QUARTERLY REPORT UNDER SECTION 13 0R 15 (D)
OF THE SECURITIES EXCHANGE ACT OF 1934
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the quarterly period ended June 30, 1998
or
[ ] 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 33-72646
ARCH COMMUNICATIONS, INC.
(Exact name of Registrant as specified in its Charter)
DELAWARE 31-1236804
(State of incorporation) (I.R.S. Employer Identification No.)
1800 WEST PARK DRIVE, SUITE 250
WESTBOROUGH, MASSACHUSETTS 01581
(address of principal executive offices) (Zip Code)
(508) 870-6700
(Registrant's telephone number, including area code)
The registrant meets the conditions set forth in General Instruction H(1)(a) and
(b) of Form 10-Q and is therefore filing this Form with the reduced disclosure
format.
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months or for such shorter period that the Registrant was
required to file such reports, and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: 848.7501 shares of the
Company's Common Stock ($.01 par value) were outstanding as of August 11, 1998.
<PAGE>
ARCH COMMUNICATIONS, INC.
(A WHOLLY-OWNED SUBSIDIARY OF ARCH COMMUNICATIONS GROUP, INC.)
QUARTERLY REPORT ON FORM 10-Q
INDEX
PART I. FINANCIAL INFORMATION PAGE
Item 1. Financial Statements:
Consolidated Condensed Balance Sheets as of June 30, 1998 and
December 31, 1997 3
Consolidated Condensed Statements of Operations for the
Three and Six Months Ended June 30, 1998 and 1997 4
Consolidated Condensed Statements of Cash Flows for the
Six Months Ended June 30, 1998 and 1997 5
Notes to Consolidated Condensed Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 10
PART II. OTHER INFORMATION 17
Item 1. Legal Proceedings
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
2
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ARCH COMMUNICATIONS, INC.
(A WHOLLY-OWNED SUBSIDIARY OF ARCH COMMUNICATIONS GROUP, INC.)
CONSOLIDATED CONDENSED BALANCE SHEETS
(in thousands)
JUNE 30, DECEMBER 31,
1998 1997
---- ----
ASSETS (unaudited)
Current assets:
Cash and cash equivalents $ 2,895 $ 1,887
Accounts receivable, net 32,483 30,147
Inventories 13,278 12,633
Prepaid expenses and other 3,582 4,917
----------- -----------
Total current assets 52,238 49,584
----------- -----------
Property and equipment, at cost 409,340 388,035
Less accumulated depreciation and amortization (179,478) (146,542)
----------- -----------
Property and equipment, net 229,862 241,493
----------- -----------
Intangible and other assets, net 678,683 718,969
----------- -----------
$ 960,783 $ 1,010,046
=========== ===========
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Current maturities of long-term debt $ -- $ 24,513
Accounts payable 22,951 22,486
Accrued restructuring 15,846 --
Accrued interest 7,378 11,174
Accrued expenses and other liabilities 29,131 26,831
----------- -----------
Total current liabilities 75,306 85,004
----------- -----------
Long-term debt 639,464 623,000
----------- -----------
Other long-term liabilities 10,240 --
----------- -----------
Stockholder's equity:
Common stock - $.01 par value -- --
Additional paid-in capital 642,225 617,563
Accumulated deficit (406,452) (315,521)
Total stockholder's equity 235,773 302,042
----------- -----------
$ 960,783 $ 1,010,046
=========== ===========
The accompanying notes are an integral part of these
consolidated financial statements.
3
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ARCH COMMUNICATIONS, INC.
(A WHOLLY-OWNED SUBSIDIARY OF ARCH COMMUNICATIONS GROUP, INC.)
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(unaudited and in thousands)
<TABLE>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Service, rental, and maintenance
revenues $ 92,883 $ 87,561 $ 184,280 $ 171,978
Product sales 10,663 11,168 21,305 22,290
--------- --------- --------- ---------
Total revenues 103,546 98,729 205,585 194,268
Cost of products sold (7,324) (7,165) (14,690) (14,291)
--------- --------- --------- ---------
96,222 91,564 190,895 179,977
--------- --------- --------- ---------
Operating expenses:
Service, rental, and maintenance 20,220 19,429 40,409 38,111
Selling 12,374 13,431 24,244 26,632
General and administrative 28,198 26,202 56,516 51,345
Depreciation and amortization 54,444 61,905 107,915 119,681
Restructuring charge 16,100 -- 16,100 --
--------- --------- --------- ---------
Total operating expenses 131,336 120,967 245,184 235,769
--------- --------- --------- ---------
Operating income (loss) (35,114) (29,403) (54,289) (55,792)
Interest expense, net (16,433) (15,653) (32,703) (31,013)
Equity in loss of affiliate (1,164) (924) (2,219) (1,812)
--------- --------- --------- ---------
Income (loss) before income tax
benefit and extraordinary item (52,711) (45,980) (89,211) (88,617)
Benefit from income taxes -- 5,300 -- 10,600
--------- --------- --------- ---------
Income (loss) before extraordinary
item (52,711) (40,680) (89,211) (78,017)
Extraordinary charge from early
extinguishment of debt (1,720) -- (1,720) --
--------- --------- --------- ---------
Net income (loss) $ (54,431) $ (40,680) $ (90,931) $ (78,017)
========= ========= ========= =========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
4
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ARCH COMMUNICATIONS, INC.
(A WHOLLY-OWNED SUBSIDIARY OF ARCH COMMUNICATIONS GROUP, INC.)
