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, 1999
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 Numbers 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 12, 1999.
<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, 1999 and
December 31, 1998 3
Consolidated Condensed Statements of Operations for the
Three and Six Months Ended June 30, 1999 and 1998 4
Consolidated Condensed Statements of Cash Flows for the
Six Months Ended June 30, 1999 and 1998 5
Notes to Consolidated Condensed Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 9
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 17
Item 5. Other Information 17
Item 6. Exhibits and Reports on Form 8-K 17
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, except share amounts)
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
---- ----
ASSETS (unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 20,682 $ 22
Accounts receivable, net 60,015 30,753
Inventories 11,011 10,319
Prepaid expenses and other 14,344 8,007
----------- -----------
Total current assets 106,052 49,101
----------- -----------
Property and equipment, at cost 670,948 428,173
Less accumulated depreciation and amortization (242,194) (209,128)
----------- -----------
Property and equipment, net 428,754 219,045
----------- -----------
Intangible and other assets, net 945,375 626,439
----------- -----------
$ 1,480,181 $ 894,585
=========== ===========
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Current maturities of long-term debt $ 3,060 $ 1,250
Accounts payable 26,082 25,683
Accrued restructuring 10,167 11,909
Accrued interest 25,492 20,922
Accrued expenses and other liabilities 95,234 27,175
----------- -----------
Total current liabilities 160,035 86,939
----------- -----------
Long-term debt 959,186 620,629
----------- -----------
Other long-term liabilities 79,968 27,235
----------- -----------
Stockholder's equity:
Common stock -- $.01 par value -- --
Additional paid-in capital 902,429 642,406
Accumulated deficit (621,437) (482,624)
Total stockholder's equity 280,992 159,782
----------- -----------
$ 1,480,181 $ 894,585
=========== ===========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
3
<PAGE>
ARCH COMMUNICATIONS, INC.
(A WHOLLY-OWNED SUBSIDIARY OF ARCH COMMUNICATIONS GROUP, INC.)
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(unaudited and in thousands)
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Service, rental, and maintenance revenues $ 122,280 $ 92,883 $ 212,809 $ 184,280
Product sales 11,213 10,663 21,572 21,305
--------- --------- --------- ---------
Total revenues 133,493 103,546 234,381 205,585
Cost of products sold (7,603) (7,324) (14,529) (14,690)
--------- --------- --------- ---------
125,890 96,222 219,852 190,895
--------- --------- --------- ---------
Operating expenses:
Service, rental, and maintenance 28,093 20,220 48,386 40,409
Selling 18,033 12,374 31,044 24,244
General and administrative 37,395 28,198 63,021 56,516
Depreciation and amortization 76,673 54,444 127,549 107,915
Restructuring charge -- 14,700 -- 14,700
--------- --------- --------- ---------
Total operating expenses 160,194 129,936 270,000 243,784
--------- --------- --------- ---------
Operating income (loss) (34,304) (33,714) (50,148) (52,889)
Interest expense, net (23,042) (15,806) (38,772) (31,384)
Other expense (42,809) (627) (43,332) (1,319)
Equity in loss of affiliate -- (1,164) (3,200) (2,219)
--------- --------- --------- ---------
Income (loss) before extraordinary item and
accounting change (100,155) (51,311) (135,452) (87,811)
--------- --------- --------- ---------
Extraordinary charge from early
extinguishment of debt -- (1,720) -- (1,720)
Cumulative effect of accounting change -- -- (3,361) --
--------- --------- --------- ---------
Net income (loss) $(100,155) $ (53,031) $(138,813) $ (89,531)
========= ========= ========= =========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
4
<PAGE>
ARCH COMMUNICATIONS, INC.
(A WHOLLY-OWNED SUBSIDIARY OF ARCH COMMUNICATIONS GROUP, INC.)
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(unaudited and in thousands)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
1999 1998
---- ----
<S> <C> <C>
Net cash provided by operating activities $ 36,925 $ 34,092
--------- ---------
Cash flows from investing activities:
Additions to property and equipment, net (38,685) (38,353)
Additions to intangible and other assets (18,679) (21,584)
Net proceeds from tower site sale 3,041 10,240
Acquisition of paging company, net of cash acquired (519,105) --
--------- ---------
Net cash used for investing activities (573,428) (49,697)
--------- ---------
Cash flows from financing activities:
Issuance of long-term debt 466,058 450,964
Repayment of long-term debt (125,999) (459,013)
Capital contribution from Arch Communications Group, Inc. 217,104 24,662
--------- ---------
Net cash (used for) provided by financing activities 557,163 16,613
--------- ---------
Net increase in cash and cash equivalents 20,660 1,008
Cash and cash equivalents, beginning of period 22 1,887
--------- ---------
Cash and cash equivalents, end of period $ 20,682 $ 2,895
========= =========
Supplemental disclosure:
Interest paid $ 35,358 $ 14,837
Accretion of discount on senior notes $ 308 $ --
Liabilities assumed in acquisition of paging company $ 122,543 $ --
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
5
<PAGE>
ARCH COMMUNICATIONS, INC.
