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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
(Mark One)
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 [NO FEE REQUIRED] X
For the Fiscal Year Ended December 31, 1997
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 [NO FEE REQUIRED]
For the transition period from to
Commission file numbers 0-23232/1-14248
Arch Communications Group, Inc.
(Exact name of Registrant as specified in its Charter)
DELAWARE 31-1358569
(State of incorporation) (I.R.S. Employer Identification No.)
1800 West Park Drive, Suite 250
Westborough, Massachusetts 01581
(address of principal executive offices) (Zip Code)
(508) 870-6700
(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE SECURITIES
EXCHANGE ACT OF 1934:
10 7/8% Senior Discount Notes due 2008 American Stock Exchange
(Title of Class) (Name of exchange on which registered)
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE SECURITIES
EXCHANGE ACT OF 1934:
Common Stock Par Value $.01 Per Share
(Title of class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES X NO
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K
The aggregate market value of the voting stock held by non-affiliates of the
Registrant at March 24, 1998 was approximately $111,580,000.
The number of shares of Registrant's Common Stock outstanding on March 24, 1998
was 20,958,570
Portions of Registrant's Definitive Proxy Statement for the 1998 Annual Meeting
of Stockholders of the Registrant to be held on May 19, 1998, are incorporated
by reference into Part III.
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PART I
ITEM 1. BUSINESS
General
Arch Communications Group, Inc. ("Arch" or the "Company") is a leading
provider of wireless messaging services, primarily paging services, and had 3.9
million pagers in service as of December 31, 1997. Arch has operations in a
total of 41 states and 180 of the 200 largest markets in the United States.
The Company offers local, regional and nationwide paging services employing
digital networks covering approximately 85% of the United States population.
Arch offers four types of paging services: digital display, alphanumeric
display, tone-only and tone-plus-voice. Arch also offers enhanced or
complementary services, including voice mail, personalized greetings, message
storage and retrieval, pager loss protection and pager maintenance. As part of
its business, the Company rents, sells and repairs pagers. The Company is
licensed by the Federal Communications Commission ("FCC") to provide paging and
related services in the markets it serves. Generally, such licenses are
exclusive to a particular radio frequency, although multiple frequencies may be
licensed in any given market. See "Business -- Regulation".
Arch has grown rapidly through a combination of internal growth and
acquisitions since it began operations in 1986. The Company's net revenues (the
sum of service revenues and product sales, less the cost of product sales), the
normal presentation of revenues in the paging industry, were $367,683,000 in the
year ended December 31, 1997. The Company's operating cash flow, or earnings
before interest, taxes, depreciation and amortization ("EBITDA"), the most
relevant measure of operating performance for the paging industry, was
$130,332,000 for the year. Because paging is a capital intensive industry,
particularly during periods of rapid growth, and because the Company has made
sizeable acquisitions accounted for by the purchase method of accounting,
significant depreciation and amortization expenses are charged against Arch's
operations. Because the Company has incurred large amounts of debt in its growth
and in the course of its acquisition program, significant interest expense is
charged against its operations. As a result of these charges, the Company
historically has incurred net losses, including a net loss of $181,874,000 for
the year ended December 31, 1997.
The following table sets forth certain information regarding the
approximate number of pagers in service with Company subscribers and net
increases in number of pagers through internal growth and acquisitions during
the periods indicated:
Pagers in
Service at Net Increase in Increase in Pagers in
Year Ended Beginning of Pagers through Pagers through Service at
August 31, Period Internal Growth(1) Acquisitions(2) End of Period
1987.... 4,000 3,000 12,000 19,000
1988.... 19,000 8,000 3,000 30,000
1989.... 30,000 14,000 34,000 78,000
1990.... 78,000 20,000 4,000 102,000
1991.... 102,000 24,000 1,000 127,000
1992.... 127,000 33,000 - 160,000
1993.... 160,000 70,000 24,000 254,000
1994.... 254,000 138,000 18,000 410,000
Four Months
Ended
December 31,
1994.... 410,000 64,000 64,000 538,000
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Pagers in
Service at Net Increase in Increase in Pagers in
Year Ended Beginning of Pagers through Pagers through Service at
December 31, Period Internal Growth(1) Acquisitions(2) End of Period
1995.... 538,000 366,000 1,102,000 2,006,000
1996.... 2,006,000 815,000 474,000 3,295,000
1997.... 3,295,000 595,000 - 3,890,000
(1) Includes internal growth in acquired paging businesses after their
acquisition by Arch. Increases in pagers through internal growth are net of
subscriber cancellations during each applicable period.
(2) Based on pagers in service of acquired paging businesses at the time of
their acquisition by Arch.
Acquisition of USA Mobile
On September 7, 1995, Arch Communications Group, Inc., a Delaware
corporation ("Old Arch"), completed its acquisition of USA Mobile, a Delaware
corporation, through the merger (the "Merger") of Old Arch with and into USA
Mobile, which simultaneously changed its name to Arch Communications Group, Inc.
In accordance with generally accepted accounting principles, Old Arch was
treated as the acquirer in the Merger for accounting and financial reporting
purposes, and the Company reports the historical financial statements of Old
Arch as the historical financial statements of the Company. As used herein,
unless the context otherwise requires, the terms "Arch" or the "Company" refer
to Arch Communications Group, Inc. from and after the Merger and Old Arch prior
to the Merger, in each case together with its wholly-owned direct and indirect
subsidiaries, and the term "USA Mobile" refers to USA Mobile Communications
Holdings, Inc. prior to the Merger together with its wholly-owned direct and
indirect subsidiaries.
Paging Industry Overview
Paging is a method of wireless communication which uses an assigned radio
frequency to contact a paging subscriber anywhere within a designated service
area. A subscriber carries a pager which receives messages by the broadcast of a
one-way radio signal. To contact a subscriber, a message is usually sent by
placing a telephone call to the subscriber's designated telephone number. The
telephone call is received by an electronic paging switch which generates a
signal that is sent to radio transmitters in the service area. Depending upon
the topography of the service area, the operating radius of a radio transmitter
typically ranges from three to 20 miles. The transmitters broadcast a signal
that is received by the pager a subscriber carries, which alerts the subscriber
by a tone or vibration that there is a voice, tone, digital or alphanumeric
message.
Arch believes that paging is the most cost-effective form of mobile
wireless communications. Paging has an advantage over conventional telephone
service because a pager's reception is not restricted to a single location, and
over a cellular telephone because a pager is smaller, has a longer battery life
and, most importantly, because pagers and air time required to transmit an
average message cost less than equipment and air time for cellular telephones.
Paging subscribers generally pay a flat monthly service fee for pager services,
regardless of the number of messages, unlike cellular telephone subscribers,
whose bills typically have a significant variable usage component. For these
reasons, some cellular subscribers use a pager in conjunction with their
cellular telephone to screen incoming calls and thus lower the expense of
cellular telephone service.
Industry sources estimate that, since 1991, the number of pagers in service
in the United States has grown at an annual rate of approximately 30% and will
continue to grow at an annual rate of approximately 15% until the year 2000.
Based on industry sources, Arch believes that there are in excess of 45 million
pagers in service in the United States at December 31, 1997. Factors
contributing to this growth include: (i) a continuing shift towards a
service-based economy; (ii) increasing mobility of workers and the population at
large; (iii) increasing awareness of the benefits of mobile communications among
the population at large; (iv) the relatively high cost of two-way mobile
communications, such as cellular telephone services; (v) introduction of new or
enhanced paging services, including nationwide paging capability; (vi)
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continuing improvements in the performance of paging equipment; and (vii)
significant price/performance improvements in paging services. The paging
industry has undergone substantial consolidation over the past ten years, and
Arch believes that the top five paging carriers represent approximately 50% of
the pagers in service. Nonetheless, Arch believes that the paging industry
remains fragmented, with more than 300 licensed carriers in the United States,
and will continue to undergo consolidation.
The paging industry has benefited from technological advances resulting
from research and development conducted by vendors of pagers and transmission
equipment. Such advances include microcircuitry, liquid crystal display
technology and standard digital encoding formats, which have enhanced the
capability and capacity of paging services while lowering equipment and air time
costs. Technological improvements have enabled Arch to provide better quality
services at lower prices to its subscribers and have generally contributed to
strong growth in the market for paging services.
The paging industry has traditionally distributed its services through
direct marketing and sales activities. In recent years, additional channels of
distribution have evolved, including: (i) carrier-operated stores; (ii)
resellers, who purchase paging services on a wholesale basis from carriers and
resell those services on a retail basis to their own customers; (iii) agents who
solicit customers for carriers and are compensated on a commission basis; (iv)
retail outlets that often sell a variety of merchandise, including pagers and
other telecommunications equipment; and (v) most recently the Internet. While
most paging subscribers traditionally have been business users, industry
observers believe that pager use among consumers has increased significantly in
recent years. In addition, paging subscribers have increasingly chosen to
purchase rather than lease their pagers. These trends are expected to continue.
Business Strategy
Arch's strategic objective is to strengthen its position as one of the
leading nationwide paging companies in the United States. Arch believes that
larger, multi-market paging companies enjoy a number of competitive advantages,
including: (i) operating efficiencies resulting from more intensive utilization
of existing paging systems; (ii) economies of scale in purchasing and
administration; (iii) broader geographic coverage of paging systems; (iv)
greater access to capital markets and lower costs of capital; (v) the ability to
obtain additional radio spectrum; (vi) the ability to offer high-quality
services at competitive prices; and (vii) enhanced ability to attract and retain
management personnel. Arch believes that the current size and scope of its
operations afford it many of these advantages. Arch also believes that major
paging companies need to have national scope and presence in order to attract
marketing affiliations and other opportunities for growth. Arch's two most
recent acquisitions, USA Mobile and Westlink Holdings, Inc. ("Westlink") have
enabled the Company to effectively compete on a national level and position Arch
to exploit such opportunities while continuing to pursue its growth strategy.
Arch employs a three-part growth strategy to expand its subscriber base and
geographic operations:
Continued Market Development and Penetration. Arch increases its subscriber
base through continued development and penetration of its existing markets,
primarily through sales and marketing efforts. Expansion of Arch's sales and
marketing activities within areas of existing service coverage broadens Arch's
potential subscriber base with minimal incremental capital investment and, over
time, contributes to higher margins through increased system utilization.
Expansion of Sales and Marketing Activities. Arch expands its marketing
coverage, principally by opening new sales offices, to areas contiguous to
existing sales operations within Arch's current system coverage. Expansion of
sales and marketing activities into new markets contiguous to existing sales
operations may solidify Arch's presence in existing markets and enable Arch to
leverage further its infrastructure within these markets.
Acquisitions. Arch makes two types of acquisitions; fold-in and strategic.
Fold-in acquisitions are acquisitions of paging businesses located within or
adjacent to Arch's current system coverage. Fold-in acquisitions increase Arch's
subscriber base and revenues and offer opportunities to achieve operating
efficiencies by consolidating staff, eliminating duplicative overhead and
integrating the acquired subscribers into Arch's own paging system and billing
and collection processes. Arch also makes strategic acquisitions to expand
Arch's geographic coverage into new markets outside of Arch's current system
coverage.
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Although today Arch operates in 90 of the top 100 U.S. markets, the Company
historically has focused on medium-sized and small market areas with lower rates
of pager penetration and attractive demographics and Arch believes that such
markets will continue to offer significant opportunities for growth. In
addition, Arch believes that its increasing national scope and presence will
provide Arch with growth opportunities in larger markets, including major
metropolitan areas adjacent to certain of Arch's existing markets.
Arch believes that its selection of low-cost operator status as its
competitive tactic provides it with flexibility to offer competitive prices
while still achieving target margins and EBITDA. Arch maintains a low-cost
operating structure through a combination of (i) the consolidation of certain
operating functions, including centralized purchases from key vendors, to
achieve economies of scale, and (ii) the installation of efficient, high-quality
transmission systems.
Arch believes that its decentralized organizational structure enables it to
offer superior customer service and to respond to subscriber needs quickly and
effectively. Arch's operating regions operate largely as independent entities,
while strategic planning, equipment purchasing, capital formation, legal,
acquisition and similar functions are conducted on a centralized basis. The
management of each operating region makes staffing, administrative, operational
and marketing decisions within guidelines established by the senior management
of Arch.
Arch has taken steps to position itself to participate in new and emerging
services and applications in narrowband wireless personal communications
("N-PCS"). These initiatives include (i) Arch's equity investment in Benbow PCS
Ventures, Inc. ("Benbow"), which gives Arch access to two regional narrowband
PCS licenses controlled by Benbow which will provide coverage to a substantial
portion of the western United States, and (ii) an equity investment in CONXUS
Communications, Inc. (formerly PCS Development Corporation), which holds
exclusive rights to regional two way messaging licenses which provide nationwide
coverage.
Paging Operations
Arch provides paging service to subscribers for a monthly fee. Subscribers
either lease the pager from Arch for an additional fixed monthly fee or they own
the pager, having purchased it either from Arch or from another vendor. The
monthly service fee is generally based upon the type of service provided, the
geographic area covered, the number of pagers provided to the customer and the
period of the subscriber's commitment. Subscriber-owned pagers provide a more
rapid recovery of Arch's capital investment than pagers owned and maintained by
Arch, but may generate less recurring revenue. Arch also sells pagers to
third-party resellers who lease or resell pagers to their own subscribers and
resell Arch's paging services under marketing agreements.
Arch also provides enhancements and ancillary services such as voice mail,
personalized greetings, message storage and retrieval, pager loss protection and
pager maintenance services. Voice mail allows a caller to leave a recorded
message that is stored in Arch's computerized message retrieval center. When a
message is left, the subscriber can be automatically alerted through the
subscriber's pager and can retrieve the stored message by calling Arch's paging
terminal. Personalized greetings allow the subscriber to record a message to
greet callers who reach the subscriber's pager or voice mail box. Message
storage and retrieval allows a subscriber who leaves Arch's service area to
retrieve calls that arrived during the subscriber's absence from the service
area. Pager loss protection allows subscribers who lease pagers to limit their
costs of replacement upon loss or destruction of the pager. Pager maintenance
services are offered to subscribers who own their own equipment.
Subscribers and Marketing
Arch's paging accounts are generally businesses with employees who travel
frequently but must be immediately accessible to their offices or customers.
Arch's subscribers include proprietors of small businesses, professionals,
management and medical personnel, field sales personnel and service forces,
members of the construction industry and trades, and real estate brokers and
developers. In addition, Arch believes that pager use among consumers will
increase significantly in the future, although consumers do not currently
account for a substantial portion of Arch's subscriber base.