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(unaudited and in thousands)
SIX MONTHS ENDED JUNE 30,
-------------------------
1998 1997
---- ----
Net cash provided by operating activities $ 44,332 $ 36,010
--------- ---------
Cash flows from investing activities:
Additions to property and equipment, net (38,353) (48,720)
Additions to intangible and other assets (21,584) (7,724)
--------- ---------
Net cash used for investing activities (59,937) (56,444)
--------- ---------
Cash flows from financing activities:
Issuance of long-term debt 450,964 82,000
Repayment of long-term debt (459,013) (56,024)
Capital contribution from (distribution to) Arch
Communications Group, Inc. 24,662 (3,896)
--------- ---------
Net cash provided by financing activities 16,613 22,080
--------- ---------
Net increase in cash and cash equivalents 1,008 1,646
Cash and cash equivalents, beginning of period 1,887 1,271
--------- ---------
Cash and cash equivalents, end of period $ 2,895 $ 2,917
========= =========
Supplemental disclosure:
Interest paid $ 35,920 $ 29,668
The accompanying notes are an integral part of these
consolidated financial statements.
5
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ARCH COMMUNICATIONS, INC.
(A WHOLLY-OWNED SUBSIDIARY OF ARCH COMMUNICATIONS GROUP, INC. )
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited)
(a) Merger and Name Change -- On June 29, 1998, Arch Communications Group,
Inc. ("Parent") effected a number of restructuring transactions involving
certain of its direct and indirect wholly-owned subsidiaries. Arch
Communications Enterprises, Inc. ("ACE") was merged (the "Merger") into a
subsidiary of USA Mobile Communications, Inc. II ("USAM") named Arch Paging,
Inc. ("API"). In connection with the Merger, USAM changed its name to Arch
Communications, Inc. ("Arch" or the "Company") and issued 100 shares of its
common stock to Parent. Immediately prior to and in connection with the Merger:
(i) USAM contributed its operating assets and liabilities to an existing
subsidiary of USAM; (ii) The Westlink Company, which held ACE's 49.9% equity
interest in Benbow PCS Ventures, Inc. ("Benbow"), distributed its Benbow assets
and liabilities to a new subsidiary of ACE, The Westlink Company II; (iii) ACE
contributed its operating assets and liabilities to an existing subsidiary of
ACE; (iv) all of USAM's subsidiaries were merged into API; and (v) The Westlink
Company II was merged into a new API subsidiary, Benbow Investments, Inc.
The Merger has been accounted for as a pooling of interests due to the
common ownership of ACI, ACE and USAM. Accordingly, the Company's consolidated
financial statements have been restated to include the results of ACE for all
periods presented. All significant intercompany accounts and transactions have
been eliminated. The results of operations for the separate companies and the
combined amounts presented in the consolidated financial statements are
presented below (in thousands):
Three Months Six Months
Ended March 31, Ended June 30,
1998 1997
------------------ ----------------
Revenues:
USAM $ 41,684 $ 79,278
ACE 60,355 114,990
--------- ---------
Combined $ 102,039 $ 194,268
========= =========
Net loss:
USAM $ (17,362) $ (31,019)
ACE (19,138) (46,998)
--------- ---------
Combined $ (36,500) $ (78,017)
========= =========
(b) Preparation of Interim Financial Statements -- The consolidated
condensed financial statements of Arch have been prepared in accordance with the
rules and regulations of the Securities and Exchange Commission. The financial
information included herein has been prepared by management without audit by
independent accountants. The consolidated condensed balance sheet at December
31, 1997 has been derived from, but does not include all the disclosures
contained in, the audited consolidated financial statements for the year ended
December 31, 1997 and has been restated to reflect the Merger using the pooling
of interests method of accounting. In the opinion of management, all of these
unaudited statements include all adjustments and accruals consisting only of
normal recurring accrual adjustments which are necessary for a fair presentation
of the results of all interim periods reported herein. These consolidated
condensed financial statements should be read in conjunction with the
consolidated financial statements and accompanying notes included in USAM's
Annual Report on Form 10-K for the year ended December 31, 1997. The results of
operations for the periods presented are not necessarily indicative of the
results that may be expected for a full year.
6
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(c) Intangible and Other Assets -- Intangible and other assets, net of
accumulated amortization, are composed of the following (in thousands):
June 30, December 31,
1998 1997
---- ----
(unaudited)
Goodwill $291,898 $312,017
Purchased FCC licenses 275,224 293,922
Purchased subscriber lists 71,933 87,281
Investment in CONXUS Communications, Inc. 6,500 6,500
Investment in Benbow PCS Ventures, Inc. 9,942 6,189
Non-competition agreements 2,268 2,783
Deferred financing costs 12,065 526
Other 8,853 9,751
-------- --------
$678,683 $718,969
======== ========
(d) Tower Site Sale -- In April 1998, Parent announced an agreement to sell
certain of Arch's tower site assets (the "Tower Site Sale") for approximately
$38 million in cash (subject to adjustment), of which $1.3 million will be paid
to a subsidiary of Benbow in payment for certain assets owned by such subsidiary
and included in the Tower Site Sale. In the Tower Site Sale, Arch is selling
communications towers, real estate, site management contracts and/or leasehold
interests involving 134 sites in 22 states and renting space on the towers on
which it currently operates communications equipment to service its own paging
network. Arch will use its net proceeds from the Tower Site Sale (estimated to
be $36 million) to repay indebtedness under the Amended Credit Facility (see
Note (f)). Arch held the initial closing of the Tower Site Sale on June 26, 1998
with gross proceeds to Arch of approximately $12 million (excluding the $1.3
million which was paid to a subsidiary of Benbow for the assets it sold). The
final closing for the balance of the transaction is expected to be completed in
the third quarter of 1998, although no assurance can be given that the final
closing will be held as expected.
