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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 for the fiscal year ended December 31, 1998.
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 for the transition period from __________________ TO
____________________.
COMMISSION FILE NUMBER 0-27416
RURAL CELLULAR CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
MINNESOTA 41-1693295
(STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION) (I.R.S. EMPLOYER IDENTIFICATION NO.)
3905 DAKOTA STREET
ALEXANDRIA, MINNESOTA 56308
(320) 762-2000
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
CLASS A 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. /X/ YES ___ 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. / /
Aggregate value of shares of common stock held by nonaffiliates of the
Registrant based upon the closing price on The Nasdaq National Market on March
22, 1999 (only stock held by directors, officers and their affiliates, and
holders of more than 5% of Class A or Class B stock are excluded): $50,605,144
Number of shares of common stock outstanding as of the close of
business on March 22, 1999:
Class A 7,822,137
Class B 1,198,557
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the Company's definitive Proxy Statement relating to the
1999 Annual Meeting of Shareholders ("Proxy Statement") are
incorporated by reference into Part III of this report.
TABLE OF CONTENTS
PAGE
PART I ....................................................................................1
ITEM 1. BUSINESS.......................................................................1
ITEM 2. PROPERTIES....................................................................12
ITEM 3. LEGAL PROCEEDINGS.............................................................12
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS...........................12
PART II...................................................................................14
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS...........................................................14
ITEM 6. SELECTED FINANCIAL DATA.......................................................15
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS...........................................17
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK....................27
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA...................................28
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE...........................................28
PART III..................................................................................29
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............................29
ITEM 11. EXECUTIVE COMPENSATION........................................................29
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT................29
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................................29
PART IV...................................................................................30
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K..............30
SIGNATURES.............................................................................31
PART I
ITEM 1. BUSINESS
(a) GENERAL DEVELOPMENT OF BUSINESS
Rural Cellular Corporation (the "Company" or "RCC") is engaged in the
construction, development, management, and operation of cellular telephone
systems in rural markets in the Midwest and New England regions of the United
States. The Company is also engaged, through a joint venture with an affiliate
of Aerial Communications, Inc. in the construction, development, management, and
operation of PCS systems in markets in Minnesota, Wisconsin, North Dakota, and
South Dakota. At December 31, 1998, the Company provided cellular telephone
services to 187,000 customers in fifteen licensed areas consisting of two
Metropolitan Statistical Areas ("MSAs") and thirteen Rural Services Areas
("RSAs") with an estimated aggregate population ("POPs") of approximately
2,341,000. The Company also provided PCS service to 5,000 customers in four
basic trading areas ("BTA") with an aggregate estimated population of 708,000.
The Company has developed its business through the acquisition and
integration of cellular telephone systems, clustering multiple systems in
order to provide broad areas of uninterrupted service and achieve certain
economies of scale. During 1998, the Company acquired the Massachusetts, New
Hampshire, New York, and Vermont cellular telephone licenses, operations, and
related assets of Atlantic Cellular Company L.P. and one of its subsidiaries
("Atlantic"). In addition, the Company acquired Atlantic's long distance
business. The Company also acquired the outstanding stock of Western Maine
Cellular, Inc. ("WMC"), which provides cellular services in western Maine.
In February 1999, the Company acquired all of the outstanding stock of The
Revering Group, Inc., which provides cellular service in northeastern South
Dakota.
The Company was organized under the laws of the State of Minnesota in 1990.
Subsequently, it has formed several subsidiaries in which different aspects of
its business are operated. MRCC, Inc., a Maine corporation ("MRCC"), was
organized to own and operate the Company's cellular licenses in the State of
Maine. RCC Atlantic, Inc., a Minnesota corporation ("Atlantic"), was organized
to acquire and operate the cellular telephone licenses in Massachusetts, New
Hampshire, New York and Vermont, as well as the long distance business acquired
from Atlantic. Wireless Alliance, LLC ("Wireless Alliance") is a joint venture
that is 51% owned by RCC and 49% owned by an affiliate of Aerial Communications,
Inc. This joint venture was formed in 1996 to pursue providing PCS service to
certain markets in Minnesota, Wisconsin, North Dakota and South Dakota. RCC
Paging, Inc. was organized to market, distribute and resell paging services in
Minnesota and North Dakota. Unless the context indicates otherwise, the
"Company" refers to RCC and its subsidiaries.
(b) FINANCIAL INFORMATION ABOUT SEGMENTS
Information regarding the Company's business segments is contained in Note 12 of
the Notes to Consolidated Financial Statements included in this Report.
1
(c) DESCRIPTION OF BUSINESS/SERVICE AREAS
RCC CELLULAR:
The Company's cellular operations consist of its Midwest operation, which
includes five contiguous RSAs in northern Minnesota and one RSA in South Dakota,
and its operations in New England, covering portions of Maine, Massachusetts,
New Hampshire, New York, and all of Vermont.
MIDWEST OPERATION:
The Company's Midwest operation ("RCC Midwest") encompasses the Company's
original service areas in northern Minnesota. In February 1999, one RSA in
northeastern South Dakota was added, bringing total POPS to approximately
705,000. This service area is adjacent to Minnesota's three largest metropolitan
areas: Minneapolis/St. Paul, Duluth and Fargo/Moorhead. Due to its location, RCC
Midwest captures significant roaming traffic from users traveling between these
metropolitan areas. The Midwest operation also offers paging services that are
part of an overall business strategy aimed at stimulating wireless usage.
Effective February 1, 1999, the Company acquired RGI, Inc. d/b/a Glacial Lakes
Cellular 2000(R) ("Glacial") for approximately $11.9 million. Operating under
the name Cellular 2000(R), Glacial provides cellular service to northeastern
South Dakota (RSA 4), which includes eight counties and is adjacent to RCC's
existing cellular operation in northern and central Minnesota. Glacial's service
encompasses 69,000 POPs and serves 7,000 customers.
NEW ENGLAND OPERATION:
The New England operation serves a geographically contiguous service area with
approximately 1.7 million POPs that covers the entire state of Vermont and
portions of Maine, New Hampshire, Massachusetts and New York. This cellular
footprint is located within short drive times of New York, Boston, Montreal,
Albany, Hartford and Providence, which have a combined Metropolitan Service Area
("MSA") population of approximately 31 million. The New England operation began
with the Company's acquisition in 1997 of service areas in Maine and was
expanded further in 1998 through the acquisition of Atlantic. The New England
operation also provides long distance service to subscribers in Vermont.
WIRELESS ALLIANCE, LLC:
Wireless Alliance, LLC ("Wireless Alliance"), a joint venture that is 51%-owned
by RCC and 49%-owned by an affiliate of Aerial Communications, Inc., was formed
in 1996 to provide PCS service to targeted markets in Minnesota, Wisconsin,
North Dakota and South Dakota. Wireless Alliance began by reselling cellular
service to gain visibility in its markets. In the second quarter of 1998, PCS
networks were launched in Fargo, North Dakota; Moorhead and Duluth, Minnesota;
Virginia and Hibbing, Minnesota and Superior, Wisconsin. In the third quarter of
1998, PCS service was launched in Sioux Falls, South Dakota, followed by Grand
Forks, North Dakota in the fourth quarter of 1998. Wireless Alliance's service
area covers 708,000 POPs. Aerial has contributed the PCS licenses to the joint
venture, and RCC is responsible for the building and managing of the networks
and marketing the services. As of December 31, 1998, Wireless Alliance served
11,000 cellular customers and 5,000 PCS customers.
2
Information regarding the Company's service areas, including Wireless Alliance,
is set forth in the following table.
PERCENTAGE DATE OF
OWNERSHIP TOTAL POPS NET POPS ACQUISITION
- -------------------------------------------- ------------ -------------- -------------- -------------------
RCC Cellular
Midwest Cluster
Minnesota RSA 1........................ 100% 50,000 50,000 4/01/91
Minnesota RSA 2........................ 100% 64,000 64,000 4/01/91
Minnesota RSA 3........................ 100% 59,000 59,000 4/01/91
South Dakota RSA 4..................... 100% 69,000 69,000 2/1/99
Minnesota RSA 5........................ 100% 206,000 206,000 4/01/91
Minnesota RSA 6........................ 100% 257,000 257,000 4/01/91
-------------- --------------
Total Midwest POPs................. 705,000 705,000
-------------- --------------
New England Cluster
MRCC
Maine, Bangor MSA...................... 100% 143,000 143,000 5/01/97
Maine RSA 1............................ 100% 83,000 83,000 7/31/98
Maine RSA 2............................ 100% 148,000 148,000 5/01/97
Maine RSA 3............................ 100% 221,000 221,000 5/01/97
-------------- --------------
Total MRCC POPs.................... 595,000 595,000
-------------- --------------
Atlantic
Massachusetts RSA 1.................... 100% 71,000 71,000 7/01/98
New Hampshire RSA 1................... 100% 223,000 223,000 7/01/98
New York RSA 2......................... 100% 226,000 226,000 7/01/98
Vermont, Burlington MSA................ 100% 148,000 148,000 7/01/98
Vermont RSA 1.......................... 100% 210,000 210,000 7/01/98
Vermont RSA 2.......................... 100% 232,000 232,000 7/01/98
-------------- --------------
Total Atlantic POPs................ 1,110,000 1,110,000
-------------- --------------
Total New England POPs............. 1,705,000 1,705,000
-------------- --------------
Total RCC Cellular POPs........ 2,410,000 2,410,000
-------------- --------------
Wireless Alliance (PCS)
Duluth, Minnesota/Superior, Wisconsin:
Cook, Lake, St. Louis and Carlton
(portion) Counties in Minnesota and 51% 270,000 138,000 4/10/97
Douglas County in Wisconsin............
Fargo, North Dakota/Moorhead, Minnesota:
Cass and Trail Counties in North 51% 175,000 89,000 4/10/97
Dakota and Clay County in Minnesota....
Grand Forks, North Dakota:
Grand Forks County in North Dakota 51% 102,000 52,000 4/10/97
and Polk County in Minnesota...........
Sioux Falls, South Dakota:
Minnehaha and Lincoln Counties in 51% 161,000 82,000 9/30/97
South Dakota...........................
-------------- --------------
Total PCS POPs..................... 708,000 361,000
-------------- --------------
Total POPs.................... 3,118,000 2,771,000
-------------- --------------
-------------- --------------
* Source: Updated for July 1, 1997 estimates, 1990 U. S. Census Bureau
Official Statistics.
3
PAGING
The Company offers paging service in northern Minnesota and eastern North
Dakota and resells paging services in Minnesota, Wisconsin, North Dakota and
Maine. The Company markets its paging services under the names
"KEYPAGE-Registered Trademark-", "KEYPAGE-Registered Trademark- Plus" and
"Unicel-Registered Trademark- Paging Services".
MARKETING
The Company, through its business units, offers a number of service plan
options to its customers. Most service plans have a fixed monthly access fee,
which includes a specified number of minutes. Usually, the higher the monthly
access fee, the more minutes of use that are included. Customers who
subscribe to cellular service in connection with a special promotion are
typically required to enter into a commitment for service. The Company
engages in ongoing analysis of its service plans and equipment pricing to
ensure competitiveness.
Many of the Company's customers are voice mail service customers. There is no
charge for leaving or retrieving messages, and the Company believes that its
voice mail feature stimulates cellular usage in the form of returned calls.
The Company has established preferred roaming contracts and developed system
integration with adjacent cellular carriers. This approach permits the
Company's customers to receive automatic call delivery (ACD), call
forwarding, toll-free access to voice mail, call hand-off and reduced roaming
rates. The Company and most other cellular carriers offer their customers ACD
and reduced roaming rates on a nationwide basis. ACD allows roamers to use
all of their home features including custom calling features, making their
roaming experience identical to their local service. Since ACD was
introduced, the use of airtime by roamers has increased. As adjacent carriers
increase their cellular customer base and the industry as a whole expands its
customer base, the number of roamers will continue to increase. ACD helps the
Company capture roaming traffic within its markets.
During 1998, the Company introduced, through its joint venture with the
Wireless Alliance LLC, PCS service plans for the combined and contiguous
areas of Wireless Alliance's digital network and the Company's existing
analog network. These service plans offer fixed and tiered monthly fees and
peak and off peak per minute charges with no long distance or roaming charges
for calls within the RCC Midwest calling area.
The Company markets paging services provided both through the Company-owned
system, covering northern Minnesota and eastern North Dakota, and as a
reseller of paging services covering most of Minnesota, Maine and areas
within Iowa, Wisconsin, and eastern North Dakota. The Company believes that
paging services complement cellular usage.
ROAMING MARKETS
The Company believes that attractively priced regional roaming is important
to the development of customers for all cellular carriers. Accordingly, where
possible, the Company attempts to arrange reciprocal roaming rates that allow
customers to roam at competitive prices. The Company believes that this
increases usage on all cellular systems, including the Company's systems.
Roamer revenues are a substantial source of incremental revenue for the
Company due, in part, to the fact that a number of the Company's cellular
systems are located along major travel and commuting corridors. While there
is an industry trend to reduce roaming rates, the Company is addressing this
trend through its roaming agreements, which are usually reciprocal in nature
and are at or near home rates. While on an industry-wide basis as reported in
the Cellular Telephone Industry Association ("CTIA") Data Survey dated June
30, 1998, approximately 10.7% of total cellular revenue nationally is from
roaming traffic, the Company's percentage of roamer revenue was approximately
20.5% of revenues for the year ended December 31, 1998.
DISTRIBUTION AND SALES
The Company markets its wireless services through independent sales agents,
direct sales personnel and Company-owned stores, which are managed by
district and territory managers in both the Midwest and New England clusters.
The Company believes that its territory manager strategy is a major
contributor to the Company's success. The Company experiences higher than
industry average retention levels and lower than industry average customer
4
acquisition costs. MRCC implemented this distribution strategy in the third
quarter of 1997 followed by Atlantic in the third and fourth quarter of 1998.
As of March 1, 1999, the Company had approximately 300 sales agents, 160
direct sales personnel and 30 Company-owned stores.
The territory managers recruit, train, and support the independent sales
agents. The training and support provided to agents is extensive and
continual. Currently, all individuals who have customer contact in the
Midwest cluster are required to complete a certification process annually in
order to continue to sell the Company's products and services or maintain any
contact with customers. The Company is currently in the process of
implementing this process in its New England cluster. The Company provides
cellular, digital, and paging equipment to the agents for sale or rent to
customers and the agents market the Company's services utilizing a
cooperative advertising program. These sales agents include retail electronic
stores, farm implement dealers, automobile dealers, automobile parts
suppliers, college and university bookstores, video and music stores, and
local telephone companies. Most of the agents sell the Company's service in
conjunction with their principal business.
CUSTOMER SERVICE
Customer service is a significant element of the Company's operating
philosophy. The Company is committed to attracting and retaining customers by
providing consistently superior customer service. In Alexandria, Minnesota,
Bangor, Maine and Colchester, Vermont, the Company has implemented
sophisticated local monitoring and control systems and maintains customer
service departments consisting of highly trained personnel who are aware of
the needs of the customers in local markets. The Company's customer service
personnel can be accessed 24 hours a day, 365 days a year, and are capable of
handling both routine and complex technical questions. The Company believes
that easy access to its customer service professionals is essential to
maintain a high level of customer satisfaction and loyalty and that its
strong emphasis on customer service contributes to its high customer
retention rate.
The customer service centers are also responsible for processing new service
orders and service changes for existing customers. The customer service
centers also maintain customer records and manage the Company's collection
process. The customer service centers implement a quality control process
that monitors call center performance and balances customer service center
resources to match call center load levels.
Territory managers work closely with customer service center personnel to
maintain high standards of service for their existing customers as well as to
attract new customers. Company customer service center representatives
attempt to contact every new customer within 30 days from the day the
customer begins service to confirm customer satisfaction and elicit feedback.
Customers are also contacted periodically to offer additional calling
features such as voice mail, call waiting, and call forwarding and to
recommend the best service pricing plan for the customer's usage levels.
These contact programs enhance customer loyalty, maintain high retention, and
increase sales of additional features that increase customer airtime usage
and generate customer referrals.
SERVICE MARKS
The Company uses the registered service mark CELLULAR 2000-Registered
Trademark- to provide the cellular services it offers in its Midwest markets.
The CELLULAR 2000-Registered Trademark- name and related marks are owned by
Cellular 2000, Inc. ("Cellular 2000"). The Company owns 50% of Cellular 2000.
The Company and other users of the service mark, all of which are cellular
providers in Minnesota or South Dakota, are shareholders of Cellular 2000.
The only business of Cellular 2000 is the licensing of its service mark to
its shareholders.
Each Cellular 2000 shareholder has entered into a license agreement with
Cellular 2000 that allows the shareholder to use the CELLULAR 2000-Registered
Trademark- service mark for marketing within its cellular service area
subject to certain restrictions. The license agreements are relatively
restrictive and Cellular 2000 has exclusive rights to control the use of the
name. Cellular 2000 and its shareholders have entered into a buy-sell
agreement that requires, in part, a Cellular 2000 shareholder who no longer
uses CELLULAR 2000-Registered Trademark- as the principal name under which it
markets its cellular service, to offer its shares of stock in Cellular 2000
for sale to Cellular 2000 and the other shareholders at the original cost.
