100% owned. The
portion of such subsidiaries not owned by the Company is shown as Minority
Interests in the Consolidated Statements of Operations and Balance Sheets.
ISSUANCE OF STOCK BY SUBSIDIARY AND INVESTEES
Changes in the Company's equity in a subsidiary or an investee caused by
issuances of the subsidiary's or investees' stock are accounted for as gains or
losses where such issuance is not part of a broader reorganization.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board ("FASB") issued Financial
Interpretation No. 46, "Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51" (FIN 46) in January 2003 and revised it in
December 2003 (FIN 46R). FIN 46 requires certain variable interest entities to
be consolidated by the primary beneficiary of the entity if the equity investors
in the entity do not have the characteristics of a controlling financial
interest or do not have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support from other parties.
The provisions of FIN 46R were applicable for the first interim or annual period
ending after March 15, 2004 for both new and existing variable interest
entities. Certain less than 50% owned investments in limited liability
companies, which were considered to be variable interest entities, needed to be
consolidated as a result of the implementation of FIN 46. The effect of
consolidating such operations resulted in increasing intangible assets and
decreasing investments in and advances to affiliated companies by approximately
$2 million and had no other significant effect on the Company's consolidated
financial statements.
In November 2002, the Emerging Issues Task Force of the FASB reached a consensus
on EITF No. 00-21, "Accounting for Revenue Arrangements with Multiple
Deliverables" ("EITF No. 00-21"). EITF No. 00-21 addresses how to account for
arrangements that may involve multiple revenue-generating activities. The
Company adopted this guidance on January 1, 2003, which did not have a material
effect on our consolidated results of operations, consolidated financial
position or consolidated cash flows.
In December 2003, the SEC issued Staff Accounting Bulletin ("SAB") No. 104,
"Revenue Recognition," which revises or rescinds certain sections of SAB No.
101, "Revenue Recognition," in order to make this interpretive guidance
consistent with current authoritative accounting and auditing guidance and SEC
rules and regulations. The changes noted in SAB No. 104 did not have a material
effect on the Company's consolidated results of operations, consolidated
financial position or consolidated cash flows.
In December 2004, the FASB issued SFAS No.153, "Exchanges of Nonmonetary
Assets", which eliminates the exception for nonmonetary exchanges of similar
productive assets and replaces it with a general exception for exchanges of
nonmonetary assets that do not have commercial substance. SFAS No.153 will be
effective for nonmonetary asset exchanges occurring in fiscal periods beginning
after June 15, 2005. The Company does not believe the adoption of SFAS No.153
will have a material impact on its consolidated financial statements.
41
In December 2004, the FASB issued SFAS No.123(R), "Share-Based Payment", which
establishes standards for transactions in which an entity exchanges its equity
instruments for goods or services. This standard requires a public entity to
measure the cost of employee services received in exchange for an award of
equity instruments based on the grant-date fair value of the award. This
eliminates the exception to account for such awards using the intrinsic method
previously allowable under APB Opinion No.25. SFAS No.123(R) will be effective
for interim or annual reporting periods beginning on or after June 15, 2005. The
Company is currently evaluating the impact of the adoption of SFAS No.123(R)
will have on its consolidated financial statements.
2. SPIN-OFF OF MORGAN
In January 2002, Interactive spun off its interest in The Morgan Group, Inc.,
its only services subsidiary, via a tax-free dividend to its shareholders of the
stock of Morgan Group Holding Co., a corporation that was formed to serve as a
holding company for Interactive's controlling interest in The Morgan Group, Inc.
Morgan Group Holding Co. is now a public company. Accordingly, operating results
of Morgan have been segregated from continuing operations and reported as a
separate line item in the Statements of Operations for 2002.
3. ACQUISITIONS
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, a 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. In March 2005,
the administrative law judge for the California Public Utilities Commission
issued a proposed opinion approving the transaction subject to various
conditions. The Company is reviewing the opinion, which remains subject to the
approval of the Commission.
In February 2004, Central Telecom Services, LLC, a 100% owned subsidiary of the
Company completed the acquisition of cable television assets at a cost of $0.4
million. The acquisition was accounted for a purchase, and accordingly, the
assets acquired and liabilities assumed were recorded using a preliminary
estimate of fair market values on the date of acquisition including $50,000
allocated to other intangible assets for the subscriber list. The operating
results of the acquired asset are included in the Statements of Operations from
their acquisition date. The Company has not provided pro forma financial
information for such acquisition because it is not significant.
On April 30, 2004, the Company acquired a 37% interest in an entity (KMG) whose
principal asset consist of a $6.0 million subordinated note and a 17% equity
interest in Lynch Telephone Corporation, a 83% owned subsidiary of the Company.
The remaining 63% ownership of KMG is held by the members or management of
Western New Mexico Telephone Company, Inc. The Company issued a $4.5 million,
8.5% five-year amortizing subordinated note and assumed an additional $0.5
million note from the seller to acquire such interest. In addition to the above
mentioned assets, KMG also owns a lumber yard in Andrews, Texas, and other
investments.