(A WHOLLY-OWNED SUBSIDIARY OF ARCH COMMUNICATIONS GROUP, INC.)
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited)
(a) Preparation of Interim Financial Statements - The consolidated
condensed financial statements of Arch Communications, Inc. ("Arch" or the
"Company") have been prepared in accordance with the rules and regulations of
the Securities and Exchange Commission. The financial information included
herein, other than the consolidated condensed balance sheet as of December 31,
1998, has been prepared by management without audit by independent accountants
who do not express an opinion thereon. The consolidated condensed balance sheet
at December 31, 1998 has been derived from, but does not include all the
disclosures contained in, the audited consolidated financial statements for the
year ended December 31, 1998. 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 Arch's
Annual Report on Form 10-K for the year ended December 31, 1998. The results of
operations for the periods presented are not necessarily indicative of the
results that may be expected for a full year. Arch is a wholly-owned subsidiary
of Arch Communications Group, Inc. ("Parent").
(b) Intangible and Other Assets - Intangible and other assets, net of
accumulated amortization, are comprised of the following (in thousands):
June 30, December 31,
1999 1998
---- ----
(unaudited)
Goodwill $257,213 $271,808
Purchased FCC licenses 379,783 256,519
Purchased subscriber lists 277,731 56,825
Deferred financing costs 23,520 13,983
Investment in Benbow PCS Ventures, Inc. ("Benbow") 871 11,347
Investment in CONXUS Communications, Inc. ("CONXUS") -- 6,500
Non-competition agreements 1,294 1,790
Other 4,963 7,667
-------- --------
$945,375 $626,439
======== ========
In June 1999, Arch, Benbow and Ms. June Walsh, who holds a 50.1% equity
interest in Benbow, agreed that:
o the shareholders agreement, the management agreement and the employment
agreement governing the establishment and operation of Benbow will be
terminated
o Benbow will not make any further FCC payments and will not pursue
construction of an N-PCS system
o Arch will not be obligated to fund FCC payments or construction of an
N-PCS system by Benbow
o the parties will seek FCC approval of the forgiveness of Benbow's
remaining payment obligations and the transfer of Ms. Walsh's equity
interest in Benbow to Arch
o the closing of the transaction will occur on the earlier of January 23,
2001 or receipt of FCC approval
o Arch will pay Ms. Walsh, in installments, an aggregate amount of $3.5
million (if the transaction closes before January 23, 2001) or $3.8
million (if the transaction closes on January 23, 2001)
As a result of these arrangements, Benbow will not have any meaningful business
operations and is unlikely to retain its N-PCS licenses. Therefore, Arch has
written off substantially all of its investment in Benbow in the amount of $8.2
million. Arch has also accrued the payment to Ms. Walsh of $3.8 million and
legal and other expenses of approximately $1.0 million which is included in
accrued expenses. In addition, Parent guaranteed Benbow's obligations in
conjunction with Benbow's purchase of the stock of PageCall in June 1998.
6
<PAGE>
On May 18, 1999, CONXUS filed for Chapter 11 protection in the U.S.
Bankruptcy Court in Delaware. Arch is unable to predict the effect of CONXUS'
bankruptcy filing on Arch's 6.6% equity interest in CONXUS or the existing
agreements between Arch and CONXUS, therefore, in June 1999, Arch wrote-off its
investment in CONXUS of $6.5 million.
(c) Acquisition of MobileMedia - On June 3, 1999 Parent completed its
acquisition of MobileMedia Communications, Inc. ("MobileMedia") for $661.7
million, consisting of cash paid of $519.1 million, including direct transaction
costs, 4,781,656 shares of Parent's common stock valued at $20.1 million and the
assumption of liabilities of $122.5 million. The cash payments were financed
through the issuance of approximately 36.2 million shares of Parent's common
stock in a rights offering for $6.00 per share, the issuance of $147.0 million
principal amount of 13 3/4% senior notes due 2008 (see note (d)) and additional
borrowings under the Company's credit facility. After consummation of the
acquisition, MobileMedia became a wholly owned subsidiary of Arch's principal
operating subsidiary, Arch Paging Inc. ("API").
The purchase price was allocated based on the fair values of assets acquired
and liabilities assumed. The allocation is subject to change based on
finalization of asset appraisals. The acquisition has been accounted for as a
purchase, and the results of MobileMedia's operations have been included in the
consolidated financial statements from the date of the acquisition. Goodwill
resulting from the acquisition is being amortized over a ten-year period using
the straight-line method.
The liabilities assumed, referred to above, include an unfavorable lease
accrual related to MobileMedia's rentals on communications towers which were in
excess of market rental rates. This accrual amounted to approximately $52.4
million and is included in other long-term liabilities. This accrual will be
amortized over the remaining lease term of 14 1/4 years.
Concurrent with the consummation of the acquisition, Arch commenced the
development of a plan to integrate the operations of MobileMedia. The cost of
acquisition may be increased to cover the costs to eliminate redundant headcount
and facilities in connection with the overall integration of operations. Once
the plan is finalized, the purchase price will be adjusted accordingly.