The Company does not pay any license fees for the use of the CELLULAR
2000-Registered Trademark- mark.
5
The Company uses the registered service mark UNICEL-Registered Trademark- to
market PCS services in its Midwest cluster and to market cellular services in
Maine. This mark is owned by the Company.
Atlantic's cellular services are marketed under the service mark
CELLULARONE-Registered Trademark- and its long distance services are marketed
under the service mark LONG DISTANCE BY CELLULARONE. The Company's use of the
CELLULARONE-Registered Trademark- and LONG DISTANCE BY CELLULARONE service
marks are governed by licenses between the Company and Cellular One Group,
the owner of the service marks.
The Company also provides paging services under the service marks
KEYPAGE-Registered Trademark-, KEYPAGE-Registered Trademark- PLUS and UNICEL
Paging Services as a complement to its wireless services. These marks are
owned by the Company.
NETWORK OPERATIONS
CELLULAR
The Company has constructed and maintains an integrated network of contiguous
cellular coverage throughout the Company's cellular service areas so that a
call can be handed off from one of the Company's cell sites to another as a
customer travels throughout cells. As a customer travels between cell sites,
the antenna works with the mobile telephone switching office ("MTSO") to
automatically monitor the signal strength of the call in progress. Call
handoff is automatic and virtually unnoticeable to customers.
As of December 31, 1998, the Company's cellular network consisted of 233 cell
sites in its Midwest and New England operations. The Company plans to
continue to develop its cellular service area by building new cell sites in
locations that increase capacity and improve hand-held coverage. The Company
constructed 23 cell sites and activated 53 PCS sites during the year ended
December 31, 1998 and plans to construct an additional 12 new cell sites
during 1999. The additional cell sites will further expand capacity and will
allow customers to use lower-powered or hand-held portable telephones
throughout the Company's service areas.
RCC Midwest uses a digital Northern Telecom MTSO located in Alexandria,
Minnesota. The MTSO used in MRCC's cellular network is located in Bangor,
Maine, and is also a digital Northern Telecom MTSO. The Company has invested
in these digital MTSOs so that it has the ability to increase capacity of
wireless telephone systems, as needed. In accordance with its strategy of
developing market clusters, the Company has selected wireless MTSOs that are
capable of serving multiple markets.
Atlantic's cellular network, which also includes 51 microwave links, is
connected to a MTSO located in Colchester, Vermont. This network currently
utilizes analog cellular technology with the ability to expand capacity
through the deployment of Narrowband Analog Mobile Phone System ("N-AMPS")
technology. N-AMPS is an enhanced technology that provides a three-fold
increase in capacity over conventional analog technology, as well as many of
the service features offered by digital cellular and PCS technology. The
Company is reviewing Atlantic's network infrastructure for potential digital
upgrades.
WIRELESS ALLIANCE
At December 31, 1998, Wireless Alliance had spent, since its inception, $23.0
million to acquire land, facilities and equipment in preparation for
deploying its PCS services. Wireless Alliance has completed the construction
of a GSM technology-based PCS network in its PCS service areas utilizing the
Aerial Communications MTSO to switch PCS calls. Wireless Alliance utilizes
the AirTouch Communications, Inc. ("AirTouch") and the Commnet Cellular Inc.
networks to transport its resale of cellular airtime within these markets.
PAGING
The Company's paging network, as of December 31, 1998, consisted of 61 paging
transmitters located throughout northern Minnesota and eastern North Dakota
and 33 paging transmitters in Maine. The paging transmitters in both networks
are connected to and controlled by a paging terminal that is connected to the
public telephone network.
6
The paging transmitters use a transmit-only radio frequency licensed for a
given coverage contour around the paging transmitter that allows messages to
be broadcast to the paging customer.
SUPPLIERS AND EQUIPMENT PARTNERS
The Company does not manufacture any customer or network equipment. The high
degree of compatibility among different manufacturers' models of handsets and
network facilities equipment allows the Company to design, supply and operate
its systems without being dependent upon a single source of such equipment.
The Company currently purchases handsets primarily from Motorola, Inc.,
Ericsson, Inc. and Nokia Telecommunications, Inc. The Company currently
purchases network equipment from Northern Telecom, Lucent Technologies Inc.,
Harris, Inc., and Nokia Telecommunications, Inc.
COMPETITION
The wireless communications industry is highly competitive. Competition for
customers is based principally upon the services and features offered, the
technical quality of the wireless system, customer service, system coverage,
capacity and price. Such competition will increase as new technologies enter
the marketplace. The following table lists the Company's principal cellular
and PCS competitors in its various markets:
TRADE NAME USED RCC TRADE NAME USED
MARKET BY RCC LICENSE BY COMPETITOR COMPETITOR
- ----------------------------------------- ------------------ --------- ------------------- ---------------------------------
RCC Cellular
Midwest Cluster
Minnesota RSA 1 and RSA 2............ Cellular.2000 B CELLULARONE Western Wireless
Minnesota RSA 3, RSA 5 and RSA 6..... Cellular.2000 B CELLULARONE American Cellular
South Dakota RSA 4.................. Cellular.2000 B COMMNET Cellular COMMNET Cellular
New England Cluster
MRCC
Maine, Bangor MSA, RSA 1, RSA 2
and RSA 3........................ Unicel B US Cellular US Cellular
Atlantic
Massachusetts RSA 1................. CELLULARONE A SNET Southern New England Telephone
New Hampshire RSA 1................ CELLULARONE A US Cellular US Cellular
New York RSA 2...................... CELLULARONE A Frontier Frontier Communications, Inc.
Vermont, Burlington MSA, RSA 1,
RSA 2, and RSA 3.................. CELLULARONE A Bell Atlantic Bell Atlantic/NYNEX
Wireless Alliance (PCS)
Duluth, Minnesota/Superior,
Wisconsin; Fargo, North CELLULARONE, American Cellular
Dakota/Moorhead, Minnesota; Grand Unicel B AIRTOUCH Airtouch
Forks, North Dakota ............... WIRELESS NORTH
CELLULARONE Western Wireless
Sioux Falls, South Dakota ......... Unicel B COMMNET Cellular Blackstone
SPRINT Swift Tel
Western Wireless Corporation ("Western Wireless"), and American Cellular
Corp. offer their service under the CELLULARONE -Registered Trademark- trade
name and are members of the North American Cellular Network, a consortium of
CELLULARONE service providers located throughout the United States that
reciprocally provide reduced roaming rates and ACD. The Company believes that
Western Wireless, American Cellular Corp. and AirTouch compete against the
Company primarily on the basis of price and have become significantly more
aggressive during the past two years.
Several companies operate relatively small paging networks in portions of the
Company's service area. One competitor, American Paging, Inc. ("American
Paging"), covers a large area within Minnesota and eastern North Dakota. The
Company has entered into an agreement with American Paging to resell American
Paging's 900 MHz paging service in the Company's service area as an
additional paging option for the customers of the Company. This service is
marketed under the trade name KEYPAGE -Registered Trademark- PLUS and is sold
in approximately 80% of the same areas
7
in which the paging service of the Company, marketed under the trade name
KEYPAGE -Registered Trademark-, is provided. Both KEYPAGE -Registered
Trademark- and KEYPAGE -Registered Trademark- PLUS provide umeric display and
alphanumeric display services. Pricing and coverage areas differentiate the
services. Other 900 MHz regional paging systems have been licensed within the
Company's service area to other potential paging carriers. The Company
resells paging services in Maine through Northeast Paging using the UNICEL
name.
The Company believes that PCS networks will be initially focused primarily in
urban areas due to capital requirements and population coverage requirements.
Narrowband PCS services typically are advanced paging and messaging services.
Broadband PCS services will consist of wireless two-way telecommunications
services for voice, data, and other transmissions employing digital
micro-cellular technology. Many broadband PCS services are expected to
compete with existing cellular systems. The FCC has issued licenses for both
narrowband and broadband PCS services. Six broadband licenses were issued in
each part of the Company's cellular service area. Under recent FCC rulings,
license holders are allowed to disaggregate the spectrum covered by their
license. Accordingly, the Company may face competition from additional
providers of PCS services.
The Company also competes to a lesser extent with dispatch and conventional
mobile telephone companies, Specialized Mobile Radio Service ("SMR")
providers, resellers, paging companies and landline telephone service
providers. The FCC requires all cellular and PCS licensees to provide service
to "resellers." A reseller provides wireless services to customers but does
not hold a FCC license or own facilities. Instead, the reseller buys blocks
of wireless telephone numbers and capacity from a licensed carrier and
resells service through its own distribution network to the public. Thus, a
reseller is both a customer of a wireless licensee's service and also a
competitor of that licensee. Several small resellers currently operate in
competition with the Company's systems.
In the future, the Company expects to face increased competition for its
cellular and PCS services from entities providing other technologies and
services, including digital mobile communications systems on Enhanced
Specialized Mobile Radio ("ESMR") frequencies, fixed wireless services, and
satellite-based telecommunications systems, as well as other cellular and PCS
providers. Although some of these technologies are currently operational,
others are being developed or may be developed in the future. The entrance of
multiple competitors in the PCS markets is mandated by the FCC.
The Company anticipates that market prices for wireless communication
services and equipment will continue to decline in the future based upon
increased competition and reductions in production costs. The Company's
ability to compete successfully is dependent, in part, on its ability to
anticipate and respond to various competitive factors affecting the industry.
The Company's marketing and sales organization includes a group that
carefully monitors and analyzes competitive products and service offerings,
changes in consumer preferences, changes in demographic trends and economic
conditions and pricing strategies by competitors that could adversely affect
the Company's operations or present strategic opportunities.
The wireless communication industry is experiencing significant technological
change, as evidenced by the increasing pace of improvements in the capacity
and quality of digital technology, shorter cycles for new products and
enhancements, and changes in consumer preferences and expectations.
Continuing technological advances in telecommunications and FCC policies that
encourage the development of new spectrum-based technologies make it
difficult to predict the extent of future competition. In addition, the
Omnibus Budget Reconciliation Act of 1993 requires, among other things, the
allocation to commercial use of a portion of 200 MHz of the spectrum
currently reserved for government use. It is possible that some portion of
the spectrum that is reallocated will be used to create new land-mobile
services or to expand existing land-mobile services.
The Company believes that it is strategically positioned to compete with
other communications technologies that now exist, such as SMR and ESMR
systems and PCS, and with cellular and paging resellers. Cellular service and
paging will also compete more directly with traditional landline telephone
service providers and with cable operators that are expanding into the
offering of traditional communications services over their cable systems. The
Company may face competition from new technologies not yet readily available
such as satellite networks.
8
REGULATION
THE FOLLOWING SUMMARY OF REGULATORY DEVELOPMENTS AND LEGISLATION DOES NOT
PURPORT TO DESCRIBE ALL PRESENT AND PROPOSED FEDERAL, STATE, AND LOCAL
REGULATION AND LEGISLATION AFFECTING THE TELECOMMUNICATIONS INDUSTRY. OTHER
EXISTING FEDERAL AND STATE LEGISLATION AND REGULATIONS ARE CURRENTLY THE
SUBJECT OF JUDICIAL PROCEEDINGS, LEGISLATIVE HEARINGS AND ADMINISTRATIVE
PROPOSALS WHICH COULD CHANGE, IN VARYING DEGREES, THE MANNER IN WHICH THIS
INDUSTRY OPERATES. NEITHER THE OUTCOME OF THESE PROCEEDINGS NOR THEIR IMPACT
UPON THE TELECOMMUNICATIONS INDUSTRY OR THE COMPANY CAN BE PREDICTED AT THIS
TIME.
OVERVIEW
The Company's services are subject to varying degrees of Federal, state and
local regulation. The FCC exercises jurisdiction over all facilities of, and
services offered by, telecommunications common carriers such as the Company,
to the extent those facilities are used to provide, originate or terminate
interstate or international communications. State regulatory commissions
retain jurisdiction over most of the same facilities and services to the
extent they are used to originate or terminate intrastate communications. In
addition, many of the regulations issued by these regulatory bodies may be
subject to judicial review, the result of which review the Company is unable
to predict.
FEDERAL REGULATION
The Company must comply with the requirements of common carriage under the
Communications Act of 1934 (the "Communications Act"). Comprehensive
amendments to the Communications Act were made by the Telecommunications Act
of 1996 (the "1996 Act"). The 1996 Act effected plenary changes in regulation
at both the Federal and state levels that affect virtually every segment of
the telecommunications industry. The stated purpose of the 1996 Act is to
promote competition in all areas of telecommunications and to reduce
unnecessary regulation to the greatest extent possible. While management
believes it will take years for the industry to feel the full impact of the
1996 Act, it is already clear the legislation provides the Company with both
opportunities and challenges.
The 1996 Act greatly expands the interconnection requirements imposed by the
FCC on incumbent local exchange carriers ("ILECs"). The 1996 Act requires the
ILECs to: (i) provide physical co-location; (ii) unbundle and provide access
to components of their local service networks to other providers of local
service; and (iii) establish "wholesale" rates for the services they offer at
retail; and requires all local exchange carriers ("LECs") to: (i) establish
number portability; (ii) establish dialing parity; and (iii) provide
nondiscriminatory access to telephone poles, ducts, conduits and
rights-of-way. In addition, the 1996 Act requires LECs to compensate
telecommunications carriers for traffic originated by the LECs and terminated
on the other carriers' networks. The 1996 Act requires all telecommunications
carriers, including the Company, to provide interconnection upon reasonable
request.
LECs, other than certain rural telephone companies which benefit from an
exemption provided for by the 1996 Act, are required to negotiate in good
faith with carriers requesting any or all of the above arrangements. If a
requesting carrier and the LEC cannot reach an agreement within the
prescribed time, either carrier may request binding arbitration by the
appropriate state commission. Where an agreement cannot be reached, carriers
remain subject to the interconnection obligations established by the FCC and
state telecommunications regulatory commissions.
Because certain of the 1996 Act's interconnection requirements apply to all
providers of telecommunications services, including the Company, it may
provide the Company with the ability to reduce its own access costs by
interconnecting directly with non-ILECs, but may also cause the Company to
incur additional administrative and regulatory expenses in replying to
interconnection requests.
Near the conclusion of the initial term of a cellular, PCS, or paging
license, licensees must file applications for renewal of licenses to obtain
authority to operate for up to an additional ten-year term. Applications for
license renewal may be denied if the FCC determines that the grant of a
license would not serve the public interest, convenience, or necessity. The
FCC also may revoke a license prior to the end of its term in extraordinary
9
circumstances. In addition, at license renewal time, other parties may file
competing applications for the authorization. The FCC has adopted specific
standards stating renewal expectancy will be awarded to a CMRS licensee that
(i) has provided substantial service during its license term and (ii) has
substantially complied with applicable FCC rules and policies and the
Communications Act. If the FCC awards the Commercial Radio Service ("CMRS")
licensee a renewal expectancy, its license renewal application is granted and
the competing applications are dismissed. The Company's cellular licenses for
Minnesota and South Dakota expire on October 1, 2000. The Company's cellular
licenses in New England expire on varying dates between October 1, 1999 and
January 22, 2008. The Company holds 13 FCC licenses for paging services,
which expire between April 1, 1999 and July 1, 2008. Wireless Alliance's PCS
licenses will expire on June 23, 2005.
Although the Company is unaware of any circumstances that would prevent the
approval of any future renewal application, no assurance can be given that
the FCC will renew any of the Company's licenses. Moreover, although
revocation and involuntary modification of licenses are extraordinary
measures, the FCC has the authority to restrict the operation of a licensed
facility or revoke or modify licenses. None of the Company's licenses has
ever been revoked or involuntarily modified.
The FCC requires registration of certain antenna structures, and the Company
has complied with such requirements. CMRS systems are subject to certain FAA
regulations respecting the location, marking, lighting, and construction of
transmitter towers and antennas and may be subject to regulation under the
National Environmental Policy Act and the environmental regulations of the
FCC. Effective September 1997, the FCC updated the guidelines and methods it
uses for evaluating radio frequency ("RF") emissions from radio equipment.
While the FCC's new rules impose more restrictive standards on RF emissions
from low power devices such as the Company's wireless devices, the Company
believes that all wireless devices currently provided by the Company to its
customers comply with the new standards.
The 1996 Act mandates that telecommunications carriers, such as the Company,
pay into the federal Universal Service Fund ("USF"). The purpose of the USF
is to ensure that basic telephone services are available and affordable for
all citizens. The USF will promote access to communications services in high
cost areas and for low income persons, schools, libraries, and rural health
care providers. The Company also is required to contribute to state universal
service funds. The federal USF is administered jointly by the FCC, the fund
administrator, and state regulatory authorities, many of which are still in
the process of establishing their administrative rules. While the FCC has
commenced collecting contributions, the financial effect of these regulations
on the Company cannot be determined at this time. However, as the Company is
permitted to collect the required contribution amounts from its customers,
the Company expects that its obligation to contribute to the USF will have a
minimal financial impact on the Company. The Company also is required to
contribute annually to the Telecommunications Relay Service Fund and the
North American Numbering Plan Administration fund and to remit regulatory
fees to the FCC with respect to its operations. The Company does not expect
that these contribution obligations will have a material financial impact on
the Company.