4. WIRELESS COMMUNICATIONS SERVICES
On February 22, 2001, Interactive spun-off to its shareholders 2,800,000 shares
of Sunshine PCS Corporation ("Sunshine") Class A Common Stock. Sunshine was
formed just prior to the spin-off through the merger of Sunshine with Fortunet
Communications Limited Partnership. Interactive converted its 49.9% partnership
interest in Fortunet into 3,000,000 shares of Class A Common Stock of Sunshine
representing 49.9% of Sunshine's common equity interest. As part of the merger,
Interactive exchanged $85 million of subordinated notes of Fortunet into $16.1
million (face value) of subordinated notes in Sunshine, Interactive's carrying
value in these notes was $3.4 million at December 31, 2001. In addition prior to
the spin-off, in exchange for $250,000, Interactive acquired 10,000 shares of
preferred stock in Sunshine with an aggregate liquidation preference of $10.0
million and warrants to purchase 4,300,000 shares of Sunshine Class A Common
Stock at $0.75 per share. Sunshine owns three 15 MHz personal communications
services ("PCS") licenses in Tallahassee, Panama City and Ocala, Florida, areas
covering a total population of 960,000 (based on 2000 census data). During 2002,
as part of a rights offering to its shareholders by Sunshine, Interactive
acquired an additional 58,824 shares of Sunshine's Class A Common Stock at $1.00
per share. Prior to the rights offering, Interactive loaned Sunshine $550,000.
This amount, plus interest of $12,000, was repaid by Sunshine with a portion of
the proceeds of the rights offering.
42
Also during 2002, Interactive exchanged subordinated notes of Sunshine with a
principal amount of $18.5 million into two classes of preferred stock.
Interactive received 12,500 shares of Sunshine's A-1 preferred stock which has a
total liquidation value of $12.5 million and 2,000 shares of Sunshine's A-2
convertible preferred stock which has a liquidation value of $2.0 million and is
convertible into 2.0 million shares of Sunshine Class A Common Stock. Since the
book value of Interactive's investment in the notes was $3.4 million, there was
no impact on the carrying value of the investment in Sunshine as a result of
this restructuring.
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. Due to the ongoing
lawsuit in which Interactive and Sunshine are defendants (see Note 12), Cingular
would not complete the sale without indemnification from losses that could
result from an adverse ruling. As a result, Interactive agreed to provide
Cingular an indemnification for up to $8 million of losses that Cingular might
incur in the event of an adverse ruling. Interactive considers it highly
unlikely that Cingular will incur losses, however, in accordance with the
provisions of FIN 45, the Company recorded an immaterial liability which
represented the Company's best estimate of the fair value of such
indemnification.
During 2000, Interactive invested in limited liability companies, which
participated in various auctions. In the Guard Band auction, PTPMS II
Communications, L.L.C. acquired three licenses at a net cost of $6.3 million;
Interactive has loans to PTPMS II of $6.1 million, and owns 49.9% of PTPMS II's
equity. 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 $5.5 million for the impairment of its investment in
PTPMS II, resulting in a net carrying value, at December 31, 2002, of $0.7
million.
At December 31, 2004 as part of the Company's annual test for impairment of
intangible assets with indefinite lives, Interactive recorded a $0.7 million
impairment of its investments in certain 10 MHz PCS licenses in Logan, UT and
Las Cruces, NM. The impairment was based on a February 2005 FCC auction for
similar spectrum in which the price per MHz of population was materially lower
than the price paid by the Company.
5. INVESTMENTS IN AFFILIATED COMPANIES
Interactive has equity investments in both broadcasting and telecommunications
companies.
Summarized financial information for broadcasting companies accounted for by the
equity method as of and for the years ended December 31, is as follows:
Broadcasting Combined
---------------------------------
2003 2004
---------------------------------
(In thousands)
Current assets $ 5,330 $ 6,896
Property, plant & equipment, intangibles & other 9,615 9,558
---------------------------------
Total Assets $ 14,945 $ 16,454
=================================
Current liabilities $ 3,182 $ 3,383
Long term liabilities 16,483 16,751
Equity (4,720) (3,680)
---------------------------------
Total liabilities & equity $ 14,945 $ 16,454
=================================
2002
-----------------
Revenues $ 14,261 $ 13,155 $ 14,007
Gross profit $ 4,748 $ 3,167 $ 4,965
Net income $ 779 $ (292) $ 1,246
43
A wholly owned subsidiary of the Company has a 20% investment in Coronet
Communications Company ("Coronet"), which operates television station WHBF-TV, a
CBS affiliate in Rock Island, Illinois. A second wholly owned subsidiary of the
Company has a 49% investment in Capital Communications Company, Inc.
("Capital"), which operates television station WOI-TV, an ABC affiliate in Des
Moines, Iowa. At December 31, 2003 and 2004, the investment in Coronet was
carried at a negative $0.8 million and a negative $0.6 million, respectively,
due to the subsidiary's guarantee of $3.8 million of Coronet's third party debt.
The guarantee is in effect for the duration of the loan which expires on
December 31, 2005 and would be payable if the equity investee fails to make such
payment in accordance with the terms of the loan. Long-term debt of Coronet, at
December 31, 2004, totaled $9.5 million payable quarterly through December 31,
2005 to a third party lender.
At December 31, 2003 and 2004, the investment in Capital is carried at zero as
its share of net losses recognized to date have exceeded its net investment and
the Company has no further commitment to Capital. The Company's shares in
Capital have been pledged as security for Capital's long term debt.
Summarized financial information for telecommunications companies which includes
the cellular telephone providers, spectrum license holders, and other
telecommunication operations accounted for by the equity method as of and for
the years ended December 31, is as follows:
Telecommunications Combined
-----------------------------
2003 2004
-----------------------------
(In Thousands)
Current assets $ 30,347 $ 36,080
Property, plant & equipment, intangibles & other 29,320 33,087
-----------------------------
Total Assets $ 59,667 $ 69,167
=============================
Current liabilities $ 23,086 $ 22,745
Long term liabilities 22,614 5,900
Equity 13,967 40,522
-----------------------------
Total liabilities & equity $ 59,667 $ 69,167
=============================
2002
---------------
Revenues $ 43,476 $ 47,392 $ 53,751
Gross profit $ 13,781 $ 16,746 $ 25,618
Net income $ 4,710 $ 12,710 $ 15,247
In January 2002, the Company sold its interest in RSA #1 (North) for $5.5
million ($3.0 million in cash and $2.5 million in satisfaction of a note payable
to the acquiror), and recorded a pre-tax gain of approximately $5.0 million.
