ITEM 1. BUSINESS
The Registrant, Lynch Corporation ("Lynch"), incorporated in 1928 under the laws of the State of Indiana, is a diversified holding company with subsidiaries engaged in multimedia, services and manufacturing. Lynch's executive offices are located at 8 Sound Shore Drive, Greenwich, Connecticut 06830. Its telephone number is 203-629-3333. The company's business development strategy is to expand its existing operations through internal growth and acquisitions. For the year ended December 31, 1996, multimedia operations provided 6% of the Registrant's consolidated revenues; services operations provided 29% of the Registrant's consolidated revenues; and manufacturing operations provided 65% of the Registrant's consolidated revenues. As used herein, the Registrant includes subsidiary corporations.
On December 5, 1996, Registrant announced that it is examining the possibility of splitting, through a spin-off, either its multimedia operations or its manufacturing operations. There are a number of matters to be examined in connection with a possible spin-off, including tax consequences, and there is no assurance that such a spin-off will be effected.
I. MULTIMEDIA
A. Telecommunications
Operations. The Registrant conducts its telecommunications operations through subsidiary corporations. The telecommunications segment is expanding through the selective acquisition of local exchange telephone companies serving rural areas and by offering additional services to existing customers. From 1989 through 1996, Registrant has acquired nine telephone companies, five of which have indirect minority ownership of 2% to 20%, whose operations range in size from less than 500 to over 9,500 access lines. In mid-March 1997, Registrant acquired approximately 60% of a tenth telephone company, with the intent to acquire the remaining stock. As of December 31, 1996, total access lines were approximately 28,984, 99% of which are served by digital switches.
These subsidiaries' principal line of business is providing telecommunications services. These services fall into four major categories: local network, network access, long distance and other. Toll service to areas outside franchised telephone service territory is furnished through switched and special access connections with intrastate and interstate long distance networks.
At December 31, 1996, the Registrant owned minority interests in wireline cellular telephone service covering several Rural Service Areas ("RSA's") in New Mexico and North Dakota, covering areas with a total population of approximately 393,000, of which the Registrant's proportionate interest is approximately 15,150. Operating results through 1996 have not been significant to date.
Inter-Community Telephone Company's participation in the Defense Com- mercial Telecommunications Network/Defense Switching Network (DCTN/DSN) was terminated in early 1996.
The Company holds franchises, licenses and permits adequate for the conduct of its business in the territories which it serves.
Future growth in telephone operations is expected to be derived from the acquisition of additional telephone companies, from providing service to new establishments, from upgrading existing customers to higher grades of service, and from offering related services such as Internet. The following table summarizes certain information regarding the Registrant's telephone operations.
* An "access line" is a single or multi-party circuit between the customer's establishment and the central switching office.
Telephone Acquisitions. The Registrant pursues an active program of acquiring operating telephone companies. From January 1, 1989 through December 31, 1996, Lynch has acquired nine telephone companies serving a total of approximately 24,750 access lines at the time of these acquisitions for an aggregate consideration totaling approximately $109 million. In May 1996, Inter-Community Telephone Company acquired from US West Communications, Inc. approximately 1,400 access lines in North Dakota. In 1996, J.B.N. Telephone acquired from United Telephone Company of Eastern Kansas 354 access lines in Kansas. In November 1996, a subsidiary of Registrant acquired the stock of Dunkirk & Fredonia Telephone Company and its subsidiaries, Cassadaga Telephone Corporation and Comantel, Inc. (collectively "DFT") for approximately $22 million. DFT serves approximately 11,129 access lines in western New York, including the community of Fredonia, the Village of Cassadaga and the Hamlet of Stockton. DFT also owns and operates other telecommunications businesses, including Internet, long distance resale, security systems, and sales and servicing of telecommunications equipment.
In mid-March 1997, Registrant acquired approximately 60% of the stock of Upper Peninsula Telephone Company ("UPTC") for approximately $15.3 million, with the intent of acquiring, and the obligation to offer to acquire, the rest of the company. UPTC serves approximately 6,200 access lines located principally in the Upper Peninsula of Michigan. UPTC also has cellular interests covering three RSA's in Michigan with a total population of approximately 550,000, of which UPTC's proportionate interest is approximately 59,000. UPTC had revenues and net income of $7.8 million and $1.9 million, respectively, for the year ended December 31, 1995 and $8.5 million and $2.0 million, respectively, for the year ended December 31, 1996.
The Registrant continually evaluates acquisition opportunities targeting domestic rural telephone companies with a strong market position, good growth potential and predictable cash flow. In addition, Registrant seeks companies with excellent local management already in place who will remain active with their company. Telephone holding companies and others actively compete for the acquisition of telephone companies and such acquisitions are subject to the consent or approval of regulatory agencies in most states. While management believes that it will be successful in making additional acquisitions, there can be no assurance that the Registrant will be able to negotiate additional acquisitions on terms acceptable to it or that regulatory approvals, where required, will be received.
Regulatory Environment. Operating telephone companies are regulated by state regulatory agencies with respect to its intrastate telephone services and the Federal Communications Commission ("FCC") with respect to its interstate telephone service and, with the enactment of the Telecommunications Act of 1996 (the "1996 Act"), certain other matters relating principally to local and intrastate competition.
The Registrant's telephone subsidiaries participate in the National Exchange Carrier Association ("NECA") common line and traffic sensitive tariffs and participate in the access revenue pools administered by NECA for interstate services. Where applicable, the Company's subsidiaries also participate in similar pooling arrangements approved by state regulatory authorities for intra-state services. Such interstate and intrastate arrangements are intended to compensate local exchange carriers ("LEC's"), such as the Registrant's operating telephone companies, for the costs, including a fair rate of return, of facilities furnished in originating and terminating interstate and intrastate long distance services.