Cellular and broadband CMRS providers must comply with the FCC's rules
regarding emergency 911 service. In 1997, the FCC released timetables and
provisions for emergency 911 service availability provided by cellular, PCS
and other mobile service providers, including "enhanced 911" ("E911")
services that provide the caller's telephone number, location and other
useful information. Phase I of the implementation requires that the
metropolitan and rural markets must be able to provide automatic number
identification (ANI) and cell site information for 911 calls to the 911
dispatch points, called Public Safety Answering Points. Phase II provides
that covered carriers must have the capability to identify the location of
mobile units making 911 calls within a radius of no more than 125 meters. The
FCC's Order mandates that CMRS providers be reimbursed for their costs to
provide enhanced 911 services, but left it up to the state governments to
determine specific cost recovery mechanisms for each state. The FCC Order
also empowered state governments to initiate carrier compliance. In the
majority of states in which the Company operates, the state has not required
the Company to comply with Phase I or Phase II of the FCC's Order while
awaiting the completion of state legislation to coordinate cost recovery
mechanisms. The full implementation by the Company of its E911 obligations
may have a financial impact on the Company. The Company is not yet able to
predict the extent of that impact.
10
Cellular and broadband PCS service providers are required to implement number
portability by November 2002. Number portability would enable customers to
change broadband CMRS providers and services without changing their telephone
number. The failure to comply with this obligation could result in a fine or
revocation of the Company's licenses.
Telecommunications carriers also are required to comply with the
Communications Assistance for Law Enforcement Act ("CALEA"). CALEA requires
carriers to modify and design their equipment, facilities and services to
support lawful electronic surveillance. The FCC recently extended the
compliance date to June 30, 2000. In November 1998, the FCC reached some
tentative conclusions and adopted a Further Notice of Proposed Rulemaking
about the technical requirements with which CMRS carriers must comply. A
significant amount of capital will be required to upgrade and install
equipment to ensure compliance with the FCC's rules. The Attorney General,
subject to availability of appropriations, may agree to reimburse wireless
providers for costs directly associated with modifications to provide the
required capacity.
Telecommunications carriers also must comply with the FCC's rules regarding
the use and protection of customer proprietary network information ("CPNI").
The FCC's new rules regarding CPNI became effective May 24, 1998. These rules
substantially increase the regulation of the Company's use of CPNI. The
Company expects that its implementation of measures to comply with these new
CPNI rules will have a financial impact upon the Company, but it does not
expect that impact to be material.
LIMITATION ON FOREIGN OWNERSHIP
Ownership of the capital stock of the Company by non-U.S. citizens is
subject to limitations under the Communications Act and FCC regulations.
STATE AND LOCAL REGULATION
The Company is also subject to certain regulation by state and local
government bodies. The extent of such regulation varies from state to state.
The Communications Act preempts state and local regulation of the entry of,
or the rates charged by, any commercial mobile radio service ("CMRS")
provider, subject to the ability of a state to petition the FCC for authority
to regulate rates due to local market conditions. The States of Minnesota,
Maine, Wisconsin, South Dakota, New York, New Hampshire, Massachusetts and
North Dakota do not currently regulate the rates for any commercial mobile
service, but could petition the FCC for such authority in the future. The
siting and construction of CMRS transmitter towers, antennas and equipment
shelters are often subject to state or local zoning, land use, and other
regulation. Such regulation may include environmental and building permit
approvals or other state or local certification.
EMPLOYEES
As of March 1, 1999, the Company had 498 employees, including 171 in sales
and marketing, 137 in customer service, 88 in network and systems operations,
and 102 in administration, finance and accounting. Seventeen of the Company's
employees were part-time. In addition, the Company has approximately 300
independent sales agents. None of the Company's employees are represented by
a labor organization, and the Company's management believes it has excellent
relations with its employees. Wireless Alliance has no full-time or part-time
employees but operates utilizing the Company's employees.
COMMUNITIES
In 1997, the Company joined the Minnesota Keystone Program as a business
entity that contributes 2% of its pre-tax earnings back to its communities.
The Company's "communities" include its customers, employees, investors,
suppliers, partners, and the communities to which it provides services
directly, as well as the wireless communications industry.
11
ITEM 2. PROPERTIES
The Company owns its principal corporate headquarters located at 3905 Dakota
Street SW, Alexandria, Minnesota 56308. The headquarters is a two-story,
50,000 square-foot facility with land available for a 24,000 square-foot
expansion. The Company also owns 3,600 and 4,050 square-foot storage
facilities in Minnesota and a 5,500 square-foot storage facility in Maine.
As of December 31, 1998, the Company had 233 cellular cell sites in Maine,
Massachusetts, Minnesota, New Hampshire, New York and Vermont, of which 118
sites are subject to leases either for tower space or land.
As of December 31, 1998, the Company owned 94 operational paging transmitters
for its paging business.
As of December 31, 1998, Wireless Alliance had 53 PCS base stations
constructed. The Company owns the equipment within all of the base stations.
Wireless Alliance owns the land of one base station site and leases the land
on the other 52 base station sites.
ITEM 3. LEGAL PROCEEDINGS
The Company is a party to routine filings and customary regulatory
proceedings with the FCC and state regulatory agencies from time to time.
Also, the Company is involved in legal proceedings from time to time relating
to claims arising out of its operations in the normal course of business.
There are no pending legal proceedings to which the Company is a party or of
which any of its property is subject which, if adversely decided, would have
a material effect on the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this report.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information with regard to
each of the executive officers of the Company:
NAME AGE POSITION
Richard P. Ekstrand 49 President, Chief Executive Officer and Director
Ann K. Newhall 48 Senior Vice President and General Counsel
Wesley E. Schultz 42 Senior Vice President of Finance, Chief Financial Officer
David J. Del Zoppo 43 Vice President, Controller
Scott G. Donlea 39 Vice President of Sales and Marketing
RICHARD P. EKSTRAND has served as President, Chief Executive Officer and a
director of the Company since 1990. Since 1984, Mr. Ekstrand has also served
as Vice President and a director of Lowry Telephone Co., Inc., a local
exchange telephone company and a shareholder of the Company, of which Mr.
Ekstrand is the sole shareholder. Mr. Ekstrand also serves as a director of
Cellular 2000. Mr. Ekstrand is past president of the Minnesota Telephone
Association ("MnTA") and the Association of Minnesota Telephone Utilities. He
currently serves as a director of the Rural Cellular Association ("RCA") and
is active in CTIA, serving on its Board of Directors, Executive Committee,
Industry Information Council Small Operators Caucus and Wireless Foundation
Board of Directors.
12
ANN K. NEWHALL joined the Company in February 1999 as Senior Vice President
and General Counsel. Prior to joining the Company she served as a shareholder
attorney with Moss & Barnett, A Professional Association, Minneapolis,
Minnesota, most recently serving also as president and a director of the
firm. Moss & Barnett, A Professional Association, serves as general counsel
to the Company.
WESLEY E. SCHULTZ joined the Company in May 1996 as Vice President of Finance
and Chief Financial Officer and was promoted to Senior Vice President of
Finance and Chief Financial Officer in July 1998. Prior to joining the
Company, Mr. Schultz had served as acting Chief Financial Officer of Spanlink
Communications, Inc. since February 1996, as Chief Financial Officer of
Nicollet Process Engineering, Inc. from March 1995 through October 1995, as
Chief Financial Officer of Data Systems & Management, Inc. from November 1994
through March 1995, and as Vice President, Finance & Administration and Chief
Financial Officer of Serving Software, Inc. from December 1991 through
October 1994. Mr. Schultz is a CPA and served for three years as an auditor
with Deloitte and Touche, LLP.
DAVID J. DEL ZOPPO joined the Company in May 1997 as Controller. In June
1998 Mr. Del Zoppo was promoted to Vice President Controller. Prior to
joining the Company Mr. Del Zoppo served as a Vice President of Operations
with Business Records Corporation from January 1988 to May 1997, and with
Jostens, Inc. as an Internal Audit Manager from 1982 to 1986. Mr. Del Zoppo
is a CPA and served for over four years as an auditor with KPMG Peat Marwick.
SCOTT G. DONLEA has served as Vice President of Sales and Marketing since
August 1995. Mr. Donlea joined the Company in 1992 as Manager of Market
Operations. From 1990 to 1992, Mr. Donlea was regional manager for CommNet
Cellular, Inc., responsible for marketing and sales in Iowa and South Dakota.
From 1988 to 1990, Mr. Donlea served as branch manager for US WEST Cellular,
Inc., in Sioux Falls, South Dakota. Mr. Donlea currently serves as
chairperson of the RCA's business and marketing committee.
13
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company's Class A Common Stock trades on The Nasdaq National Market under
the symbol RCCC. The following table indicates the high and low closing price
for each quarter of the 1998 and 1997 fiscal years.
FIRST QUARTER SECOND QUARTER THIRD QUARTER FOURTH QUARTER
HI LOW HI LOW HI LOW HI LOW
- --------------- ----------- ------------ ------------ ------------ -------------- ---------- -------------- ---------
1998 17 3/8 11 1/2 18 1/4 15 5/8 16 9/16 10 7/8 12 13/16 10 1/8
1997 11 9 3/8 10 7/8 8 5/8 13 10 1/8 13 1/4 10 3/4
The Company's Class B Common Stock is not publicly traded.
As of March 22, 1999, there were approximately 83 holders of record of the
Company's Class A Common Stock and approximately 30 holders of record of the
Company's Class B Common Stock.
DIVIDEND POLICY
The Company has never paid dividends on its Common Stock. The Company
currently intends to retain all future earnings, if any, for the operation
and expansion of its business and does not expect to pay any cash dividends
on its Common Stock in the foreseeable future. Further, the documents related
to the Company's credit facility, the 9 5/8 Senior Subordinated Notes, and
Exchangable Preferred Stock limit the Company's ability to pay dividends on
its Common Stock.
14
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial data for the periods
indicated. This information should be read in conjunction with the
Consolidated Financial Statements and related notes contained in Item 14
herein and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" contained in Item 7 herein. The Company's acquisitions
and issuance of subordinated notes and preferred stock in 1998 and its
acquisition in 1997 affect comparability of the Selected Financial Data. See
Notes 2, 4, and 6 of Notes to Consolidated Financial Statements.
(In thousands, except per share and
other cellular operating data). YEARS ENDED DECEMBER 31,
--------------------------------------------------------------
1998 1997 1996 1995 1994
STATEMENT OF OPERATIONS DATA:
Revenues:
Service............................ $ 75,633 $ 43,408 $ 23,120 $ 14,289 $ 9,784
Roamer............................. 20,199 9,475 6,414 4,562 3,897
Equipment.......................... 2,700 1,020 927 1,476 2,008
-------- -------- --------- --------- ---------
Total revenues................... 98,532 53,903 30,461 20,327 15,689
-------- -------- --------- --------- ---------
Operating expenses:
Network costs...................... 18,877 11,578 6,731 4,974 3,293
Costs of equipment sales........... 5,968 2,807 1,375 1,914 2,214
Selling, general and administrative 39,156 25,225 13,576 7,700 6,570
Depreciation and amortization...... 26,532 12,458 5,539 3,249 2,426
-------- -------- --------- --------- ---------
Total operating expenses......... 90,533 52,068 27,221 17,837 14,503
-------- -------- --------- --------- ---------
Operating income ..................... 7,999 1,835 3,240 2,490 1,186
-------- -------- --------- --------- ---------
Other income (expense):
Interest expense................... (19,060) (6,065) (281) (1,365) (1,195)
Interest and dividend income....... 1,461 232 335 277 170
Equity in earnings (losses) of
unconsolidated subsidiaries...... (535) (350) 52 (37) (37)
Minority interest.................. 4,553 3,082 331 - -
-------- -------- --------- --------- ---------
Other income (expense), net...... (13,581) (3,101) 437 (1,125) (1,062)
-------- -------- --------- --------- ---------
Income (loss) before income taxes and
extraordinary item................. (5,582) (1,266) 3,677 1,365 124
Income tax provision (benefit)........ - - 200 575 (486)
-------- -------- --------- --------- ---------
Net Income (loss) before extraordinary
item............................. (5,582) (1,266) 3,477 790 610
-------- -------- --------- --------- ---------
Extraordinary item - early
extinguishment of debt........... (1,042) - - - -
-------- -------- --------- --------- ---------
Net income (loss) .................... (6,624) (1,266) 3,477 790 610
-------- -------- --------- --------- ---------
Preferred stock dividend.............. (9,090) - - - -
-------- -------- --------- --------- ---------
Net income (loss) applicable to common
shares........................... $(15,714) $ (1,266) $ 3,477 $ 790 $ 610
======== ======== ========= ========= =========
Basic and diluted net income (loss)
per common share................... $(1.76) $(0.14) $0.41 $0.13 $0.11
======== ======== ========= ========= =========
Basic and diluted weighted average 8,916 8,853 8,509 5,983 5,522
common shares outstanding.......... ======== ======== ========= ========= =========
15
DECEMBER 31,
1998 1997 1996 1995 1994
------------ ----------- ----------- ------------ ------------
BALANCE SHEET DATA:
Working capital (deficit).......... $ (9,538) $ 514 $(11,215) $(4,415) $ 80
Net property and equipment......... 131,714 77,920 41,935 23,517 16,479
Total assets....................... 480,524 181,588 60,507 30,138 22,439
Total debt......................... 298,851 128,000 8,492 19,123 15,117
Total shareholders' equity......... 19,279 33,731 34,996 5,458 4,668
OTHER OPERATING DATA YEARS ENDED DECEMBER 31,
1998 1997 1996 1995 1994
---------- ----------- ----------- ------------ -----------
Customers at period end:
RCC Cellular 186,892 84,600 45,094 26,764 17,402
Wireless Alliance - Cellular 11,079 17,167 - - -
Wireless Alliance - PCS 5,129 - - - -
Other 11,550 9,312 6,890 3,783 2,089
---------- ----------- ----------- ------------ -----------
Total customers 214,650 111,079 51,984 30,547 19,491
Penetration: (1)
RCC Cellular 8.0% 7.6% 7.5% 4.5% 2.9%
Wireless Alliance - PCS 0.7% 3.3% - - -
Retention: (2)
RCC Cellular 98.5% 98.4% 98.7% 99.0% 99.2%
Wireless Alliance - PCS 98.2% 98.7% - - -
Average monthly revenue per customer: (3)
RCC Cellular $52 $55 $66 $69 $84
Wireless Alliance - PCS 64 61 - - -
Acquisition cost per customer: (4)
RCC Cellular $362 $403 $307 $395 $448
Wireless Alliance - PCS 565 280 - - -
Cell sites / Base Stations:
RCC Cellular 233 121 72 64 55
Wireless Alliance - PCS 53 - - - -
- --------------------------------------------------------------------------------------------
(1) Represents the ratio of cellular customers at the end of the period to
POPs.
(2) Determined for each period by dividing total cellular customers
discontinuing service during such period by the average cellular customers
for such period (customers at the beginning of the period plus customers at
the end of the period, divided by two), dividing that result by the number
of months in the period, and subtracting such result from one.
(3) Determined for each period by dividing the sum of access, airtime, roaming,
long distance, features, connections, disconnection, and other revenues for
such period by average cellular customers for such period (customers at the
beginning of the period plus customers at the end of the period, divided by
two), and dividing that result by the number of months in such period.
(4) Determined for each period by dividing selling and marketing expenses,
costs of equipment sales, and depreciation of rental telephone equipment by
the gross cellular customers added during such period.
16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Over the past three years, acquisitions of additional cellular operations,
development of the PCS markets through Wireless Alliance, and the issuance of
subordinated notes and preferred stock have affected the Company's financial
performance and, accordingly, the year-to-year comparability of such
performance. Further, the Company's past performance, especially the changes
from year to year, should not be considered predictive of the Company's
future performance.
ACQUISITIONS
UNITY CELLULAR SYSTEM, INC
Effective May 1, 1997, the Company completed the acquisition of the related
assets of the Maine wireless telephone operations and related assets of Unity
Cellular Systems, Inc. and related cellular and microwave licenses from
InterCel, Inc. In addition, the Company acquired InterCel's 51% interest in
the Northern Maine Cellular Partnership, which holds a cellular license for
Maine RSA2 and acquired the remaining 49% in Northern Maine from an unrelated
third party. The costs for all of the acquired properties in Maine (the "MRCC
Acquisition") was $86 million. The acquired licenses cover the Bangor, Maine
MSA and Maine RSA 3 (which includes Augusta, the state capitol). The Company
operates its Maine operations through a wholly owned subsidiary, MRCC.
Headquartered in Bangor, MRCC serves a 20,500 square-mile service area that
encompasses approximately 518,000 POPs. The acquisitions (the "MRCC
Acquisitions") have been accounted for under the purchase method of
accounting.
ATLANTIC CELLULAR COMPANY, L.P.