Interactive owns a one-third interest in two cellular telephone providers in New
Mexico: New Mexico RSA #3 and RSA #5. The Company's net investment in these
partnerships was $4.6 million and $6.5 million at December 31, 2003 and 2004,
respectively and included in Investment in and Advances to Affiliates.
Undistributed earnings of companies accounted for using the equity method that
are included in consolidated retained earnings are $2.0 million and $3.1 million
at December 31, 2003 and 2004, respectively.
6. NOTES PAYABLE TO BANKS AND LONG-TERM AND CONVERTIBLE DEBT
Long-term debt represents borrowings by specific entities, which are
subsidiaries of Interactive.
44
December 31,
2003 2004
-------------------------------------
(In Thousands)
Long-term debt consists of (all interest rates are at December 31, 2003):
Rural Electrification Administration (REA) and Rural Telephone Bank $ 59,917 $ 57,129
(RTB) notes payable in equal quarterly installments through 2027 at fixed
interest rates ranging from 2% to 7.5% (5.1% weighted average), secured by
assets of the telephone companies of $150 million
Bank credit facilities utilized by certain telephone and telephone holding
companies through 2016, $9.4 million at fixed interest rates averaging
8.3% and $61.0 million at variable interest rates averaging 5.2% 78,646 70,402
Unsecured notes issued in connection with acquisitions through 2008, all at
fixed interest rates averaging 9.75% (primarily held by management of
telephone company's) 34,389 38,983
Other 2,831 2,452
-------------------------------------
175,783 168,966
Current maturities (13,162) (14,364)
-------------------------------------
$ 162,621 $ 154,602
=====================================
REA debt of $8.0 million which bears interest at 2% has been reduced by a
purchase price adjustment of $1.7 million to discount the debt to an imputed
interest rate of 5%. Such discount is being amortized into interest expense
based on the effective interest method over the remaining life of the notes.
Interactive maintains a short-term line of credit facility totaling $7.0
million, on December 31, 2004, which was reduced to $5.0 million on January 31,
2005 and will remain at that level until it expires on August 31, 2005.
Borrowings under this facility were zero and $1.1 million at December 31, 2003
and 2004, respectively. Borrowings outstanding under this facility and other
lines of credit are classified as notes payable in the consolidated balance
sheet. During 2004, the average balance of notes payable outstanding was $5.7
million, the highest amount outstanding was $7.8 million and the average
interest rate was 4.6%.
In general, the long-term debt facilities are secured by substantially all of
the Company's property, plant and equipment, receivables and common stock of
certain subsidiaries and contain certain covenants restricting distributions to
Lynch Interactive. A subsidiary of the Company with a $3.0 million debt facility
received a waiver for a covenant violation at December 31, 2003. At December 31,
2004, the Company is in compliance with all covenants. At December 31, 2003 and
2004, substantially all the subsidiaries' net assets are restricted from
distribution to Lynch Interactive.
The Company has a need for resources primarily to fund future long-term growth
initiatives. The Company considers various alternative long-term financing
sources: debt, equity, or sale of an investment asset. While management expects
to obtain adequate financing resources to enable the Company to meet its
obligations, there is no assurance that such can be readily obtained or at
reasonable costs.
Cash payments for interest were $14.0 million, $12.0 million and $11.1 million
for the years ended December 31, 2002, 2003 and 2004, respectively and $0.2
million, $0.2 million and $0.2 million of interest was capitalized during such
respective periods. Aggregate principal maturities of long-term debt at December
31, 2004 for each of the next five years are as follows: 2005--$14.4 million,
2006--$41.1 million, 2007--$25.0 million, 2008--$24.2 million, 2009--$11.8
million, and the remaining $52.5 million thereafter.
7. RELATED PARTY TRANSACTIONS
Interactive leases its corporate headquarters from an affiliate of its Chief
Executive Officer ("CEO"). The lease was renewed in December 2002 for five years
and calls for an annual payment of $103,000 including utilities. In 2004, an
additional $8,000 was paid due to escalation clauses. Prior to the renewal, the
annual payment was $70,000. In addition, expenses relating to administrative
support, transportation (includes charges for a leased airplane), and
communications (approximately $104,000, $98,000 and $102,000 for the years ended
December 31, 2002, 2003 and 2004, respectively) are paid to an affiliate of its
CEO. See Note 4 for additional references to related party transactions.
45
Expenditures for fees that the Company is incurring with regard to the False
Claims Act litigation are based on allocations among defendants, and are subject
to negotiation. It is expected that the final allocation may be adjusted subject
to final conclusion of the litigation.
At December 31, 2003 and 2004, assets of $15.1 million and $15.2 million, which
are classified as cash and cash equivalents, are invested in United States
Treasury money market funds for which affiliates of the Company's CEO serve as
investment managers to the respective funds.
In 1999, to assist the Company in obtaining the private placement of a $25
million unsecured note to Cascade Investment LLC ("Cascade"), the CEO of the
Company agreed to give Cascade an option to sell the note to him at 105% of the
principal amount thereof. The CEO received no compensation for providing this
option to sell. In 2001, Cascade exercised this option to demand payment on $15
million of the notes. In November 2002, Cascade exercised its option to demand
payment on the remaining $10 million in notes and the Company paid such amount
plus the $0.5 million premium. During the year ended December 31, 2002, the
Company's total expense, interest and fees, associated with the $10 million was
$0.7 million and of this amount $0.1 was paid to an affiliate of the CEO.