The following unaudited pro forma summary presents the consolidated results
of operations as if the acquisition had occurred at the beginning of the periods
presented, after giving effect to certain adjustments, including depreciation
and amortization of acquired assets and interest expense on acquisition debt.
These pro forma results have been prepared for comparative purposes only and do
not purport to be indicative of what would have occurred had the acquisition
been made at the beginning of the period presented, or of results that may occur
in the future.
Six Months Ended
June 30,
1999 1998
---- ----
(in thousands, except per share amounts)
Revenues $ 410,243 $ 428,999
Income (loss) before extraordinary item (162,854) (130,239)
Net income (loss) (162,854) (131,959)
In connection with the acquisition of MobileMedia, Parent issued
approximately 48.3 million warrants to purchase Parent's common stock. Each
warrant represents the right to purchase one-third of one share of Parent's
common stock at an exercise price of $3.01 ($9.03 per share). The warrants
expire on September 1, 2001.
(d) Senior Notes -- On June 3, 1999, Arch received the proceeds of an
offering of $147.0 million principal amount of 13 3/4% Senior Notes due 2008
(the "13 3/4% Notes") to qualified institutional buyers under Rule 144A
promulgated under the Securities Act of 1933, as amended. The 13 3/4% Notes were
sold at an initial price to investors of 95.091% for net proceeds of $134.6
million (after deducting the discount to the Initial Purchasers and offering
expenses). The 13 3/4% Notes mature on April 15, 2008 and bear interest at a
rate of 13 3/4% per annum, payable semi-annually in arrears on April 15 and
October 15 of each year, commencing October 15, 1999.
7
<PAGE>
The indenture governing the 13 3/4% 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.
(e) Change in Accounting Principle - 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. Arch adopted SOP 98-5 effective January 1,
1999. Initial application of SOP 98-5 resulted in a $3.4 million charge, which
was reported as the cumulative effect of a change in accounting principle. This
charge represents the unamortized portion of start-up and organization costs,
which had been deferred in prior years.
(f) Divisional Reorganization - As of June 30, 1999, 359 employees had
been terminated due to the divisional reorganization announced in June 1998. The
Company's restructuring activity as of June 30, 1999 is as follows (in
thousands):
Reserve
Initially Utilization of Remaining
Established Reserve Reserve
----------- ------- -------
Severance costs $ 9,700 $ 3,611 $ 6,089
Lease obligation costs 3,500 645 2,855
Other costs 1,500 277 1,223
--------- --------- ---------
Total $ 14,700 $ 4,533 $ 10,167
========= ========= =========
In conjunction with the completion of the MobileMedia Merger, management is
reviewing the timing and implementation of certain aspects of the Divisional
Reorganization. Management expects, based on reviews that are currently
underway, that adjustments to this reserve and additional restructuring reserves
may be necessary to affect the change in timing and the integration of
operations of the companies.
8
<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".
MOBILEMEDIA MERGER
On August 18, 1998, Parent entered into an Agreement and Plan of Merger (as
amended as of September 3, 1998, December 1, 1998 and February 8, 1999, the
"MobileMedia Merger Agreement") providing for a merger (the "MobileMedia
Merger") of MobileMedia Communications, Inc. ("MobileMedia") with and into a
subsidiary of Arch. The MobileMedia Merger was part of MobileMedia's Plan of
Reorganization (as amended, the "Reorganization Plan") to emerge from Chapter 11
bankruptcy. Parent's stockholders approved the MobileMedia Merger on January 26,
1999. On February 5, 1999, the Federal Communications Commission (the "FCC")
released an order approving the transfer of MobileMedia's FCC licenses to Arch
in connection with the MobileMedia Merger, subject to approval and confirmation
of the Reorganization Plan. The order granting the transfer became a final
order, no longer subject to reconsideration or judicial review, on March 8,
1999. The Reorganization Plan was confirmed by the U.S. Bankruptcy Court for the
District of Delaware on April 12, 1999. The MobileMedia Merger and the
associated debt and equity financings (described below) (collectively, the
"MobileMedia Transactions") was consummated on June 3, 1999.
Pursuant to the MobileMedia Merger, Parent: (i) issued certain stock and
warrants; (ii) paid $479.0 million in cash to certain creditors of MobileMedia;
(iii) paid approximately $40.0 million of administrative, transaction and
related costs; (iv) raised $217.2 million in cash through offerings of rights to
purchase its common stock; and (v) caused Arch and API to borrow a total of
approximately $320.8 million. After consummation of the MobileMedia Transactions
on June 3, 1999, MobileMedia became a wholly owned subsidiary of API. (See the
Notes to Consolidated Condensed Financial Statements)
DIVISIONAL REORGANIZATION
In June 1998, Parent's Board approved a divisional reorganization (the
"Divisional Reorganization"). As part of the Divisional Reorganization, which is
being implemented over a period of 18 to 24 months, Arch has consolidated its
former Midwest, Western, and Northern divisions into four existing operating
divisions, and is in the process of consolidating certain regional
administrative support functions, such as customer service, collections,
inventory and billing, to reduce redundancy and take advantage of various
operating efficiencies.