Effective July 1, 1998, the Company completed the acquisition of the Vermont,
New Hampshire, New York and Massachusetts cellular telephone licenses,
operations and related assets of Atlantic Cellular Company L.P. and one of
its subsidiaries ("Atlantic"), for approximately $262.5 million. Under the
terms of the agreement, the Company acquired a contiguous, multi-state
service area of 21,000 square miles, encompassing approximately 1.1 million
POPs. The cellular properties acquired from Atlantic include: (i) the entire
state of Vermont (RSA 1, RSA 2, and the Burlington MSA); (ii) western New
Hampshire (RSA 1); (iii) the northeastern corner of New York (RSA 2); and
(iv) northwestern Massachusetts (RSA 1). In addition, the Company has
acquired Atlantic's long distance business. The Company operates its Atlantic
operations as RCC Atlantic, Inc.
WESTERN MAINE CELLULAR, INC.
Effective July 31, 1998, the Company completed the acquisition of the
outstanding stock of Western Maine Cellular ("WMC"), a wholly-owned
subsidiary of Utilities, Inc. for approximately $7.5 million. WMC provides
cellular service to western Maine RSA 1, a 3,700 square-mile area of western
Maine encompassing 83,000 POPs. The Company operates WMC through its wholly
owned subsidiary, MRCC.
EVENTS SUBSEQUENT TO DECEMBER 31, 1998
Effective February 1, 1999, the Company acquired RGI, Inc. d/b/a Glacial
Lakes Cellular 2000 ("Glacial") for approximately $11.9 million. Operating
under the name Cellular 2000(R), Glacial provides cellular service to
northeastern South Dakota (RSA 4), which includes eight counties and is
adjacent to RCC's existing cellular operation in northern and central
Minnesota. Glacial Lakes' service area encompasses 69,000 POPs and the
operation serves more than 6,800 customers.
On February 2, 1999, the Company entered into two swap transactions with TD
Bank Financial Group, which together, effectively lower the interest on the
Senior Subordinated Notes from 9.625% to 8.535% through May 2003. During the
period of June 2003 through May 2008, 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
17
specified by the terms of the contracts. The notional principal amount of the
interest rates swaps outstanding was $125 million at February 2, 1999.
JOINT VENTURE
Wireless Alliance, LLC ("Wireless Alliance"), a joint venture that is
51%-owned by RCC and 49%-owned by an affiliate of Aerial Communications,
Inc., was formed in 1996 to provide PCS service to targeted markets in
Minnesota, Wisconsin, North Dakota and South Dakota. Wireless Alliance began
by reselling cellular service to gain visibility in its markets. In the
second quarter of 1998, PCS networks were launched in Fargo, North Dakota;
Moorhead and Duluth, Minnesota; Virginia/Hibbing, Minnesota and Superior,
Wisconsin. In the third quarter of 1998, PCS service was launched in Sioux
Falls, South Dakota followed by Grand Forks, North Dakota in the fourth
quarter of 1998. Wireless Alliance's service area covers 708,000 POPs. In all
of these markets, Aerial contributed the licenses, and RCC is responsible for
the building and managing of the networks and marketing of the PCS services.
Like Aerial's other PCS systems, Wireless Alliance utilizes industry-standard
Global System for Mobile ("GSM") technology. Of the $19.6 million total
investment, as of December 31, 1998, the Company has contributed $10.0
million towards its 51 percent ownership while APT has contributed $9.6
million in PCS licenses. In addition, the Company has contributed $28.1
million in excess of its 51 percent ownership, which is reflected as a note
receivable from Wireless Alliance eliminated in consolidation.
GENERAL
The Company's principal operating objective is to increase revenues and
achieve profitability through the acquisition and development of new cellular
and digital markets and increased penetration in existing markets. Its total
market encompasses 3.1 million POPs. The Company has continued to penetrate
its existing Midwest markets through innovative sales initiatives. However,
the development of the Wireless Alliance PCS network and the customers added
through the acquisition of MRCC and Atlantic were the primary factors in the
Company's increased revenues in Fiscal 1998. Total customers increased 93% to
214,650 in 1998 as compared to 111,079 in 1997. Offsetting the increase in
customers was a decrease in the average monthly cellular revenue per customer
from $55 in 1997 to $52 in 1998. The Company believes that this decrease
reflects an industry wide trend of adding lower-usage customers, who use
cellular service for personal convenience, security or as an alternative
communication resource to their traditional landline telephone service. The
Company intends to pursue acquisitions to the extent they enhance or extend
its network or increase shareholder value, although there can be no assurance
any such acquisition will be consummated.
The Company emphasizes customer support in an effort to maximize its customer
retention. For the year ended December 31, 1998, the Company experienced an
average monthly cellular retention rate of 98.5%, as compared to an industry
average monthly retention rate of 97.9%, as reported in the CTIA Data Survey
dated June 30, 1998. Customer retention continues to be a challenge as the
Company's customer base grows and competition increases. However, the Company
believes that it will continue to maintain relatively high retention rates
due in part to its territory manager distribution philosophy, by offering
communication service packages and value-added features anticipating customer
needs, and by providing high quality and knowledgeable customer service.
The Company's revenues consist of charges to customers for cellular and
paging service, roamer revenues and equipment sales. Service revenues include
monthly access charges, charges for airtime used in excess of the time
included in the service package purchased, long distance charges derived from
calls placed by the Company's customers and cellular and paging equipment
lease revenues. In addition, other charges include activation and feature
charges for such features as voice mail, call waiting, and call forwarding.
Roamer revenues consist of airtime, long distance and service fees charged
for providing service to customers of other cellular systems that place or
receive a call within the Company's cellular service area. The per minute
rate paid by a roamer, or the intercarrier exchange rate, is determined by an
agreement between the Company and the roamer's cellular carrier. The Company
has reciprocal agreements with cellular licensees in adjacent cellular
service areas that allow the Company to provide service to its customers
calling from or receiving calls in these territories at favorable rates. The
Company believes that roamer revenues will continue to increase as a result
of an
18
increase in both the number of roaming customers and roaming minutes of use
as the cellular industry matures. The Company believes these increases will
more than offset an expected decline in intercarrier exchange rates.
Equipment sales consist of cellular and paging equipment and accessory sales
to customers. Within certain markets, the Company rents equipment to
customers in order to reduce the customers' perception that the cost of
purchasing cellular service is prohibitive. This program may negatively
affect equipment sales; however, its effect is lessened by other equipment
sales programs initiated in newly acquired markets.
19
RESULTS OF OPERATIONS
The following table presents certain consolidated statements of operations data
as a percentage of total revenues for the periods indicated:
YEARS ENDED DECEMBER 31,
1998 1997 1996
-------------- -------------- --------------
REVENUES:
Service................................... 76.8% 80.5% 75.9%
Roamer.................................... 20.5 17.6 21.1
Equipment................................. 2.7 1.9 3.0
-------------- -------------- --------------
Total revenues.......................... 100.0 100.0 100.0
-------------- -------------- --------------
OPERATING EXPENSES:
Network costs............................. 19.2 21.5 22.1
Cost of equipment sales................... 6.1 5.2 4.5
Selling, general and administrative....... 39.7 46.8 44.6
Depreciation and amortization............. 26.9 23.1 18.2
-------------- -------------- --------------
Total operating expenses................ 91.9 96.6 89.4
-------------- -------------- --------------
OPERATING INCOME 8.1 3.4 10.6
-------------- -------------- --------------
OTHER INCOME (EXPENSE):
Interest expense.......................... (19.4) (11.3) (0.9)
Interest and dividend income.............. 1.5 0.4 1.1
Equity in earnings (losses) of
unconsolidated affiliates............... (0.5) (0.6) 0.2
Minority interest......................... 4.6 5.7 1.1
-------------- -------------- --------------
Other expense, net...................... (13.8) (5.8) 1.5
-------------- -------------- --------------
INCOME (LOSS) BEFORE INCOME TAX AND
EXTRAORDINARY ITEM (5.7) (2.4) 12.1
INCOME TAX PROVISION - - 0.7
-------------- -------------- --------------
NET INCOME (LOSS) BEFORE EXTRAORDINARY ITEM (5.7) (2.4) 11.4
-------------- -------------- --------------
EXTRAORDINARY ITEM-EARLY EXTINGUISHMENT OF
DEBT (1.0) - -
-------------- -------------- --------------
NET INCOME (LOSS) (6.7) (2.4) 11.4
-------------- -------------- --------------
PREFERRED STOCK DIVIDEND (9.2) - -
-------------- -------------- --------------
NET INCOME (LOSS) APPLICABLE TO COMMON
SHARES (15.9)% (2.4)% 11.4%
============== ============== ==============
EBITDA (1)................................... 35.1% 26.5% 28.8%
ADJUSTED EBITDA (1).......................... 44.9% 41.7% 31.2%
(1) EBITDA is the sum of earnings before interest, taxes, depreciation and
amortization and is utilized as a performance measure within the cellular
industry. EBITDA is not intended to be a performance measure that should be
regarded as an alternative for other performance measures and should not be
considered in isolation. EBITDA is not a measurement of financial
performance under generally accepted accounting principles and does not
reflect all expenses of doing business (e.g., interest expense,
depreciation). Accordingly, EBITDA should not be considered as having
greater significance than or as an alternative to net income or operating
income as an indicator of operating performance or to cash flows as a
measure of liquidity. Adjusted EBITDA represents EBITDA excluding Wireless
Alliance's EBITDA.
20
YEARS ENDED DECEMBER 31, 1998 AND 1997
REVENUES
Service revenues for the year ended December 31, 1998 increased 74.2% to
$75.6 million from $43.4 million in 1997. This growth was primarily due to a
26.1% increase in customers from existing markets and a 67.1% increase in
customers through the RCC Atlantic acquisition. Increased customer count
however, was offset by a decrease of 5.8% in the average revenue per cellular
customer from $55 in 1997 to $52 in 1998. During the year ended December 31,
1998, Wireless Alliance generated service revenues of $12.2 million.
Roamer revenues for year ended December 31, 1998 increased 113.2% to $20.2
million from $9.5 million for the comparable period in 1997. Roamer revenues
have increased due to the activation of additional cell sites and
acquisitions of new service areas. Reflecting the RCC Atlantic acquisition
and its greater percentage of roamer revenue as compared to MRCC and RCC
Midwest, roamer revenues as a percentage of cellular revenues (excluding
equipment sales and the impact of Wireless Alliance) increased to 34.2% from
29.1% in 1997. Wireless Alliance had no roamer revenues in 1997 because it
was exclusively engaged in reselling cellular services and generated an
immaterial amount in roamer revenues during 1998.
Equipment revenues for 1998 increased 164.7% to $2.7 million from $1.0
million in 1997. This growth was primarily due to an increase in customers
acquired through the RCC Atlantic acquisition that utilize a direct phone
sales program as oppose to an equipment rental program currently popular in
the Company's Midwest markets.
OPERATING EXPENSES
Network costs include switching and transport expenses and the expenses
associated with the maintenance and operation of the Company's wireless
network facilities, as well as charges from other service providers for
resold minutes and services. Network costs for the year ended December 31,
1998, increased 63.0% to $18.9 million from $11.6 million in 1997. The
increase in network costs resulted primarily from expenses incurred by
Wireless Alliance, RCC Atlantic, and MRCC, which more than offset network
cost reductions in the Company's Midwest operations. However, as a percentage
of total revenues, network costs decreased to 19.2% in 1998 from 21.5% in
1997. Contributing to the reduction of network costs in the Midwest service
area was the completed installation of the Company's MTSO in the third
quarter of 1997, thereby reducing the Company's network costs for switching
services provided by Switch 2000, LLC. Network costs for Wireless Alliance
increased to $9.3 million for the year ended December 31, 1998 from $6.0
million in 1997. The increase is attributed to additional network costs
associated with increased cellular reselling customers.
Selling, general, and administrative ("SG&A") expenses include salaries,
benefits, and operating expenses such as marketing, commissions, customer
support, accounting, administration, and billing. SG&A expenses for the year
ended December 31, 1998 increased 55.2% to $39.2 million from $25.2 million
in 1997. The increase in SG&A over the prior year resulted primarily from
additional costs related to the acquisition of Atlantic on July 1, 1998 and
operating MRCC during all of 1998. As a percentage of total revenue, SG&A
decreased to 39.7% in 1998 from 46.8% in 1997, reflecting operating
efficiencies achieved through the integration of the Company's New England
operation.
Depreciation and amortization expense for year ended December 31, 1998
increased 113.0% to $26.5 million from $12.5 million in 1997. The increase
reflects the Company's continued construction and acquisition efforts and its
investments in network facilities and rental equipment. Specifically
contributing to the increase was the depreciation relating to the
construction of 23 additional cell sites for RCC Cellular, an additional 89
cell sites from the RCC Atlantic Acquisition, and the activation of 53
Wireless Alliance PCS cell sites. In addition, license and other intangible
asset amortization resulting from acquisitions increased $6.6 million for the
year ended December 31, 1998 from $1.5 million in the prior year.
21
OTHER INCOME (EXPENSE)
Interest expense for 1998 increased to $19.1 million from $6.1 million in
1997. The increase in interest expense was a result of higher average
borrowings under credit facilities and interest related to the 9 5/8% Senior
Subordinated Notes ("Senior Subordinated Notes") used to finance the
acquisitions of Atlantic Cellular and WMC, the construction of 23 cell sites
for the Company's cellular network and other growth initiatives. Other income
also includes an increase in 1998 in the minority partner's absorption of
Wireless Alliance losses.
EXTRAORDINARY ITEM
On May 28, 1998, the Company repayed approximately $140 million of the
outstanding amount under its $160 million credit facility utilizing the
proceeds from its issuance of $125 million in Senior Subordinated Notes and
$125 million in Exchangeable Preferred Stock ("Exchangeable Preferred
Stock"). Accordingly, the Company recognized an extraordinary loss of
approximately $1 million related to the early retirement of debt representing
the unamortized debt issuance costs.
YEARS ENDED DECEMBER 31, 1997 AND 1996
REVENUES
Service revenues for 1997 increased 87.8% to $43.4 million from $23.1 million
in 1996. This growth was primarily due to the increase in the number of
customers partially offset by a decrease of 16.7% in the average revenue per
customer. Customer growth in existing markets accounted for approximately 25%
of the increase in customers while newly acquired or developing markets
accounted for the other 75%. Newly acquired or developing markets include
customers gained through the MRCC Acquisition and the formation of Wireless
Alliance. In 1997, Wireless Alliance generated service revenues of $7.3
million.
Roamer revenues for 1997 increased 47.7% to $9.5 million from $6.4 million in
1996, reflecting the increase in the number of markets served. Markets have
increased as a result of the activation of additional cell sites and
acquisitions of new service areas. Individual customer roamer revenue
remained relatively unchanged when compared to 1996.
Equipment revenues for 1997 increased 10.0% to $1.0 million from $927,000 in
1997. This growth reflects an increase in customers acquired through the MRCC
Acquisition purchasing their cellular handsets and equipment as compared to
the Company's Midwest customers who more frequently rent them.
OPERATING EXPENSES
Network costs for 1997, which increased 72.0% to $11.6 million from $6.7
million in 1996, improved as a percentage of total revenues from 22.1% in
1996 to 21.5% in 1997. The increase in network costs resulted primarily from
expenses incurred by Wireless Alliance and MRCC, which more than offset
network cost reductions in the Company's Midwest Cellular operations.
Contributing to the reduction of network costs in the Midwest service area
was the substantial completion in late 1996 of the digital microwave network,
which reduced the Company's reliance on third-party assistance in connecting
cell site communication to the MTSO. In addition, the Company completed
installation of its own MTSO in the third quarter of 1997 thereby reducing
the Company's network costs for switching services provided by Switch 2000,
Inc. Network costs for Wireless Alliance increased to $6.0 million in 1997
from $220,000 in 1996. The increase is attributable to additional network
costs associated with increased customers.
SG&A expenses for 1997 increased 85.8% to $25.2 million from $13.6 million in
1996. The increase in SG&A over the prior year results primarily from
additional costs from MRCC and a $6.2 million increase in costs of Wireless
Alliance.
22
Depreciation and amortization expense for 1997 increased 124.9% to $12.5
million from $5.5 million in 1996. The increase reflects the Company's
continued construction and acquisition efforts and its investments in network
facilities, including the Company's newly installed MTSO, and rental
equipment. Contributing to the increase was the depreciation relating to the
construction of 15 additional cell sites and the acquisition of 35 cell sites
in Maine. In addition, the Company shortened the depreciation life from three
years to two years for new rental telephones placed in service during 1997.
OTHER INCOME (EXPENSE)
Interest expense for 1997 increased to $6.1 million from $280,000 in 1996.
The increase in interest expense was a result of higher average borrowings to
finance the MRCC Acquisitions, the construction of 15 cell sites for the
Company's cellular network and other growth initiatives. Other income also
includes an increase in 1997 in the minority partners absorption of losses.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary liquidity requirements are for working capital, capital
expenditures, debt service, acquisitions, and customer growth. These
requirements have been met through cash flow from operations and borrowings
under the Company's credit facility. On July 1, 1998, the Company entered
into a new revolving Credit Facility with a syndicate of banks totaling $300
million ("the Credit Facility") which replaced its previous $160 million
credit facility, (See Note 4 in the Notes to Consolidated Financial
Statements regarding the terms of the Credit Facility). As of December 31,
1998, the Company had $173 million outstanding under its Credit Facility.