8. SHAREHOLDER'S EQUITY
In 1999, Interactive's Board of Directors authorized the purchase of up to
100,000 shares of its common stock. Through December 31, 2004, 67,000 shares
have been purchased at an average investment of $32.32 per share. Subsequent to
year-end, the Company has purchased an additional 5,700 shares at an average
investment of $31.53 per share.
9. INCOME TAXES
Interactive files a consolidated income tax return with its subsidiaries for
federal income tax purposes. Certain entities file separate state and local
income tax returns, while others file on a combined or consolidated basis.
Deferred income taxes for 2003 and 2004 are provided for the temporary
differences between the financial reporting bases and the tax bases of the
Company's assets and liabilities. Cumulative temporary differences at December
31, 2003 and 2004 are as follows:
2003 Deferred Tax 2004 Deferred Tax
Asset Liability Asset Liability
-----------------------------------------------------------------------------
(In Thousands)
Fixed assets revalued under purchase
accounting and tax over book depreciation $ -- $ 9,852 $ -- $ 11,029
Discount on long term debt -- 550 -- 488
Unrealized gains on marketable securities -- 1,441 -- 1,827
Partnership tax losses in excess of book losses 1,863 2,274 1,863 2,669
Other reserves and accruals -- 1,400 -- 1,536
Other 800 -- 1,216 --
-----------------------------------------------------------------------------
Total deferred income taxes 2,663 15,517 3,079 17,549
Valuation Allowance (2,663) -- (3,079) --
-----------------------------------------------------------------------------
$ -- $ 15,517 $ -- $ 17,549
=============================================================================
Due to uncertainty regarding its realization, a valuation allowance of
approximately $1.9 million exists against certain reserves for impairment. The
Company had approximately $16.6 million of state tax net operating loss
carryforwards, expiring between 2005 and 2024. A full valuation allowance has
been recorded against these net operating loss carryforwards.
46
The provision (benefit) for income taxes is summarized as follows:
2002 2003 2004
---------------------------------------------
(In Thousands)
Current payable taxes:
Federal $ 3,016 $ (4,775) $ 831
State and local 510 874 649
---------------------------------------------
3,526 (3,901) 1,480
Deferred taxes:
Federal 15 8,529 1,470
State and local 383 340 128
---------------------------------------------
398 8,869 1,598
---------------------------------------------
$ 3,924 $ 4,968 $ 3,078
=============================================
A reconciliation of the provision (benefit) for income taxes and the amount
computed by applying the statutory federal income tax rate to income before
income taxes, minority interest, and operations of Morgan follows:
2002 2003 2004
------------------------------------------------
(In Thousands)
Tax at statutory rate $ 2,963 $ 4,720 $ 2,847
Increases (decreases):
State and local taxes, net of federal benefit 589 801 513
Other 372 (553) (282)
------------------------------------------------
$ 3,924 $ 4,968 $ 3,078
================================================
Net cash payments (refunds) for income taxes were $3.2 million, $1.0 million,
and ($1.2) million for the three years ended December 31, 2002, 2003 and 2004,
respectively.
10. ACCUMULATED OTHER COMPREHENSIVE INCOME
Balances of accumulated other comprehensive income, net of tax, which consists
of unrealized gains (losses) on available for sale securities at December 31,
2003 and 2004 are as follows:
Unrealized
Gain (Loss) Tax Effect Net
----------------------------------------
(In Thousands)
Balance at December 31, 2002 $ 915 $ (381) $ 534
Reclassification adjustment (280) 110 (170)
Change in unrealized gains (losses), net 405 (83) 322
--------- -------- ---------
Balance at December 31, 2003 1,040 (354) 686
Change in unrealized gains (losses), net 1,370 (468) 902
--------- -------- ---------
Balance at December 31, 2004 $ 2,410 $ (822) $ 1,588
========= ======== =========
Reclassification adjustment represents realized gains (losses) on sales of
available for sale securities.
11. EMPLOYEE BENEFIT PLANS
Interactive maintains several defined contribution plans at its telephone
subsidiaries and corporate office. Interactive's contributions under these
plans, which vary by subsidiary, are based primarily on the financial
performance of the business units and employee compensation. Total expense of
these plans was $1.0 million, $1.1 million and $1.2 million for 2002, 2003 and
2004, respectively.
The Company has a Principal Executive Bonus Plan that has been approved by the
shareholders, for which $0.3 million, $1.3 million, and $0.3 million were
recorded in 2002, 2003, and 2004, respectively.
47
In addition, three of the Company's telephone subsidiaries participate in a
multi-employer defined benefit plan, which is administrated by a telephone
industry association. Under this plan accumulated benefits and plan assets are
not determined or allocated separately by individual employees. Accordingly,
such data is not currently available. Total expenses of these plans were $0.1
million for 2002 and 2003 and $0.2 million in 2004.
12. COMMITMENTS AND CONTINGENCIES
LEASES.
The Company leases certain land, buildings, computer equipment, computer
software, and network services equipment under non-cancelable operating leases
that expire in various years through 2028. Rental expense under operating leases
was $0.3 million, $0.5 million and $0.3 million for years ended December 31,
2002, 2003 and 2004 respectively. Minimum lease payments due under
non-cancelable operating leases at December 31, 2004 are as follows: $0.3
million in 2005; $0.3 million in 2006; $0.2 million in 2007; $0.1 million in
2008, $0.1 million in 2009 and $0.3 million thereafter.