Arch markets its paging services through a direct marketing and sales
organization which, as of December 31, 1997, operated approximately 200 retail
stores. Arch also markets its paging services indirectly through independent
resellers,
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agents and retailers. Arch typically offers resellers paging services in large
quantities at wholesale rates that are lower than retail rates, and resellers
offer the services to end-users at a mark-up. Arch's costs of administering and
billing resellers are lower than the costs of direct end-users on a per pager
basis. Arch also acts as a reseller of other paging carriers' services when
existing or potential Arch customers have travel patterns that require paging
service beyond the coverage of Arch's own networks.
Competition
Arch experiences competition from one or more competitors in all markets in
which it operates, but no single competitor competes with Arch in all of its
markets, although certain competitors hold nationwide licenses that would enable
them to compete in all of Arch's markets if they choose to do so. Although some
of Arch's competitors are small, privately owned companies serving one market
area, others are large diversified telecommunications companies, including AT&T.
Some of Arch's competitors possess financial, technical and other resources
greater than those of Arch. Major paging carriers that currently compete in one
or more of Arch's markets include Paging Network, Inc., MobileMedia Corporation,
Metrocall, Inc. and AirTouch Communications, Inc. As paging services become
increasingly interactive, and as two-way services become increasingly
competitive, the scope of competition for communications service customers in
Arch's markets may broaden. For example, in 1995, the FCC commenced issuing
licenses for the provision of broadband personal communications services
("PCS"), with many grants going to major telecommunications companies or
conglomerates with greater financial resources than Arch. Some of these carriers
have initiated broadband PCS services in many major markets which include "short
messaging", a form of advanced alphanumeric paging, as part of its two-way voice
communications product. In addition, the FCC has created potential sources of
competition by opening up new spectrum for such services as General Wireless
Communications Services ("GWCS") and Wireless Communications Services ("WCS") as
well as speeding up licensing of other services through auctions including the
Local Multipoint Distribution Service ("LMDS") and 220-222 MHz.
Arch believes that competition for paging subscribers is based on quality
of service, geographic coverage and price. Arch believes it generally competes
effectively based on these factors.
Sources of Equipment
Arch does not manufacture any of the pagers or other equipment used in its
paging operations. The equipment used in Arch's paging operations is generally
available for purchase from multiple sources. Arch centralizes price and
quantity negotiations for all of its operating subsidiaries in order to achieve
cost savings from volume purchases. Arch buys pagers primarily from Motorola and
NEC and purchases terminals and transmitters primarily from Glenayre and
Motorola. Arch anticipates that equipment and pagers will continue to be
available in the foreseeable future, consistent with normal manufacturing and
delivery lead times.
Because of the high degree of compatibility among different models of
transmitters, computers and other paging equipment manufactured by suppliers,
Arch is able to design its systems without being dependent upon any single
source of such equipment. Arch routinely evaluates new developments in paging
technology in connection with the design and enhancement of its paging systems
and selection of products to be offered to subscribers. Arch believes that its
paging system equipment is among the most technologically sophisticated in the
paging industry.
Regulation
Paging operations and the construction, modification, ownership and
acquisition of paging systems are subject to extensive regulation by the FCC
under the Communications Act of 1934, as amended (the "Communications Act"),
and, to a much more limited extent, by public utility or public service
commissions in certain states. The following description does not purport to be
a complete discussion of all present and proposed legislation and regulations
relating to Arch's paging operations.
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Federal Regulation
Paging companies historically have been subject to different federal
regulatory requirements depending upon whether they were providing service as a
Radio Common Carrier ("RCC"), a Private Carrier Paging ("PCP") operator or as a
reseller. Arch's paging operations encompass RCC, PCP and resale operations.
However, federal legislation enacted in 1993 required the FCC to reduce the
disparities in the regulatory treatment of similar mobile services (such as RCC
and PCP services), and the FCC has taken, and continues to take, actions to
implement this legislation.
Under the new regulatory structure, all of Arch's paging services are
classified as commercial mobile radio service ("CMRS"). As a CMRS provider, Arch
is regulated as a common carrier, except that the FCC has exempted paging
services, which have been found to be highly competitive, from some typical
common carrier regulations, such as tariff filing requirements.
The classification of Arch's paging operations as CMRS affects the level of
permissible foreign ownership and the nature and extent of state regulation to
which Arch is subject. In addition, the FCC now is required to resolve competing
requests for CMRS spectrum by conducting an auction, which may have the effect
of increasing the costs of acquiring additional spectrum in markets in which
Arch operates. Also, Arch is obligated to pay certain regulatory fees in
connection with its paging operations.
The FCC's review and revision of rules affecting paging companies is
ongoing and the regulatory requirements to which Arch is subject may change
significantly over time. For example, the FCC has adopted a market area
licensing scheme for all paging channels under which carriers would be licensed
to operate on a particular channel throughout a broad geographic area (for
example, a Major Trading Area as defined by Rand McNally) rather than being
licensed on a site-by-site basis. These geographic area licenses will be awarded
pursuant to an auction. After auction, existing paging facilities will be
entitled to protection as grandfathered systems. Arch is participating actively
in this proceeding in order to protect its existing operations and retain
flexibility, on an interim and long-term basis, to modify systems as necessary
to meet subscriber demands. The FCC is also considering whether CMRS operators
should be obligated to interconnect their systems with others and be prohibited
from placing restrictions on the resale of their services (except with respect
to paging, which has already been relieved of the obligation to provide resale).
Arch depends in its business on the assignment and use of standard and toll free
telephone numbers for its paging units. The FCC, in some states, have
proceedings underway that may have a significant impact on the manner in which
telephone numbers are assigned and utilized by common carriers, including paging
companies, and on the ability of subscribers to retain their telephone numbers
if, or when, they change paging companies. Some of the alternatives under
consideration by the FCC, if adopted, could increase the cost to Arch of
telephone numbers, restrict the manner in which certain numbers could be used or
affect the ability of Arch to retain certain numbers previously assigned.
The Communications Act requires that Arch obtain licenses from the FCC to
use radio frequencies to conduct its paging operations within specified
geographic areas, and Arch is licensed by the FCC to provide paging services in
each geographic area in which it has operations. Licenses issued by the FCC to
Arch set forth the technical parameters, such as power strength and tower
height, under which Arch is authorized to use those frequencies. In many
instances, Arch requires the prior approval of the FCC before it can implement
any significant changes to its radio systems. Once the FCC's market area
licensing rules are implemented, all of these site-specific licensing
obligations will be eliminated, with the exception of applications still
required by Section 22.369 of the FCC Rules (request for authority to operate in
a designated Quiet Zone), Section 90.77 (request for authority to operate in a
protected radio receiving location) and Section 1.1301 et seq.
(construction/modification that may have a significant environmental impact), or
for coordination with Canada or Mexico.
The FCC licenses granted to Arch are for varying terms of up to ten years,
at the end of which time renewal applications must be approved by the FCC. Some
of the authorizations held by Arch are subject to FCC construction obligations
which must be met for the licenses to be retained. In the past, FCC renewal
applications routinely have been granted in most cases upon a demonstration of
compliance with FCC regulations and adequate service to the public. The FCC has
granted each renewal application Arch has filed. Although Arch is unaware of any
circumstances which would prevent the grant of any pending or future renewal
applications, no assurance can be given that any of Arch's renewal applications
will be free of challenge or will be granted by the FCC. Furthermore, although
revocation and involuntary
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modification of licenses are extraordinary regulatory measures, the FCC has the
authority to restrict the operation of licensed facilities or to revoke or
modify licenses.
The Communications Act requires licensees, such as Arch, to obtain prior
approval from the FCC for the assignment or transfer of control of any
construction permit or station license, or any rights thereunder. The
Communications Act also requires prior approval by the FCC for acquisitions of
the licenses of, or controlling equity interests in, other paging companies by
Arch. To date, the FCC has approved each assignment and transfer of control for
which Arch has sought approval. Although there can be no assurance that any
requests for approval or applications filed by Arch will be acted upon in a
timely manner by the FCC, or that the FCC will grant the approval or relief
requested, Arch knows of no reason to believe any such requests, applications or
relief will not be approved or granted. Currently underway at the FCC is a
proceeding wherein the FCC's Wireless Telecommunications Bureau (the Bureau
directly regulating Arch's paging activities) is proposing to eliminate all
filing requirements associated with pro forma assignments and transfers of
control of wireless authorizations. This proposal would expedite the process and
reduce the cost related to corporate reorganizations.
The Communications Act also limits foreign ownership of entities that hold
licenses from the FCC. Because Arch, through its subsidiaries, holds licenses
from the FCC, in general, no more than 25% of Arch's stock may be owned or voted
by aliens or their representatives, a foreign government or its representatives,
or a foreign corporation. An FCC licensee may, however, make prior application
to the FCC for a determination that it is in the public interest for an
individual licensee to exceed the 25 percent foreign ownership benchmark.
The Telecommunications Act of 1996 directly affects Arch. Some aspects of
the new statute could have a beneficial effect on Arch's business. For example,
proposed federal guidelines regarding antenna siting issues may remove local and
state barriers to the construction of communications facilities, although states
and municipalities continue to exercise significant control with regard to such
siting issues. In addition, efforts to increase competition in the local
exchange and interexchange industries may reduce the cost to Arch of acquiring
necessary communications services and facilities. On the other hand, some
provisions relating to the assignment of new area codes and universal service
obligations (and potentially, provisions relating to telephone number
portability) place additional burdens upon Arch or subject Arch to increased
competition.
State Regulation
In addition to regulation by the FCC, certain states impose various
regulations on the common carrier paging operations of Arch. Regulation in some
states historically required Arch to obtain certificates of public convenience
and necessity before constructing, modifying or expanding paging facilities or
offering or abandoning paging services. Rates, terms and conditions under which
Arch provided services, or any changes to those rates, have also been subject to
state regulation. However, under the Federal Budget Reconciliation Act of 1993
(the "Budget Act"), as a general rule, states are preempted from exercising rate
and entry regulation of CMRS, but may choose to regulate other terms and
conditions of service (for example, requiring the identification of an agent to
receive complaints). The preemption of state entry regulation was confirmed in
the Telecommunications Act of 1996. In certain instances, the construction and
operation of radio transmitters also will be subject to zoning, land use, public
health and safety, consumer protection and other state and local taxes, levies
and ordinances. States also were accorded an opportunity to petition the FCC for
authority to continue to regulate CMRS rates under the Budget Act if certain
conditions were met. State filings seeking rate authority have all been denied
by the FCC, although new petitions seeking such authority may be filed in the
future.
States also may regulate terms and conditions (other than entry or rates)
of paging services provided within such states. Arch believes that to date all
required state filings for Arch's paging operations have been made.
Future Regulation
From time to time, legislation which could potentially affect Arch, either
beneficially or adversely, is proposed by federal or state legislators. There
can be no assurance that legislation will not be enacted by the federal or state
governments, or that regulations will not be adopted or actions taken by the FCC
or state regulatory authorities, which
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might materially adversely affect the business of Arch. Changes such as the
allocation by the FCC of radio spectrum for services that compete with Arch's
business could adversely affect Arch's results of operations.
Trademarks
The Company holds a federal registration for the service mark "Arch
Nationwide Paging(R)".
Employees
At December 31, 1997, Arch employed approximately 2,800 personnel. None of
Arch's employees is represented by a labor union. Arch believes that its
employee relations are good.
ITEM 2. PROPERTIES
At December 31, 1997, Arch owned five office buildings and leased office
space (including its executive offices) in over 200 localities in 35 states for
use in conjunction with its paging operations. Arch also owned 141 transmitter
sites in 20 states and the transmitter broadcast towers on most of those sites.
Arch leases transmitter sites and/or owns transmitters on commercial broadcast
towers, buildings and other fixed structures in approximately 3,189 locations in
45 states. Arch's leases are for various terms and provide for monthly lease
payments at various rates. As of December 31, 1997, Arch was obligated to make
total lease payments of approximately $16.9 million under its office facility
and tower site leases for the year ending December 31, 1998. Arch believes that
it will be able to obtain additional space as needed at an acceptable cost.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in various lawsuits and claims arising in the
normal course of business. The Company believes that none of such matters will
have a material adverse effect on the Company's business or financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to stockholders during the three months ended
December 31, 1997.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock is included in the Nasdaq National Market under
the symbol "APGR". The following table sets forth for the periods indicated the
high and low last sales prices per share of the common stock as reported by the
Nasdaq National Market.
1997 High Low
First Quarter........................................ 9 3/4 3 7/8
Second Quarter....................................... 8 1/8 3 13/16
Third Quarter........................................ 9 3/8 6 1/4
Fourth Quarter....................................... 8 7/8 4 1/2
1996
First Quarter........................................ 26 3/4 20
Second Quarter....................................... 26 1/4 18 5/8
Third Quarter........................................ 19 1/2 12 1/2
Fourth Quarter....................................... 13 1/2 8 3/8
The number of stockholders of record as of March 18, 1998 was 164. The
Company believes that the number of beneficial stockholders is in excess of
1500.
The Company has never declared or paid cash dividends on the common stock
and does not intend to declare or pay cash dividends on the common stock in the
foreseeable future. Certain covenants in the credit facilities and debt
obligations of the Company and its subsidiaries will effectively prohibit the
declaration or payment of cash dividends by the Company for the foreseeable
future. See Note 3 to the Company's Consolidated Financial Statements.
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11
ITEM 6. SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA
The following Selected Consolidated Financial and Operating Data should be
read in conjunction with Item 1 - "Business," Item 7 - "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and the
Consolidated Financial Statements and Notes thereto. Dollars in thousands except
per share amounts.