(e) Senior Notes -- On June 29, 1998, Arch issued and sold $130.0 million
principal amount of 12 3/4% Senior Notes due 2007 (the "Notes") for net proceeds
of $122.6 million (after deducting the discount to the Initial Purchasers and
offering expenses paid by Arch) in a private placement (the "Note Offering")
under Rule 144A promulgated under the Securities Act of 1933, as amended. The
Notes were sold at an initial price to investors of 98.049%. The Notes mature on
July 1, 2007 and bear interest at a rate of 12 3/4% per annum, payable
semi-annually in arrears on January 1 and July 1 of each year, commencing
January 1, 1999.
The indenture governing the Notes ( the "Indenture") contains certain
covenants that, among other things, limit the ability of Arch to incur
additional indebtedness, issue preferred stock, pay dividends or make other
distributions, repurchase Capital Stock (as defined in the Indenture), repay
subordinated indebtedness or make other Restricted Payments (as defined in the
Indenture), create certain liens, enter into certain transactions with
affiliates, sell assets, issue or sell Capital Stock of Arch's Restricted
Subsidiaries (as defined in the Indenture) or enter into certain mergers and
consolidations.
(f) Amended Credit Facility -- Contemporaneously with the Merger, ACE's
existing credit facility was amended and restated to establish senior secured
revolving credit and term loan facilities with API, as borrower, in the
aggregate amount of $400.0 million (collectively, the "Amended Credit Facility")
consisting of (i) a $175.0 million reducing revolving credit facility (the
"Tranche A Facility"), (ii) a $100.0 million 364-day revolving credit facility
under which the principal amount outstanding on the 364th day following the
closing will convert to a term loan (the "Tranche B Facility") and (iii) a
$125.0 million term loan which was available in a single drawing on the closing
date (the "Tranche C Facility").
The Tranche A Facility is subject to scheduled quarterly reductions
commencing on September 30, 2000 and will mature on June 30, 2005. The term loan
portion of the Tranche B Facility will be amortized in quarterly installments
7
<PAGE>
commencing September 30, 2000, with an ultimate maturity date of June 30, 2005.
The Tranche C Facility will be amortized in annual installments commencing
December 31, 1999, with an ultimate maturity date of June 30, 2006.
API's obligations under the Amended Credit Facility are secured by its
pledge of the capital stock of the former ACE operating subsidiaries. The
Amended Credit Facility is guaranteed by Parent, Arch and the former ACE
operating subsidiaries. Parent's guarantee is secured by a pledge of Parent's
stock and notes in Arch, and the guarantees of the former ACE operating
subsidiaries are secured by a security interest in those assets of such
subsidiaries which were pledged under ACE's previous credit facility.
Borrowings under the Amended Credit Facility bear interest based on a
reference rate equal to either the Agent Bank's Alternate Base Rate or LIBOR, in
each case plus a margin based on Arch's or API's ratio of total debt to
annualized earnings before interest, taxes, depreciation and amortization
("EBITDA").
The Amended Credit Facility requires payment of fees on the daily average
amount available to be borrowed under the Tranche A Facility and the Tranche B
Facility, which fees vary depending on Arch's or API's ratio of total debt to
annualized EBITDA.
The Amended Credit Facility contains restrictions that limit, among other
things: additional indebtedness and encumbrances on assets; cash dividends and
other distributions; mergers and sales of assets; the repurchase or redemption
of capital stock; investments; acquisitions that exceed certain dollar
limitations without the lenders' prior approval; and prepayment of indebtedness
other than indebtedness under the Amended Credit Facility. In addition, the
Amended Credit Facility requires API and its subsidiaries to meet certain
financial covenants, including covenants with respect to ratios of EBITDA to
fixed charges, EBITDA to debt service, EBITDA to interest service and total
indebtedness to EBITDA.
(g) Equity Investment from Parent - On June 29, 1998, two partnerships
managed by Sandler Capital Management Company, Inc., an investment management
firm ("Sandler"), together with certain other private investors, made an equity
investment in Parent of $25.0 million in the form of Series C Convertible
Preferred Stock of Parent ("Series C Preferred Stock"). Simultaneously, Parent
contributed to Arch as an equity investment (the "Equity Investment") $24.0
million of the net proceeds from the sale of Series C Preferred Stock, Arch
contributed such amount to API as an equity investment and API used such amount
to repay indebtedness under ACE's existing credit facility as part of the
establishment of the Amended Credit Facility.
(h) Divisional Reorganization - In June 1998, Parent's Board of Directors
approved a reorganization of Arch's operations (the "Divisional
Reorganization"). As part of the Divisional Reorganization, which is being
implemented over a period of 18 to 24 months, Parent plans to consolidate its
seven operating divisions into four operating divisions and consolidate certain
regional administrative support functions, resulting in various operating
efficiencies. In connection with the Divisional Reorganization, Parent (i)
anticipates a net reduction of approximately 10% of its workforce, (ii) plans to
close certain office locations and redeploy other real estate assets and (iii)
has recorded a restructuring charge of $16.1 million during the second quarter
of 1998. The restructuring charge consisted of approximately (i) $9.7 million
for employee severance and benefits, (ii) $3.5 million for lease obligations and
terminations and (iii) $2.9 million for the writedown of related assets.
The write-down of fixed assets relates to a non-cash charge which will
reduce the carrying amount of certain leasehold improvements and other fixed
assets that the Company will not continue to utilize following the Divisional
Reorganization to their estimated net realizable value as of the date such
assets are projected to be disposed of or abandoned by the Company. The net
realizable value of these assets was determined based on management's estimates,
which considered such factors as the nature and age of the assets to be disposed
of, the timing of the assets' disposal and the method and potential costs of
disposal. Such estimates are subject to change.