In connection with the Divisional Reorganization, Arch (i) anticipates a net
reduction of approximately 10% of its workforce, (ii) is closing certain office
locations and redeploying other real estate assets and (iii) recorded a
restructuring charge of $14.7 million during 1998. The restructuring charge
consisted of approximately (i) $9.7 million for employee severance, (ii) $3.5
million for lease obligations and terminations, and (iii) $1.5 million of other
costs. The severance costs and lease obligations will require cash outlays
throughout the 18 to 24 month restructuring period. There can be no assurance
that the desired cost savings will be achieved or that the anticipated
reorganization of Arch's business will be accomplished smoothly, expeditiously
or successfully. See Note (f) to Arch's Consolidated Condensed Financial
Statements.
In conjunction with the completion of the MobileMedia Merger, management is
reviewing the timing and implementation of certain aspects of the Divisional
Reorganization. Management expects, based on reviews that are currently
underway, that adjustments to this reserve and additional restructuring reserves
may be necessary to affect the change in timing and the integration of
operations of the companies.
9
<PAGE>
RESULTS OF OPERATIONS
Total revenues increased to $133.5 million (a 28.9% increase) and $234.4
million (a 14.0% increase) in the three and six months ended June 30, 1999,
respectively, from $103.5 million and $205.6 million in the three and six months
ended June 30, 1998, respectively. Net revenues (total revenues less cost of
products sold) increased to $125.9 million (a 30.8% increase) and $219.9 million
(a 15.2% increase) in the three and six months ended June 30, 1999,
respectively, from $96.2 million and $190.9 million in the three and six months
ended June 30, 1998, respectively. Total revenues and net revenues in the 1999
period increased primarily due to the MobileMedia Merger, but were adversely
affected by a general slowing of paging industry growth, compared to prior
years. Revenues were also adversely affected by: (i) Arch's decision in the
fourth quarter of 1998, in anticipation of the MobileMedia Merger, not to
replace normal attrition among direct sales personnel; (ii) the reduced
effectiveness of the reseller channel of distribution; and (iii) reduced sales
through Arch's company owned stores. Arch expects revenue to continue to be
adversely affected in 1999 due to these factors. Service, rental and maintenance
revenues, which consist primarily of recurring revenues associated with the sale
or lease of pagers, increased to $122.3 million (a 31.6% increase) and $212.8
million (a 15.5% increase) in the three and six months ended June 30, 1999,
respectively, from $92.9 million and $184.3 million in the three and six months
ended June 30, 1998, respectively. These increases in revenues were due
primarily to the acquisition of MobileMedia on June 3, 1999. Maintenance
revenues represented less than 10% of total service, rental and maintenance
revenues in the three and six months ended June 30, 1999 and 1998. Arch does not
differentiate between service and rental revenues. Product sales, less cost of
products sold, increased to $3.6 million (a 8.1% increase) and $7.0 million (a
6.5% decrease) in the three and six months ended June 30, 1999, respectively,
from $3.3 million and $6.6 million in the three and six months ended June 30,
1998, respectively, as a result of the MobileMedia acquisition.
Service, rental and maintenance expenses, which consist primarily of
telephone line and site rental expenses, were $28.1 million (22.3% of net
revenues) and $48.4 million (22.0% of net revenues) in the three and six months
ended June 30, 1999, respectively, compared 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. The increases in the three- and six-month
periods were due primarily to increased expenses associated with the provision
of paging services to a greater number of units. The acquisition of MobileMedia
added approximately 2.8 million units in service. As existing paging systems
become more populated through the addition of new paging units, the fixed costs
of operating these paging systems are spread over a greater subscriber base.
Annualized service, rental and maintenance expenses per unit were $21 and $20 in
the three and six months ended June 30, 1999, respectively, compared to $20 in
both the corresponding 1998 periods.
Selling expenses were $18.0 million (14.3% of net revenues) and $31.0 million
(14.1% of net revenues) in the three and six months ended June 30, 1999,
respectively, compared 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. These increases are due to increased headcount primarily as a
result of the MobileMedia Merger.
General and administrative expenses increased to $37.4 million (29.7% of net
revenues) and $63.0 million (28.7% of net revenues) in the three and six months
ended June 30, 1999, respectively, from $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. The increases were primarily due to the added headcount,
administrative and facility costs associated with MobileMedia which were
partially offset by a reduction in headcount as a result of the divisional
reorganization which began in June 1998.
Depreciation and amortization expenses increased to $76.7 million and $127.5
million in the three and six months ended June 30, 1999, respectively, from
$54.4 million and $107.9 million in the three and six months ended June 30,
1998, respectively. These expenses principally reflect Arch's acquisitions of
paging businesses in prior periods, as well as the acquisition of MobileMedia,
accounted for as purchases, and investment in pagers and other system expansion
equipment to support growth. Additionally, depreciation expense for the three
and six months ended June 30, 1999 includes the write-off of approximately $7.1
million of costs associated with the development of an integrated billing and
management system. The Company decided to discontinue development efforts due to
the capabilities of the system acquired in conjunction with the MobileMedia
Merger.