FOUR MONTHS ENDED Year Ended
YEAR ENDED DECEMBER 31, DECEMBER 31, (1) AUGUST, 31, (1)
--------------------------------------- ----------------- ------------------
1997 1996 1995 1994 1994 1993 1994 1993
STATEMENT OF OPERATIONS DATA:
Service, rental & maintenance
revenues ...................... $ 351,944 $ 291,399 $ 138,466 $ 61,529 $ 22,847 $ 16,457 $ 55,139 $ 39,610
Product sales ................... 44,897 39,971 24,132 14,374 5,178 2,912 12,108 5,698
--------- --------- --------- -------- -------- -------- -------- --------
Total revenues .................. 396,841 331,370 162,598 75,903 28,025 19,369 67,247 45,308
Cost of products sold ........... (29,158) (27,469) (20,789) (12,787) (4,690) (2,027) (10,124) (4,031)
--------- --------- --------- -------- -------- -------- -------- --------
367,683 303,901 141,809 63,116 23,335 17,342 57,123 41,277
Operating expenses:
Service, rental & maintenance .. 79,836 64,957 29,673 14,395 5,231 3,959 13,123 9,532
Selling ........................ 51,474 46,962 24,502 11,523 4,338 3,058 10,243 7,307
General & administrative ....... 106,041 86,181 40,448 19,229 7,022 5,510 17,717 13,123
Depreciation & amortization .... 232,347 191,871 60,205 18,321 6,873 5,549 16,997 13,764
--------- --------- --------- -------- -------- -------- -------- --------
Operating income (loss) ......... (102,015) (86,070) (13,019) (352) (129) (734) (957) (2,449)
Interest & non-operating
expenses, net .................. (97,159) (75,927) (22,522) (4,973) (1,993) (1,132) (4,112) (2,861)
Equity in loss of affiliate(2) .. (3,872) (1,968) (3,977) - - - - -
--------- --------- --------- -------- -------- -------- -------- --------
Income (loss) before income
tax benefit and extraordinary
item ........................... (203,046) (163,965) (39,518) (5,325) (2,122) (1,866) (5,069) (5,310)
Income tax benefit .............. 21,172 51,207 4,600 - - - - -
--------- --------- --------- -------- -------- -------- -------- --------
Income (loss) before
extraordinary item ............. (181,874) (112,758) (34,918) (5,325) (2,122) (1,866) (5,069) (5,310)
Extraordinary item(3) ........... - (1,904) (1,684) (1,137) (1,137) - - (415)
--------- --------- --------- -------- -------- -------- -------- --------
Net income (loss) ............... $(181,874) $(114,662) $ (36,602) $ (6,462) $ (3,259) $ (1,866) $ (5,069) $ (5,725)
========= ========= ========= ======== ======== ======== ======== ========
Basic income (loss) per common
share before extraordinary item $ (8.77) $ (5.53) $ (2.60) $ (.74) $ (.29) $ (.26) $ (.71) $ (.74)
Extraordinary item(3) ........... - (.09) (.12) (.16) (.16) - - (.06)
Basic net income (loss) per
common share(4) ................ $ (8.77) $ (5.62) $ (2.72) $ (.90) $ (.45) $ (.26) $ (.71) $ (.80)
Basic weighted average shares
outstanding(4) ................. 20,746,240 20,445,943 13,497,734 7,182,955 7,238,624 7,149,136 7,153,044 7,125,164
OTHER OPERATING DATA:
EBITDA(5) ....................... $ 130,332 $ 105,801 $ 47,186 $ 17,969 $ 6,744 $ 4,815 $ 16,040 $ 11,315
EBITDA margin (6) ............... 35% 35% 33% 28% 29% 28% 28% 27%
Capital expenditures, excluding
acquisitions ................... $ 102,769 $ 165,206 $ 60,468 $ 33,450 $ 15,279 $ 7,486 $ 25,657 $ 20,853
Pagers in service, at end of
period ......................... 3,890,000 3,295,000 2,006,000 538,000 538,000 288,000 410,000 254,000
DECEMBER 31, AUGUST 31,
----------------------------------------------------- -----------------------
1997 1996 1995 1994 1994 1993
---- ---- ---- ---- ---- ----
BALANCE SHEET DATA:
Current assets .................. $ 51,025 $ 43,611 $ 33,671 $ 8,483 $ 6,751 $ 4,690
Total assets .................... 1,020,720 1,146,756 785,376 117,858 76,255 62,209
Long-term debt, less current
maturities ..................... 968,896 918,150 457,044 93,420 67,328 49,748
Redeemable preferred stock ...... - 3,712 3,376 - - -
Stockholders' equity (deficit) .. (33,255) 147,851 246,884 9,368 (3,304) 1,563
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(1) On October 17, 1994, Arch announced that it was changing its fiscal year
end from August 31 to December 31. Arch was required to file a transition
report on Form 10-K with audited financial statements for the period
September 1, 1994 through December 31, 1994 and has elected to include
herein, for comparative purposes, unaudited financial statements for the
periods September 1, 1993 through December 31, 1993 and January 1, 1994
through December 31, 1994.
(2) Represents Arch's pro rata share of USA Mobile's net losses for the period
of time from Arch's acquisition of its initial 37% interest in USA Mobile
on May 16, 1995 through the completion of Arch's acquisition of USA Mobile
on September 7, 1995 and Arch's pro rata share of Benbow PCS Ventures,
Incorporated's losses since May 21, 1996.
(3) Reflects extraordinary charge resulting from prepayment of indebtedness.
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Results of Operations".
(4) Net income (loss) per common share is based on the weighted average number
of common shares outstanding. Other shares of stock issuable pursuant to
stock options and upon conversion of Arch's convertible subordinated
debentures have not been considered, as their effect would be anti-dilutive
and thus diluted net income (loss) per common share is the same as basic
net income (loss) per common share.
(5) EBITDA is a standard measure of financial performance in the paging
industry and is also one of the financial measures used to calculate
whether Arch and its subsidiaries are in compliance with the covenants
under their respective indebtedness, but should not be construed as an
alternative to operating income or cash flows from operating activities as
determined in accordance with generally accepted accounting principles.
EBITDA does not reflect equity in loss of affiliate, income tax benefit,
interest expense, net and extraordinary items.
(6) Calculated by dividing EBITDA by total revenues less cost of products sold.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview
Arch is a leading provider of wireless messaging services, primarily paging
services, and had 3.9 million pagers in service as of December 31, 1997. From
January 1, 1995 through December 31, 1997, the Company's total subscriber base
grew at a compound annual rate of 93.4% and its compound annual rate of internal
subscriber base growth (excluding pagers added through acquisitions) was 62.6%.
Arch derives the majority of its revenues from fixed periodic (usually
monthly) fees, not dependent on usage, charged to subscribers for paging
services. As long as a subscriber remains on service, operating results benefit
from the recurring payments of the fixed periodic fees without incurrence of
additional selling expenses by Arch. Arch's service, rental and maintenance
revenues and the related expenses exhibit substantially similar growth trends.
Arch's average revenue per subscriber has declined over the last three years as
a result of two principal reasons: (i) an increase in the number of subscriber
owned and reseller owned pagers for which Arch receives no recurring equipment
revenue and (ii) an increase in the number of reseller customers whose airtime
is purchased at wholesale rates. The reduction in average paging revenue per
subscriber resulting from these trends has been more than offset by the
elimination of associated expenses so that Arch's margins have improved over
such period.
Arch's total revenues have increased from $162.6 million in the year ended
December 31, 1995 to $331.4 million in the year ended December 31, 1996 and to
$396.8 million in the year ended December 31, 1997. Over the same periods,
through operating efficiencies and economies of scale, Arch has been able to
reduce its per pager operating costs to enhance its competitive position in its
markets. Due to the rapid growth in its subscriber base, Arch has incurred
significant selling expenses, which are charged to operations in the period
incurred. Arch has reported net losses of $36.6 million, $114.7 million and
$181.9 million in the years ended December 31, 1995, 1996 and 1997,
respectively, as a result of significant depreciation and amortization expenses
related to acquired and developed assets and interest charges associated with
indebtedness. However, as its subscriber base has grown, Arch's operating
results have improved, as evidenced by an increase in its earnings before
interest, taxes, depreciation and amortization ("EBITDA") from $47.2 million in
the year ended December 31, 1995 to $105.8 million in the year ended December
31, 1996 and to $130.3 million in the year ended December 31, 1997.
EBITDA is a standard measure of financial performance in the paging
industry and also is one of the financial measures used to calculate whether
Arch and its subsidiaries are in compliance with the covenants under their
respective debt agreements, but should not be construed as an alternative to
operating income or cash flows from operating activities as determined in
accordance with generally accepted accounting principles. One of Arch's
financial objectives is to increase its EBITDA, as such earnings are a
significant source of funds for servicing indebtedness and for investment in
continued growth, including purchase of pagers and paging system equipment,
construction and expansion of paging systems and possible acquisitions.
Forward-Looking Statements
This Form 10-K contains forward-looking statements. For this purpose, any
statements contained herein that are not statements of historical fact may be
deemed to be forward-looking statements. Without limiting the foregoing, the
words "believes", "anticipates", "plans", "expects" and similar expressions are
intended to identify forward-looking statements. There are a number of important
factors that could cause the Company's actual results to differ materially from
those indicated or suggested by such forward-looking statements. These factors
include, without limitation, those set forth below under the caption "Factors
Affecting Future Operating Results".
Shift in Operating Focus
In April 1997, the Company announced it was shifting its operating focus to
put a higher priority on leverage reduction than subscriber unit growth. Arch's
deleveraging efforts are focusing on, but are not limited to, slowing capital
expenditures, implementing across-the-board efficiencies and the possible sale
of non-strategic assets.
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Results of Operations
The following table presents certain items from Arch's Consolidated
Statements of Operations as a percentage of net revenues (total revenues less
cost of products sold) and certain other information for the periods indicated:
Year Ended December 31,
1997 1996 1995
Total revenues.................... 107.9% 109.0% 114.7%
Cost of products sold............. (7.9) (9.0) (14.7)
Net revenues...................... 100.0 100.0 100.0
Operating expenses:
Service, rental and
maintenance .................. 21.7 21.4 20.9
Selling........................ 14.0 15.4 17.3
General and administrative..... 28.8 28.4 28.5
Depreciation and amortization.. 63.2 63.1 42.5
Operating income (loss)........... (27.7)% (28.3)% (9.2)%
Net income (loss)................. (49.5)% (37.7)% (25.8)%
EBITDA............................ 35.4% 34.8% 33.3%
Annual service, rental and
maintenance expenses per pager.. $ 22 $ 25 $ 28
Year Ended December 31, 1997 Compared with Year Ended December 31, 1996
Total revenues increased $65.5 million, or 19.8%, to $396.8 million in the
year ended December 31, 1997 from $331.4 million in the year ended December 31,
1996 and net revenues increased $63.8 million, or 21.0%, from $303.9 million to
$367.7 million over the same period. Service, rental and maintenance revenues,
which consist primarily of recurring revenues associated with the sale or lease
of pagers, increased $60.5 million, or 20.8%, to $351.9 million in the year
ended December 31, 1997 from $291.4 million in the year ended December 31, 1996.
These increases in revenues were due primarily to the increase in the number of
pagers in service from 3,295,000 at December 31, 1996 to 3,890,000 at December
31, 1997 and the full year impact of the Westlink Holdings, Inc. ("Westlink")
acquisition which was completed in May 1996. All net new subscribers were
generated through internal growth. Maintenance revenues represented less than
10% of total service, rental and maintenance revenues in the years ended
December 31, 1996 and 1997. Arch does not differentiate between service and
rental revenues. Product sales, less cost of products sold, increased 25.9% to
$15.7 million in the year ended December 31, 1997 from $12.5 million in the year
ended December 31, 1996 as a result of a greater number of pager unit sales.
Service, rental and maintenance expenses, which consist primarily of
telephone line and site rental expenses, increased to $79.8 million (21.7% of
net revenues) in the year ended December 31, 1997 from $65.0 million (21.4% of
net revenues) in the year ended December 31, 1996. The increase was due
primarily to increased expenses associated with system expansions and the
provision of paging services to a greater number of subscribers. As existing
paging systems become more populated through the addition of new subscribers,
the fixed costs of operating these paging systems are spread over a greater
subscriber base. Annual service, rental and maintenance expenses per subscriber
decreased to $22 in the year ended December 31, 1997 from $25 in the year ended
December 31, 1996.
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15
Selling expenses increased to $51.5 million (14.0% of net revenues) in the
year ended December 31, 1997 from $47.0 million (15.4% of net revenues) in the
year ended December 31, 1996. The increase in selling expenses was primarily due
to the full year impact of the Westlink acquisition and the marketing costs
incurred to promote the Company's Arch Paging brand identity. Arch's selling
cost per net new pager in service increased to $87 in the year ended December
31, 1997 from $58 in the year ended December 31, 1996, primarily due to fixed
selling costs and increased marketing costs being spread over fewer net new
pagers put into service. Most selling expenses are directly related to the
number of net new subscribers added. Therefore, such expenses may increase in
the future if pagers in service are added at a more rapid rate than in the past.
General and administrative expenses increased to $106.0 million (28.8% of
net revenues) in the year ended December 31, 1997 from $86.2 million (28.4% of
net revenues) in the year ended December 31, 1996. The increase in absolute
dollars was due primarily to increased expenses associated with supporting more
pagers in service including the full year impact of Westlink.
Depreciation and amortization expenses increased to $232.3 million (63.2%
of net revenues) in the year ended December 31, 1997 from $191.9 million (63.1%
of net revenues) in the year ended December 31, 1996. These expenses reflect
Arch's acquisitions of paging businesses, accounted for as purchases, and
continued investment in pagers and other system expansion equipment to support
continued growth.
Operating loss increased to $102.0 million in the year ended December 31,
1997 from $86.1 million in the year ended December 31, 1996 as a result of the
factors outlined above.
Net interest expense increased to $97.2 million in the year ended December
31, 1997 from $75.9 million in the year ended December 31, 1996. The increase
was attributable to an increase in Arch's average outstanding debt. In 1997 and
1996 interest expense includes approximately $33 million and $24 million,
respectively, of non-cash interest accretion on the Company's 107/8% Senior
Discount Notes due 2008 under which semi-annual interest payments commence on
September 15, 2001. See Note 3 to Arch's Consolidated Financial Statements.
During the years ended December 31, 1997 and 1996, the Company recognized
income tax benefits of $21.2 million and $51.2 million, respectively,
representing the tax benefit of operating losses subsequent to the acquisitions
of USA Mobile Communications Holdings, Inc. ("USA Mobile") and Westlink which
were available to offset deferred tax liabilities arising from the Company's
acquisitions of USA Mobile in September 1995 and Westlink in May 1996.
During 1996, Arch recognized an extraordinary charge of $1.9 million,
representing the write-off of unamortized deferred financing costs associated
with the prepayment of indebtedness under separate prior credit facilities.
Net loss increased to $181.9 million in the year ended December 31, 1997
from $114.7 million in the year ended December 31, 1996 as a result of the
factors outlined above. Included in the net loss for the years ended December
31, 1997 and 1996 were charges of $3.9 million and $2.0 million, respectively,
representing Arch's pro rata share of Benbow PCS Ventures, Inc.'s ("Benbow")
losses since May 21, 1996.