LITIGATION. FALSE CLAIMS ACT LITIGATION.
Interactive and several other parties, including Interactive's CEO, and Fortunet
Communications, L.P., which was Sunshine PCS Corporation's
predecessor-in-interest, have been named as defendants in a lawsuit originally
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 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 (FCC) 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 case prior to trebling.
Later computations have increased this amount. As discussed below, the bidding
credits the defendants received were considerably less than the $88 million
amount reported.
Interactive strongly believes that this lawsuit is completely without merit and
that relator's damage computations are 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 costs 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.
Interactive was formally served with the complaint on July 10, 2002. On
September 19, 2002, the defendants 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; the defendants 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 time, the judge approved a
scheduling order and discovery commenced.
On July 28, 2004, the judge denied in part and granted in part our motion to
dismiss. Defendant bidding entities that did not win licenses were dismissed and
the "reverse" false claims act count was dismissed as redundant. Interactive and
its subsidiaries remain parties to the litigation.
48
In December 2004, the defendants filed a motion in the United States District
Court for the District of Columbia to compel the FCC to provide certain
information subpoenaed by them in order to enable them to conduct a defense.
This motion was denied in May 2005 and the defendants have filed a notice of
appeal with the United States Court of Appeals for the D.C. Circuit. See
"History of Lynch's "C" Block Activities" below.
Also see Footnote 4 - Wireless Communication Services with regards to a
potential indemnification obligation of the Company.
HISTORY OF LYNCH'S "C" BLOCK ACTIVITIES.
As part of the Omnibus Budget Resolution of 1993, Congress authorized the FCC to
employ competitive bidding procedures to select among mutually exclusive
applicants for certain spectrum licenses. Initially the FCC had an initiative to
include, among others, African Americans, Native Americans, Asian Americans and
women. As a result of this, the FCC conducted auctions beginning in 1995 to
allocate spectrum in a competitive manner. Interactive was a participating
investor and/or service provider to various entities in this "C-Block" auction.
By December 18, 1995, Interactive (through its predecessor Lynch Corporation)
had investments in five entities that participated in the FCC auction for
broadband PCS "C" block spectrum (Auction 5). When the auction closed, on May 6,
1996, these five entities, on a combined basis, were the higher bidders for
thirty-one 30 MHz licenses at a gross cost of $288.2 million. These entities
were initially put together under the FCC's initiative to include, among others,
women, African Americans, Native Americans and Asian Americans. As a result of
changes in these initiatives, these same individuals were qualified as small
businesses and remained eligible as bidders. These entities received $72 million
of bidding credits, and accordingly the net cost was $216.2 million. The federal
government provided financing for 90% of the cost of these licenses, or $194.6
million. Interactive's investments in these entities totaled $21 million.
Events during and subsequent to Auction 5, made financing these licenses through
the capital markets much more difficult than originally anticipated. On April
18, 1997, among other reasons, in order to obtain some economies of scale, such
as financing, the five entities merged into Fortunet Communications, Inc. The
FCC, in partial response to actions by Nextwave and others, promoted a plan for
refinancing the "C" block licenses. In 1997, many of the license holders from
Auction 5, including Fortunet, petitioned the FCC for relief in order to afford
these small businesses the opportunity to more realistically restructure and
build out their systems. The President of Fortunet, Karen Johnson, participated
in an FCC sponsored forum on this issue on June 30, 1997. The response from the
FCC, which was announced on September 26, 1997 and modified on March 24, 1998,
afforded license holders four options. One of these options was the resumption
of current debt payments, which had been suspended earlier in 1997 for all such
license holders. Another option, amnesty, was to return all licenses and forgo
any amounts deposited in exchange for forgiveness of the FCC debt. Other options
included: disaggregation, splitting a 30 MHz license into two 15 MHz licenses
and forgoing 50% of the amount deposited; and prepayment, return of certain
licenses and utilizing 70% of the amount deposited to acquire other licenses,
with the other 30% of the deposits to be forfeited.
On June 8, 1998, Fortunet elected to apply its eligible credits relating to its
original down payment to the purchase of three licenses for 15 MHz of PCS
spectrum in Tallahassee, Panama City and Ocala, Florida. Consistent with an FCC
promulgated disaggregation alternative, Fortunet surrendered all the remaining
licenses and forfeited 30% of its original down payment in full satisfaction of
its government obligations, including forgiveness of all accrued interest.
Accordingly, Fortunet retained 15 MHz of spectrum in the three Florida markets
covering a population of approximately 962,000 at a net auction cost of $15.8
million. As a result of this FCC process, disaggregation resulted in a reduction
of the bidding credits to $5.3 million. Fortunet also lost $6.0 million of its
down payment. A lawyer who worked on many applications for FCC licenses, Mr.
Taylor, the relator in this case, is aware of the details of these FCC initiated
alternatives for the "C" Block, as presumably are his law firms. As a result of
this decision, during 1997, Interactive recorded a $7.0 million write down of
its investment in Fortunet.
On April 15, 1999, the FCC completed a reauction of all the C-Block licenses
that were surrendered, including the 15 MHz of spectrum that Fortunet returned
to the FCC on June 8, 1998 in respect of the Tallahassee, Panama City and Ocala,
Florida markets. In that reauction, the successful bidders paid a total of $2.7
million for those three 15 MHz licenses returned by Fortunet versus the $15.8
million paid by Fortunet. As a result of this auction, Interactive recorded a
further write down of its investment of $15.4 million, including capitalized
costs, to reflect the amount bid for the similar licenses in the reauction.