10
<PAGE>
Operating losses were $34.3 million and $50.1 million in the three and six
months ended June 30, 1999, respectively, compared to $33.7 million and $52.9
million in the three and six months ended June 30, 1998, respectively, as a
result of the factors outlined above.
Net interest expense increased to $23.0 million and $38.8 million in the
three and six months ended June 30, 1999, respectively, from $15.8 million and
$31.4 million in the three and six months ended June 30, 1998, respectively. The
increases were principally attributable to an increase in Arch's outstanding
debt.
Other expense increased to $42.8 million and $43.3 million in the three and
six months ended June 30, 1999, respectively, from $0.6 million and $1.3 million
in the three and six months ended June 30, 1998, respectively. In the 1999
periods, other expense includes $6.5 million representing the write-off of
Arch's investment in CONXUS (see note (b) to the Notes to Consolidated Condensed
Financial Statements) and $35.8 million associated with the arrangements made
between Arch, Benbow and Ms. Walsh in June 1999 (see note (b) to the Notes to
Consolidated Condensed Financial Statements).
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.
On January 1, 1999, Arch adopted SOP 98-5. SOP 98-5 requires costs of
start-up activities and organization costs to be expensed as incurred. Initial
application of SOP 98-5 resulted in a $3.4 million charge which was reported as
the cumulative effect of a change in accounting principle. This charge
represents the unamortized portion of start-up and organization costs which had
been deferred in prior years.
Net loss increased to $100.2 million and $138.8 million in the three and six
months ended June 30, 1999, respectively, from $53.0 million and $89.5 million
in the three and six months ended June 30, 1998, respectively, as a result of
the factors outlined above.
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.
Relating to Operations
Integrating Arch and MobileMedia presents challenges
Arch may not be able to successfully integrate MobileMedia's operations. Any
difficulties or problems encountered in the integration process could have a
material adverse effect on Arch. Even if integrated in a timely manner, there
can be no assurance that Arch's operating performance will be successful or will
fulfill management's objectives. Until integration is complete, the two
companies will continue to operate with some autonomy. This degree of autonomy
may blunt the implementation of the combined company's operating strategy.
The combination of the two companies will require, among other things,
coordination of administrative, sales and marketing, distribution and accounting
and finance functions and expansion of information and management systems. The
integration process could cause the interruption of the activities of the two
businesses, or a loss of momentum. The difficulties of such integration may
initially be increased by the necessity of coordinating geographically separate
organizations and integrating personnel with disparate business backgrounds and
corporate cultures. Arch may not be able to retain key employees. The process of
integrating the businesses of Arch and MobileMedia may require a
disproportionate amount of time and attention of Arch's management and financial
and other resources of Arch and may involve other, unforeseen difficulties.
Similar risks will attend future acquisition opportunities which Arch intends
to pursue. Furthermore, no assurance can be given that suitable acquisition
transactions can be identified, financed and completed on acceptable terms, or
that Arch will participate in any future consolidation of the paging industry.
Disruption of MobileMedia's operations that occurred during insolvency
proceedings may continue
MobileMedia's business operations were adversely affected by difficulties in
integrating the operations of certain businesses acquired in 1995 and 1996, by
liquidity problems arising prior to its January 30, 1997 bankruptcy filing and
11
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by the reluctance of some customers and potential customers to do business with
MobileMedia while it operated under Chapter 11. Any continued deterioration of
MobileMedia's business, including the loss of significant numbers of key
employees, could have material adverse effects.
Downturn in MobileMedia's units in service may continue
Cancellation of units in service can significantly affect the results of
operations of wireless messaging service providers. The sales and marketing
costs associated with attracting new subscribers are substantial compared to the
costs of providing service to existing customers. Because the paging business is
characterized by high fixed costs, cancellations directly and adversely affect
EBITDA.
After filing for bankruptcy protection on January 30, 1997, MobileMedia
experienced a significant decline in units in service. At March 31, 1999,
MobileMedia had 3,106,775 units in service compared to 3,440,342 units in
service at December 31, 1997. A failure to correct this cancellation trend could
have a material adverse effect on the combined company.
Competition and technological change may undermine Arch's business
There can be no assurance that Arch will be able to compete successfully with
current and future competitors in the paging business or with competitors
offering alternative communication technologies.
Competition may intensify and may adversely affect margins. Arch and
MobileMedia have each faced competition from other paging service providers in
all markets in which they operate, including some competitors who hold
nationwide licenses. Due in part to competitive conditions, monthly fees for
basic paging services have generally declined in recent years. Arch may face
significant price-based competition in the future which could have a material
adverse effect on its revenues and EBITDA. Some competitors possess greater
financial, technical and other resources than Arch. 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
on Arch's or MobileMedia's historical markets, this could have a material
adverse effect on the combined company.