EBITDA increased 23.2% to $130.3 million (35.4% of net revenues) in the
year ended December 31, 1997 from $105.8 million (34.8% of net revenues) in the
year ended December 31, 1996 as a result of the factors outlined above.
Year Ended December 31, 1996 Compared with Year Ended December 31, 1995
Total revenues increased $168.8 million, or 103.8%, to $331.4 million in
the year ended December 31, 1996 from $162.6 million in the year ended December
31, 1995 and net revenues increased $162.1 million, or 114.3%, from $141.8
million to $303.9 million over the same period. Service, rental and maintenance
revenues increased $152.9 million, or 110.4%, to $291.4 million in the year
ended December 31, 1996 from $138.5 million in the year ended December 31, 1995.
These increases in revenues were due primarily to the increase in the number of
pagers in service from 2,006,000 at December 31, 1995 to 3,295,000 at December
31, 1996. Acquisitions of paging companies added 474,000 pagers in service
during 1996, with the remaining 815,000 pagers added through internal growth.
Maintenance revenues represented less
15
16
than 10% of total service, rental and maintenance revenues in the years ended
December 31, 1995 and 1996. Product sales, less cost of products sold, increased
274.0% to $12.5 million in the year ended December 31, 1996 from $3.3 million in
the year ended December 31, 1995 as a result of a greater number of pager unit
sales.
Service, rental and maintenance expenses, increased to $65.0 million (21.4%
of net revenues) in the year ended December 31, 1996 from $29.7 million (20.9%
of net revenues) in the year ended December 31, 1995. The increase was due
primarily to increased expenses associated with system expansions and the
provision of paging services to a greater number of subscribers. Annual service,
rental and maintenance expenses per subscriber decreased to $25 in the year
ended December 31, 1996 from $28 in the year ended December 31, 1995.
Selling expenses increased to $47.0 million (15.4% of net revenues) in the
year ended December 31, 1996 from $24.5 million (17.3% of net revenues) in the
year ended December 31, 1995. The increase in selling expenses was due to the
addition of sales personnel to support continued growth in the subscriber base,
as the number of net new pagers in service resulting from internal growth
increased by 122.7% from the year ended December 31, 1995 to the year ended
December 31, 1996. Arch's selling cost per net new pager in service decreased to
$58 in the year ended December 31, 1996 from $67 in the year ended December 31,
1995, primarily due to increased sales through indirect distribution channels.
General and administrative expenses increased to $86.2 million (28.4% of
net revenues) in the year ended December 31, 1996 from $40.4 million (28.5% of
net revenues) in the year ended December 31, 1995. The increase was due
primarily to increased expenses associated with supporting more pagers in
service.
Depreciation and amortization expenses increased to $191.9 million (63.1%
of net revenues) in the year ended December 31, 1996 from $60.2 million (42.5%
of net revenues) in the year ended December 31, 1995. These expenses reflect
Arch's acquisitions of paging businesses, accounted for as purchases, and
continued investment in pagers and other system expansion equipment to support
continued growth.
Operating loss increased to $86.1 million in the year ended December 31,
1996 from $13.0 million in the year ended December 31, 1995 as a result of the
factors outlined above.
Net interest expense increased to $75.9 million in the year ended December
31, 1996 from $22.5 million in the year ended December 31, 1995. The increase
was attributable to an increase in Arch's average outstanding debt. Interest
expense in 1996 includes approximately $24 million of non-cash interest
accretion on the Company's 107/8% Senior Discount Notes due 2008 under which
semi-annual interest payments commence on September 15, 2001. See Note 3 to
Arch's Consolidated Financial Statements.
During the years ended December 31, 1996 and 1995, the Company recognized
income tax benefits of $51.2 million and $4.6 million, respectively,
representing the tax benefit of operating losses subsequent to the acquisitions
of USA Mobile and Westlink which were available to offset deferred tax
liabilities arising from the Company's acquisitions of USA Mobile and Westlink.
During 1996 and 1995, Arch recognized an extraordinary charge of $1.9
million and $1.7 million, respectively, representing the write-off of
unamortized deferred financing costs associated with the prepayment of
indebtedness under separate prior credit facilities.
Net loss increased to $114.7 million in the year ended December 31, 1996
from $36.6 million in the year ended December 31, 1995 as a result of the
factors outlined above. Included in the net loss for the year ended December 31,
1995 was a charge of $4.0 million representing Arch's pro rata share of USA
Mobile's net loss for the period of time from Arch's acquisition of its initial
37% interest in USA Mobile on May 16, 1995 through the completion of Arch's
acquisition of USA Mobile on September 7, 1995. Included in the net loss for the
year ended December 31, 1996 was a charge of $2.0 million representing Arch's
pro rata share of Benbow's losses since May 21, 1996.
EBITDA increased 124.2% to $105.8 million (34.8 % of net revenues) in the
year ended December 31, 1996 from $47.2 million (33.3% of net revenues) in the
year ended December 31, 1995 as a result of the factors outlined above.
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Liquidity and Capital Resources
Arch's business strategy requires the availability of substantial funds to
finance the expansion of existing operations, to fund capital expenditures for
pagers and paging system equipment, to finance acquisitions and to service debt.
Capital Expenditures and Commitments
Excluding acquisitions of paging businesses, Arch's capital expenditures
were $60.5 million in the year ended December 31, 1995, $165.2 million in the
year ended December 31, 1996 and $102.8 million in the year ended December 31,
1997. To date, Arch has funded its capital expenditures with net cash provided
by operating activities, the issuance of equity securities and the incurrence of
debt.
Arch has agreed, to the extent such funds are not available to Benbow from
other sources and subject to the approval of Arch's designee on Benbow's Board
of Directors, to advance to Benbow sufficient funds to service debt obligations
incurred by Benbow in connection with its acquisition of its narrowband PCS
licenses and to finance the build out of a regional narrowband PCS system. Arch
estimates that the total cost to Benbow of servicing such debt obligations and
constructing such regional narrowband PCS system will be approximately $100
million over the next five years.
Arch currently anticipates capital expenditures of approximately $90
million to $100 million for the year ending December 31, 1998, primarily for the
purchase of pagers and paging system equipment. Such amounts are subject to
change based on the Company's internal growth rate and acquisition activity, if
any, during 1998. Arch believes that it will have sufficient cash available from
operations and credit facilities to fund these expenditures.
Acquisitions
In May 1996, Arch completed its acquisition of Westlink for aggregate
consideration of $325.4 million in cash (including direct transaction costs).
See Note 2 to the Company's Consolidated Financial Statements.
In September 1995, Arch completed its acquisition of USA Mobile for an
aggregate consideration of $582.2 million, consisting of $88.9 million in cash
(including direct transaction costs), 7,599,493 shares of common stock valued at
$209.0 million on the date of completion and the assumption of liabilities of
$284.3 million, including $241.2 million of long-term debt. See Note 2 to the
Company's Consolidated Financial Statements.
During 1995, the Company also completed five additional acquisitions for
aggregate consideration of $36.1 million in cash plus the issuance of 395,000
shares of common stock valued at $6.9 million on the date of completion. See
Note 2 to the Company's Consolidated Financial Statements.
The Company has pursued and intends to continue to pursue acquisitions of
paging businesses as part of its growth strategy. As a result, the Company
evaluates acquisition opportunities on an ongoing basis and from time to time is
engaged in discussions with respect to possible acquisitions.
Sources of Funds
Arch's net cash provided by operating activities was $63.6 million, $37.8
million and $14.7 million in the years ended December 31, 1997, 1996 and 1995,
respectively.
Arch believes that its capital needs for the foreseeable future will be
funded with borrowings under current and future credit facilities, net cash
provided by operations and, depending on the Company's needs and market
conditions, possible sales of equity or debt securities. For additional
information, see Note 3 to the Company's Consolidated Financial Statements.
17
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Inflation
Inflation has not had a material effect on Arch's operations to date.
Paging systems equipment and operating costs have not increased in price and
Arch's pager costs have declined substantially in recent years. This reduction
in costs has generally been reflected in lower pager prices charged to
subscribers who purchase their pagers. Arch's general operating expenses, such
as salaries, employee benefits and occupancy costs, are subject to normal
inflationary pressures.
Factors Affecting Future Operating Results
The following important factors, among others, could cause the Company's
actual operating results to differ materially from those indicated or suggested
by forward-looking statements made in this Form 10-K or presented elsewhere by
the Company's management from time to time.
Indebtedness and High Degree of Leverage
The Company is highly leveraged. At December 31, 1997, the Company had
outstanding $993.4 million of total debt, including: (i) $332.5 million accreted
value of the 10 7/8% Senior Discount Notes due 2008; (ii) $125 million principal
amount of the 9 1/2% Senior Notes due 2004 of USA Mobile II; (iii) $100 million
principal amount of the 14% Senior Notes due 2004 of USA Mobile II; (iv) $359.5
million borrowed under the Arch Enterprises Credit Facility; (v) $63.0 million
borrowed under the USA Mobile II Credit Facility; and (vi) $13.4 million
principal amount of the Company's 6 3/4% Convertible Subordinated Debentures due
2003. The ability of the Company to make payments of principal and interest on
its indebtedness will be dependent upon the Company's subsidiaries achieving and
sustaining levels of performance in the future that will permit such
subsidiaries to pay sufficient dividends, distributions or fees to the Company.
Many factors, some of which will be beyond the Company's control, such as
prevailing economic conditions, will affect the performance of the Company and
its subsidiaries. In addition, covenants imposed by the current and future
credit facilities and other indebtedness of the Company and its subsidiaries
could restrict the ability of the Company and its subsidiaries to incur
additional indebtedness and prohibit certain activities and may limit other
aspects of the Company's operations. There can be no assurance that the Company
or its subsidiaries will be able to generate sufficient cash flow to cover
required interest and principal payments on their current and future
indebtedness. If the Company is unable to meet interest and principal payments
in the future, it may, depending upon the circumstances which then exist, seek
additional equity or debt financing, attempt to refinance its existing
indebtedness or sell all or part of its business or assets to raise funds to
repay its indebtedness. There can be no assurance that sufficient equity or debt
financing will be available or, if available, that it will be on terms
acceptable to the Company, that the Company will be able to refinance its
existing indebtedness or that sufficient funds could be raised through asset
sales. The Company's high degree of leverage may have important consequences for
the Company, including: (i) the ability of the Company and its subsidiaries to
obtain additional financing for acquisitions, working capital, capital
expenditures or other purposes, if necessary, may be impaired or such financing
may not be on favorable terms; (ii) a substantial portion of the cash flow of
the Company's subsidiaries will be used to pay interest expense, which will
reduce the funds which would otherwise be available for operations and future
business opportunities; (iii) the Company may be more highly leveraged than its
competitors which may place it at a competitive disadvantage; and (iv) the
Company's high degree of leverage will make it more vulnerable to a downturn in
its business or the economy generally.
Future Capital Needs
The Company's business strategy requires the availability of substantial
funds to service debt and finance the continued development and future growth
and expansion of its operations, including possible acquisitions. The amount of
capital required by the Company will depend upon a number of factors, including
subscriber growth, technological developments, marketing and sales expenses,
competitive conditions, acquisition strategy and acquisition opportunities. No
assurance can be given that additional equity or debt financing will be
available to the Company on acceptable terms, if at all. The unavailability of
sufficient financing when needed would have a material adverse effect on the
Company.
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History of Losses
The Company has not reported any net income since its inception. The
Company reported net losses of $181.9 million, $114.7 million and $36.6 million
in the years ended December 31, 1997, 1996 and 1995, respectively. These net
losses have resulted principally from (i) substantial depreciation and
amortization expenses, primarily related to intangible assets and pager
depreciation and (ii) interest expense on debt incurred primarily to finance
acquisitions of paging operations and other costs of growth. Substantial and
increased amounts of debt are expected to be outstanding for the foreseeable
future, which will result in significant additional interest expense which could
have a substantial negative impact on the Company. The Company expects to
continue to report net losses for the foreseeable future.
Growth and Acquisition Strategy
The Company has pursued and intends to continue to pursue acquisitions of
paging businesses as well as the continued internal growth of the Company's
paging business. The process of integrating acquired paging businesses may
involve unforeseen difficulties and may require a disproportionate amount of the
time and attention of the Company's management and the financial and other
resources of the Company. No assurance can be given that suitable additional
acquisitions can be identified, financed and completed on acceptable terms, or
that the Company's future acquisitions will be successful. Implementation of the
Company's growth strategies will be subject to numerous other contingencies
beyond the control of the Company, including general and regional economic
conditions, interest rates, competition, changes in regulation or technology and
the ability to attract and retain skilled employees. Accordingly, no assurance
can be given that the Company's growth strategies will prove effective or that
the goals of the Company will be achieved.
Dependence on Key Personnel
The success of the Company will be dependent, to a significant extent, upon
the continued services of a relatively small group of executive personnel. The
Company does not have employment agreements with any of its current executive
officers, although all current executive officers have entered into
non-competition and executive retention agreements with the Company. The loss or
unavailability of one or more of its executive officers or the inability to
attract or retain key employees in the future could have an adverse effect upon
the Company's operations.
Competition and Technological Change
The Company faces competition from other paging service providers in all
markets in which it operates as well as from certain competitors who hold
nationwide licenses. The Company believes that competition for paging
subscribers is based on quality of service, geographic coverage and price and
that the Company generally competes effectively based on these factors. Monthly
fees for basic paging services have, in general, declined since the Company
commenced operations in September 1986, due in part to competitive conditions,
and the Company may face significant price-based competition in the future which
could adversely affect the Company. Some of the Company's competitors possess
greater financial, technical and other resources than the Company. A trend
towards increasing consolidation in the paging industry in particular and the
wireless communications industry in general in recent years has led to
competition from increasingly larger and better capitalized competitors. If any
of such competitors were to devote additional resources to the paging business
or focus its strategy on the Company's markets, the Company's results of
operations could be adversely affected. A variety of wireless two-way
communication technologies currently are in use or under development. Although
such technologies generally are higher priced than paging services or not widely
available, technological improvements could result in increased capacity and
efficiency for wireless two-way communication and, accordingly, could result in
increased competition for the Company. Two-way service providers also could
elect to provide paging service as an adjunct to their primary services. Future
technological advances in the telecommunications industry could increase new
services or products competitive with the paging services provided by the
Company or could require the Company to reduce the price of its paging services
or incur additional capital expenditures to meet competitive requirements.