49
In February 2000, Fortunet merged with Sunshine PCS Corporation, which by way of
a spin-off from Lynch Interactive became a public company. It traded under the
symbol SUNPA.
On December 31, 2003, Sunshine, after appropriate corporate and regulatory
steps, sold its three 15 MHz licenses to Cingular Wireless for $13.75 million.
Interactive received $7.6 million as part of the sale transaction versus its
cash investment of $21 million initially invested in the original five entities
in 1992.
OTHER LITIGATION.
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.
13. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
2003-Three Months Ended
----------------------------------------------------------------------
March 31 June 30 Sept. 30 Dec. 31
----------------------------------------------------------------------
(In Thousands, Except Per Share Amounts)
Revenues $ 20,773 $ 20,928 $ 21,827 $ 21,864
Operating profit 4,774 4,693 5,379 3,582
Net Income 1,413 1,156 1,432 3,389(a)
Basic and diluted earnings per share: $ .51 $ .41 $ .51 $ 1.22
2004-Three Months Ended
----------------------------------------------------------------------
March 31 June 30 Sept. 30 Dec. 31
----------------------------------------------------------------------
(In Thousands, Except Per Share Amounts)
Revenues $ 21,401 $ 21,141 $ 22,865 $ 22,387
Operating profit 4,888 3,227 5,087 2,529
Net Income 1,603 384 1,542 937
Basic and diluted earnings per share: $ .58 $ .14 $ .56 $ .33
(a) Includes a $3.9 million gain on the sale of investments in Sunshine PCS.
14. EARNINGS (LOSS) PER SHARE
Basic and dilutive earnings per share are based on the average weighted number
of shares outstanding. On December 13, 1999, Lynch Interactive issued a $25
million 6% convertible promissory note, which was convertible into 588,235
shares of the Company's common stock. In January 2001, $15 million of the note
was repaid. The remaining $10 million convertible note was convertible into
235,294 shares of the Company's common stock. In November 2002 the remaining $10
million was repaid. This security was excluded from the calculation of dilutive
earnings per share in 2002, since assuming conversion would have been
anti-dilutive.
15. SEGMENT INFORMATION
The Company is engaged in one business segment: multimedia.
16. SUBSEQUENT EVENTS
In February 2005, Lynch 3G participated in Auction 58 for PCS Spectrum and was
high bidder for two licenses, Marquette, MI and Klamath Falls, OR, for a total
cost of $0.5 million.
On March 18, 2005, a subsidiary of the Company, Central Telcom Services, LLC,
has closed on an agreement with Precis Communications, LLC, to acquire a cable
television system for a purchase price of $3.5 million. The system has 2,411
cable subscribers located in Sanpete and Sevier Counties, Utah.
50
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
LYNCH INTERACTIVE CORPORATION
CONDENSED STATEMENT OF OPERATIONS
Years Ended December 31,
---------------------------------------------
2002 2003 2004
---------------------------------------------
(In Thousands)
Income:
Interest and dividend income $ 326 $ 12 $ 15
Gain on sale of investment in Sunshine PCS and other securities -- 3,919 185
Equity in earnings of affiliated companies -- -- 83
---------------------------------------------
326 3,931 283
Cost and expenses:
Unallocated corporate administrative expense 1,994 3,095 4,790
Interest expense 1,620 827 881
---------------------------------------------
Total cost and expenses 3,614 3,922 5,671
---------------------------------------------
Loss before income taxes and equity in income (loss) of subsidiaries (3,288) 9 (5,388)
Income tax benefit 1,117 (3) 1,828
Equity in income (loss) of subsidiaries 5,932 7,384 8,026
Loss from operations of Morgan - net (1,888) -- --
---------------------------------------------
Net income $ 1,873 $ 7,390 $ 4,466
=============================================
51
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
LYNCH INTERACTIVE CORPORATION
CONDENSED BALANCE SHEETS
December 31,
----------------------------
2003 2004
----------------------------
(In Thousands)
Assets
Current assets
Cash and cash equivalents $ 1,087 $ 198
Deferred income taxes 85 85
Other current assets 194 183
----------------------------
1,366 466
Office equipment (net) 18 24
Marketable securities 2,494 3,724
Investment in affiliated companies -- 5,270
Other assets (principally investment in and advances to subsidiaries) 39,589 44,980
----------------------------
Total assets $ 43,467 $ 54,464
============================
Liabilities and Shareholders' Equity
Current liabilities $2,725 $4,430
Long term debt 8,475 13,084
Deferred credits 2,380 2,380
Total shareholders' equity 29,887 34,570
----------------------------
Total liabilities and shareholders' equity $ 43,467 $ 54,464
============================
52
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
LYNCH INTERACTIVE CORPORATION
CONDENSED STATEMENT OF CASH FLOWS
Years Ended December 31,
----------------------------------------------
2002 2003 2004
----------------------------------------------
(In Thousands)
Operating activities:
Net income $ 1,873 $ 7,390 $ 4,466
Depreciation 14 4 7
Equity in earnings of affiliated companies -- -- (83)
Gain on sale of investment in Sunshine PCS -- (3,919) (185)
Changes in current assets and liabilities (3,147) 1,683 (282)
----------------------------------------------
Cash provided by (used in) operating activities (1,260) 5,158 3,923
----------------------------------------------
Investing activities:
Investment and advances to Brighton communications 2,479 (1,891) (5,805)
Purchase of securities (158) (84) --
Investment in affiliates -- -- (4,688)
Proceeds from sale of investment in Sunshine PCS -- 7,587 244
Capital expenditures (3) (9) (13)
----------------------------------------------
Net cash provided by (used in) investing activities 2,318 5,603 (10,262)
----------------------------------------------
Financing activities:
Net borrowings under:
Lines of credit 2,400 (10,000) 1,124
Issuance of long term debt -- 480 5,009
Repayment of long term debt (10,000) -- --
Purchase of treasury stock (956) (287) (683)
Other -- -- --
----------------------------------------------
Net cash provided by (used in) financing activities (8,556) (9,807) 5,450
----------------------------------------------
Total increase (decrease) cash and cash equivalents (7,498) 954 (889)
Cash and cash equivalents at beginning of year 7,631 133 1,087
----------------------------------------------
Cash and cash equivalents at end of year $ 133 $ 1,087 $ 198
==============================================
NOTES TO CONDENSED FINANCIAL STATEMENTS
Note A - Basis Of Presentation. The Company's investment in subsidiaries is
stated at cost plus equity in undistributed earnings of the subsidiaries.