8
<PAGE>
The provision for lease obligations and terminations relates primarily to
future lease commitments on local, regional and divisional office facilities
that will be closed as part of the Divisional Reorganization. The charge
represents future lease obligations on such leases past the dates the offices
will be closed by the Company, or for certain leases, the cost of terminating
the leases prior to their scheduled expiration. Cash payments on the leases and
lease terminations will occur over the remaining lease terms, the majority of
which expire prior to 2001.
Through the elimination of certain local and regional administrative
operations and the consolidation of certain support functions, the Company will
eliminate approximately 280 net positions. As a result of eliminating these
positions, the Company will terminate up to 900 personnel. The majority of the
positions to be eliminated are in local and regional offices which will be
closed as a result of the Divisional Reorganization. The majority of the
severance and benefits costs to be paid by the Company will be paid during the
remainder of 1998 and in 1999.
The Company's restructuring activity as of June 30, 1998 is as follows (in
thousands):
Reserve
Initially Utilization of Reserve Remaining
Established Cash Non-Cash Reserve
----------- ---- -------- -------
Severance costs............. $ 9,700 $ 205 $ -- $ 9,495
Lease obligation costs...... 3,500 20 -- 3,480
Write-down of related assets 2,900 29 -- 2,871
------- ------ -------- -------
Total................... $16,100 $ 254 $ -- $15,846
======= ====== ======== =======
(i) New and Pending Accounting Pronouncements -- In June 1997, the
Financial Accounting Standards Board issued Statement of Financial Accounting
Standards ("SFAS") No. 130 "Reporting Comprehensive Income". SFAS No. 130
establishes standards for reporting and display of comprehensive income and its
components (revenue, expenses, gains and losses) in a full set of
general-purpose financial statements. The Company adopted SFAS No. 130 in 1998.
The adoption of this standard did not have an effect on its reporting of income.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131
"Disclosures about Segments of an Enterprise and Related Information". SFAS No.
131 establishes standards for reporting information about operating segments in
annual financial statements and requires selected information about operating
segments in interim financial reports. SFAS No. 131 also establishes standards
for related disclosures about products and services, geographic areas and major
customers. Arch intends to adopt SFAS No. 131 for its year ending December 31,
1998. The adoption of this standard is not expected to have a significant impact
on Arch's financial reporting.
In April 1998, the Accounting Standards Executive Committee of the
Financial Accounting Standards Board issued Statement of Position 98-5 ("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.
Initial application of SOP 98-5 will be reported as the cumulative effect of a
change in accounting principle. Arch 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
Arch's financial position or results of operations.
In June 1998, the Financial Accounting Standards Board issued SFAS No.133 "
Accounting for Derivative Instruments and Hedging Activities". SFAS No. 133
requires that every derivative instrument be recorded in the balance sheet as
either an asset or liability measured at its fair value and that changes in the
derivative's fair value be recognized currently in earnings. Arch intends to
adopt this standard effective January 1, 2000. Arch has not yet quantified the
impact of adopting SFAS No. 133 on its financial statements, however, adopting
SFAS No. 133 could increase volatility in earnings and other comprehensive
income.
9
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
This Form 10-Q contains forward-looking statements. For this purpose, any
statements contained herein that are not statements of historical fact may be
deemed to be forward-looking statements. Without limiting the foregoing, the
words "believes", "anticipates", "plans", "expects" and similar expressions are
intended to identify forward-looking statements. There are a number of important
factors that could cause the Company's actual results to differ materially from
those indicated or suggested by such forward-looking statements. These factors
include, without limitation, those set forth below under the caption "Factors
Affecting Future Operating Results".
TOWER SITE SALE
In April 1998, Parent announced an agreement to sell certain of Arch's
tower site assets (the "Tower Site Sale") for approximately $38 million in cash
(subject to adjustment), of which $1.3 million will be paid to a subsidiary of
Benbow in payment for certain assets owned by such subsidiary and included in
the Tower Site Sale. In the Tower Site Sale, Arch is selling communications
towers, real estate, site management contracts and/or leasehold interests
involving 134 sites in 22 states and renting space on the towers on which it
currently operates communications equipment to service its own paging network.
Arch will use its net proceeds from the Tower Site Sale (estimated to be $36
million) to repay indebtedness under the Amended Credit Facility. Arch held the
initial closing of the Tower Site Sale on June 26, 1998 with gross proceeds to
Arch of approximately $12 million (excluding the $1.3 million which was paid to
a subsidiary of Benbow for the assets it sold). The final closing for the
balance of the transaction is expected to be completed in the third quarter of
1998, although no assurance can be given that the final closing will be held as
expected.
DIVISIONAL REORGANIZATION
In June 1998, Parent's Board of Directors approved a reorganization of
Arch's operations (the "Divisional Reorganization"). As part of the Divisional
Reorganization, which is being implemented over a period of 18 to 24 months,
Parent plans to consolidate its seven operating divisions into four operating
divisions and consolidate certain regional administrative support functions,
resulting in various operating efficiencies. Arch estimates that the Divisional
Reorganization, once fully implemented, will result in annual cost savings of
approximately $15 million. Arch expects to reinvest a portion of these cost
savings to expand its sales activities.
In connection with the Divisional Reorganization, Parent (i) anticipates a
net reduction of approximately 10% of its workforce, (ii) plans to close certain
office locations and redeploy other real estate assets and (iii) has recorded a
restructuring charge of $16.1 million during the second quarter of 1998. The
restructuring charge consisted of approximately (i) $9.7 million for employee
severance and benefits, (ii) $3.5 million for lease obligations and terminations
and (iii) $2.9 million for the writedown of related assets. See Note (h) to
Consolidated Condensed Financial Statements.