Recent and proposed regulatory changes by the FCC are aimed at encouraging such
technological advances and new services. For example, the FCC has created
potential sources of competition by opening up new spectrum for such services as
the General Wireless Communications Service ("GWCS") and the Wireless
Communications Service ("WCS") as well as speeding up licensing of other
services through auctions, including the Local Multipoint Distribution Service
("LMDS"), 220-222 MHz and broadband PCS services. Entities offering service on
wireless two-way communications technology, including cellular
19
20
telephones and specialized mobile radio services, also compete with the paging
services that the Company provides. There can be no assurance that the Company
will be able to compete successfully with its current and future competitors in
the paging business or with competitors offering alternative communication
technologies.
Subscriber Turnover
The results of operations of wireless messaging service providers, such as
the Company, can be significantly affected by subscriber cancellations. The
sales and marketing costs associated with attracting new subscribers are
substantial relative to the costs of providing service to existing customers.
Because the paging business is characterized by high fixed costs,
disconnection's directly and adversely affect operating cash flow. An increase
in its subscriber cancellation rate may adversely affect the Company's results
of operations.
Dependence on Suppliers
The Company does not manufacture any of the pagers used in its paging
operations. The Company buys pagers primarily from Motorola, Inc. ("Motorola")
and NEC America, Inc. ("NEC") and therefore is dependent on such manufacturers
to obtain sufficient pager inventory for new subscriber and replacement needs.
In addition, the Company purchases terminals and transmitters primarily from
Glenayre Technologies, Inc. ("Glenayre") and Motorola and thus is dependent on
such manufacturers for sufficient terminals and transmitters to meet its
expansion and replacement requirements. To date, the Company has not experienced
significant delays in obtaining pagers, terminals or transmitters, but there can
be no assurance that the Company will not experience such delays in the future.
The Company has never had a purchase agreement with Glenayre or NEC. The
Company's purchase agreement with Motorola expired in December 1997, with a
provision for automatic renewal for a one-year term. Although the Company
believes that sufficient alternative sources of pagers, terminals and
transmitters exist, there can be no assurance that the Company would not be
adversely affected if it were unable to obtain these items from current supply
sources or on terms comparable to existing terms.
Government Regulation, Foreign Ownership and Possible Redemption of Capital
Stock
The paging operations of the Company are subject to regulation by the FCC
and various state regulatory agencies. There can be no assurance that those
agencies will not propose or adopt regulations or take actions that would have a
material adverse effect on the Company's business. Changes in regulation of the
Company's paging business or the allocation of radio spectrum for services that
compete with the Company's business could adversely affect the Company's results
of operations. Indeed, the FCC has created potential sources of competition by
opening up new spectrum for such services as the GWCS and the WCS as well as,
speeding up licensing of other services through auctions, including the LMDS,
220-222 MHz and broadband PCS services. Further, the FCC has recently adopted
rules implementing a market area licensing scheme. In addition, some aspects of
the recently enacted Telecommunications Act of 1996 could have a beneficial
effect on Arch's business, but other provisions may place additional burdens
upon Arch or subject Arch to increased competition. The Communications Act of
1934, as amended, limits foreign ownership of entities that hold certain
licenses from the FCC. Because the Company, through its subsidiaries, holds FCC
licenses, in general, no more than 25% of the Company's stock can be owned or
voted by aliens or their representatives, a foreign government or its
representative or a foreign corporation, the Company's Restated Certificate of
Incorporation permits the redemption of shares of the Company's capital stock
from foreign stockholders where necessary to protect the Company's regulatory
licenses, but such redemption would be subject to the availability of capital to
the Company and any restrictions contained in the debt instruments of the
Company and under Delaware law. The failure to redeem such shares promptly could
jeopardize the Company's FCC licenses.
Impact of the Year 2000 Issue
The Company is currently working to resolve the potential impact of the
year 2000 on the processing of date-sensitive information by the Company's
computerized systems and transmission equipment. The year 2000 problem is the
result of computer programs being written using two digits (rather than four) to
define the applicable year. Any of the Company's programs that have
time-sensitive software may recognize a date using "00" as the year 1900 rather
than the year 2000. This could result in a system failure or miscalculations
causing disruptions of operations, including, among other things, a
20
21
temporary inability to process transactions, send invoices, or engage in similar
normal business activities. Based on preliminary information, costs of
addressing potential problems are not currently expected to have a material
adverse impact on the Company's financial position, results of operations or
cash flows in future periods. However, if the Company, its customers or vendors
are unable to resolve such processing issues in a timely manner, it could result
in a material financial risk. Accordingly, the Company plans to devote the
necessary resources to resolve all significant year 2000 issues in a timely
manner.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and schedules listed in Item 14(a)(1) and (2)
are included in this Report beginning on Page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
The information required by Items 10 through 13 are incorporated by
reference to the Registrant's definitive Proxy Statement for its 1998 annual
meeting of stockholders scheduled to be held on May 19, 1998.
21
22
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) (1) Financial Statements
Consolidated Balance Sheets as of December 31, 1997 and 1996
Consolidated Statements of Operations for Each of the Three Years in the
Period Ended December 31, 1997
Consolidated Statements of Stockholders' Equity (Deficit) for Each of
the Three Years in the Period Ended December 31, 1997
Consolidated Statements of Cash Flows for Each of the Three Years in the
Period Ended December 31, 1997
Notes to Consolidated Financial Statements
(a) (2) Financial Statement Schedule
Schedule II - Valuation and Qualifying Accounts
(b) Reports on Form 8-K
Noreports on Form 8-K were filed during the three months ended December
31, 1997.
(c) Exhibits
The exhibits listed on the accompanying index to exhibits are filed as
part of this Annual Report on Form 10-K.
22
23
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.
ARCH COMMUNICATIONS GROUP, INC.
By: /s/ C. Edward Baker, Jr.
------------------------
C. Edward Baker, Jr.
Chairman of the Board and
Chief Executive Officer
March 27, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
on the dates indicated.
/S/ C. EDWARD BAKER, JR. Chairman of the Board and March 27, 1998
- -------------------------- Chief Executive Officer
(principal executive officer)
/S/ JOHN B. SAYNOR Executive Vice President, March 27, 1998
- ------------------------- Director
/S/ J. ROY POTTLE Executive Vice President March 27, 1998
- ------------------------- and Chief Financial Officer
(principal financial officer and
principal accounting officer)
/S/ R. SCHORR BERMAN Director March 27, 1998
- -------------------------
/S/ JAMES S. HUGHES Director March 27, 1998
- -------------------------
/S/ ALLAN L. RAYFIELD Director March 27, 1998
- -------------------------
/S/ JOHN A. SHANE Director March 27, 1998
- -------------------------
23
24
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Public Accountants............................ F-2
Consolidated Balance Sheets as of December 31, 1997 and 1996........ F-3
Consolidated Statements of Operations for Each of the Three
Years in the Period Ended December 31, 1997....................... F-4
Consolidated Statements of Stockholders' Equity (Deficit) for Each
of the Three Years in the Period Ended December 31, 1997.......... F-5
Consolidated Statements of Cash Flows for Each of the Three
Years in the Period Ended December 31, 1997....................... F-6
Notes to Consolidated Financial Statements.......................... F-7
F-1
25
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Arch Communications Group, Inc.:
We have audited the accompanying consolidated balance sheets of Arch
Communications Group, Inc. (a Delaware corporation) (the "Company") and
subsidiaries as of December 31, 1997 and 1996 and the related consolidated
statements of operations, stockholders' equity (deficit) and cash flows for each
of the three years in the period ended December 31, 1997. These consolidated
financial statements and the schedule referred to below are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these consolidated financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Arch Communications Group,
Inc. and subsidiaries as of December 31, 1997 and 1996 and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in the index at Item
14(a)(2) is presented for purposes of complying with the Securities and Exchange
Commission's rules and is not part of the basic financial statements. This
schedule has been subjected to the auditing procedures applied in our audits of
the basic financial statements and, in our opinion, fairly states, in all
material respects, the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Boston, Massachusetts
February 9, 1998
F-2
26
ARCH COMMUNICATIONS GROUP, INC.
CONSOLIDATED BALANCE SHEETS
December 31, 1997 and 1996
(in thousands, except share amounts)
1997 1996
---------- ----------
ASSETS
Current assets:
Cash and cash equivalents ....................... $ 3,328 $ 3,497
Accounts receivable (less reserves of $5,744
and $4,111 in 1997 and 1996, respectively) ..... 30,147 25,344
Inventories ..................................... 12,633 10,239
Prepaid expenses and other ...................... 4,917 4,531
---------- ----------
Total current assets ......................... 51,025 43,611
---------- ----------
Property and equipment, at cost:
Land, buildings and improvements ................ 10,089 8,780
Paging and computer equipment ................... 361,713 339,391
Furniture, fixtures and vehicles ................ 16,233 9,921
---------- ----------
388,035 358,092
Less accumulated depreciation and amortization .. 146,542 96,448
---------- ----------
Property and equipment, net ..................... 241,493 261,644
---------- ----------
Intangible and other assets (less accumulated
amortization of $260,932 and $141,710 in 1997 and
1996, respectively) ............................... 728,202 841,501
---------- ----------
$1,020,720 $1,146,756
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Current maturities of long-term debt ............ $ 24,513 $ 46
Accounts payable ................................ 22,486 17,395
Accrued expenses ................................ 11,894 14,287
Accrued interest ................................ 11,249 10,264
Customer deposits ............................... 6,150 6,698
Deferred revenue ................................ 8,787 7,181
---------- ----------
Total current liabilities .................... 85,079 55,871
---------- ----------
Long-term debt, less current maturities ............ 968,896 918,150
---------- ----------
Deferred income taxes .............................. -- 21,172
---------- ----------
Commitments and Contingencies
Redeemable preferred stock ......................... -- 3,712
---------- ----------
Stockholders' equity (deficit):
Preferred stock -- $.01 par value, authorized
10,000,000 shares, no shares issued ............ -- --
Common stock -- $.01 par value, authorized
75,000,000 shares, issued and outstanding:
20,863,563 and 20,712,220 shares in 1997 and
1996, respectively ............................. 209 207
Additional paid-in capital ...................... 351,210 350,444
Accumulated deficit ............................. (384,674) (202,800)
---------- ----------
Total stockholders' equity (deficit) ......... (33,255) 147,851
---------- ----------
$1,020,720 $1,146,756
========== ==========
The accompanying notes are an integral part of these
consolidated financial statements
F-3
27
ARCH COMMUNICATIONS GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31,
(in thousands, except share and per share amounts)
1997 1996 1995
---- ---- ----
Service, rental and maintenance revenues ........................ $ 351,944 $ 291,399 $ 138,466
Product sales ................................................... 44,897 39,971 24,132
------------ ------------ ------------
Total revenues ............................................. 396,841 331,370 162,598
Cost of products sold ........................................... (29,158) (27,469) (20,789)
------------ ------------ ------------
367,683 303,901 141,809
------------ ------------ ------------
Operating expenses:
Service, rental and maintenance ............................... 79,836 64,957 29,673
Selling ....................................................... 51,474 46,962 24,502
General and administrative .................................... 106,041 86,181 40,448
Depreciation and amortization ................................. 232,347 191,871 60,205
------------ ------------ ------------
Total operating expenses ................................... 469,698 389,971 154,828
------------ ------------ ------------
Operating income (loss) ......................................... (102,015) (86,070) (13,019)
Interest expense ................................................ (98,063) (77,353) (22,560)
Interest income ................................................. 904 1,426 38
Equity in loss of affiliate ..................................... (3,872) (1,968) (3,977)
------------ ------------ ------------
Income (loss) before income tax benefit and extraordinary item... (203,046) (163,965) (39,518)
Benefit from income taxes ....................................... 21,172 51,207 4,600
------------ ------------ ------------
Income (loss) before extraordinary item ......................... (181,874) (112,758) (34,918)
Extraordinary charge from early extinguishment of debt .......... -- (1,904) (1,684)
------------ ------------ ------------
Net income (loss) ............................................... (181,874) (114,662) (36,602)
Accretion of redeemable preferred stock ......................... (32) (336) (102)
------------ ------------ ------------
Net income (loss) to common stockholders ........................ $ (181,906) $ (114,998) $ (36,704)
============ ============ ============
Basic income (loss) per common share before extraordinary item
and accretion of preferred stock .............................. $ (8.77) $ (5.51) $ (2.59)
Basic extraordinary charge from early extinguishment of
debt per common share .......................................... -- (.09) (.12)
Basic accretion of redeemable preferred stock per common share .. -- (.02) (.01)
------------ ------------ ------------
Basic net income (loss) per common share ........................ $ (8.77) $ (5.62) $ (2.72)
============ ============ ============
Basic weighted average number of common shares outstanding ...... 20,746,240 20,445,943 13,497,734
============ ============ ============
The accompanying notes are an integral part of these
consolidated financial statements.
F-4
28
ARCH COMMUNICATIONS GROUP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(in thousands, except share amounts)
Additional Total
Common Paid-In Accumulated Stockholders'
Stock Capital Deficit Equity(Deficit)
----- ------- ------- ---------------
Balance, December 31, 1994 ...................... $ 81 $ 60,823 $ (51,536) $ 9,368
Exercise of options to purchase 475,903
shares of common stock ..................... 5 5,137 -- 5,142
Issuance of 7,994,493 shares of common
stock to acquire stock of paging companies . 80 215,819 -- 215,899
Issuance of 2,706,659 shares of common
stock (net of issuance costs of $3,016) .... 27 46,354 -- 46,381
Issuance of 417,311 shares of common stock
upon conversion of convertible
subordinated debentures (net of costs of
conversion of $192) ........................ 4 6,794 -- 6,798
Accretion of redeemable preferred stock ...... -- (102) -- (102)
Net loss ..................................... -- -- (36,602) (36,602)
--------- --------- --------- ---------
Balance, December 31, 1995 ...................... 197 334,825 (88,138) 246,884
Exercise of options to purchase 169,308 shares
of common stock ............................ 2 1,469 -- 1,471
Issuance of 46,842 shares of common stock
under Arch's Employee Stock Purchase Plan .. -- 373 -- 373
Issuance of 843,039 shares of common stock
upon conversion of convertible subordinated
debentures ................................. 8 14,113 -- 14,121
Accretion of redeemable preferred stock ....... -- (336) -- (336)
Net loss ...................................... -- -- (114,662) (114,662)
--------- --------- --------- ---------
Balance, December 31, 1996 ...................... 207 350,444 (202,800) 147,851
Issuance of 151,343 shares of common stock
under Arch's Employee Stock Purchase Plan .. 2 798 -- 800
Accretion of redeemable preferred stock ....... -- (32) -- (32)
Net loss ...................................... -- -- (181,874) (181,874)
--------- --------- --------- ---------
Balance, December 31, 1997 ...................... $ 209 $ 351,210 $(384,674) $ (33,255)
========= ========= ========= =========
The accompanying notes are an integral part of these
consolidated financial statements.