Income taxes are computed at the federal statutory rate of 34%.
Note B -No dividends were received from subsidiaries in any period.
Note C - Long-Term Debt. Interactive has a note payable to a subsidiary, with a
principal amount of $8.5 million at December 31, 2004, at a fixed interest
rate of 6% per annum, due in 2005. The note is convertible, at the
subsidiary's option, into common stock of Lynch Corporation (1 share) and
Interactive (2 shares) with a combined exercise price of $120 per share.
In 2004, Interactive issued a $4.5 million 8.5% five-year amortizing
subordinated note payable and assumed an additional $0.5 million note in
connection with the acquisition of a 37% interest in KMG. KMG's principal
asset consists of a $6.0 million subordinated note and a 17% equity interest
in Lynch Telephone Corporation, an 83% owned subsidiary of the Corporation.
Note D - See notes to consolidated financial statements for additional
information.
Note E - Prior reporting periods amounts have been reclassified to conform with
current year reporting presentations.
53
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
LYNCH INTERACTIVE CORPORATION
YEARS ENDED DECEMBER 31, 2002, 2003 AND 2004
COLUMN A COLUMN B COLUMN C - ADDITIONS COLUMN D COLUMN E
CHARGED TO
DESCRIPTION BALANCE
AT CHARGED TO OTHER BALANCE
BEGINNING COSTS AND ACCOUNTS DEDUCTIONS AT END OF
OF PERIOD EXPENSES DESCRIBE DESCRIBE PERIOD
---------------------------------------------------------------------------
Year ended December 31, 2004 Allowance for
uncollectible accounts $ 262,000 $ 222,000 -- $ 224,000(A) $ 260,000
Year ended December 31, 2003
Allowance for uncollectible accounts $ 316,000 $ 223,000 -- $ 277,000(A) $ 262,000
Year ended December 31, 2002
Allowance for uncollectible accounts $ 424,000 $1,037,000 -- $1,145,000(A) $ 316,000
(A) UNCOLLECTIBLE ACCOUNTS WRITTEN OFF ARE NET OF RECOVERIES.
54
EXHIBIT INDEX
Exhibit No. Description
----------- -----------
2 Separation Agreement(1)
3.1 Amended and Restated Certificate of Incorporation of Registrant
(1)
3.2 Amended By-laws of Registrant(2)
4.1 Mortgage, Security Agreement and Financing Statement among
Haviland Telephone Company, Inc., the United States of America
and the Rural Telephone Bank(1)
4.2 Restated Mortgage, Security Agreement and Financing Statement
between Western New Mexico Telephone Company, Inc. and the United
States of America(1)
10(a) Partnership Agreement dated March 11, 1987, between Lombardo
Communications, Inc. and Lynch Entertainment Corporation
(incorporated by reference to Exhibit 10(e) of the Lynch
Corporation ("Lynch")'s Annual Report on Form 10-K for the year
ended December 31, 1987).
10(b) Lynch Corporation 401(k) Savings Plan (incorporated by reference
to Exhibit 10(b) to Lynch's Form 10-K for the year ended December
31, 1995).
10(c) Shareholders Agreement among Capital Communications Company,
Inc., Lombardo Communications, Inc. and Lynch Entertainment
Corporation II (incorporated by reference to Exhibit 10 of
Lynch's Form 8-K, dated March 14, 1994).
10(d)(i) Loan Agreement, dated as of November 6, 1995, between Lynch PCS
Corporation A and Aer Force Communications L.P. (now Fortunet
Wireless, L.P.) (plus four similar loan agreements with Fortunet
Wireless, L.P.) (incorporated by reference to Exhibit 10(w) to
Lynch's Form 10-K for the year ended December 31, 1995.
10(d)(ii) Amendment No. 1 to the Loan Agreement, dated as of November 6,
1995, referred to in 10(d)(i) incorporated by reference to
Exhibit 10(a) to Lynch's Form 10-Q for quarter ended March 31,
1996).
10(e)(i) Letter Agreement, dated as of August 12, 1996, between Rivgam
Communicators, L.L.P. and Lynch PCS Corporation G (incorporated
by reference to Exhibit 10(u)(ii) to Lynch's Form 10-K for the
year ended December 31, 1996).
10(f)(ii) Letter Agreement dated as of December 16, 1998, between Rivgam
Communicators, L.L.P. and Lynch PCS Corporation G (incorporated
by reference in Exhibit 10(u)(iv) to Lynch's Form 10-K for the
year ended December 31, 1998).
10(f) Letter Agreement between Lynch PCS Corporation G and Bal/Rivgam,
L.L.C. (incorporated by reference to Exhibit 10(x) to Lynch's
Form 10-Q for the Quarter ended September 30, 1997).