RESULTS OF OPERATIONS
Total revenues increased to $103.5 million (a 4.9% increase) and $205.6
million (a 5.8% increase) in the three and six months ended June 30, 1998,
respectively, from $98.7 million and $194.3 million in the three and six months
ended June 30, 1997, respectively. Net revenues (total revenues less cost of
products sold) increased to $96.2 million (a 5.1% increase) and $190.9 million
(a 6.1% increase) in the three and six months ended June 30, 1998, respectively,
from $91.6 million and $180.0 million in the three and six months ended June 30,
1997, respectively. Service, rental and maintenance revenues, which consist
primarily of recurring revenues associated with the sale or lease of pagers,
increased to $92.9 million (a 6.1% increase) and $184.3 million (a 7.2%
increase) in the three and six months ended June 30, 1998, respectively, from
10
<PAGE>
$87.6 million and $172.0 million in the three and six months ended June 30,
1997, respectively. These increases in revenues were due primarily to the
increase through internal growth in the number of pagers in service from 3.7
million at June 30, 1997 to 4.1 at June 30, 1998. Maintenance revenues
represented less than 10% of total service, rental and maintenance revenues in
the three and six months ended June 30, 1998 and 1997. Arch does not
differentiate between service and rental revenues. Product sales, less cost of
products sold, decreased to $3.3 million (a 16.6% decrease) and $6.6 million (a
17.3% decrease) in the three and six months ended June 30, 1998, respectively,
from $4.0 million and $8.0 million in the three and six months ended June 30,
1997, respectively, as a result of a decline in the average revenue per pager
sold.
Service, rental and maintenance expenses, which consist primarily of
telephone line and site rental expenses, increased to $20.2 million (21.0% of
net revenues) and $40.4 million (21.2% of net revenues) in the three and six
months ended June 30, 1998, respectively, from $19.4 million (21.2% of net
revenues) and $38.1 million (21.2% of net revenues) in the three and six months
ended June 30, 1997, respectively. The increases were due primarily to increased
expenses associated with system expansions and the provision of paging services
to a greater number of subscribers. As existing paging systems become more
populated through the addition of new subscribers, the fixed costs of operating
these paging systems are spread over a greater subscriber base. Annualized
service, rental and maintenance expenses per subscriber were $20 in both the
three and six months ended June 30, 1998, respectively, as compared to $22 in
the corresponding 1997 periods.
Selling expenses decreased to $12.4 million (12.9% of net revenues) and
$24.2 million (12.7% of net revenues) in the three and six months ended June 30,
1998, respectively, from $13.4 million (14.7% of net revenues) and $26.6 million
(14.8% of net revenues) in the three and six months ended June 30, 1997,
respectively. The decreases were due primarily to a decrease in the number of
net new pagers in service and marketing costs incurred in 1997 to promote the
Company's new Arch Paging brand identity. The number of net new pagers in
service resulting from internal growth decreased by 23.8% and 35.0% in the three
and six months ended June 30, 1998 compared to the three and six months ended
June 30, 1997, respectively, primarily due to Arch's shift in operating focus
from unit growth to capital efficiency and leverage reduction. Most selling
expenses are directly related to the number of net new subscribers added.
General and administrative expenses increased to $28.2 million (29.3% of
net revenues) and $56.5 million (29.6% of net revenues) in the three and six
months ended June 30, 1998, respectively, from $26.2 million (28.6% of net
revenues) and $51.3 million (28.5% of net revenues) in the three and six months
ended June 30, 1997, respectively. The increases were due primarily to
administrative and facility costs associated with supporting more pagers in
service.
Depreciation and amortization expenses decreased to $54.4 million and
$107.9 million in the three and six months ended June 30, 1998, respectively,
from $61.9 million and $119.7 million in the three and six months ended June 30,
1997, respectively. These expenses principally reflect Arch's acquisitions of
paging businesses in prior periods, accounted for as purchases, and investment
in pagers and other system expansion equipment to support growth.
Operating losses were $35.1 million and $54.3 million in the three and six
months ended June 30, 1998, respectively, as compared to $29.4 million and $55.8
million in the three and six months ended June 30, 1997, respectively, as a
result of the factors outlined above including the $16.1 million restructuring
charge recorded in the second quarter of 1998.
Net interest expense increased to $16.4 million and $32.7 million in the
three and six months ended June 30, 1998, respectively, from $15.7 million and
$31.0 million in the three and six months ended June 30, 1997, respectively. The
increases were principally attributable to an increase in Arch's outstanding
debt.
11
<PAGE>
The Company recognized income tax benefits of $5.3 million and $10.6
million in the three and six months ended June 30, 1997, respectively. These
benefits represent the tax benefit of operating losses incurred subsequent to
the acquisitions of USA Mobile Communications Holdings. Inc. ("USA Mobile") and
Westlink Holdings, Inc. ("Westlink") which were available to offset deferred tax
liabilities arising from the Company's acquisition of USA Mobile in September
1995 and Westlink in May 1996. The tax benefit of these operating losses was
fully recognized during 1997. Accordingly, the Company has established a
valuation reserve against its deferred tax asset which reduced the income tax
benefit to zero. The Company does not expect to recover, in the foreseeable
future, its deferred tax asset and will continue to increase its valuation
reserve accordingly.
In June 1998, Arch recognized an extraordinary charge of $1.7 million
representing the write-off of unamortized deferred financing costs associated
with the prepayment of indebtedness under prior credit facilities.
Net loss increased to $54.4 million and $90.9 million in the three and six
months ended June 30, 1998, respectively, from $40.7 million and $78.0 million
in the three and six months ended June 30, 1997, respectively, as a result of
the factors outlined above.