F-5
29
ARCH COMMUNICATIONS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
(in thousands)
1997 1996 1995
---- ---- ----
Cash flows from operating activities:
Net income (loss) ............................................. $(181,874) $(114,662) $ (36,602)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization ................................. 232,347 191,871 60,205
Deferred income tax benefit ................................... (21,172) (51,207) (4,600)
Extraordinary charge from early extinguishment of debt ........ -- 1,904 1,684
Equity in loss of affiliate ................................... 3,872 1,968 3,977
Accretion of discount on senior notes ......................... 33,259 24,273 --
Accounts receivable loss provision ............................ 7,181 8,198 3,915
Changes in assets and liabilities, net of effect from
acquisitions of paging companies:
Accounts receivable ........................................ (11,984) (15,513) (9,582)
Inventories ................................................ (2,394) 1,845 (3,176)
Prepaid expenses and other ................................. (386) 89 (511)
Accounts payable and accrued expenses ...................... 3,683 (12,520) (551)
Customer deposits and deferred revenue ..................... 1,058 1,556 (10)
--------- --------- ---------
Net cash provided by operating activities ....................... 63,590 37,802 14,749
--------- --------- ---------
Cash flows from investing activities:
Additions to property and equipment, net ...................... (87,868) (138,899) (45,331)
Additions to intangible and other assets ...................... (14,901) (26,307) (15,137)
Acquisition of paging companies, net of cash acquired ......... -- (325,420) (132,081)
--------- --------- ---------
Net cash used for investing activities .......................... (102,769) (490,626) (192,549)
--------- --------- ---------
Cash flows from financing activities:
Issuance of long-term debt .................................... 91,000 676,000 191,617
Repayment of long-term debt ................................... (49,046) (225,166) (63,705)
Repayment of redeemable preferred stock ..................... (3,744) -- --
Net proceeds from sale of common stock ........................ 800 1,844 51,180
--------- --------- ---------
Net cash provided by financing activities ....................... 39,010 452,678 179,092
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents ............ (169) (146) 1,292
Cash and cash equivalents, beginning of period .................. 3,497 3,643 2,351
--------- --------- ---------
Cash and cash equivalents, end of period ........................ $ 3,328 $ 3,497 $ 3,643
========= ========= =========
Supplemental disclosure:
Interest paid ................................................. $ 62,231 $ 48,905 $ 20,933
========= ========= =========
Issuance of common stock for acquisition of paging companies .. $ -- $ -- $ 215,899
========= ========= =========
Issuance of common stock for convertible debentures ........... $ -- $ 14,121 $ 6,990
========= ========= =========
Accretion of redeemable preferred stock ....................... $ 32 $ 336 $ 102
========= ========= =========
Liabilities assumed in acquisition of paging companies ........ $ -- $ 58,233 $ 314,139
========= ========= =========
The accompanying notes are an integral part of these
consolidated financial statements.
F-6
30
ARCH COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Significant Accounting Policies
Organization -- Arch Communications Group, Inc. ("Arch") is a leading
provider of wireless messaging services, primarily paging services.
Principles of Consolidation -- The accompanying consolidated financial
statements include the accounts of Arch and its wholly-owned subsidiaries. All
significant intercompany accounts and transactions have been eliminated.
Revenue Recognition -- Arch recognizes revenue under rental and service
agreements with customers as the related services are performed. Maintenance
revenues and related costs are recognized ratably over the respective terms of
the agreements. Sales of equipment are recognized upon delivery. Commissions are
recognized as an expense when incurred.
Use of Estimates -- The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Cash Equivalents -- Cash equivalents include short-term, interest-bearing
instruments purchased with remaining maturities of three months or less. The
carrying amount approximates fair value due to the relatively short period to
maturity of these instruments.
Inventories -- Inventories consist of new pagers which are held
specifically for resale. Inventories are stated at the lower of cost or market,
with cost determined on a first-in, first-out basis.
Property and Equipment -- Pagers sold or otherwise retired are removed from
the accounts at their net book value using the first-in, first-out method.
Property and equipment is stated at cost and is depreciated using the
straight-line method over the following estimated useful lives:
Estimated
Asset Classification Useful Life
-------------------- -----------
Buildings and improvements............ 20 Years
Leasehold improvements................ Lease Term
Pagers................................ 3 Years
Paging and computer equipment......... 5-8 Years
Furniture and fixtures................ 5-8 Years
Vehicles.............................. 3 Years
Effective October 1, 1995, Arch changed its estimate of the useful life of
pagers from four years to three years. This change was made to better reflect
the estimated period during which pagers will produce equipment rental revenue.
The change did not have a material effect on depreciation expense or net loss in
the quarter ended December 31, 1995.
Depreciation and amortization expense related to property and equipment
totaled $108,019,000, $87,450,000 and $25,034,000 for the years ended December
31, 1997, 1996 and 1995, respectively.
F-7
31
Intangible and Other Assets -- Intangible and other assets, net of
accumulated amortization, are composed of the following at December 31, 1997 and
1996 (in thousands):
1997 1996
---- ----
Goodwill ..................................... $312,017 $351,969
Purchased FCC licenses ....................... 293,922 330,483
Purchased subscriber lists ................... 87,281 120,981
Deferred financing costs ..................... 8,752 12,449
Investment in CONXUS Communications, Inc. .... 6,500 6,500
Investment in Benbow PCS Ventures,Inc ........ 6,189 3,642
Non-competition agreements ................... 2,783 3,594
Other ........................................ 10,758 11,883
-------- --------
$728,202 $841,501
======== ========
Amortization expense related to intangible and other assets totaled
$124,328,000, $104,421,000 and $35,171,000 for the years ended December 31,
1997, 1996 and 1995, respectively.
Subscriber lists, Federal Communications Commission ("FCC") licenses and
goodwill are amortized over their estimated useful lives, ranging from five to
ten years using the straight-line method. Non-competition agreements are
amortized over the terms of the agreements using the straight-line method. Other
assets consist of contract rights, organizational and FCC application and
development costs which are amortized using the straight-line method over their
estimated useful lives not exceeding ten years. Development and start up costs
include nonrecurring, direct costs incurred in the development and expansion of
paging systems, and are amortized over a two-year period.
Deferred financing costs incurred in connection with Arch's credit
agreements (see Note 3) are being amortized over periods not to exceed the terms
of the related agreements. As credit agreements are amended or renegotiated,
unamortized deferred financing costs are written-off as an extraordinary charge.
A charge of $1,684,000 was recognized in the second quarter of 1995 in
connection with the closing of a new credit facility and a charge of $1,904,000
was recognized in the second quarter of 1996 in connection with the closing of
another new credit facility.
On November 8, 1994, CONXUS Communications, Inc. ("CONXUS"), formerly PCS
Development Corporation, was successful in acquiring the rights to a two-way
paging license in five designated regions in the United States in the FCC
narrowband wireless spectrum auction. As of December 31, 1997 Arch's investment
in CONXUS totaled $6.5 million representing an equity interest of 10.5%
accounted for under the cost method.
In connection with Arch's May 1996 acquisition of Westlink Holdings, Inc.
("Westlink") (see Note 2), Arch acquired Westlink's 49.9% share of the capital
stock of Benbow PCS Ventures, Inc. ("Benbow"). Benbow has exclusive rights to a
50kHz outbound/12.5kHz inbound narrowband personal communications license in
each of the central and western regions of the United States. Arch has agreed,
to the extent such funds are not available to Benbow from other sources and
subject to the approval of Arch's designee on Benbow's Board of Directors, to
advance Benbow sufficient funds to build out its narrowband personal
communications system. Arch's investment in Benbow is accounted for under the
equity method whereby Arch's share of Benbow's losses since the acquisition date
of Westlink are recognized in Arch's accompanying consolidated statements of
operations under the caption equity in loss of affiliate.
In accordance with Statement of Financial Accounting Standards ("SFAS") No.
121 "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to
be Disposed of" Arch evaluates the recoverability of its carrying value of the
Company's long-lived assets and certain intangible assets based on estimated
undiscounted cash flows to be generated from each of such assets as compared to
the original estimates used in measuring the assets. To the extent impairment is
identified, Arch reduces the carrying value of such impaired assets. To date,
Arch has not had any such impairments.
Fair Value of Financial Instruments -- Arch's financial instruments, as
defined under SFAS No. 107 "Disclosures about Fair Value of Financial
Instruments", include its cash, its debt financing and interest rate protection
agreements. The fair value of cash is equal to the carrying value at December
31, 1997 and 1996.
F-8
32
As discussed in Note 3, Arch's debt financing primarily consists of (1)
senior bank debt, (2) fixed rate senior notes and (3) convertible subordinated
debentures. Arch considers the fair value of senior bank debt to be equal to the
carrying value since the related facilities bear a current market rate of
interest. Arch is unable to determine the fair value of the convertible
subordinated debentures due to the specific terms and conversion features
available in their respective agreements. These various facilities were
negotiated with the creditors based on the facts and circumstances available at
the time the debt was incurred. Since Arch has undergone significant change over
the past year, management is unable to determine what rates and terms would be
available currently.
Arch's fixed rate senior notes are traded publicly. The following table
depicts the fair value of this debt based on the current market quote as of
December 31, 1997 and 1996 (in thousands):
December 31, 1997 December 31, 1996
-------------------- --------------------
Carrying Fair Carrying Fair
Description Value Value Value Value
----------- ----- ----- ----- -----
10 7/8% Senior Discount Notes due 2008 .......... $332,532 $288,418 $299,273 $265,236
9 1/2% Senior Notes due 2004 of USA Mobile II ... 125,000 122,488 125,000 117,500
14% Senior Notes due 2004 of USA Mobile II ...... 100,000 112,540 100,000 115,000
Arch had off balance sheet interest rate protection agreements consisting
of interest rate swaps and interest rate caps with notional amounts of $140
million and $80 million, respectively at December 31, 1997 and $165 million and
$55 million, respectively, at December 31, 1996. The fair values of the interest
rate swaps and interest rate caps were $47,000 and $9,000, respectively, at
December 31, 1997 and $361,000 and $10,000, respectively, at December 31, 1996.
Basic Net Income (Loss) Per Common Share -- In February 1997, the Financial
Accounting Standards Board issued SFAS No. 128 "Earnings Per Share". The Company
adopted this standard in 1997. The adoption of this standard did not have an
effect on the Company's financial position, results of operations or income
(loss) per share. Basic net income (loss) per common share is based on the
weighted average number of common shares outstanding. Shares of stock issuable
pursuant to stock options and upon conversion of the subordinated debentures
(see Note 3) have not been considered, as their effect would be anti-dilutive
and thus diluted net income (loss) per common share is the same as basic net
income (loss) per common share.
Reclassifications -- Certain amounts of prior periods were reclassified to
conform with the 1997 presentation.
2. Acquisitions
On May 21, 1996, Arch completed its acquisition of all the outstanding
capital stock of Westlink for $325.4 million in cash, including direct
transaction costs. The purchase price was allocated based on the fair values of
assets acquired and liabilities assumed (including deferred income taxes arising
in purchase accounting), which amounted to $383.6 million and $58.2 million,
respectively.
On September 7, 1995, Arch completed its acquisition of USA Mobile
Communications Holdings, Inc. ("USA Mobile"). The acquisition was completed in
two steps. First, in May 1995, Arch acquired approximately 37%, or 5,450,000
shares, of USA Mobile's then outstanding common stock for $83.9 million in cash,
funded by borrowings under the Arch Enterprises Credit Facility (see Note 3).
Accordingly, Arch accounted for its investment in USA Mobile under the equity
method of accounting. Arch recorded a charge of $4.0 million for the year ended
December 31, 1995 representing it's pro rata share of USA Mobile's net loss from
May until the acquisition was completed. Second, on September 7, 1995, the
acquisition was completed through the merger of Arch with and into USA Mobile
("the Merger"). Upon consummation of the Merger, USA Mobile was renamed Arch
Communications Group, Inc. In the Merger, each share of USA Mobile's outstanding
common stock was exchanged for Arch common stock on a .8020-for-one basis (an
aggregate of 7,599,493 shares of Arch common stock) and the 5,450,000 USA Mobile
shares purchased by Arch in May 1995 were retired. Outstanding shares of USA
Mobile's Series A Redeemable Preferred Stock were not affected by the Merger
(see Note 4). Arch is treated as the acquirer in the Merger for accounting and
financial reporting purposes and the purchase price was allocated based upon the
fair market values of assets acquired and liabilities assumed. The aggregate
consideration paid or exchanged in the Merger was $582.2 million, consisting of
F-9
33
cash paid of $88.9 million, including direct transaction costs, 7,599,493 shares
of Arch common stock valued at $209.0 million and the assumption of liabilities
of $284.3 million, including $241.2 million of long-term debt.
During the year ended December 31, 1995, Arch completed five acquisitions
of paging companies, in addition to the Merger, for purchase prices aggregating
approximately $43.0 million, consisting of cash of $36.1 million and 395,000
shares of Arch common stock valued at $6.9 million. Goodwill resulting from the
acquisitions and the Merger is being amortized over a ten-year period using the
straight-line method.
These acquisitions have been accounted for as purchases, and the results of
their operations have been included in the consolidated financial statements
from the dates of the respective acquisitions. The following unaudited pro forma
summary presents the consolidated results of operations as if the acquisitions
had occurred at the beginning of the periods presented, after giving effect to
certain adjustments, including depreciation and amortization of acquired assets
and interest expense on acquisition debt. These pro forma results have been
prepared for comparative purposes only and do not purport to be indicative of
what would have occurred had the acquisitions been made at the beginning of the
period presented, or of results that may occur in the future.