Under the Credit Facility, amounts may be borrowed or repaid at any time
through maturity provided that, at no time, the aggregate outstanding
borrowings exceed the total of the Credit Facility. The Company believes that
it will have adequate capital resources to satisfy all its liquidity
requirements for at least the next twelve months.
Net cash provided by operating activities was $28.6 million for the year
December 31, 1998. Adjustments to the $6.6 million net loss to reconcile to
net cash used in operating activities included $26.5 million in depreciation
and amortization and a $9.1 million increase in accounts payable partially
offset by a $4.5 million decrease in minority interest.
Net cash used in investing activities for the year ended December 31, 1998
was $313.2 million. The principal uses of cash included the Company's $270.0
million acquisition of Atlantic and WMC, and purchases of property and
equipment of $41.5 million, of which $13.3 million was attributable to
Wireless Alliance capital expenditures. These purchases reflect the
construction and launch of Wireless Alliance's PCS network, expansion of
existing coverage in RCC Cellular, and the continued upgrading of existing
cell sites and switching equipment. Capital expenditures (including $5.7
million for Wireless Alliance) are expected to be approximately $30.5 million
in 1999. Capital expenditures and debt service are expected to be funded
through internally generated cash flows and, if necessary, borrowings under
the $300 million Credit Facility.
Net cash provided by financing activities was $284.7 million for the year
ended December 31, 1998. Financing activities for such period consisted
primarily of the placement on May 14, 1998 of $125 million of 9 5/8% Senior
Subordinated Notes due May 15, 2008 and $125 million of 11 3/8% Exchangeable
Preferred Stock. The net proceeds were used to repay a portion of
indebtedness and to finance the acquisitions of Atlantic and WMC.
In the ordinary course of business, the Company continues to evaluate
acquisition opportunities and other potential business transactions. Such
acquisitions, joint ventures and business transactions may be material. Such
transactions may also require the Company to seek additional sources of
funding through the issuance of additional debt and/or additional equity.
There can be no assurance that such funds will be available to the Company on
acceptable or favorable terms.
23
OTHER MATTERS
INFLATION
The impact of inflation on the Company has not been significant.
YEAR 2000 READINESS
GENERAL
Issues regarding Year 2000 readiness exist because many computer systems and
applications currently in use employ two-digit fields to designate a year. As
a result, date sensitive systems may recognize the year 2000 as 1900 or not
at all. This inability to recognize or properly treat the Year 2000 may
result in system failures or miscalculations causing disruptions of
operations, including, among other things, an inability to process
transactions, send invoices, or engage in normal business activities. Hence,
the computerized systems used by the Company must be reviewed, evaluated and
if and where necessary, modified or replaced to ensure that all financial,
information and operating systems are Year 2000 ("Y2K") compliant.
STATE OF READINESS
The Company has formed a Y2K Project Team, representing all business units,
and staffed with subject matter experts to address Y2K readiness matters. The
Y2K Project Team's plan is made up of six phases: inventory, assessment,
remediation, test and acceptance, implementation, and contingency planning.
Major areas being addressed by the Y2K project team include: the cellular
network; interconnect arrangements to connect the cellular network with
landline systems; clearinghouse arrangements to allow verification and
billing of roaming traffic; the Company's wide area and local area networks;
the Company's internal communications systems; Company server hardware,
software and desktop systems; billing software and related elements;
financial and operational reporting systems; information integration systems;
critical suppliers including financial institutions, payroll/benefits
processing, credit bureaus, benefit plans, building systems, and office
equipment.
With respect to internal matters, the project team has prepared an inventory
of all computer hardware, software, and computer based systems. The Company
has distributed inquiries and requests for Y2K readiness certification to all
known system vendors. Although the Company is still in the process of
obtaining and assessing vendor responses and declarations of Y2K readiness,
it has been determined that critical areas with non -Y2K compliant software
and hardware include switching and billing systems.
RISKS RELATING TO Y2K COMPLIANCE MATTERS
The failure of the Company to upgrade its billing and switching systems to be
Y2K ready may result in the Company being unable to continue operations.
Accordingly, the Company is working toward Y2K certification of its various
billing systems to insure Y2K readiness. The Company also upgraded its MTSO
software for two of its three switches in 1998 and has plans to upgrade the
third switch software in the second quarter of 1999.
The Company anticipates having mission critical software and hardware
remedied and Y2K ready by mid-year 1999 and will continue testing throughout
the third and fourth quarters of 1999. Although the Company believes that
these efforts should result in a cellular network that will continue to
function without material service affecting outages due to Y2K problems,
network equipment suppliers have been unwilling to give unqualified
warranties that network equipment is Y2K compliant. Service affecting
outages, if prolonged and widespread, will materially affect the Company's
revenues.
The terms and conditions under which the Company provides cellular and paging
services to its customers contain provisions that limit the Company's liability
in the event that there is a service failure. The terms and conditions provide
that the Company is not liable for any consequential or incidental damages to
its customers. They further provide that no credit will be given for service
outages of less than 24 hours in duration. In addition, they limit
24
damages for failure to provide service to a credit for the pro rated number
of days that service was unavailable. Service affecting outages have occurred
in limited geographic areas in the past and the Company has not been found
liable to any person for damages in excess of the limitations imposed by the
terms and conditions of service. The Company believes it is unlikely that an
outage occasioned by a failure attributable to a Y2K readiness would lead to
a different result. The Company has adopted a policy of not giving any
warranties to customers regarding Y2K readiness. The Company, at this time,
does not anticipate any litigation involving the Company that would arise as
a result of Y2K readiness issues.
ESTIMATED Y2K COMPLIANCE COSTS
During 1998, the Company did not incur material costs related to bringing
systems into Y2K compliance. For 1999, the Company has budgeted $2.0 million
to cover costs associated with Y2K assessments, modifications, and associated
upgrades.
THIRD PARTY PROVIDERS
The potential impact of the Y2K will also depend on the way in which the Y2K
issue is addressed by customers, vendors, service providers, utilities,
governmental agencies and other entities with which the Company does
business. The Company is communicating with these parties to learn how they
are addressing the Y2K issue and to evaluate any likely impact on the
Company. The Company has requested commitment dates from the various parties
as to their Y2K readiness and delivery of compliant software and other
products. The Y2K efforts of third parties are not within the Company's
control, however their failure to respond to Y2K issues successfully could
result in business disruption and increased operating costs for the Company.
At the present time, it is not possible to determine whether any such events
are likely to occur, or to quantify any potential negative impact they may
have on the Company's future results of operations and financial condition.
CONTINGENCY PLANNING
The Company has begun the process of developing contingency plans that might
be available in the event of either internal or external Y2K compliance
problems. To this end, the Company's Y2K Project Team has begun to prepare
potential contingency alternatives. The Company intends to complete its
contingency planning in respect of Y2K compliance during the remainder of
1999.
Y2K FORWARD LOOKING INFORMATION
The foregoing discussion regarding the Y2K project's timing, effectiveness,
implementation, and cost, contains forward-looking statements, which are
based on management's best estimates derived using assumptions. These
forward-looking statements involve inherent risks and uncertainties, and
actual results could differ materially from those contemplated by such
statements. Factors that might cause material differences include, but are
not limited to, the availability of key Y2K personnel, the Company's ability
to locate and correct all relevant computer codes, the readiness of third
parties, and the Company's ability to respond to unforeseen Y2K
complications. Such material differences could result in, among other things,
business disruption, operational problems, financial loss, legal liability
and similar risks.
SEASONALITY
The Company experiences seasonal fluctuations in revenues and operating
income (loss). Somewhat offset by the New England acquisitions which have
better roaming revenues year around, the Company's average monthly roamer
revenue per cellular customer increases during the second and third calendar
quarters. This increase reflects greater usage by the Company's roamer
customers who travel in the Company's cellular service area for weekend and
vacation recreation or work in seasonal industries, such as agriculture and
construction. Because the Company's cellular service area includes many
seasonal recreational areas, the Company expects that roamer revenues will
continue to fluctuate seasonally more than service revenues.
25
Certain unaudited quarterly results for 1998 and 1997 are set forth below
(in thousands, except average monthly revenue per cellular customer):
1998 QUARTER ENDED
-------------------------------------------------
Mar 31 Jun 30 Sep 30 Dec 31
------ ------ ------ ------
Total revenues............... $14,797 $17,672 $33,955 $32,108
Operating income (loss)...... (524) 364 5,903 2,256
EBITDA (*)................... 3,694 5,211 14,361 11,266
Average monthly revenue
per cellular customer.... $46 $53 $57 $51
1997 QUARTER ENDED
--------------------------------------------------
Mar 31 Jun 30 Sep 30 Dec 31
------ ------ ------ ------
Total revenues............... $8,323 $13,326 $16,747 $15,507
Operating income (loss)...... (354) 511 1,781 (103)
EBITDA(*).................... 1,608 3,438 5,429 3,818
Average monthly revenue
per cellular customer.... $52 $58 $61 $50
(*) See footnote (1) on page 20 under "Item 7. Management Discussion and
Analysis of Financial Condition and Results of Operations" for a definition
and discussion of EBITDA.
FORWARD-LOOKING INFORMATION
Forward-looking statements herein are made pursuant to the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. Although
the Company believes that the expectations reflected in such forward-looking
statements are reasonable, it can give no assurance that such expectations
will prove to be correct. A number of factors could cause actual results,
performance, achievements of the Company, or industry results to be
materially different from any future results, performance or achievements
expressed or implied by such forward-looking statements. These factors
include but are not limited to, the competitive environment in the wireless
and telecommunications industries, changes in economic conditions in general
and in the Company's business, demographic changes, changes in prevailing
interest rates and the availability of and terms of financing to fund the
anticipated growth of the Company's business, the ability to attract and
retain qualified personnel, the significant indebtedness of the Company, and
changes in the Company's acquisition and capital expenditure plans. Investors
are cautioned that all forward-looking statements involve risks and
uncertainties.
In addition, such forward-looking statements are necessarily dependent upon
assumptions, estimates and data that may be incorrect or imprecise and
involve known and unknown risks, uncertainties and other factors.
Accordingly, any forward-looking statements included herein do not purport to
be predictions of future events or circumstances and may not be realized. All
subsequent written and oral forward-looking statements attributable to the
Company or persons acting on its behalf are expressly qualified in their
entirety by the foregoing cautionary statements. The Company disclaims any
obligation to update any such factors or to announce publicly the results of
any revisions to any of the forward-looking statements contained herein to
reflect future events or developments.
26
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Rural Cellular Corporation uses Exchangeable Preferred Stock, Senior
Subordinated Notes, and bank credit facilities to finance its operations.
These on-balance sheet financial instruments, to the extent they provide for
variable rates of interest, expose the Company to interest rate risk, with
the primary interest rate risk exposure resulting from changes in LIBOR or
the prime rate, which are used to determine the interest rates that are
applicable to borrowings under the Company's bank credit facilities. The
Company uses off-balance sheet derivative financial instruments, including
interest rate swap and interest rate protection agreements, to partially
hedge interest transactions. All of the Company's derivative financial
instrument transactions are entered into for non trading purposes. The terms
and characteristics of the derivative financial instruments are matched with
the underlying on-balance sheet instrument or anticipated transaction and do
not constitute speculative or leveraged positions independent of these
exposures.
The information below summarizes the Company's sensitivity to market risk
associated with fluctuations in interest rates as of December 31, 1998. To
the extent that the Company's financial instruments expose the Company to
interest rate risk, they are presented within each market risk category in
the table below. The table presents principal cash flows and related interest
rates by year of maturity for the Company's Senior Subordinated Notes, and
bank credit facilities in effect at December 31, 1998. The table also
presents payments in kind, interest and related interest rates by year of
maturity for the Company's Exchangeable Preferred Stock in effect at December
31, 1998. The cash flows related to the variable portion of interest rate
swaps are determined by dealers using valuation models that estimate the
future level of interest rates, with consideration of the applicable yield
curve as of December 31, 1998. For interest rate swaps and interest rate
protection agreements, the table presents notional amounts and the related
reference interest rates by year of maturity. Fair values included herein
have been determined based on (i) quoted market prices for Exchangeable
Preferred Stock and Senior Subordinated Notes; (ii) the carrying value for
the bank credit facilities at December 31, 1998 as interest rates are reset
periodically; and (iii) estimates obtained from dealers to settle interest
rate swaps and interest rate protection agreements. Notes 4, 5 and 6 to the
Consolidated Financial Statements contain descriptions of the Company's
Exchangeable Preferred Stock, Senior Subordinated Notes and the Credit
Facility, and interest rate risk management agreements and should be read in
conjunction with the table below.
TOTAL
THERE INTEREST
(IN THOUSANDS) 1998 1999 2000 2001 2002 AFTER PAID FAIR VALUE
- ------------------------------------------------------------------------------------------------------------------
INTEREST RATE SENSITIVITY:
SENIOR SUBORDINATED NOTES:
Fixed Rate $7,653 $12,031 $12,031 $12,031 $12,031 $64,802 $120,579 $131,250
Average Interest Rate 9.63% 9.63% 9.63% 9.63% 9.63% 9.63% 9.63%
EXCHANGEABLE PREFERRED STOCK
Fixed Rate $9,099 $15,711 $17,553 $19,637 $22,133 $144,136 $228,269 126,250
Average Interest Rate 11.38% 11.38% 11.38% 11.38% 11.38% 11.38% 11.38%
CREDIT FACILITY
Variable Rate $11,407 $11,850 $11,902 $12,024 $12,110 $49,184 $108,477 $173,000
Average Interest Rate 7.07% 6.85% 6.88% 6.95% 7.00% 7.05% 6.95%
INTEREST RATE SWAPS:
Fixed to Variable - $(1,249) $(1,363) $(1,363) $(1,363) $10,881 $ 5,543 $939
Average Pay Rate - - - - - 1.86% 1.86%
Average Receive Rate - 1.09% 1.09% 1.09% 1.09% - 1.09%
Variable to Fixed $122 $998 $972 $866 $783 $292 $4,033 $(4,758)
Average Pay Rate 0.66% 0.63% 0.59% 0.53% 0.48% 0.43% 0.55%
27
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Consolidated Financial Statements and Notes thereto commencing on Page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
28
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding directors of the Company is set forth in the Proxy
Statement under the heading "Election of Directors" and is incorporated
herein by reference. The information regarding executive officers of the
Company is contained in Part I of this Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION
Information required by this item is set forth in the Proxy Statement under
the headings "Election of Directors" and "Executive Compensation" and is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required by this item is set forth in the Proxy Statement under
the heading "Common Stock Ownership" and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by this item is set forth in the Proxy Statement under
the heading "Certain Transactions" and is incorporated herein by reference.
29
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
Page Number
In this
(a) (1) CONSOLIDATED FINANCIAL STATEMENTS Form 10-K
--------------------------------- ---------
Report of Independent Public Accountants F-1
Consolidated Balance Sheets as of December 31, 1998 and 1997 F-2
Consolidated Statements of Operations for the Years Ended
December 31, 1998, 1997 and 1996 F-4
Consolidated Statements of Shareholders' Equity for the Years
Ended December 31, 1998, 1997 and 1996 F-5
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1998, 1997 and 1996 F-6
Notes to Consolidated Financial Statements F-7
(2) CONSOLIDATED FINANCIAL STATEMENT SCHEDULE
The following financial statement schedule is filed as
part of this Form 10-K:
Report of Independent Public Accountants S-1
Schedule II - Valuation and Qualifying Accounts S-2
All schedules not included are omitted either because
they are not applicable or because the information
required therein is included in Notes to Consolidated
Financial Statements.
(3) EXHIBITS
See Exhibit Index on page 54.
(b) REPORTS ON FORM 8-K
None
(c) EXHIBITS
See Exhibit Index on page 54.
(d) OTHER FINANCIAL STATEMENTS
Not applicable.
30
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.
Rural Cellular Corporation
/s/ Richard P. Ekstrand
---------------------------------------
RICHARD P. EKSTRAND
PRESIDENT AND CHIEF EXECUTIVE OFFICER
Date: March 29, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed by the following persons in the capacities and on the
date indicated.
SIGNATURE TITLE DATE
- --------- ----- ----
/s/ Richard P. Ekstrand President and March 29, 1999
- ------------------------------------------------ Chief Executive Officer
Richard P. Ekstrand (Principal Executive Officer
and Director)
/s/ Wesley E. Schultz Vice President of Finance and March 29, 1999
- ------------------------------------------------ Chief Financial Officer
Wesley E. Schultz (Principal Financial
and Accounting Officer)
/s/ David J. Del Zoppo Vice President, Controller March 29, 1999
- ------------------------------------------------
David J. Del Zoppo
/s/ George W. Wikstrom Jr. Director March 29, 1999
- ------------------------------------------------
George W. Wikstrom Jr.