Earnings before interest, taxes, depreciation and amortization ("EBITDA")
increased 9.0% to $35.4 million (36.8% of net revenues) and 9.1% to $69.7
million (36.5% of net revenues) in the three and six months ended June 30, 1998,
respectively, from $32.5 million (35.5% of net revenues) and $63.9 million
(35.5% of net revenues) in the three and six months ended June 30, 1997,
respectively, as a result of the factors outlined above. EBITDA is a commonly
used measure of financial performance in the paging industry and is also one of
the financial measures used to calculate whether Arch and its subsidiaries are
in compliance with the covenants under their respective debt agreements, but
should not be construed as an alternative to operating income or cash flows from
operating activities as determined in accordance with generally accepted
accounting principles. EBITDA does not reflect restructuring charges, income tax
benefit and interest expense. One of Arch's principal financial objectives is to
increase its EBITDA, as such earnings are a significant source of funds for
servicing indebtedness and for investments in continued growth, including the
purchase of pagers and paging system equipment, construction and expansion of
paging systems and possible acquisitions. EBITDA, as determined by Arch, may not
necessarily be comparable to similarly titled data of other paging companies.
FACTORS AFFECTING FUTURE OPERATING RESULTS
The following important factors, among others, could cause Arch's actual
operating results to differ materially from those indicated or suggested by
forward-looking statements made in this Form 10-Q or presented elsewhere by
Arch's management from time to time.
INDEBTEDNESS AND HIGH DEGREE OF LEVERAGE
Arch is highly leveraged. At June 30, 1998, Arch had outstanding $639.5
million of total debt. The Company's high degree of leverage may have important
consequences for the Company, including: (i) the ability of the Company and its
subsidiaries to obtain additional financing for acquisitions, working capital,
capital expenditures or other purposes, if necessary, may be impaired or such
financing may not be available on favorable terms; (ii) a substantial portion of
the cash flow of the Company and its subsidiaries will be used to pay interest
expense, which will reduce the funds which would otherwise be available for
operations and future business opportunities; (iii) the Amended Credit Facility,
the Indenture and the indentures under which the Arch Notes are outstanding
contain financial and restrictive covenants, the failure to comply with which
may result in an event of default which, if not cured or waived, could have a
material adverse effect on the Company; (iv) the Company may be more highly
leveraged than its competitors which may place it at a competitive disadvantage;
(v) the Company's high degree of leverage will make it more vulnerable to a
downturn in its business or the economy generally; and (vi) the Company's high
degree of leverage may impair its ability to participate in future consolidation
of the paging industry. In April 1997, Parent reordered its operating priorities
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<PAGE>
to improve capital efficiency and strengthen its balance sheet by placing a
higher priority on leverage reduction than subscriber unit growth. As part of
its reordered operating priorities, Parent has implemented various initiatives
to reduce capital costs while sustaining acceptable levels of unit and revenue
growth. As a result, Arch's rate of internal growth in pagers in service has
slowed and is expected to remain below the rate of internal growth previously
achieved by Arch, but Arch has not yet reduced its financial leverage
significantly. There can be no assurance that Arch will be able to reduce its
financial leverage significantly or that Arch will achieve an appropriate
balance between growth which it considers acceptable and future reductions in
financial leverage. If Arch is not able to achieve continued growth in EBITDA,
it may be precluded from incurring additional indebtedness due to cash flow
coverage requirements under existing debt instruments, including Parent's 10
7/8% Senior Discount Notes due 2008 (the "Parent Discount Notes").
FUTURE CAPITAL NEEDS
The Company's business strategy requires the availability of substantial
funds to finance the continued development and further growth and expansion of
its operations, including possible acquisitions. The amount of capital required
by the Company will depend upon a number of factors, including subscriber
growth, the type of paging devices and services demanded by customers, service
revenues, technological developments, marketing and sales expenses, competitive
conditions, the nature and timing of the Company's N-PCS strategy, acquisition
strategy and acquisition opportunities. No assurance can be given that
additional equity or debt financing will be available to the Company on
acceptable terms, if at all. The unavailability of sufficient financing when
needed would have a material adverse effect on the business, financial
condition, results of operations or prospects of the Company.
HISTORY OF LOSSES
The Company has not reported any net income since its inception. The
Company's historical net losses have resulted principally from (i) substantial
depreciation and amortization expenses, primarily related to intangible assets
and pager depreciation, and (ii) interest expense on debt incurred primarily to
finance acquisitions of paging operations and other costs of growth. Substantial
and increased amounts of debt are expected to be outstanding for the foreseeable
future, which will result in significant additional interest expense which could
have a material adverse effect on the business, financial condition, results of
operations or prospects of the company. The Company expects to continue to
report net losses for the foreseeable future.
POSSIBLE ACQUISITION TRANSACTIONS
Arch believes that the paging industry will undergo further consolidation,
and Arch expects to participate in such consolidation, either as an acquiror or
an acquiree. The Company has evaluated and expects to continue to evaluate
possible acquisition transactions on an ongoing basis, and at any given time may
be, engaged in discussions with respect to possible acquisitions or other
business combinations. The process of integrating acquired paging businesses may
involve unforeseen difficulties and may require a disproportionate amount of the
time and attention of the Company's management and the financial and other
resources of the Company. No assurance can be given that suitable acquisition
transactions can be identified, financed and completed on acceptable terms, that
the Company's future acquisitions will be successful, or that the Company will
participate in any future consolidation of the paging industry.