(unaudited and in thousands except
for per share amounts)
Year Ended December 31,
--------------------------------------
1996 1995
Revenues.................................. $ 358,900 $321,963
Income (loss) before extraordinary item... (128,444) (92,395)
Net income (loss)......................... (130,348) (94,079)
Basic net income (loss) per common share.. (6.39) (6.97)
3. Long-term Debt
Long-term debt consisted of the following at December 31, 1997 and 1996 (in
thousands):
1997 1996
---- ----
Senior bank debt ................................ $422,500 $380,500
10 7/8% Senior Discount Notes due 2008 .......... 332,532 299,273
9 1/2% Senior Notes due 2004 of USA Mobile II ... 125,000 125,000
14% Senior Notes due 2004 of USA Mobile II ...... 100,000 100,000
Convertible subordinated debentures ............. 13,364 13,364
Other ........................................... 13 59
-------- --------
993,409 918,196
Less-current maturities ......................... 24,513 46
-------- --------
Long-term debt .................................. $968,896 $918,150
======== ========
Senior Bank Debt -- Arch, through its operating subsidiaries, has entered
into two credit agreements. Arch Communications Enterprises, Inc. ("Arch
Enterprises"), a wholly-owned subsidiary of Arch, entered into a credit facility
dated May 5, 1995, as amended, with a group of banks and financial institutions
who agreed, subject to certain terms and conditions to provide (i) a $250
million, seven-year reducing revolver facility (the "Arch Enterprises
Revolver"), (ii) a $150 million, seven-year term loan (the "Tranche A Term
Loan"), and (iii) a $100 million, eight-year term loan (the "Tranche B Term
Loan"). The Arch Enterprises Revolver, which is available for working capital
and other purposes, the Tranche A Term Loan and the Tranche B Term Loan are
collectively referred to as the Arch Enterprises Credit Facility. The Arch
Enterprises Credit Facility is secured by all assets of the operating
subsidiaries of Arch Enterprises and a pledge of all the stock of Arch's direct
and indirect subsidiaries. In addition, Arch and the operating subsidiaries of
Arch Enterprises have guaranteed all obligations under the Arch Enterprises
Credit Facility.
The Arch Enterprises Revolver is subject to scheduled mandatory reductions
commencing on December 31, 1999. The Tranche A Term Loan and Tranche B Term Loan
will be amortized in quarterly installments commencing on March 31, 1998.
F-10
34
Except for the Tranche B Term Loan, borrowings under the Credit Facilities
bear interest based on a reference rate equal to either (i) the agent bank's
Alternate Base Rate, or (ii) the agent bank's LIBOR rate, in each case plus a
margin which is based on the ratio of total debt to annualized operating cash
flow. Borrowings under the Tranche B Term Loan bear interest at either the agent
bank's Alternate Base Rate plus 1.75%, or the agent bank's LIBOR rate plus
3.00%. Interest is payable quarterly in arrears. In addition, a commitment fee
of .375% per annum is payable on the average daily unused portion of the Arch
Enterprises Revolver.
Arch Enterprises is also required to maintain interest rate protection on
at least 50% of outstanding borrowings under the Arch Enterprises Credit
Facility, and has therefore entered into interest rate swap and interest rate
cap agreements. Entering into interest rate cap and swap agreements involves
both the credit risk of dealing with counterparties and their ability to meet
the terms of the contracts and interest rate risk. In the event of
non-performance by the counterparty to these interest rate protection
agreements, Arch Enterprises would be subject to the prevailing interest rates
specified in the Arch Enterprises Credit Facility.
Under the interest rate swap agreements, the Company will pay the
difference between LIBOR and the fixed swap rate if the swap rate exceeds LIBOR,
and the Company will receive the difference between LIBOR and the fixed swap
rate if LIBOR exceeds the swap rate. Settlement occurs on the quarterly reset
dates specified by the terms of the contracts. The notional principal amount of
the interest rate swaps outstanding was $140 million at December 31, 1997. The
weighted average fixed payment rate was 5.818% while the weighted average rate
of variable interest payments under the Arch Enterprises Credit Facility was
5.872% at December 31, 1997. At December 31, 1997 and 1996, the Company had a
net receivable of $18,000 and a net payable of $124,000, respectively, on the
interest rate swaps.
The interest rate cap agreements will pay the Company the difference
between LIBOR and the cap level if LIBOR exceeds the cap levels at any of the
quarterly reset dates. If LIBOR remains below the cap level, no payment is made
to the Company. The total notional amount of the interest rate cap agreements
was $80 million with cap levels between 7.5% and 8% at December 31, 1997. The
transaction fees for these instruments are being amortized over the terms of the
agreements.
The Arch Enterprises Credit Facility contains restrictive and financial
covenants which, among other things, limit the ability of Arch Enterprises to:
incur additional indebtedness, advance funds to Benbow (see Note 1), pay
dividends, grant liens on its assets, merge, sell or acquire assets; repurchase
or redeem capital stock; incur capital expenditures; and prepay indebtedness
other than indebtedness under the Arch Enterprises Credit Facility. As of
December 31, 1997, Arch Enterprises and its operating subsidiaries were in
compliance with the covenants of the Arch Enterprises Credit Facility.
As of December 31, 1997, $359.5 million was outstanding and $28.7 million
was available under the Arch Enterprises Credit Facility. At December 31, 1997,
such advances bore interest at an average annual rate of 8.76%.
USA Mobile Communications, Inc. II ("USA Mobile II") and the direct
subsidiaries of USA Mobile II (the "USA Mobile II Borrowing Subsidiaries) are
parties to a $110 million reducing revolving credit facility dated March 19,
1997, as amended, with a group of banks pursuant to which the banks have agreed
to make advances for working capital and other purposes (the "USA Mobile II
Credit Facility").
Upon the closing of the USA Mobile II Credit Facility, the banks did not
require the contemporaneous grant of a security interest in the assets of USA
Mobile II and its subsidiaries but they have reserved the right to require such
a security interest upon the occurrence of certain triggering events. Arch and
USA Mobile II have guaranteed the obligations of the USA Mobile II Borrowing
Subsidiaries under the USA Mobile II Credit Facility. Arch's guarantee is
secured by the pledge of the stock of Arch Enterprises and USA Mobile II.
Obligations under the USA Mobile II Credit Facility bear interest based on
a reference rate equal to either (i) the agent bank's Alternate Base Rate or
(ii) the agent bank's LIBOR rate, in each case plus a margin which is based on
the ratio of USA Mobile II's total indebtedness to annualized operating cash
flow. A commitment fee of .375% per annum is also payable on the average daily
unused portion of the USA Mobile II Credit Facility.
The USA Mobile II Credit Facility contains restrictive and financial
covenants which, among other things, limit the ability of USA Mobile II to:
incur additional indebtedness, pay dividends, grant liens on its assets, merge,
sell or acquire assets; repurchase or redeem capital stock; incur capital
expenditures; and prepay indebtedness other than indebtedness
F-11
35
under the USA Mobile II Credit Facility. As of December 31, 1997, USA Mobile II
and the USA Mobile Borrowing Subsidiaries were in compliance with the covenants
of the USA Mobile II Credit Facility.
As of December 31, 1997, $63.0 million was outstanding and $4.6 million was
available under the USA Mobile II Credit Facility. At December 31, 1997, such
advances bore interest at an average annual rate of 8.55%.
Senior Notes - On March 12, 1996, Arch completed a public offering of 10
7/8% Senior Discount Notes due 2008 (the "Senior Discount Notes") in the
aggregate principal amount at maturity of $467.4 million ($275.0 million initial
accreted value). Interest does not accrue on the Senior Discount Notes prior to
March 15, 2001. Commencing September 15, 2001, interest on the Senior Discount
Notes is payable semi-annually at an annual rate of 10 7/8%. The $266.1 million
net proceeds from the issuance of the Senior Discount Notes, after deducting
underwriting discounts and commissions and offering expenses, were used
principally to fund a portion of the purchase price of Arch's acquisition of
Westlink (see Note 2).
Interest on the USA Mobile II 14% Notes and the USA Mobile II 9 1/2% Notes
(collectively, the "Senior Notes") is payable semi-annually. The Senior Discount
Notes and the Senior Notes contain certain restrictive and financial covenants
which, among other things, limit the ability of Arch or USA Mobile II to: incur
additional indebtedness; pay dividends; grant liens on its assets; sell assets;
enter into transactions with related parties; merge, consolidate or transfer
substantially all of its assets; redeem capital stock or subordinated debt; and
make certain investments.
Convertible Subordinated Debentures - On March 6, 1996, the holders of
$14.1 million principal amount of Arch's 6 3/4% Convertible Subordinated
Debentures due 2003 ("Arch Convertible Debentures") elected to convert their
Arch Convertible Debentures into Arch common stock at a conversion price of
$16.75 per share and received approximately 843,000 shares of Arch common stock
together with a $1.6 million cash premium.
Interest on the remaining outstanding Arch Convertible Debentures is
payable semiannually on June 1 and December 1. The Arch Convertible Debentures
are unsecured and are subordinated to all existing indebtedness of Arch.
The Arch Convertible Debentures are redeemable, at the option of Arch, in
whole or in part, at certain prices declining annually to 100% of the principal
amount at maturity plus accrued interest. The Arch Convertible Debentures also
are subject to redemption at the option of the holders, at a price of 100% of
the principal amount plus accrued interest, upon the occurrence of certain
events.
The Arch Convertible Debentures are convertible at their principal amount
into shares of Arch's common stock at any time prior to redemption or maturity
at an initial conversion price of $16.75 per share, subject to adjustment.
Maturities of Debt -- Scheduled long-term debt maturities at December 31,
1997, are as follows (in thousands):
Year Ending December 31,
------------------------
1998 ................... $ 24,513
1999 ................... 37,750
2000 ................... 83,000
2001 ................... 74,750
2002 ................... 122,500
Thereafter ............. 650,896
--------
$993,409
========
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36
4. Redeemable Preferred Stock and Stockholders' Equity
Redeemable Preferred Stock -- In connection with the Merger (see Note 2),
Arch assumed the obligations associated with 22,530 outstanding shares of Series
A Redeemable Preferred Stock issued by USA Mobile. The preferred stock is
recorded at its accreted redemption value, based on 10% annual accretion through
the redemption date. On January 30, 1997 all outstanding preferred stock was
redeemed for $3,744,000 in cash.
Stock Options -- Arch has a 1989 Stock Option Plan (the "1989 Plan") and a
1997 Stock Option Plan (the "1997 Plan") which provide for the grant of
incentive and nonqualified stock options to key employees, directors and
consultants to purchase Arch's common stock. Incentive stock options are granted
at exercise prices not less than the fair market value on the date of grant.
Options generally vest over a five-year period from the date of grant with the
first such vesting (20% of granted options) occurring one year from the date of
grant and continuing ratably at 5% on a quarterly basis thereafter. However, in
certain circumstances, options may be immediately exercised in full. Options
generally have a duration of 10 years. The 1989 Plan provides for the granting
of options to purchase a total of 1,128,944 shares of common stock. All
outstanding options on September 7, 1995, under the 1989 Plan, became fully
exercisable and vested as a result of the Merger. The 1997 Plan provides for the
granting of options to purchase a total of 1,500,000 shares of common stock.
Effective October 23, 1996, the Compensation Committee of the Board of
Directors of Arch authorized the grant of new options to each employee who had
an outstanding option at a price greater than $12.50 (the fair market value of
Arch's common stock on October 23, 1996). The new option would be for the total
number of shares (both vested and unvested) subject to each employee's
outstanding stock option agreement(s). As a result of this action 424,206
options were terminated and regranted at a price of $12.50. The Company treated
this as a cancellation and reissuance under APB opinion No. 25 "Accounting for
Stock Issued to Employees".
As a result of the Merger, Arch assumed a stock option plan originally
adopted by USA Mobile in 1994 and amended and restated on January 26, 1995 (the
"1994 Plan"), which provides for the grant of up to 601,500 options to purchase
Arch's common stock. Under the 1994 Plan, incentive stock options may be granted
to employees and nonqualified stock options may be granted to employees,
directors and consultants. Incentive stock options are granted at exercise
prices not less than the fair market value on the date of grant. Option duration
and vesting provisions are similar to the 1989 Plan. All outstanding options
under the 1994 Plan became fully exercisable and vested as a result of the
Merger.
In January 1995, Arch adopted a 1995 Outside Directors' Stock Option Plan
(the "1995 Directors' Plan"), which terminated upon completion of the Merger.
Prior to termination of the 1995 Directors' Plan, 15,000 options were granted at
an exercise price of $18.50 per share. Options have a duration of ten years and
vest over a five-year period from the date of grant with the first such vesting
(20% of granted options) occurring one year from the date of grant and
continuing ratably at 5% on a quarterly basis thereafter.
As a result of the Merger, Arch assumed from USA Mobile the Non-Employee
Directors' Stock Option Plan (the "Outside Directors Plan"), which provides for
the grant of up to 80,200 options to purchase Arch's common stock to
non-employee directors of Arch. Outside directors receive a grant of 3,000
options annually under the Outside Directors Plan, and newly elected or
appointed outside directors receive options to purchase 3,000 shares of common
stock as of the date of their initial election or appointment. Options are
granted at fair market value of Arch's common stock on the date of grant.
Options have a duration of ten years and vest over a three-year period from the
date of grant with the first such vesting (25% of granted options) occurring on
the date of grant and future vesting of 25% of granted options occurring on each
of the first three anniversaries of the date of grant.
On December 16, 1997, the Compensation Committee of the Board of Directors
of Arch authorized the Company to offer an election to its employees who had
outstanding options at a price greater than $5.06 to cancel such options and
accept new options at a lower price. In January 1998, as a result of this
election by certain of its employees, the Company canceled 1,083,216 options
with exercise prices ranging from $5.94 to $20.63 and granted the same number of
new options with an exercise price of $5.06 per share, the fair market value of
the stock on December 16, 1997.
On December 29, 1997, Arch adopted a Deferred Compensation Plan for
Nonemployee Directors. Under this plan, outside directors may elect to defer,
for a specified period of time, receipt of some or all of the annual and meeting
fees which would otherwise be payable for service as a director. A portion of
the deferred compensation may be converted
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37
into phantom stock units, at the election of the director. The number of phantom
stock units granted equals the amount of compensation to be deferred as phantom
stock divided by the fair value of Arch's common stock on the date the
compensation would have otherwise been paid. At the end of the deferral period,
the phantom stock units will be converted to cash based on the fair market value
of the Company's common stock on the date of distribution.