/s/ Don C. Swenson Director March 29, 1999
- ------------------------------------------------
Don C. Swenson
/s/ Jeffrey S. Gilbert Director March 29, 1999
- ------------------------------------------------
Jeffrey S. Gilbert
/s/ Marvin C. Nicolai Director March 29, 1999
- ------------------------------------------------
Marvin C. Nicolai
/s/ George M. Revering Director March 29, 1999
- ------------------------------------------------
George M. Revering
31
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Rural Cellular Corporation:
We have audited the accompanying consolidated balance sheets of Rural
Cellular Corporation (a Minnesota corporation) and subsidiaries as of
December 31, 1998 and 1997, and the related consolidated statements of
operations, shareholders' equity and cash flows for each of the three years
in the period ended December 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements 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 Rural Cellular Corporation
and subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period
ended December 31, 1998 in conformity with generally accepted accounting
principles.
ARTHUR ANDERSEN LLP
Minneapolis, Minnesota,
February 5, 1999
F-1
RURAL CELLULAR CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31,
(IN THOUSANDS)
ASSETS
1998 1997
----------- -----------
CURRENT ASSETS:
Cash............................................................. $ 2,062 $ 1,995
Accounts receivable, less allowance of $1,555 and $1,146 ........ 13,796 9,621
Inventories...................................................... 2,321 1,774
Other current assets............................................. 813 766
----------- -----------
Total current assets........................................... 18,992 14,156
----------- -----------
PROPERTY AND EQUIPMENT, less accumulated depreciation of $42,538 and
$23,874 ....................................................... 131,714 77,920
----------- -----------
LICENSES AND OTHER ASSETS:
Licenses and other intangible assets, less accumulated
amortization of $8,108 and $1,490.............................. 309,672 81,348
Deferred debt issuance costs, less accumulated amortization of
$509 and $120.................................................. 11,761 1,080
Other assets..................................................... 8,385 7,084
----------- -----------
Total licenses and other assets................................ 329,818 89,512
----------- -----------
$480,524 $181,588
=========== ===========
The accompanying notes are an integral part of
these consolidated balance sheets.
F-2
RURAL CELLULAR CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31,
(IN THOUSANDS)
LIABILITIES AND SHAREHOLDERS' EQUITY
1998 1997
--------- ----------
CURRENT LIABILITIES:
Accounts payable................................................. $ 16,524 $ 7,960
Advance billings and customer deposits........................... 3,229 2,541
Accrued interest................................................. 3,508 1,595
Dividends payable................................................ 1,880 -
Other accrued expenses........................................... 3,389 1,546
---------- ---------
Total current liabilities...................................... 28,530 13,642
LONG-TERM DEBT...................................................... 298,851 128,000
Total liabilities.............................................. 327,381 141,642
COMMITMENTS AND CONTINGENCIES (Note 9)
MINORITY INTEREST................................................... 1,663 6,215
EXCHANGEABLE PREFERRED STOCK........................................ 132,201 -
SHAREHOLDERS' EQUITY:
Class A common stock; $.01 par value; 15,000 shares authorized,
7,780 and 7,593 shares issued and outstanding.................. 78 76
Class B common stock; $.01 par value; 5,000 shares authorized,
1,203 and 1,260 shares issued and outstanding.................. 12 13
Additional paid-in capital....................................... 35,707 34,446
Accumulated deficit.............................................. (16,518) (804)
---------- ---------
Total shareholders' equity..................................... 19,279 33,731
---------- ---------
$ 480,524 $ 181,588
========== =========
The accompanying notes are an integral part of
these consolidated balance sheets.
F-3
RURAL CELLULAR CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31,
(IN THOUSANDS, EXCEPT PER SHARE DATA)
1998 1997 1996
------- ------- -------
REVENUES:
Service ............................................ $75,633 $43,408 $23,120
Roamer ............................................. 20,199 9,475 6,413
Equipment .......................................... 2,700 1,020 927
------- ------- -------
Total revenues.................................... 98,532 53,903 30,460
------- ------- -------
OPERATING EXPENSES:
Network costs....................................... 18,877 11,578 6,731
Cost of equipment sales............................. 5,968 2,807 1,375
Selling, general and administrative................. 39,156 25,225 13,575
Depreciation and amortization....................... 26,532 12,458 5,539
------- ------- -------
Total operating expenses.......................... 90,533 52,068 27,220
------- ------- -------
OPERATING INCOME ...................................... 7,999 1,835 3,240
------- ------- -------
OTHER INCOME (EXPENSE):
Interest expense.................................... (19,060) (6,065) (280)
Interest and dividend income........................ 1,461 232 335
Equity in earnings (losses) of
unconsolidated affiliates......................... (535) (350) 51
Minority interest................................... 4,553 3,082 331
------- ------- -------
Other income (expense), net....................... (13,581) (3,101) 437
------- ------- -------
INCOME (LOSS) BEFORE INCOME TAX AND
EXTRAORDINARY ITEM................................ (5,582) (1,266) 3,677
INCOME TAX PROVISION................................... - - 200
------- ------- -------
NET INCOME (LOSS) BEFORE EXTRAORDINARY ITEM............ (5,582) (1,266) 3,477
------- ------- -------
EXTRAORDINARY ITEM - EARLY EXTINGUISHMENT OF
DEBT.............................................. (1,042) - -
------- ------- -------
NET INCOME (LOSS)...................................... (6,624) (1,266) 3,477
PREFERRED STOCK DIVIDEND............................... (9,090) - -
------- ------- -------
NET INCOME (LOSS) APPLICABLE TO COMMON SHARES.......... $(15,714) $(1,266) $ 3,477
------- ------- -------
------- ------- -------
NET INCOME (LOSS) PER BASIC AND DILUTED /
COMMON SHARES..................................... $(1.76) $(0.14) $ 0.41
------- ------- -------
------- ------- -------
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING,
BASIC AND DILUTED................................. 8,916 8,853 8,509
------- ------- -------
------- ------- -------
The accompanying notes are an integral part of
these consolidated financial statements.
F-4
RURAL CELLULAR CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(IN THOUSANDS)
RETAINED
CLASS A CLASS B ADDITIONAL EARNINGS TOTAL
COMMON STOCK COMMON STOCK PAID -IN (ACCUMULATED SHAREHOLDER'S
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT) EQUITY
- --------------------------------- ----------- ---------- ----------- --------- -------------- -------------- --------------
BALANCE, December 31, 1995....... 4,303 $43 1,680 $17 $ 8,413 $ (3,015) $ 5,458
Issuance of common stock,
net of offering expenses.... 2,870 29 - - 26,033 - 26,062
Conversion of Class B common
stock to Class A common
stock....................... 330 3 (330) (3) - - -
Net Income.................... - - - - - 3,477 3,477
- --------------------------------- ----------- ---------- ----------- --------- -------------- -------------- --------------
BALANCE, December 31, 1996....... 7,503 75 1,350 14 34,446 462 34,997
Conversion of Class B common
stock to Class A common
stock....................... 90 1 (90) (1) - - -
Net Loss...................... - - - - - (1,266) (1,266)
- --------------------------------- ----------- ---------- ----------- --------- -------------- -------------- --------------
BALANCE, December 31, 1997....... 7,593 76 1,260 13 34,446 (804) 33,731
Conversion of Class B common
stock to Class A common
stock....................... 57 1 (57) (1) - - 0
Stock issued through
employee stock purchase
plan........................ 6 0 - - 57 - 57
Stock options exercised....... 124 1 - - 1,204 - 1,205
Net Loss...................... - - - - - (15,714) (15,714)
- --------------------------------- ----------- ---------- ----------- --------- -------------- -------------- --------------
BALANCE, December 31, 1998....... 7,780 $78 1,203 $12 $35,707 $(16,518) $19,279
================================= =========== ========== =========== ========= ============== ============== ==============
The accompanying notes are an integral part of
these consolidated financial statements.
F-5
RURAL CELLULAR CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
(IN THOUSANDS)
1998 1997 1996
-------------- -------------- --------------
OPERATING ACTIVITIES:
Net income (loss)..................................... $ (6,624) $ (1,266) $ 3,477
Adjustments to reconcile to net cash provided by
operating activities................................
Depreciation and amortization....................... 26,532 12,458 5,539
Extraordinary item - early extinguishment of debt... 1,042 - -
Equity in (earnings) losses of unconsolidated
affiliates......................................... 655 350 (52)
Change in minority interest......................... (4,552) (3,082) (331)
Other............................................... 7 (42) (184)
Change in other operating elements:
Accounts receivable............................... (1,058) (1,008) (3,220)
Inventories....................................... (230) (27) (682)
Other current assets.............................. 365 (262) (246)
Accounts payable.................................. 9,097 (2,525) 4,872
Advance billings and customer deposits............ (16) 797 435
Other accrued expenses............................ 3,346 2,649 31
-------------- -------------- --------------
Net cash provided by operating activities....... 28,564 8,042 9,639
-------------- -------------- --------------
INVESTING ACTIVITIES:
Purchases of property and equipment, net............. (41,491) (34,928) (24,214)
Contributions to unconsolidated affiliates........... - (2) (225)
Purchases of Atlantic and Western Maine Cellular..... (269,984) - -
Purchases of Unicel and Northern Maine............... - (85,706) -
Other................................................ (1,734) (3,983) (997)
-------------- -------------- --------------
Net cash used in investing activities.............. (313,209) (124,619) (25,436)
-------------- -------------- --------------
FINANCING ACTIVITIES:
Proceeds from exercise of stock options.............. 1,262 - -
Proceeds from issuance of senior subordinated notes.. 125,000 - -
Proceeds from issuance of preferred stock............ 125,000 -
Proceeds from issuance of common stock............... - - 26,540
Proceeds from issuance of long-term debt............. 193,625 137,695 14,741
Proceeds from termination of interest rate swap...... 1,003 - -
Repayments of long-term debt......................... (148,625) (18,161) (25,372)
Payments of debt issuance costs...................... (12,553) (1,199) -
-------------- -------------- --------------
Net cash provided by financing activities.......... 284,712 118,335 15,909
-------------- -------------- --------------
NET INCREASE IN CASH................................... 67 1,758 112
CASH, at beginning of year............................. 1,995 237 125
-------------- -------------- --------------
CASH, at end of period................................. $ 2,062 $ 1,995 $ 237
-------------- -------------- --------------
-------------- -------------- --------------
The accompanying notes are an integral part of
these consolidated financial statements.
F-6
RURAL CELLULAR CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997
(CONTINUED)
1. ORGANIZATION AND NATURE OF BUSINESS:
Rural Cellular Corporation and its subsidiaries ("Company" or "RCC") provide
cellular communication service in the northern half of Minnesota and portions of
New England and paging service in northern Minnesota, eastern North Dakota and
portions of Maine. The Company operates its cellular and paging systems under
licenses granted by the Federal Communications Commission ("FCC"). The Company's
operations are subject to the applicable rules and regulations of the FCC.
2. ACQUISITIONS:
UNITY CELLULAR SYSTEM, INC.
Effective May 1, 1997, the Company completed the acquisition of the Maine
wireless telephone operations and related assets of Unity Cellular Systems, Inc.
and related cellular and microwave licenses from InterCel, Inc. In addition, the
Company acquired InterCel's 51% interest in the Northern Maine Cellular
Partnership, which holds a cellular license for Maine RSA2 and acquired the
remaining 49% in Northern Maine from an unrelated third party. The costs for all
of the acquired properties in Maine (the "MRCC Acquisition") was $86 million.
The acquired licenses cover the Bangor, Maine MSA and Maine RSA 3 (which
includes Augusta, the state capitol). The Company operates its Maine operations
through a wholly owned subsidiary, MRCC. Headquartered in Bangor, MRCC serves a
20,500 square-mile service area that encompasses approximately 518,000 POPs. The
acquisitions (the "MRCC Acquisitions") have been accounted for under the
purchase method of accounting.
ATLANTIC CELLULAR COMPANY, L.P.
Effective July 1, 1998, the Company completed the acquisition of the
Massachusetts, New Hampshire, New York, Vermont and cellular telephone licenses,
operations and related assets of Atlantic Cellular Company L.P. and one of its
subsidiaries ("Atlantic"), an independent provider of wireless communication
services in the New England region for approximately $262.5 million. Under the
terms of the agreement, the Company acquired a contiguous, multi-state service
area of 21,000 square miles, encompassing approximately 1.1 million POPs. The
cellular properties acquired from Atlantic include: (i) northwestern
Massachusetts (RSA 1); (ii) western New Hampshire (RSA 1); (iii) the
northeastern corner of New York (RSA 2); and (iv) the entire state of Vermont
(RSA 1, RSA 2, and the Burlington MSA). In addition, the Company has acquired
Atlantic's long distance business. The Company operates its Atlantic operations
through its wholly-owned subsidiary, RCC Atlantic, Inc. ("RCC Atlantic").
WESTERN MAINE CELLULAR, INC.
Effective July 31, 1998, the Company completed the acquisition of the
outstanding stock of Western Maine Cellular, Inc. ("WMC"), a wholly-owned
subsidiary of Utilities, Inc. for approximately $7.5 million. WMC provides
cellular service to western Maine RSA 1, which incorporates a 3,700 square-mile
service area of western Maine and encompasses 83,000 POPs. The Company operates
WMC through its wholly-owned subsidiary, MRCC, Inc.
("MRCC").
ACCOUNTING TREATMENT
In addition, the purchase price for Atlantic, WMC and Unity was allocated to the
net assets based on their estimated fair values and the excess was recorded as
goodwill and is being amortized over 33 to 39 years. The purchase price
allocations for Atlantic and WMC have been completed on a preliminary basis,
subject to adjustment should new or additional facts about the businesses become
known. All of the above acquisitions have been accounted for under the purchase
method of accounting; accordingly operating results have been included from the
date of acquisition.
F-7
RURAL CELLULAR CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997
(CONTINUED)
The following unaudited pro forma information presents the consolidated results
of operations as if the acquisitions of MRCC, Atlantic, and WMC had occurred as
of January 1, 1997. This summary is not necessarily indicative of what the
results of operations of the Company and the acquired entities would have been
if they had been a single entity during such period, nor does it purport to
represent results of operations for any future periods.
YEARS ENDED DECEMBER 31,
(In thousands except for per share data) 1998 1997
--------------- ---------------
Total revenues............................ $122,198 $100,786
Operating income.......................... 12,125 8,958
Net loss.................................. $(25,151) $(27,602)
--------------- ---------------
--------------- ---------------
Basic and diluted net loss per share $(2.82) $(3.12)
--------------- ---------------
--------------- ---------------
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
The Company adopted Statement of Financial Accounting Standards ("SFAS") No.
130, "Reporting Comprehensive Income", effective January 1, 1998. SFAS 130
establishes standards for reporting and display of comprehensive earnings
and its components in financial statements; however, the adoption of this
Statement had no impact on the Company's net earnings or shareholders' equity.
SFAS 130 requires minimum pension liability adjustments, unrealized
gains or losses on the Company's available-for-sale securities and foreign
currency translation adjustments, which prior to adoption were reported
separately in shareholders' equity, to be included in other comprehensive
earnings. There were no material differences between net earnings and
comprehensive earnings for any periods presented in the accompanying
consolidated financial statements.
The Company adopted SFAS 131, "Disclosures about Segments of an Enterprise
and Related Information" effective January 1, 1998. This new standard
requires companies to disclose segment data based on how management makes
decisions about allocating resources to segments and how it measures segment
performance. SFAS 131 requires companies to disclose a measure of segment
profit or loss (operating income, for example), segment assets and
reconciliations to consolidated totals. It also requires entity-wide
disclosures about a company's products and services, its major customers and
the material countries in which it holds assets and reports revenues.
SFAS 133, "Accounting for Derivative Instruments and for Hedging Activities"
was issued in July 1998. This standard establishes accounting and reporting
standards requiring that every derivative instrument be recorded on the
balance sheet as either an asset or liability measured at fair value. SFAS
133 requires that changes in a derivative's fair value be recognized
currently in earnings unless specific hedge accounting criteria are met.
Special accounting for qualifying hedges allows a derivative's gains and
losses to offset related results on the hedged item in the income statement
and requires that a company must formally document, and designate and assess
the effectiveness of transactions that receive hedge accounting treatment.
SFAS No. 133 is effective for fiscal years beginning after June 15, 1999, and
cannot be applied retroactively. The Company has not yet quantified the
impacts of adopting SFAS 133 on its financial statements; however, SFAS 133
could increase the volatility of reported earnings and other comprehensive
income once adopted.
In April 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants ("AICPA") issued Statement of Position
("SOP") 98-5, "Reporting on the Costs of Start-up Activities". SOP 98-5 requires
costs of start-up activities and organization costs to be expensed as incurred.
The initial application of SOP 98-5 will be reported as the cumulative effect of
a change in accounting principle. The Company intends to adopt SOP 98-5
effective January 1, 1999. The adoption of SOP 98-5 is not expected to have a
material effect on the Company's financial position or results of operations.
F-8
RURAL CELLULAR CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997
(CONTINUED)
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of RCC and its
wholly-owned subsidiaries, RCC Atlantic, Inc., MRCC, Inc., RCC Paging, Inc., RCC
Atlantic Long Distance, Inc., RCC Network, Inc. and its majority owned joint
venture, Wireless Alliance, LLC ("Wireless Alliance"). All significant
intercompany balances and transactions have been eliminated. Investments in
unconsolidated affiliates represent investments in companies in which RCC has a
20% to 50% ownership interest and which are accounted for under the equity
method.