On June 22, 1998, Parent and Arch each filed a Form 8-K with the
Securities and Exchange Commission reporting that Parent is engaged in
discussions concerning the possible acquisition of MobileMedia Communications,
Inc. ("MobileMedia"). There are a number of significant issues which must be
resolved prior to execution of an acquisition agreement, and Parent is aware
that other parties are in discussions with respect to a possible business
combination with MobileMedia. Parent has not entered into a letter of intent or
definitive agreement for the acquisition of MobileMedia and discussions could be
terminated at any time. If Parent does enter into an agreement for the
13
<PAGE>
acquisition of MobileMedia, the closing would be subject to approval by Parent's
stockholders, Bankruptcy Court approval, FCC approval, antitrust regulatory
approval, the availability of sufficient financing and other customary
conditions. THERE CAN BE NO ASSURANCE THAT ARCH WILL ACQUIRE MOBILEMEDIA OR
THAT, IF PARENT ACQUIRES MOBILEMEDIA, ARCH WOULD REALIZE ITS ANTICIPATED
IMPROVEMENTS IN FINANCIAL LEVERAGE, OPERATING SYNERGIES OR COST SAVINGS. An
acquisition of MobileMedia by Parent may involve significant operational and
financial risks, including but not limited to the risks associated with
integrating MobileMedia's operations with the current operations of Parent and
its subsidiaries, and these risks may be exacerbated by the fact that
MobileMedia is currently operating as a debtor-in-possession under Chapter 11 of
the United States Bankruptcy Code.
DEPENDENCE ON KEY PERSONNEL
The success of the Company will be dependent, to a significant extent, upon
the continued services of a relatively small group of executive personnel. The
Company does not have employment agreements with, or maintain insurance on the
lives of, any of its current executive officers, although certain executive
officers have entered into non-competition agreements and all executive officers
have entered into executive retention agreements with the Company. The loss or
unavailability of one or more of its executive officers or the inability to
attract or retain key employees in the future could have a material adverse
effect on the business, financial condition, results of operations or prospects
of the Company.
COMPETITION AND TECHNOLOGICAL CHANGE
The Company faces competition from other paging service providers in all
markets in which it operates as well as from certain competitors who hold
nationwide licenses. The Company believes that competition for paging
subscribers is based on quality of service, geographic coverage and price and
that the Company has generally competed effectively based on these factors.
Monthly fees for basic paging services have, in general, declined since the
Company commenced operations, due in part to competitive conditions, and the
Company may face significant price-based competition in the future which could
adversely affect the Company. One of the Company's competitors possess greater
financial, technical and other resources than the Company. A trend towards
increasing consolidation in the paging industry in particular and the wireless
communications industry in general in recent years has led to competition from
increasingly larger and better capitalized competitors. If any of such
competitors were to devote additional resources to the paging business or focus
its strategy on the Company's markets, there could be a material adverse effect
on the business, financial condition, results of operations or prospects of the
Company. A variety of two-way paging technologies are currently are in use or
under development by competitors. The Company does not presently provide such
two-way services, other than as a reseller. Although such services generally are
higher priced than traditional one-way paging services, technological
improvements could result in increased capacity and efficiency for such two-way
paging technologies and, accordingly, could result in increased competition for
the Company. Future technological advances in the telecommunications industry
could increase new services or products competitive with the paging services
provided by the Company or could require the Company to reduce the price of its
paging services or incur additional capital expenditures to meet competitive
requirements. Recent and proposed regulatory changes by the Federal
Communications Commission (the "FCC") are aimed at encouraging such
technological advances and new services. Other forms of wireless two-way
communications technology, including cellular and broadband personal
communications services ("PCS"), and specialized mobile radio services, also
compete with the paging services that the Company provides. While such services
are primarily focused on two-way voice communications, service providers could
elect to provide paging services as an adjunct to their primary services.
Technological change also may affect the value of the technologically advanced
pagers, including but not limited to two-way pagers, the Company could incur
additional inventory costs and capital expenditures if it were required to
replace pagers leased to its subscribers within a short period of time. If the
Company is required to incur such additional investment or capital prospects of
the Company. There can be not assurance that the Company will be able to compete
14
<PAGE>
successfully with its current and future competitors in the paging business or
with competitors offering alternative communication technologies.
SUBSCRIBER TURNOVER
The results of operations of wireless messaging service providers, such as
the Company, can be significantly affected by subscriber cancellations. The
sales and marketing costs associated with attracting new subscribers are
substantial relative to the costs of providing service to existing customers.
Because the paging business is characterized by high fixed costs, disconnections
directly and adversely affect operating cash flow. An increase in its subscriber
cancellation rate have a material adverse effect on the business, financial
condition, results of operations or prospects of the Company.
DEPENDENCE ON SUPPLIERS
The Company does not manufacture any of the pagers used in its paging
operations. The Company buys pagers primarily from Motorola, Inc. ("Motorola")
and NEC America, Inc. ("NEC") and therefore is dependent on such manufacturers
to obtain sufficient pager inventory for new subscriber and replacement needs.
In addition, the Company purchases terminals and transmitters primarily from
Glenayre Technologies, Inc. ("Glenayre") and Motorola and thus is dependent on
such manufacturers for sufficient terminals and transmitters to meet its
expansion and replacement requirements. To date, the Company has not experienced
significant delays in obtaining pagers, terminals or transmitters, but there can
be no assurance that the Company will not experience such delays in the future.
The Company's purchase agreement with Motorola expires on June 19, 1999, with a
provision for automatic renewal for one-year terms. Although the Company
believes that sufficient alternative sources of pagers, terminals and
transmitters exist, there can be no assurance that the Company would not be
adversely affected if it were unable to obtain these items from current supply
sources or on terms comparable to existing terms.
GOVERNMENT REGULATION, FOREIGN OWNERSHIP AND POSSIBLE REDEMPTION
The paging operations of the Company are subject to regulation by the FCC
and various state regulatory agencies. There can be no assurance that those
agencies will not propose or adopt regulations or take actions that would have a
material adverse effect on the Company's business. Changes in regulation of the
Company's business could adversely affect the Company's results of operations.