New two-way paging technology may adversely affect Arch's competitive
position. Competitors are currently using and developing a variety of two-way
paging technologies. Neither Arch nor MobileMedia currently provides such
two-way services, other than as a reseller. Although these services generally
are higher priced than traditional one-way paging services, this situation may
change. Technological improvements could result in increased capacity and
efficiency for two-way paging technologies and this could result in increased
competition for Arch. Future technological advances in the telecommunications
industry could increase new services or products competitive with the paging
services historically provided by Arch and MobileMedia. Future technological
advances could also require Arch to reduce the price of its paging services or
incur additional capital expenditures to meet competitive requirements. Recent
and proposed regulatory changes by the FCC are aimed at encouraging such
technological advances and new services. Other forms of wireless two-way
communications technology also compete with the paging services that the
combined company provides. These include cellular and broadband personal
communications services, which are commonly referred to as PCS, as well as
specialized mobile radio services. Although these services are primarily focused
on two-way voice communications, many service providers are electing to provide
paging services as an adjunct to their primary services.
Obsolescence in company-owned units may impose additional costs on Arch.
Technological change may also adversely affect the value of the paging units
owned by Arch that are leased to its subscribers. If Arch's current subscribers
request more technologically advanced units, including two-way units, Arch could
incur additional inventory costs and capital expenditures if required to replace
units leased to its subscribers within a short period of time. Such additional
investment or capital expenditures could have a material adverse effect on the
combined company.
Government regulation may burden operations
Licenses may not be automatically renewed. Arch's FCC paging licenses are for
varying terms of up to 10 years. When the licenses expire, renewal applications
must receive approval from the FCC. To date, the FCC has approved each
12
<PAGE>
assignment and transfer of control for which Arch and MobileMedia have sought
approval; however, no assurance can be given that any of the combined company's
renewal applications will be free of challenge or will be granted by the FCC.
Regulatory changes could add burdens or benefit competing technologies. The
FCC continually reviews and revises its rules affecting paging companies.
Therefore, regulatory requirements that apply to Arch may change significantly
over time. Acquisitions of Parent's stock by foreigners could jeopordize Arch's
licenses. The Communications Act limits foreign investment in and ownership of
radio common carriers licensed by the FCC. Parent may not have more than 25% of
its stock owned or voted by aliens or their representatives, a foreign
government or its representatives or a foreign corporation if the FCC finds that
the public interest would be served by denying such ownership. Arch and Arch's
subsidiaries that are radio common carrier licensees are subject to more
stringent requirements and may have only up to 20% of their stock owned or voted
by aliens or their representatives, a foreign government or their
representatives or a foreign corporation. This ownership restriction is not
subject to waiver. Parent's certificate of incorporation permits the redemption
of shares of its capital stock from foreign stockholders where necessary to
protect FCC licenses held by Arch or its subsidiaries, but such a redemption
would be subject to the availability of capital to Parent and any restrictions
contained in applicable debt instruments and under the Delaware corporations
statute. These restrictions currently would not permit any such redemptions. The
failure to redeem shares promptly could jeopardize the FCC licenses held by Arch
or its subsidiaries. See "--High degree of leverage burdens operations" and
"--Competition and technological change may undermine Arch's business".
Arch cannot control third parties on whom Arch depends for products and
services
Arch does not manufacture any of the paging units used in its paging
operations. It is dependent primarily on Motorola and NEC America Inc. to obtain
sufficient pager inventory for new subscriber and replacement needs and on
Glenayre Electronics, Inc. and Motorola for sufficient terminals and
transmitters to meet its expansion and replacement requirements. Significant
delays in obtaining paging units, terminals or transmitters, such as MobileMedia
experienced before its bankruptcy filing, could lead to disruptions in
operations and adverse financial consequences. Arch's purchase agreement with
Motorola expires on March 17, 2000. There can be no assurance that the agreement
with Motorola will be renewed or, if renewed, that such agreements will be on
terms and conditions as favorable to Arch as those under the current agreement.
Arch relies on third parties to provide satellite transmission for some
aspects of its paging services. To the extent there are satellite outages or if
satellite coverage is impaired in other ways, Arch may experience a loss of
service until such time as satellite coverage is restored, which could have a
material adverse effect.
Loss of key personnel could adversely impact operations
Arch's success will depend, to a significant extent, upon the continued
services of a relatively small group of executive personnel. Arch does not have
employment agreements with any of its current executive officers, or maintain
life insurance on their lives, although all executive officers have entered into
executive retention agreements with Arch. 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 Arch.
Divisional reorganization may not achieve objectives
Arch is currently reorganizing its operating divisions. Once fully
implemented, this divisional reorganization is expected to result in annual cost
savings of approximately $15.0 million. Arch recorded a restructuring charge of
$14.7 million in 1998. There can be no assurance that the expected cost savings
will be achieved or that the reorganization of Arch's business will be
accomplished smoothly, expeditiously or successfully. The difficulties of the
divisional reorganization may be increased by the need to integrate
MobileMedia's operations in many locations and to combine two corporate
cultures. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Divisional Reorganization".
13
<PAGE>
Impact of the Year 2000 issue is not fully known
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 combined
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.
Arch has created a cross-functional Y2K project group to work on the Year
2000 problem. The Y2K project group is continuing its analysis of external and
internal areas likely to be affected by the Year 2000 problem and classifying
the identified areas of concern into either a mission critical or non-mission
critical status. For external areas, Arch has distributed, and continues to
distribute, surveys requesting information about the Year 2000 readiness of
certain vendors. As part of its evaluation of Year 2000 vulnerability related to
its pager and paging equipment vendors, Arch has discussed with such vendors
their efforts to identify potential issues associated with their equipment
and/or software. Internally, Arch is completing an inventory audit of hardware
and software testing for both its corporate and divisional operations.