10(g) Letter Agreement, dated January 20, 1998, between Lynch PCS
Corporation G and BCK/Rivgam, L.L.C. (incorporated by reference
to Exhibit 10(y) to Lynch's Form 10-K for the year ended December
31, 1997).
10(h) 2000 Stock Option Plan (incorporated by reference to the Exhibit
to Registrant's Proxy Statement dated April 18, 2000).
10(i) Lease Agreement between Lynch and Gabelli Funds, Inc.
(incorporated by reference to Exhibit 10(a)(a) to Lynch's Form
10-Q for the Quarter ended March 31, 1998).
55
Exhibit No. Description
----------- -----------
10(j) Letter Agreement dated November 11, 1998, between Registrant and
Gabelli & Company, Inc. (incorporated by reference to Exhibit
10(c)(c) to Lynch Form 10-K for the year ended December 31,
1998).
10(l) Agreement and Plan of Merger dated as of May 25, 1999, among
Central Scott Telephone Company, Brighton Communications
Corporation and Brighton Iowa Acquisition Corporation (schedules
omitted) (incorporated by reference to Exhibit 10.1 to Lynch's
Form 8-K dated July 16, 1999).
10(m) Separation and Distribution Agreement, dated as of January 18,
2002, by and among Lynch Interactive Corporation, Morgan Group
Holding Co. and The Morgan Group, Inc.(2)
10(n) Agreement for Purchase and Sale of Licenses dated August 18,
2003, by and between Sunshine PCS Corporation, Cingular Wireless
LLC and for purposes of Articles X and XII, certain stockholders
including Lynch Interactive Corporation. (3)
10(o) Stock Purchase Agreement by and among Lynch Telephone Corporation
XI, Lynch Interactive Corporation, Brighton Communications
Corporation, California-Oregon Telecommunications Company
("COTC") and the Shareholders of COTC dated as of March 22,
2004.(3)
14.1 Lynch Interactive Corporation Code of Ethics(3)
14.2 Lynch Interactive Corporation Conflicts of Interest Policy(3)
21 Subsidiaries of Registrant(4)
23.1 Consent of Ernst & Young LLP(4)
23.2 Consent of Deloitte & Touche LLP(4)
23.3 Consents of Siepert & Co., L.L.P. for use of:(4)
- Report of Siepert & Co., L.L.P. on the financial statements
of Cuba City Telephone Exchange Company for the year ended
December 31, 2002
- Report of Siepert & Co., L.L.P. on the financial statements
of Belmont Telephone Company for the year ended December
31, 2002
- Report of Siepert & Co., L.L.P. on the financial statements
of Upper Peninsula Telephone Company for the year ended
December 31, 2002
24 Powers of Attorney(4)
31.1 Rule 13a-14(a) Certification of the Chief Executive Officer+
31.2 Rule 13a-14(a) Certification of the Chief Financial Officer+
32.1 Section 1350 Certification of the Chief Executive Officer+
32.2 Section 1350 Certification of the Chief Financial Officer+
56
Exhibit No. Description
----------- -----------
99.1 Reports of Independent Auditors(4)
- Report of Siepert & Co., L.L.P. on the financial statements
of Cuba City Telephone Exchange Company for the year ended
December 31, 2002
- Report of Siepert & Co., L.L.P. on the financial statements
of Belmont Telephone Company for the year ended December
31, 2002
- Report of Siepert & Co., L.L.P. on the financial statements
of Lynch Michigan Telephone Holding Corporation for the
year ended December 31, 2002
+ Filed herewith.
(1) Incorporated by reference to the exhibits to the Registrant's Registration
Statement on Form 10A-1.
(2) Incorporated by reference to the exhibits to the Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 2002.
(3) Incorporated by reference to the exhibits to the Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 2003.
(4) Incorporated by reference to the exhibits to the Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 2004.
The Exhibits listed above have been filed separately with the Securities and
Exchange Commission in conjunction with this Annual Report on Form 10-K or have
been incorporated by reference into this Annual Report on Form 10-K. Lynch
Interactive Corporation will furnish to each of its shareholders a copy of any
such Exhibit for a fee equal to Lynch Interactive Corporation's cost in
furnishing such Exhibit. Requests should be addressed to the Office of the
Secretary, Lynch Interactive Corporation, 401 Theodore Fremd Avenue, Rye, New
York 10580.
57
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
LYNCH INTERACTIVE CORPORATION
By: /s/ Robert E. Dolan
---------------------------------
Robert E. Dolan
Chief Financial Officer
Dated: September 7, 2005
Signature Capacity Date
/s/ Mario J. Gabelli Chairman of the Board of Officer September 7, 2005
-------------------- (Principal Executive Officer)
MARIO J. GABELLI Directors and Chief Executive
/s/ Morris Berkowitz Director September 7, 2005
--------------------
MORRIS BERKOWITZ
/s/ Paul J. Evanson Director September 7, 2005
-------------------
PAUL J. EVANSON
/s/ John C. Ferrara Director September 7, 2005
-------------------
JOHN C. FERRARA
/s/ Daniel R. Lee Director September 7, 2005
-----------------
DANIEL R. LEE
/s/ Lawrence R. Moats Director September 7, 2005
---------------------
LAWRENCE R. MOATS
/s/ Salvatore Muoio Director September 7, 2005
-------------------
SALVATORE MUOIO
/s/ Robert E. Dolan Chief Financial Officer September 7, 2005
------------------- (Principal Financial and
ROBERT E. DOLAN Accounting Officer)
/s/ Robert E. Dolan Attorney-in-fact
-------------------
ROBERT E. DOLAN
58