In addition, some aspects of the Telecommunications Act of 1996 could have a
beneficial effect on Arch's business, but other provisions may place additional
burdens upon Arch or subject Arch to increased competition. The Communications
Act of 1934, as amended, limits foreign ownership of entities that hold certain
licenses from the FCC. Because Parent and its subsidiaries hold FCC licenses, in
general, no more than 25% of Parent's stock can be owned or voted by
non-resident aliens or their representatives, a foreign government or its
representative or a foreign corporation. A FCC licensee may, however, make prior
application to the FCC for a determination that it is not in the public interest
to deny an individual licensee's foreign ownership in excess of the 25% foreign
ownership benchmark. Most recently, the FCC substantially liberalized its
authorization process for foreign entities investing in paging companies that
are domiciled in countries which are signatories to the World Trade Organization
agreement. Parent's Restated Certificate of Incorporation permits the redemption
of shares of Parent's capital stock from foreign stockholders where necessary to
protect FCC licenses held by Parent or its subsidiaries, but such redemption
would be subject to the availability of capital to Parent and any restrictions
contained in applicable debt instruments and under Delaware law (which currently
would not permit any such redemptions). The failure to redeem such shares
promptly could jeopardize the FCC licenses held by Arch or its subsidiaries.
From time to time, legislation and regulations which could potentially adversely
affect the Company are proposed or enacted by federal or state legislators and
regulators. For example, the FCC and certain states require paging companies to
contribute a portion of specified revenues to support broad telecommunications
policies, such as the universal availability of telephone service. Additional
states and localities may in the future seek to impose similar requirements and
15
<PAGE>
the FCC recently adopted an order requiring paging companies to compensate pay
telephone providers for 800 and similar telephone calls. Arch has generally
passed these costs on to its subscribers, which makes the Company's services
more expensive and which could affect the attraction or retention of
subscribers. There can be no assurance that Arch will be able to continue to
pass on these costs. Although these requirements have not to date had a material
impact on the Company, these or similar requirements could in the future have a
material adverse effect on the business, financial condition, results of
operations or prospects of the Company.
IMPACT OF THE YEAR 2000 ISSUE
Arch is currently upgrading its information systems in a manner which will
also resolve the potential impact of the Year 2000 problem on the processing of
date-sensitive information by the Company's computerized systems and
transmission equipment. The Year 2000 problem is the result of computer programs
being written using two digits (rather than four) to define the applicable year.
Any of the Company's programs that have time-sensitive software may recognize a
date using "00" as the year 1900 rather than the year 2000. This could result in
a system failure or miscalculations causing disruptions of operations,
including, among other things, a temporary inability to process transactions,
send invoices or engage in similar normal business activities.
In 1997 the Company designated members of its Information Services and
Engineering Departments to assess the impact of the so-called Year 2000 problem
on its information systems and information systems of its customers, vendors and
other parties that service or otherwise interact with the Company. Data
processing for the Company's major operating systems is conducted in-house using
programs developed primarily by third-party vendors. Assessment of inventory and
year 2000 readiness for all systems and applications has been substantially
completed and most third-party vendors who provide applications to the Company
have been contacted. Arch intends to bring its major operating systems and
outsourced applications into compliance with year 2000 requirements through the
installation of updated or replacement programs developed by third parties or by
new and enhanced software programs developed internally. The Company currently
believes that it will be able to modify or replace any affected systems by
September 30, 1999 in order to minimize any detrimental effects on the Company's
operations. In a number of cases, Year 2000 compliant systems are currently
installed or are already in the process of implementation in the normal course
of upgrade and functionality improvement.
The Company expects that it will incur costs to replace existing hardware
and software which will be capitalized and amortized in accordance with the
Company's existing accounting policies, while maintenance or modification costs
will be expensed as incurred. Based on the Company's preliminary estimate of the
costs to be incurred, the Company does not expect that resolution of the Year
2000 problem will have a material adverse effect on its results of operations
and financial condition. Costs of the Year 2000 project are based on current
estimates and actual results may vary significantly from such estimates.
The ability of third parties with whom the Company transacts business to
adequately address their Year 2000 issues is outside the Company's control. If
the Company, its customers or vendors are unable to resolve Year 2000 issues in
a timely manner, there could be a material adverse effect on the business,
financial condition, results of operations or prospects of the Company.
16
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is involved in various lawsuits and claims arising in the
normal course of business. The Company believes that none of such
matters will have a material adverse effect on the Company's business
or financial condition.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The exhibits listed on the accompanying index to exhibits are
filed as part of this Quarterly Report on Form 10-Q.
(b) The following reports on Form 8-K were filed for the quarter for
which this report is filed:
Current Report on Form 8-K dated June 22, 1998 (reporting that
Parent is engaged in discussions concerning the possible
acquisition of MobileMedia Corporation) filed June 22, 1998.
Current Report on Form 8-K dated June 26, 1998 (reporting the
Merger, the Amended Credit Facility, the issuance and sale of the
Notes, the Equity Investment, the Tower Site Sale, the Divisional
Reorganization and the acquisition by Benbow PCS Ventures, Inc.
of Page Call, Inc.) filed July 23, 1998.
17
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report on Form 10-Q for the quarter ended June
30, 1998, to be signed on its behalf by the undersigned thereunto duly
authorized.
ARCH COMMUNICATIONS, INC.
Dated: August 12, 1998 By: /S/ J. ROY POTTLE
-----------------
J. Roy Pottle
Executive Vice President and
Chief Financial Officer
18
<PAGE>
INDEX TO EXHIBITS
EXHIBIT DESCRIPTION
27.1* - Financial Data Schedule.
* Filed herewith
19
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