REVENUE RECOGNITION
The Company earns revenue by providing cellular and paging services to customers
of the Company and of other cellular carriers traveling (roaming) in the
Company's service area and from sales and rentals of cellular and paging
equipment and accessories. Service revenue consists of the base monthly service
fee and airtime revenue. Base monthly service fees are billed one month in
advance and are recognized in the month earned. Airtime revenue is recognized
when service is provided. Roamer revenue consists of the fee charged to other
cellular carriers' customers for roaming in the Company's service area as well
as related airtime revenue for use of RCC's cellular network. Roamer revenue is
recognized when the service is rendered. The Company recognizes other service
revenues from equipment installations, equipment leases and connection fees when
earned.
INCOME TAXES
The Company follows the liability method of accounting for income taxes, and
deferred income taxes are based on the estimated future tax effects of
differences between the financial statement and tax bases of assets and
liabilities based on enacted tax laws.
NET INCOME (LOSS) PER COMMON SHARE
In 1997, the Company adopted SFAS Statement No. 128, "Earnings per Share". SFAS
128 replaced primary earnings per share ("EPS") with basic EPS. Basic EPS is
computed by dividing net income (loss) by the weighted average number of shares
outstanding during the year. Diluted EPS is computed by including dilutive
common stock equivalents with the basic weighted average shares outstanding. At
the time of adoption, all prior year EPS was restated in accordance with SFAS
No. 128.
INVENTORIES
Inventories consist of cellular telephone equipment, pagers and accessories and
are stated at the lower of cost, determined using the specific identification
method, or market.
F-9
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Additions, improvements or major
renewals are capitalized, while expenditures, that do not enhance or extend the
asset's useful life, are charged to operating expenses as incurred. Depreciation
is computed using the straight-line method based on the estimated useful life of
the asset.
The components of property and equipment and the useful lives of the assets are
as follows as of December 31:
PROPERTY AND EQUIPMENT (IN THOUSANDS) 1998 1997 USEFUL LIVES
------------------------------------------------------------------------------------------------------------
Land $ 4,247 $ 1,965 N/A
Building and towers 43,947 23,836 15 Years
Equipment 115,661 62,164 2-10 Years
Furniture and fixtures 9,620 6,604 3-10 Years
Assets under construction 777 7,225 N/A
------------------------------------------------------------------------------------------------------------
174,252 101,794
Less--accumulated depreciation (42,538) (23,874)
------------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------
PROPERTY AND EQUIPMENT, NET $131,714 $ 77,920
------------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------
The Company's network construction expenditures are recorded as assets under
construction until the system or assets are placed in service, at which time the
assets are transferred to the appropriate property and equipment category. As a
component of assets under construction, the Company capitalizes salaries of the
Company's engineering employees during the construction period for projects that
extend beyond one year.
LICENSES AND OTHER INTANGIBLE ASSETS
Licenses consist of the cost of acquiring paging licenses, the value assigned to
the Wireless Alliance Personal Communication Systems ("PCS") licenses, and the
value assigned to cellular licenses acquired through the acquisitions of Unicel,
Northern Maine, Atlantic Cellular, and WMC. Other intangibles, resulting
primarily from the acquisitions of Unicel, Northern Maine, Atlantic and WMC,
include the value assigned to subscriber lists and goodwill.
F-10
The components of licenses and other intangible assets are as follows as of
December 31:
(In thousands) 1998 1997 AMORTIZABLE LIVES
----------------------------------------------------------------------------------------
LICENSES:
Cellular $135,407 $31,891 33 - 39 Years
PCS 9,629 9,629 40 Years
Paging 275 275 30 Years
OTHER INTANGIBLE ASSETS:
Goodwill 122,744 26,452 33 - 39 Years
Subscriber lists 49,725 14,591 10 - 33 Years
----------------------------------------------------------------------------------------
317,780 82,838
Less-accumulated amortization (8,108) (1,490)
----------------------------------------------------------------------------------------
LICENSES AND OTHER INTANGIBLE
ASSETS, NET $309,672 $81,348
----------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------
DEFERRED DEBT ISSUANCE COSTS
Deferred debt issuance costs relate to the Credit Facility, the Senior
Subordinated Notes and the Exchangeable Preferred Stock (see Notes 4 and 6).
These costs are being amortized over the respective instruments' terms.
OTHER ASSETS
Other assets primarily consist of costs related to spectrum relocation,
restricted investments, and investments in unconsolidated affiliates.
Investments in unconsolidated affiliates are accounted for using the equity
method and represent the Company's ownership interests in Cellular 2000, Inc.
Cellular 2000, Inc. is an entity organized to own the trade name and related
trademark for Cellular 2000. Restricted investments represent the Company's
investments in stock of the St. Paul Bank for Cooperatives and are stated at
cost, which approximates fair value. The restricted investments were purchased
pursuant to the terms of a loan agreement and are restricted as to withdrawal.
BUSINESS AND CREDIT CONCENTRATIONS
The Company's cellular customers are geographically located in the northern half
of Minnesota, eastern North Dakota, western and central Maine, Vermont, New
Hampshire, northeastern New York, and north central Massachusetts. No single
customer accounted for a significant amount of revenues or accounts receivable.
LONG-LIVED ASSETS
The Company periodically evaluates the value of all long-lived assets to
determine if events have occurred that indicate the remaining estimated useful
lives of these assets may warrant revision, or whether the remaining balance may
not be recoverable. If asset recovery is in question, the Company uses an
estimate of future net cash flows over the remaining useful lives of the
long-lived assets to measure recoverability.
FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS 107, "Disclosures about Fair Value of Financial Instruments", requires
disclosure of fair value information about financial instruments for which it
is practicable to estimate that value, whether or not recognized in the
balance sheet. In cases where quoted market prices are not available, fair
values are based on estimates using present value or other valuation
techniques. SFAS 107 excludes certain financial instruments and all
nonfinancial instruments from its disclosure requirements. Accordingly, the
aggregate fair value amounts do not represent the underlying value of the
Company.
F-11
The carrying amounts and fair values of the Company's financial instruments at
December 31, 1998 and 1997 are as follows
CARRYING AMOUNT ESTIMATED FAIR VALUE
(In thousands) 1998 1997 1998 1997
- ----------------------------------------------------------------------------------------------------------
FINANCIAL ASSET
Cash $ 2,062 $ 1,995 $ 2,062 $ 1,995
FINANCIAL LIABILITIES
$300 million credit facility 173,000 - 173,000 -
$160 million credit facility - 128,000 - 128,000
9 5/8 % Senior Subordinated Notes 125,000 - 131,250 -
OTHER FINANCIAL INSTRUMENTS
$65 million Toronto Dominion Bank - - (1,701) -
interest rate swap agreement
$65 million Bank Boston interest rate - - (2,238) -
swap agreement
$35 million PNC Bank interest rate - - (819) -
swap agreement
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 reported periods.
Ultimate results could differ from those estimates.
RECLASSIFICATIONS
Certain 1997 and 1996 amounts in the accompanying consolidated financial
statements have been reclassified to conform to the 1998 presentation. These
reclassifications had no effect on consolidated net income or total
shareholders' equity as previously reported.
F-12
4. LONG-TERM DEBT:
The Company had the following long-term debt outstanding at:
DECEMBER 31,
(In thousands) 1998 1997
-----------------------------------------------------------------------
$300 million credit facility $173,000 -
$160 million credit facility - 128,000
Deferred gain on hedge agreement 851 -
9 5/8% Senior Subordinated Notes 125,000 -
--------------------------------
Long-term debt $298,851 $128,000
================================
9 5/8 % SENIOR SUBORDINATED NOTES - On May 14, 1998, the Company issued $125
million principal amount of 9 5/8 % Senior Subordinated Notes due 2008 (the
"Senior Subordinated Notes"). Interest on the Senior Subordinated Notes began to
accrue on May 14, 1998, and is payable semi-annually on May 15 and November 15
of each year, commencing on November 15, 1998. The Senior Subordinated Notes
will mature on May 15, 2008, and are redeemable, in whole or in part, at the
option of the Company, at any time on or after May 15, 2003. In addition, at any
time prior to May 15, 2001, the Company may redeem up to 25% of the aggregate
principal amount of Senior Subordinated Notes with the net cash proceeds of a
qualified event at a price equal to 109.625% of the aggregate principal amount
thereof, plus accrued and unpaid interest, if any, to the date of redemption;
provided that at least $90 million in aggregate principal amount of Senior
Subordinated Notes remains outstanding immediately after such redemption. A
qualified event is a public equity offering or one or more strategic equity
investments which in either case results in aggregate net proceeds to the
Company of not less than $50 million. Within 30 days after the occurrence of a
change of control, the Company will be required to make an offer to purchase all
outstanding Senior Subordinated Notes at a price equal to 101% of the aggregate
principal amount thereof, plus accrued and unpaid interest, if any, to the date
of purchase. The Senior Subordinated Notes are unsecured senior subordinated
obligations of the Company and will be subordinated in right of payment to
future senior indebtedness (as defined in the Indenture related to the Senior
Subordinated Notes) of the Company and effectively subordinated to all
obligations of the Company's subsidiaries (including the guarantees by such
subsidiaries of the Credit Facility described below).
$160 MILLION CREDIT FACILITY - On May 28, 1998, the Company repayed $140 million
of the outstanding principal amount of its $160 million credit facility
utilizing the proceeds from its issuance of Senior Subordinated Notes and $125
million in 11 3/8% Exchangeable Preferred Stock ("Exchangeable Preferred
Stock"). Accordingly, the Company recognized an extraordinary loss of
approximately $1 million related to the early retirement of debt, representing
the unamortized debt issuance costs.
$300 MILLION CREDIT FACILITY - On July 1, 1998, the Company entered into a new
revolving Credit Facility for $300 million with a syndicate of banks (the
"Credit Facility"), which replaced the $160 million credit facility. At the
Company's discretion, advances under the Credit Facility bear interest at the
London Interbank Offering Rate ("LIBOR") plus an applicable margin (1.75% as of
December 31, 1998) and will be based on the Company's ratio of indebtedness to
annualized operating cash flow as of the end of the most recently completed
fiscal quarter. As of December 31, 1998, the effective rate of interest on the
Credit Facility, excluding the impact of the hedge agreements, was 7.07%. A
commitment fee of 0.375% on the unused portion of the Credit Facility is payable
quarterly. Borrowings under the Credit Facility are secured by a pledge of all
the assets of the Company excluding its ownership in the stock of Cellular 2000,
Inc. Mandatory commitment reductions will be required upon any material sale of
assets. The Credit Facility is subject to various covenants including the ratio
of indebtedness to annualized operating cash flow and the ratio of annualized
operating cash flow to interest expense. As of December 31, 1998, the Company
was in compliance with all covenants under the Credit Facility.
F-13
The Credit Facility is to be reduced in equal quarterly amounts as follows:
(In thousands)
-------------------------------------
YEAR AMOUNT
-------------------------------------
1999 $ 0
2000 0
2001 9,731
2002 16,219
2003 23,787
Thereafter 123,263
-------------------------------------
Total $ 173,000
-------------------------------------
5. FINANCIAL INSTRUMENTS:
As required by the Credit Facility, the Company maintains interest rate swaps on
at least 50% of the principal amount of the loans outstanding such that the
weighted average term of all interest rate protection is not less than three
years at all dates of determination, and as otherwise provided in the Credit
Facility. Under the interest rate swap agreements, the Company will pay the
difference between LIBOR and the fixed swap rate if the LIBOR exceeds the swap
rate. Income and expense associated with swap transactions are accrued over the
periods prescribed by the contracts. As of December 31, 1998, the Company is
party to three interest rate swaps expiring August 6, 2003, with a total
outstanding notional amount of $165 million and a fair market value of $(4.8)
million.
In anticipation of the offering of the Senior Subordinated Notes and
Exchangeable Preferred Stock, the Company also entered into a $150 million hedge
agreement. On May 12, 1998, the Company settled the hedge agreement, resulting
in a gain of approximately $1.0 million. This gain is being accreted as a
reduction of interest expense over the lives of the underlying debt instruments.
6. EXCHANGEABLE PREFERRED STOCK:
On May 14, 1998, the Company completed the placement of 125,000 shares of 11
3/8% Exchangeable Preferred Stock with a liquidation preference of $1,000 per
share. The Exchangeable Preferred Stock is senior to all classes of junior
preferred stock and common stock of the Company with respect to dividend rights
and rights on liquidation, winding-up and dissolution of the Company. The
Exchangeable Preferred Stock is non-voting, except as otherwise required by law
and as provided in the Certificate of Designation. Dividends on the Exchangeable
Preferred Stock are cumulative, accrue at 11 3/8% per annum from May 14, 1998,
are payable quarterly, and may be paid, at the Company's option, on any dividend
payment date occurring on or before May 15, 2003, either in cash or by the
issuance of additional shares of Exchangeable Preferred Stock having an
aggregate liquidation preference equal to the amount of such dividends.
Thereafter, all dividends will be payable in cash only. As of December 31, 1998,
the Company has accrued $1.9 million in preferred stock dividends which were
distributed on February 15, 1999.
7. SHAREHOLDERS' EQUITY:
AUTHORIZED SHARES
The Company's Restated Articles of Incorporation authorize the issuance of
30,000,000 shares of $.01 par value stock. Of such authorized shares, 9,550,000
have not been designated as to class as of December 31, 1998.
F-14
INITIAL PUBLIC OFFERING
During 1996, the Company completed an initial public offering (the "Offering")
of 3,450,000 shares of Class A common stock, of which 2,869,863 shares were sold
by the Company and 580,137 previously issued shares were sold by certain
shareholders. The net proceeds to the Company of approximately $26.0 million
were used to repay long-term debt and to provide capital for future expansion.
In connection with the Offering, the exercise price of 150,600 employee stock
options was fixed at $10.00 per share, the price at which the stock was sold to
the public in the Offering.
COMMON STOCK RIGHTS
Class A common shareholders are entitled to one vote for each share owned while
Class B common shareholders are entitled to ten votes for each share owned. Each
share of Class B common stock may at any time be converted into one share of
Class A common stock at the option of the holder. Additionally, all issued Class
B common shares will be converted into an equivalent number of Class A common
shares upon the affirmative vote of not less than 66-2/3 of the then issued
Class B common shares. Further, Class B common shares are automatically
converted to an equal number of Class A common shares if they are transferred to
anyone who is not an affiliate of the transferring shareholder of the Company.
STOCK COMPENSATION PLANS
The stock compensation plan (the "Plan") for employees authorizes the issuance
of up to 1,400,000 shares of Class A common stock in the form of stock options,
stock appreciation rights or other stock-based awards. The Plan provides that
the exercise price of any option shall not be less than 85% of the fair market
value of the Class A common stock as of the date of the grant (100% in the case
of incentive stock options). Options and other awards granted under the Plan
shall vest and become exercisable as determined by the Board of Directors or a
stock option committee.
The stock option plan for nonemployee directors authorizes the issuance of up to
210,000 shares of Class A common stock. The plan provides that the option price
shall not be less than the fair market value of the Class A common stock
outstanding on the date of grant. The options vest and become exercisable over
one to three years and expire between four and six years from the date of grant.
Options outstanding as of December 31, 1998 have exercise prices ranging
between $8.75 and $16.81. Information related to stock options is as follows:
1998 1997 1996
-------------------------- ----------------------------- ---------------------------
Weighted Weighted
Average Weighted Average
Exercise Average Exercise
Shares Price Shares Exercise Price Shares Price
-------------------------- ----------------------------- ---------------------------
OPTIONS
Outstanding, beginning
of period 735,200 $ 9.47 459,700 $ 9.99 - $ -
Granted 291,250 14.66 319,750 9.09 549,700 10.32
Exercised (123,750) 9.78 - - - -
Canceled (30,000) 9.13 (44,250) 8.75 (90,000) 12.00
-------------------------- ----------------------------- ---------------------------
Outstanding, end of
period 872,700 11.17 735,200 9.47 459,700 9.99
-------------------------- ----------------------------- ---------------------------
-------------------------- ----------------------------- ---------------------------
Exercisable, end of
period 264,590 $ 10.06 161,895 $ 9.92 55,200 $ 9.92
-------------------------- ----------------------------- ---------------------------
-------------------------- ----------------------------- ---------------------------
Weighted average fair
value of options granted $ 10.94 $ 6.40 $ 5.60
-------------------------- ----------------------------- ---------------------------
-------------------------- ----------------------------- ---------------------------
F-15
The Company accounts for stock options under Accounting Principles Board Opinion
No. 25, under which no compensation cost has been recognized. Had compensation
cost for the Company's plans been determined consistent with SFAS No. 123,
"Accounting for Stock-Based Compensation," the Company's results of operations
and net loss per share would have been reduced to the following pro forma
amounts:
YEARS ENDED DECEMBER 31,
(in thousands except for per share data) 1998 1997 1996
---------- ------------ -----------
Net loss:
As reported $(15,714) $(1,266) $3,477
Pro forma (16,790) (1,890) 3,215
Basic and diluted net loss per share:
As reported $ (1.76) $ (.14) $ .41
Pro forma (1.88) (.21) .38
The fair value of each option grant is estimated on the date of the grant using
the Black-Scholes option-pricing model with the following weighted average
assumptions used for grants in 1998 and 1997: expected volatility of 50.50 and
51.61%, respectively; risk-free interest rates of 5.6%; and no expected dividend
yield. The per share weighted average fair value of options granted in 1998 and
1997 was $10.04 per share and $6.40 per share, respectively.