Arch is in the process of reviewing, evaluating and, where necessary,
modifying or replacing its computerized systems and applications to enable it to
be Year 2000 ready. This includes both information and non-information
technology systems. Any failure of systems or products to be Year 2000 ready
could have a material adverse effect on Arch's business, financial condition,
results of operations or prospects.
The costs associated with the replacement of hardware, software and paging
equipment have been capitalized and amortized in accordance with Arch's existing
accounting policies and any future costs relating thereto will be capitalized
and amortized in a similar manner. Maintenance or modification costs have been,
and will be expensed as incurred. Based on Arch's costs incurred to date, as
well as estimated costs to be incurred later in 1999, Arch 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 once plans are further developed and implemented.
Although Arch and MobileMedia each began testing its internal
business-related hardware and software applications in 1998, there can be no
assurance that such testing has detected or will detect all applications that
may be affected by Year 2000 compliance problems. Arch's objective is to make
its internal computer systems Year 2000 ready by end of year 1999 but there can
be no assurance that this objective will be met. Furthermore, it is possible
that one or more mission critical vendors, such as utility providers, telephone
carriers, other paging carriers, satellite carriers or other telecommunication
providers, may not be Year 2000 compliant. Because of the unique nature of
vendors, alternative providers of these services may not be available.
Furthermore, all pagers and paging-related equipment used by Arch and its
customers are manufactured by third parties. Although Arch has initiated testing
of such equipment, it has relied to a large extent on the representations of its
vendors with respect to their readiness and cannot offer any assurance about the
accuracy of its vendors' representations.
Arch is designing and implementing contingency plans relating to the Year
2000 problem, identifying the likely risks and determining commercially
reasonable solutions. Arch intends to complete its Year 2000 contingency
planning during calendar year 1999.
Continued losses are likely
Arch expects to continue to report net losses for the foreseeable future and
cannot predict when, if ever, it is likely to attain profitability.
Arch and MobileMedia have reported losses in all but one of the periods shown
in the table below:
Three Months
Ended
Year Ended December 31, March 31,
1996 1997 1998 1999
---- ---- ---- ----
Net income (loss): (dollars in millions)
Arch $ (87.0) $(146.6) $(167.1) $ (38.7)
MobileMedia $(1,059.9) $(124.6) $ 35.6 $ (7.7)
14
<PAGE>
Furthermore, MobileMedia had net income during the year ended December 31,
1998 solely because of a $94.2 million gain on the sale of transmission towers
and related equipment. After giving effect to the MobileMedia acquisition, Arch
would have incurred, on a pro forma basis, losses before extraordinary item of
$193.2 million for the year ended December 31, 1998 and $60.1 million for the
three months ended March 31, 1999. For both Arch and MobileMedia, these
historical net losses have resulted principally from substantial depreciation
and amortization expense, primarily related to intangible assets and pager
depreciation, interest expense, the impairment of long-lived assets in the case
of MobileMedia and other costs of growth. Substantial and increased amounts of
debt are expected to be outstanding for the foreseeable future. This will result
in significant additional interest expense which could have a material adverse
effect on Arch's future income or loss. See "--Funding for future capital needs
is not assured" and "--High degree of leverage burdens operations".
Revenues and operating results may fluctuate
Arch believes that future fluctuations in its revenues and operating results
may occur due to many factors, including competition, subscriber turnover, new
service developments and technological change. Arch's current and planned debt
repayment levels are, to a large extent, fixed in the short term, and are based
in part on its expectations as to future revenues and cash flow growth. Arch may
be unable to adjust spending in a timely manner to compensate for any revenue or
cash flow shortfall. It is possible that, due to future fluctuations, Arch's
revenue, cash flow or operating results may not meet the expectations of
securities analysts or investors. This may have a material adverse effect on the
price of Arch's common stock. If shortfalls were to cause Arch not to meet the
financial covenants contained in its debt instruments, the debtholders could
declare a default and seek immediate repayment.
Relating to Liquidity, Capital Resources and Capital Structure.
High degree of leverage burdens operations
Each of Arch and MobileMedia has been highly leveraged, and the combined
company expects to continue to be highly leveraged. The following table compares
the total debt, total assets and latest three-month annualized adjusted pro
forma EBITDA of Arch at or as of June 30, 1999.
(dollars in millions)
Total debt $ 962.2
Total assets $ 1,480.2
Annualized adjusted pro forma EBITDA $ 251.1
Adjusted EBITDA is not a measure defined in GAAP and should not be considered
in isolation or as a substitute for measures of performance prepared in
accordance with GAAP. Adjusted EBITDA, as determined by Arch, may not
necessarily be comparable to similarly titled data of other paging companies.