The following table summarizes the activity under Arch's stock option plans
for the periods presented:
Number of Weighted Average
Options Exercise Price
Options Outstanding at August 31, 1994 .... 602,744 $ 7.19
Granted .............................. 41,740 $ 18.58
Exercised ............................ (2,000) $ 5.94
Terminated ........................... -- $ --
---------- ---------
Options Outstanding at December 31, 1994 .. 642,484 $ 7.95
Granted .............................. 278,750 $ 23.46
Assumed in Merger .................... 571,024 $ 11.59
Exercised ............................ (475,903) $ 10.80
Terminated ........................... (10,600) $ 17.57
---------- ---------
Options Outstanding at December 31, 1995 .. 1,005,755 $ 13.02
Granted .............................. 695,206 $ 15.46
Exercised ............................ (169,308) $ 8.69
Terminated ........................... (484,456) $ 21.60
---------- ---------
Options Outstanding at December 31, 1996 .. 1,047,197 $ 11.37
Granted .............................. 500,394 $ 6.68
Exercised ............................ -- $ --
Terminated ........................... (190,636) $ 10.58
---------- ---------
Options Outstanding at December 31, 1997 .. 1,356,955 $ 9.75
========== =========
Options Exercisable at December 31 1997 ... 639,439 $ 9.64
========== =========
The following table summarizes the options outstanding and options
exercisable by price range at December 31, 1997:
Weighted
Average Weighted Weighted
Remaining Average Average
Range of Exercise Options Contractual Exercise Options Exercise
Prices Outstanding Life Price Exercisable Price
------ ----------- ---- ----- ----------- -----
$ 3.13 - $ 5.94 186,284 1.58 $ 4.39 169,784 $ 4.36
$ 6.25 - $ 8.25 617,654 7.45 7.09 195,010 7.77
$10.29 - $14.10 410,377 8.08 12.34 209,853 12.19
$15.85 - $20.63 124,640 8.10 20.12 51,292 19.66
$23.50 - $27.56 18,000 7.84 25.53 13,500 25.53
- --------------- ------ ---- ----- ------ -----
$ 3.13 - $27.56 1,356,955 6.90 $ 9.75 639,439 $ 9.64
=============== ========= ==== ======= ======= =======
Employee Stock Purchase Plan -- On May 28, 1996, the stockholders approved
the 1996 Employee Stock Purchase Plan (ESPP). The ESPP allows eligible employees
the right to purchase common stock, through payroll deductions not exceeding 10%
of their compensation, at the lower of 85% of the market price at the beginning
or the end of each six-month offering period. During 1997 and 1996, 151,343 and
46,842 shares were issued at an average price per share of $5.29 and $7.97,
respectively. At December 31, 1997, 51,815 shares are available for future
issuance.
F-14
38
Accounting for Stock-Based Compensation -- Arch accounts for its stock
option and stock purchase plans under APB Opinion No. 25 "Accounting for Stock
Issued to Employees", since all options have been issued at a grant price equal
to fair market value, no compensation cost has been recognized in the Statement
of Operations. Had compensation cost for these plans been determined consistent
with SFAS No. 123 "Accounting for Stock-Based Compensation", Arch's net income
(loss) and income (loss) per share would have been increased to the following
pro forma amounts:
(in thousands except per share amounts)
Year Ended December 31,
1997 1996 1995
Net income (loss): As reported $ (181,874) $ (114,662) $ (36,602)
Pro forma (183,470) (115,786) (36,740)
Basic net income (loss)
per common share: As reported (8.77) (5.62) (2.72)
Pro forma (8.85) (5.68) (2.73)
Because the SFAS No. 123 method of accounting has not been applied to the
options granted prior to January 1, 1995, the resulting pro forma compensation
cost may not be representative of that to be expected in future years. The fair
value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model. In computing these pro forma amounts Arch
has assumed a risk-free interest rate of 6%, an expected life of 5 years, an
expected dividend yield of zero and an expected volatility of 50% - 60%.
The weighted average fair values (computed consistent with SFAS No. 123) of
options granted under all plans in 1997, 1996 and 1995, were $3.37, $4.95 and
$11.89, respectively. The weighted average fair value of shares sold under the
ESPP in 1997 and 1996 was $2.83 and $5.46, respectively.
Stockholders Rights Plan -- Upon completion of the Merger, Arch's existing
stockholders rights plan was terminated. In October 1995, Arch's Board of
Directors adopted a new stockholders rights plan (the Rights) and declared a
dividend of one preferred stock purchase right (a Right) for each outstanding
share of common stock to stockholders of record at the close of business on
October 25, 1995. Each Right entitles the registered holder to purchase from
Arch one one-thousandth of a share of Series B Junior Participating Preferred
Stock, at a cash purchase price of $150, subject to adjustment. Pursuant to the
Plan, the Rights automatically attach to and trade together with each share of
common stock. The Rights will not be exercisable or transferable separately from
the shares of common stock to which they are attached until the occurrence of
certain events. The Rights will expire on October 25, 2005, unless earlier
redeemed or exchanged by Arch in accordance with the Plan.
5. Income Taxes
Arch accounts for income taxes under the provisions of SFAS No. 109
"Accounting for Income Taxes". Deferred tax assets and liabilities are
determined based on the difference between the financial statement and tax bases
of assets and liabilities given the provisions of enacted laws.
The components of the net deferred tax asset (liability) recognized in the
accompanying consolidated balance sheets at December 31, 1997 and 1996 are as
follows (in thousands):
1997 1996
---- ----
Deferred tax assets .......... $ 134,944 $ 94,597
Deferred tax liabilities ..... (90,122) (115,769)
--------- ---------
44,822 (21,172)
Valuation allowance .......... (44,822) --
--------- ---------
$ -- $ (21,172)
========= =========
F-15
39
The approximate effect of each type of temporary difference and
carryforward at December 31, 1997 and 1996 is summarized as follows (in
thousands):
1997 1996
---- ----
Net operating losses ................... $ 106,214 $ 89,764
Intangibles and other assets ........... (87,444) (115,769)
Depreciation of property & equipment ... 24,388 3,692
Accruals and reserves .................. 1,664 1,141
--------- ---------
44,822 (21,172)
Valuation allowance .................... (44,822) --
--------- ---------
$ -- $ (21,172)
========= =========
The effective income tax rate differs from the statutory Federal tax rate
primarily due to the nondeductibility of goodwill amortization. The net
operating loss (NOL) carryforwards expire at various dates through 2012. The
Internal Revenue Code contains provisions that may limit the NOL carryforwards
available to be used in any given year if certain events occur, including
significant changes in ownership, as defined.
The Company has established a valuation reserve against its net deferred
tax asset until it becomes more likely than not that this asset will be realized
in the foreseeable future.
6. Commitments and Contingencies
Arch has operating leases for office and transmitting sites with lease
terms ranging from one month to approximately ten years. In most cases, Arch
expects that, in the normal course of business, leases will be renewed or
replaced by other leases.
Future minimum lease payments under noncancellable operating leases at
December 31, 1997 are as follows (in thousands):
Year Ending December 31,
------------------------
1998 ................... $16,909
1999 ................... 7,706
2000 ................... 4,546
2001 ................... 2,689
2002 ................... 950
Thereafter ............. 1,680
-------
Total .................. $34,480
=======
Total rent expense under operating leases for the years ended December 31,
1997, 1996 and 1995 approximated $19,836,000, $14,746,000 and $6,423,000,
respectively.
7. Employee Benefit Plans
Arch has a retirement savings plan, qualifying under Section 401(k) of the
Internal Revenue Code covering eligible employees, as defined. Under the plan, a
participant may elect to defer receipt of a stated percentage of the
compensation which would otherwise be payable to the participant for any plan
year (the deferred amount) provided, however, that the deferred amount shall not
exceed the maximum amount permitted under Section 401(k) of the Internal Revenue
Code. The plan provides for Arch matching contributions. Matching contributions
for the years ended December 31, 1997, 1996 and 1995 approximated $302,000,
$217,000 and $124,000, respectively.
F-16
40
8. Quarterly Financial Results (unaudited)
Quarterly financial information for the years ended December 31, 1997 and
1996 is summarized below (in thousands, except per share amounts):
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Year Ended December 31, 1997:
Revenues ................................... $ 95,539 $ 98,729 $ 101,331 $ 101,242
Operating income (loss) .................... (26,632) (29,646) (27,208) (18,529)
Net income (loss) .......................... (45,815) (49,390) (47,645) (39,024)
Basic net income (loss) per common share:
Net income (loss) ........................ (2.21) (2.38) (2.29) (1.88)
Year Ended December 31, 1996:
Revenues ................................... $ 67,171 $ 78,983 $ 90,886 $ 94,330
Operating income (loss) .................... (12,949) (18,821) (23,647) (30,653)
Income (loss) before extraordinary item .... (19,377) (25,678) (32,178) (35,525)
Extraordinary charge ....................... -- (1,904) -- --
Net income (loss) .......................... (19,377) (27,582) (32,178) (35,525)
Basic net income (loss) per common share:
Income (loss) before extraordinary item .. (.98) (1.26) (1.56) (1.72)
Extraordinary charge ..................... -- (.09) -- --
Net income (loss) ........................ (.98) (1.35) (1.56) (1.72)
F-17
41
SCHEDULE II
ARCH COMMUNICATIONS GROUP, INC.
VALUATION AND QUALIFYING ACCOUNTS
Years Ended December 31, 1997, 1996 and 1995
(in thousands)
Balance
at Other Balance
Beginning Charged Addition to at End
Allowance for Doubtful Accounts of Period to Expense Allowance(1) Write-Offs of Period
- ------------------------------- --------- ---------- ------------ ---------- ---------
Year ended December 31, 1997 . $ 4,111 $ 7,181 $ -- $ (5,548) $ 5,744
Year ended December 31, 1996 . $ 2,125 $ 8,198 $ 1,757 $ (7,969) $ 4,111
Year ended December 31, 1995 . $ 707 $ 3,915 $ 1,251 $ (3,748) $ 2,125
(1) Additions arising through acquisitions of paging companies
S-1
42
INDEX
Exhibit Description
------- -----------
3.1 - Restated Certificate of Incorporation. (1)
3.2 - Certificate of Designations establishing the Series B Junior Participating
Preferred Stock. (2)
3.3 - Certificate of Correction, filed with the Secretary of State of Delaware on
February 15, 1996.(1)
3.4 - By-laws, as amended.(1)
4.1 - Indenture, dated February 1, 1994, between USA Mobile Communications, Inc. II
("USA Mobile II") and United States Trust Company of New York, as Trustee,
relating to the 91/2% Senior Notes due 2004 of USA Mobile II. (3)
4.2 - Indenture, dated December 15, 1994, between USA Mobile II and United States
Trust Company of New York, as Trustee, relating to the 14% Senior Notes due
2004 of USA Mobile II. (4)
4.3 - Indenture, dated as of December 1, 1993, between Arch and The Bank of New York,
relating to the 63/4% Convertible Subordinated Debentures due 2003 of Arch. (5)
4.4 - Indenture, dated March 12, 1996, between Arch and IBJ
Schroder Bank & Trust Company, relating to the 107/8% Senior
Discount Notes due 2008 of Arch.(9)
10.1 - First Amended and Restated Credit Agreement Dated May 21, 1996 By and Among
Arch Communications Enterprises, Inc., the Lenders party thereto, the Co-Agents
party thereto, and The Bank of New York as Administrative Agent(8)
10.2 - Amendment No. 2 to the First Amended and Restated Credit Agreement Dated May
21, 1996 By and Among Arch Communications Enterprises, Inc., The Lenders party
thereto, the Co-Agents party thereto, and The Bank of New York as
Administrative Agent. (12)
10.3*! - Amendment No. 5 and Waiver No. 1 to and under the First Amended and Restated
Credit Agreement Dated May 21, 1996.
10.4 - First Amended and Restated Credit Agreement, dated March 19, 1997 (the "USA
Mobile II Credit Agreement"), among Premiere Page of Kansas, Inc., Q Media
Paging-Alabama, Inc., USA Mobile Communications, Inc. III, Q Media
Company-Paging, Inc., W.Q. Communications, Inc., USA Mobile II, The Lenders
Party Hereto, and The Bank of New York, as Administrative Agent.(12)
10.5*! - Amendment No. 3 to the USA Mobile II Credit Agreement.
+10.6 - Amended and Restated Stock Option Plan. (6)
+10.7 - Non-Employee Directors' Stock Option Plan. (7)
+10.8 - 1989 Stock Option Plan, as amended.(1)
+10.9 - 1995 Outside Directors' Stock Option Plan (5)
+10.10 - 1996 Employee Stock Purchase Plan(10)
+10.11 - 1997 Stock Option Plan(11)
+10.12* - Deferred Compensation Plan for Nonemployee Directors
+10.13* - Form of Executive Retention Agreement by and between Arch and Messrs. Baker,
Daniels, Kuzia. Pottle and Saynor
10.15 - Letter Agreement dated January 7, 1997 and Amendment 1 dated May 1, 1997
between Arch and Motorola, Inc. (12)
21.1* - Subsidiaries of the Registrant.
23.1* - Consent of Arthur Andersen LLP.
27.1* - Financial Data Schedule
* Filed herewith
+ Identifies exhibits constituting a management contract or compensatory plan
! Confidential treatment requested with respect to portions of this exhibit
(1) Incorporated by reference from the Registration Statement on Form S-3 (File
no. 333-542) of Arch.
(2) Incorporated by reference from the Current Report on Form 8-K of Arch dated
October 13, 1995 and filed on October 24, 1995.
(3) Incorporated by reference from the Registration Statement on Form S-1 (File
no. 33-72646) of USA Mobile II
(4) Incorporated by reference from the Registration Statement on Form S-1 (File
no. 33-85580) of USA Mobile II
43
(5) Incorporated by reference from the Registration Statement on Form S-3 (File
no. 33-87474) of Arch.
(6) Incorporated by reference from the Annual Report on Form 10-K of Arch (then
known as USA Mobile) for the fiscal year ended December 31, 1994.
(7) Incorporated by reference from the Registration Statement on Form S-4 (File
no. 33-83648) of Arch (then known as USA Mobile).
(8) Incorporated by reference from the Quarterly Report on Form 10-Q of Arch
for the quarter ended June 30, 1996. Confidential treatment previously
granted with respect to portions of this exhibit.
(9) Incorporated by reference from Amendment No. 1 to the Quarterly Report on
Form 10-Q/A for the quarter ended September 30, 1995. Confidential
treatment previously granted with respect to portions of this exhibit.
(10) Incorporated by reference from the Annual Report on Form 10-K of Arch for
the fiscal year ended December 31, 1995.
(11) Incorporated by reference from the Annual Report on Form 10-K of Arch for
the fiscal year ended December 31, 1996.
(12) Incorporated by reference from the Quarterly Report on Form 10-Q of Arch
for the quarter ended March 31, 1997. Confidential Treatment previously
granted with respect to portions of this exhibit.