8. INCOME TAXES:
The components of the Company's income tax provisions are as follows (in
thousands):
YEARS ENDED DECEMBER 31,
-------------------------------------------
1998 1997 1996
----------- ------------------ ----------
Current:
Federal............... $ - $ - $106
State................. - - 94
----------- ------------------ ----------
- - 200
Deferred................... - - -
----------- ------------------ ----------
$ - $ - $200
----------- ------------------ ----------
----------- ------------------ ----------
F-16
Reconciliation between the federal income tax rate and the effective income tax
rate is as follows:
YEARS ENDED DECEMBER 31,
--------------------------------------
1998 1997 1996
----------- ------------- ----------
Federal income tax rate................................ -% -% 34.0%
Tax benefit of loss carryforwards...................... - - (29.8)
Penalties and fines.................................... - - -
State income taxes, net of federal tax benefit......... - - 1.2
Other, net............................................. - - -
----------- ------------- ----------
-% -% 5.4%
----------- ------------- ----------
----------- ------------- ----------
The income tax effect of the items that create deferred income tax assets and
liabilities are as follows (amounts in thousands):
DECEMBER 31,
-------------------------
1998 1997
-------- ------------
Deferred income tax assets:
Operating loss carryforwards................. $ 14,383 $ 4,488
Tax credit carryforwards..................... 485 -
Temporary differences:
Allowance for doubtful accounts............ 616 450
Other...................................... 1,745 302
Valuation allowance.......................... (7,781) (400)
-------- ------------
Total deferred income tax assets........... 9,448 4,840
Deferred income tax liabilities:
Depreciation................................. (6,225) (3,971)
Intangible assets............................ (3,223) (724)
Other........................................ - (145)
-------- ------------
Net deferred income tax asset.............. $ - $ -
-------- ------------
-------- ------------
A valuation allowance was established in 1997 for net deferred income tax assets
not expected to be offset by deferred income tax liabilities due to the
uncertainty of the realization of future tax benefits.
As of December 31, 1998, the Company had tax operating loss carryforwards of
approximately $36 million available to offset future income tax liabilities.
These carryforwards expire in the years 2006 through 2018. The Tax Reform Act of
1986 contains provisions that may limit the availability and timing of usage of
net operating loss carryforwards in the event of certain changes in the
ownership of the Company's common stock.
9. COMMITMENTS AND CONTINGENCIES:
CAPITAL EXPENDITURE COMMITMENTS
The Company had capital expenditure purchase commitments outstanding of
approximately $7 million as of December 31, 1998.
EMPLOYMENT AGREEMENTS
The Company has employment agreements with executive officers with terms ranging
from two to three years. These agreements provide for payment of amounts up to
three times their annual compensation if there is a
F-17
termination of their employment as a result of change in control of the
Company, as defined in the agreements. The maximum contingent liability under
these agreements was $1.7 million at December 31, 1998.
LEGAL AND REGULATORY MATTERS
The Company is subject to various legal and regulatory matters arising in the
normal course of business. Management does not believe any of these matters will
have a significant effect on the Company and, accordingly, no provision for any
liability that may result from these matters has been made.
LEASES (IN THOUSANDS)
The Company leases office space and real estate under noncancelable operating
leases. Future minimum payments under these leases as of December 31, 1998 are
as follows:
Year Amount
-----------------------------------
1999.............. $ 2,275
2000.............. 1,963
2001.............. 1,525
2002.............. 1,155
2003.............. 806
Thereafter........ 389
-------
Total.......... $ 8,113
-------
-------
Under the terms of the lease agreements, the Company also is responsible for
certain operating expenses and taxes. Total rent expense of $2,300, $839 and
$379 was charged to operations for the years ended December 31, 1998, 1997 and
1996.
10. RELATED-PARTY TRANSACTIONS (IN THOUSANDS):
AFFILIATE AGREEMENT
The Company pays Switch 2000, Inc. for cellular switching and interconnection
services. The rates of reimbursement are negotiated by the parties to the
agreement and are similar to rates charged by other service providers. Amounts
billed by Switch 2000, Inc. to the Company totaled $710, $3,230 and $4,824 for
the years ended December 31, 1998, 1997 and 1996 respectively. In September
1998, the Company sold its interest in Switch 2000.
ROAMING AGREEMENT
The Company has a roaming agreement with a partnership that is affiliated with a
beneficial owner of greater than 10% of the Company's common stock. Roaming
charges are passed through to the customer. The rates of reimbursement are
negotiated by the parties to the agreement and reflect rates charged by other
service providers. Net payments by the Company to the partnership were $47, $167
and $331 for the years ended December 31, 1998, 1997 and 1996, respectively.
11. DEFINED CONTRIBUTION PLAN (IN THOUSANDS):
The Company has a defined contribution savings and profit-sharing plan for
employees who meet certain age and service requirements. Under the savings
portion of the plan, employees may elect to contribute a percentage of their
salaries to the plan, with the Company contributing a matching percentage of the
employees' contributions. Under the profit-sharing portion of the plan, the
Company contributes a percentage of employees' salaries. Contributions charged
to operations for the years ended December 31, 1998, 1997 and 1996 were $297,
$162 and $74, respectively. The percentages the Company matches under the
savings portion of the plan and contributes under the profit-sharing portion of
the plan are determined annually by the Company's Board of Directors.
F-18
12. SEGMENT INFORMATION:
The Company's consolidated financial statements consist of the business units
RCC Cellular and Wireless Alliance. RCC Cellular includes cellular operations in
Minnesota, Maine, Massachusetts, New Hampshire, New York and Vermont. Wireless
Alliance, a joint venture that commenced cellular reselling operations in
November 1996 and launched its first PCS networks in the second quarter of 1998,
is 51%-owned by the Company and 49%-owned by APT Inc., an affiliate of Aerial
Communications, Inc. Information about the Company's operations in its business
units for the years ended December 31, 1998 and 1997 is as follows:
YEARS ENDED DECEMBER 31,
---------------------------------------
(In thousands) 1998 1997
---------------------------------------
STATEMENT OF OPERATIONS:
Revenues
RCC Cellular $ 87,720 $ 47,591
Wireless Alliance LLC 12,369 7,339
Eliminating (1,557) (1,027)
---------------------------------------
Total revenue 98,532 53,903
---------------------------------------
Operating expenses
RCC Cellular 71,853 39,531
Wireless Alliance LLC 20,237 13,564
Eliminating (1,557) (1,027)
---------------------------------------
Total operating expenses 90,533 52,068
Operating income (loss)
RCC Cellular 15,867 8,060
Wireless Alliance LLC (7,868) (6,225)
---------------------------------------
Total operating income 7,999 1,835
---------------------------------------
Depreciation and amortization
RCC Cellular 23,490 11,800
Wireless Alliance LLC 3,043 658
---------------------------------------
Total depreciation and 26,533 12,458
amortization
Interest expense
RCC Cellular 19,208 6,065
Wireless Alliance LLC 1,439 65
Eliminating (1,587) (65)
---------------------------------------
Total interest expense 19,060 6,065
OTHER OPERATING DATA:
EBITDA (*)
RCC Cellular 39,357 19,860
Wireless Alliance LLC (4,825) (5,567)
---------------------------------------
Total EBITDA 34,532 14,293
Capital expenditures
RCC Cellular 29,563 26,127
Wireless Alliance LLC 13,300 8,801
---------------------------------------
Total capital expenditures 42,863 34,928
BALANCE SHEET DATA:
Property and equipment
RCC Cellular 151,227 92,630
Wireless Alliance LLC 23,025 9,164
---------------------------------------
Total property and equipment 174,252 101,794
Total assets
RCC Cellular 480,251 175,612
Wireless Alliance LLC 34,870 24,273
Eliminating (30,597) (18,297)
---------------------------------------
Total assets 480,524 181,588
(*)EBITDA is the sum of earnings before interest, taxes, depreciation
and amortization and is utilized as a performance measure within the
cellular industry. EBITDA is not intended to be a performance measure
that should be regarded as an alternative for other performance
measures and should not be considered in isolation. EBITDA is not a
measurement of financial performance under generally accepted
accounting principles and does not reflect all expenses of doing
business (e.g., interest expense, depreciation). Accordingly, EBITDA
should not be considered as having greater significance than or as an
alternative to net income or operating income as an indicator of
operating performance or to cash flows as a measure of liquidity.
F-19
RURAL CELLULAR CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997
(CONTINUED)
13. SUPPLEMENTAL CASH FLOW INFORMATION:
YEARS ENDED DECEMBER 31,
-------------------------------------------
(IN THOUSANDS) 1998 1997 1996
--------- ---------- ------------
Cash paid for:
Interest............................................ $16,273 $4,630 $ 564
Income taxes........................................ - 64 805
Non-cash investing and financing activity:
Preferred stock dividends paid in kind.............. 7,201 - -
Contribution by an affiliate of Aerial Communications,
Inc. of PCS licenses.............................. - $3,175 $6,453
14. EVENTS SUBSEQUENT TO DECEMBER 31, 1998:
Effective February 1, 1999, the Company acquired RGI, Inc. d/b/a Glacial
Lakes Cellular 2000 ("Glacial") for approximately $11.9 million. Operating
under the name Cellular 2000-Registered Trademark-, Glacial provides cellular
service to northeastern South Dakota (RSA 4), which includes eight counties
and is adjacent to RCC's existing cellular operation in northern and central
Minnesota. Glacial's service area encompasses 69,000 POPs and the operation
serves more than 7,000 customers.
On February 2, 1999, the Company entered into two Swap transactions with TD
Bank Financial Group, which together, effectively lower the interest on the
Senior Subordinated Notes from 9.625% to 8.535% through May 2003. During the
period of June 2003 through May 2008, 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 rates swaps outstanding was $125 million at February 2, 1999.
F-20
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Rural Cellular Corporation:
We have audited, in accordance with generally accepted auditing
standards, the consolidated financial statements included in Rural Cellular
Corporation's Form 10-K and have issued our report thereon dated February 5,
1999. Our audit was made for the purpose of forming an opinion on those
statements taken as a whole. The schedule listed in the index of consolidated
financial statements is the responsibility of the Company's management and is
presented for purposes of complying with the Securities and Exchange
Commission's rules and is not part of the basic consolidated financial
statements. This schedule has been subjected to the auditing procedures
applied in the audits of the basic consolidated 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 consolidated
financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Minneapolis, Minnesota,
February 5, 1999
S-1
RURAL CELLULAR CORPORATION AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
ALLOWANCE FOR UNCOLLECTIBLE ACCOUNTS:
YEARS ENDED DECEMBER 31,
------------------------------------------------------
(IN THOUSANDS) 1998 1997 1996
-------------- ------------ ------------
Balance, at beginning of year.......................... $1,146 $ 308 $163
Additions charged to income........................ 2,843 1,511 602
Write-offs, net of recoveries...................... (2,434) (673) (457)
-------------- ------------ ------------
Balance, at end of year................................ $1,555 $1,146 $308
============== ============ ============
S-2
EXHIBIT INDEX
- ---------------------------------------------------------------------------------------------------------------------
Number Description Page
- ---------------------------------------------------------------------------------------------------------------------
1.1 Purchase Agreement dated as of May 7, 1998 by and among the Company and TD Securities [i]
(USA) Inc., NationsBanc Montgomery Securities LLC, and BancBoston Inc. (the Initial
Purchasers)
2.1 Asset Purchase Agreement among Atlantic Cellular Company, L.P., Atlantic Cellular/New [ii]
Hampshire RSA Number One Limited Partnership and RCC Atlantic Inc., Rural Cellular
Corporation as of February 13, 1998
2.2 Stock Purchase Agreement among the shareholders of RGI Group, Inc. and the Company as of [viii]
February 1, 1999
3.1 Articles of Incorporation, as amended and restated to date [iii]
3.2 Bylaws, as amended and restated to date [viii]
4.1 Indenture dated May 14, 1998 between the Registrant, as Issuer, and Norwest Bank [i]
Minnesota, N.A., as Trustee, with respect to the 9 5/8% Senior Subordinated Notes Due 2008
4.2 Form of the 9 5/8% Senior Subordinated Notes Due 2008 (included as an exhibit to the [i]
Indenture, filed herewith as Exhibit 4.1)
4.3 Notes Exchange and Registration Rights Agreement dated as of May 14, 1998 by and among [i]
the Registrant and the Initial Purchasers
4.4 Certificate of Designation of 11 3/8% Senior Exchangeable Preferred Stock [i]
4.5 Preferred Stock Exchange and Registration Rights Agreement dated as of May 14, 1998 by [i]
and among the Registrant and the Initial Purchasers
10.1 (a) Loan Agreement dated May 1, 1997 (the "Loan Agreement") among the Registrant and The Toronto
Dominion Bank, Bank Boston, N.A., St. Paul Bank for Cooperatives, CoBank, Fleet National
Bank, First National Bank of Maryland, Societe Generale, New York Branch, and Merita Bank
Ltd New York Branch (the "Banks"), BankBoston, N.A. and St. Paul Bank for Cooperatives (the
"Co-Agents"), and Toronto Dominion (Texas), Inc. (the "Administrative Agent") [iv]
10.1 (b) Amendment to the Loan Agreement dated August 4, 1997 [i]
10.1 (c) Amendment to the Loan Agreement dated December 30, 1997 [v]
10.1 (d) Amendment to the Loan Agreement dated April 17, 1998 [i]
10.1 (e) Amendment to the Loan Agreement dated April 24, 1998 [i]
10.2 (a) Amended and Restated Loan Agreement among the Registrant, as borrower, the financial [vi]
institutions whose names appear as lenders on the signature
pages thereof, TD Securities (USA), Inc., as arranging agent for
the lenders, and Toronto Dominion (Texas), Inc., as
administrative agent for the lenders, dated as of July 1, 1998
10.2 (b) Exhibit A-Form of Amended and Restated Borrower's Pledge Agreement [vi]
10.2 (c) Exhibit E-Form of Revolving Loan Note [vi]
10.2 (d) Exhibit F-Form of Amended and Restated Security Agreement [vi]
10.2 (e) Exhibit G-Form of Subsidiary Guaranty [vi]
10.2 (f) Exhibit H-Form of Subsidiary Pledge Agreement [vi]
10.2 (g) Exhibit I-Form of Subsidiary Security Agreement [vi]
10.2 (h) Exhibit J-Form of Term Loan Note [vi]
10.2 (i) Exhibit K-Form of Incremental Facility Note [vi]
10.2 (j) Exhibit Q-Form of Assignment and Assumption Agreement [vi]
10.3 (a) Trademark and Trade Name License Agreements between Cellular 2000, Inc. and: [iii]
(i) North Woods Cellular Partnership
(ii) Northern Lights Cellular Partnership
(iii) Great River Cellular Partnership
(iv) Cellular Five Partnership
(v) Heartland Cellular Partnership
10.3 (b) Assignment and Assumption Agreements by and between the Registrant and each partnership [iii]
*10.4 1995 Stock Compensation Plan, as amended to date [i]
*10.5 Stock Option Plan for Non-employee Directors, as amended to date [vii]
*10.6 Employment Agreement with Richard P. Ekstrand effective January 22, 1999 [viii]
*10.7 Employment Agreement with Wesley E. Schultz effective January 22, 1999 [viii]
*10.8 (a) Employment Agreement with Scott G. Donlea effective December 1, 1995 [vii]
*10.8 (b) Amendment to Employment Agreement with Mr. Donlea effective December 18, 1996 [vii]
*10.8 (c) Amendment to Employment Agreement with Mr. Donlea effective December 18, 1997 [v]
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------
21 Subsidiaries of Registrant [viii]
23 Consent of Arthur Andersen LLP [viii]
- ---------------------------------------------------------------------------------------------------------------------
*Indicates management contract or compensatory plan or agreement required to be
filed as an exhibit to this Form.
[i] Filed as an exhibit to Registration Statement on Form S-4 (SEC No.
333-57677), filed June 25, 1998, and incorporated herein by reference.
[ii] Filed as an exhibit to Report on Form 10-Q for the quarter ended
March 31, 1998 and incorporated herein by reference.
[iii] Filed as an exhibit to Registration Statement on Form S-1 (Sec. No.
33-80189) filed December 8, 1995 and incorporated herein by reference.
[iv] Filed as an exhibit to Report on Form 8-K dated May 1, 1997 and
incorporated herein by reference.
[v] Filed as an exhibit to Report on Form 10-K for the year ended
December 31, 1997 and incorporated herein by reference.
[vi] Filed as an exhibit to Report on Form 8-K dated July 1, 1998 and
incorporated herein by reference.
[vii] Filed as an exhibit to Report on Form 10-K for the year ended
December 31, 1996 and incorporated herein by reference.
[viii] Filed herewith.