Arch's high degree of leverage may have adverse consequences for Arch. These
include the following:
o High leverage may impair or extinguish Arch's ability to obtain additional
financing necessary for acquisitions, working capital, capital
expenditures or other purposes on acceptable terms, if at all.
o A substantial portion of Arch's cash flow will be required to pay interest
expense; this will reduce the funds which would otherwise be available for
operations and future business opportunities.
o Arch's credit facilities and indentures contain financial and restrictive
covenants; the failure to comply with these covenants may result in an
event of default which could have a material adverse effect on Arch if not
cured or waived.
o Arch may be more highly leveraged than its competitors which may place it
at a competitive disadvantage.
o Arch's high degree of leverage will make it more vulnerable to a downturn
in its business or the economy generally.
o Arch's high degree of leverage may impair its ability to participate in
the future consolidation of the paging industry.
15
<PAGE>
There can be no assurance that Arch will be able to reduce its financial
leverage as it intends, nor 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.
Debt instruments restrict operations
Various debt instruments impose operating and financial restrictions on Arch.
Arch's secured credit facility requires various Arch operating subsidiaries to
maintain specified financial ratios, including a maximum leverage ratio and a
minimum fixed charge coverage ratio. In addition, the secured credit facility
limits or restricts, among other things, the operating subsidiaries' ability to:
o declare dividends or redeem or repurchase capital stock;
o prepay, redeem or purchase debt;
o incur liens and engage in sale/leaseback transactions;
o make loans and investments;
o incur indebtedness and contingent obligations;
o amend or otherwise alter debt instruments and other material agreements;
o engage in mergers, consolidations, acquisitions and asset sales;
o engage in transactions with affiliates; and
o alter its lines of business or accounting methods.
Other debt instruments limit, among other things:
o the incurrence of additional indebtedness by Arch and its subsidiaries;
o the payment of dividends and other restricted payments by Arch and its
subsidiaries;
o asset sales;
o transactions with affiliates;
o the incurrence of liens; and
o mergers and consolidations.
Arch's ability to comply with such covenants may be affected by events beyond
its control, including prevailing economic and financial conditions. A breach of
any of these covenants could result in a default under the secured credit
facility and/or other debt instruments. Upon the occurrence of an event of
default, the creditors could elect to declare all amounts outstanding to be
immediately due and payable, together with accrued and unpaid interest. If Arch
were unable to repay any such amounts, the secured creditors could proceed
against the collateral securing a portion of the indebtedness. If the lenders
under the secured credit facility or other debt instruments accelerated the
payment of such indebtedness, there can be no assurance that the assets of Arch
would be sufficient to repay in full such indebtedness and other indebtedness of
Arch. In addition, because the secured credit facility and other debt
instruments limit Arch's ability to engage in certain transactions except under
certain circumstances, Arch may be prohibited from entering into transactions
that could be beneficial to Arch.
Funding for future capital needs is not assured
Arch's business strategy requires substantial funds to be available to
finance the continued development and future growth and expansion of its
operations, including possible acquisitions. Future amounts of capital required
by Arch will depend upon a number of factors. These factors include 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 Arch's N-PCS strategy, and acquisition
strategies and opportunities. No assurance can be given that additional equity
or debt financing will be available to Arch when needed on acceptable terms, if
16
<PAGE>
at all. If sufficient financing is unavailable when needed, this may have a
material adverse effect on Arch.
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 April 28, 1999 (reporting that
supplements to Parent's prospectus dated January 5, 1999 and proxy
statement/prospectus dated December 18, 1998 were distributed) filed
April 29, 1999.
Current Report on Form 8-K dated June 3, 1999 (reporting the completion
of the MobileMedia Merger) filed June 18, 1999.
Amendment No. 1 to Current Report dated June 3, 1999 on Form 8-K/A
(filing MobileMedia's financial statements and certain pro forma
financial statements) filed June 24, 1999.
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, 1999, to be signed on its behalf by the undersigned thereunto duly
authorized.
ARCH COMMUNICATIONS, INC.
Dated: August 13, 1999 By: /s/ J. Roy Pottle
--------------------------------
J. Roy Pottle
Executive Vice President and
Chief Financial Officer
18
<PAGE>
INDEX TO EXHIBITS
Exhibit Description
10.1 - Amendment No. 4 to the Second Amended and Restated Credit Agreement
(Tranche A and Tranche C Facilities). (1)
10.2 - Amendment No. 4 to the Second Amended and Restated Credit Agreement
(Tranche B Facility). (1)
10.3+ - Paging Products Sales Agreement, dated March 17, 1999, by and
between Motorola, Inc. and the Company. (1)
10.4+ - Satellite Services Agreement, dated September 1, 1998, between
AvData Systems, Inc. and MobileMedia Communications, Inc. (1)
10.5 - Master Lease For Transmitter Systems Space by and between Pinnacle
Towers, Inc. and MobileMedia Communications, Inc. (1)
27.1* - Financial Data Schedule.
- -------------- ----
* Filed herewith
+ A Confidential Treatment Request has been filed with respect to portions of
this exhibit
(1) Incorporated by reference from the Quarterly Report on Form 10-Q of Arch
Communications Group, Inc. for the quarter ended June 30, 1999.
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