In addition to access pool participation, certain of the Registrant's subsidiaries are compensated for their intrastate costs through billing and keeping access charge revenues (without participating in an access pool). The access charge revenues are developed based on intrastate access rates filed with the state regulatory agency.
Various aspects of federal and state telephone regulation have in recent years been subject to re-examination and on-going modification. In February 1996, the 1996 Act, which is the most substantial revision of communication law since the 1930's, became law. The Act is intended generally to allow telephone, cable, broadcast and other telecommunications providers to compete in each other's businesses, while loosening regulation of those businesses. Among other things, the Act (i) would allow major long distance telephone companies and cable television companies to provide local exchange telephone service; (ii) would allow new local telephone service providers to connect into existing local telephone exchange networks and purchase services at wholesale rates for resale; (iii) would provide for a commitment to universal service for high-cost, rural areas and authorizes state regulatory commissions to consider their status on certain competition issues; (iv) would allow the Regional Bell Operating Companies to offer long distance telephone service and enter the alarm services and electronic publishing businesses; (v) would remove rate regulation over non-basic cable service in three years; and (vi) would increase the number of television stations that can be owned by one party.
The FCC is in the process of promulgating new regulations covering these and related matters. The Federal/State Joint Board designated by the FCC has recently proposed modifications to the three major sources of interstate funding for the commitment to universal service for high-cost, rural areas. The Joint Board proposed modification to the Universal Service Fund (USF) and the Weighted DEM and Long-Term Support (LTS) subsidy portions of interstate access charges. The USF for rural telephone companies, such as Lynch's telephone subsidiaries, would be frozen for the next three years at the amounts received during 1997 (adjusted for any change in the number of access lines). Weighted DEM and LTS revenues would also be frozen (with an adjustment for access lines) but at 1996 levels. After the three year freeze, the USF, weighted DEM and LTS revenues would begin an additional three-year transitional phase-in to where ultimately, the reimbursement would be based on a cost model which is yet to be determined, rather than a telephone company's actual cost. New USF rules are scheduled to be adopted in May 1997. The 1996 Act would also permit states to allow competitive carriers to obtain USF funding under certain circumstances. In December 1996, the FCC proposed certain changes to the rules applicable to interstate access charges which long distance telephone carriers pay to local exchange companies. The proposed changes would apply principally to "price cap" companies (see paragraph below), although non-price cap companies may be affected by the FCC's proposed changes, including the allocation of USF support to interstate revenue requirements and possible changes to transportation and common line rate structures. The FCC is expected to begin an access charge preceding to propose access rule changes for non-price cap companies later in 1997. All of Registrant's telephone companies are non-price cap companies for interstate access charges. Since USF and access charges constituted approximately 60% of the revenues of the Registrant's nine telephone companies in 1996, modifications could have a material effect.
In addition, a 1989 FCC decision provided for price cap regulation for certain interstate services. The price cap approach differs from traditional rate-of-return regulation by focusing primarily on the prices of communications services. The intention of price cap regulation is to focus on productivity and the approved plan for telephone operating companies. This allows for the sharing with its customers of profits achieved by increasing productivity. Alternatives to rate-of-return regulation have also been adopted or proposed in some states as well. Inter-Community Telephone Company is an example of one such subsidiary which has elected a price cap limitation on local exchange access charges. However, management does not believe that this agreement will have a material effect on the Registrant's results. In certain states, regulators have ordered the restructuring of local service areas to eliminate nearby long distance calls and substitute extended calling areas.
Registrant cannot predict the effect of the 1996 Act and proposed Federal regulations, but because its telecommunications and multimedia properties (other than its television stations interests) are primarily in high-cost, rural areas, Registrant expects competitive changes to be slower in coming.
Competition. All of the Registrant's current telephone companies are currently monopoly providers in their respective area of local telephone exchange service. However, as a result of FCC and state agency regulatory and judicial decisions, competition has been introduced into certain areas of the toll network wherein certain providers are attempting to bypass local exchange facilities to connect directly with high-volume toll customers. For example, in the last few years the States of Wisconsin, New York and Michigan passed or amended telecommunications bills intended to introduce more competition among providers of local services and reduce regulation. A substantial impact is yet to be seen on Registrant's telephone companies. The Registrant's subsidiaries do not expect bypass to pose a significant near-term competitive threat due to a limited number of high-volume customers they serve. Regulatory authorities in certain states have taken steps to promote competition in local telephone exchange service, including in New York, by requiring certain companies to offer wholesale rates to resellers. In addition, cellular radio or similar radio-based services, including personal communication services (PCS) could provide an alternative local telephone exchange service at some point in the future.
B. Entertainment
STATION WHBF-TV -- Lynch Entertainment Corporation ("Lynch Entertainment I"), a wholly-owned subsidiary of Registrant, and Lombardo Communications, Inc., wholly-owned by Philip J. Lombardo, are the general partners of Coronet Communications Company ("Coronet"). Lynch Entertainment I has a 20% interest in Coronet and Lombardo Communications, Inc. has an 80% interest. Coronet owns a CBS-affiliated television station WHBF-TV serving Rock Island and Moline, Illinois and Davenport and Bettendorf, Iowa.
STATION WOI-TV -- Lynch Entertainment Corporation II ("LEC-II"), a wholly-owned subsidiary of Registrant, owns 49% of the outstanding common shares of Capital Communications Corporation ("Capital") and a convertible preferred stock, which when converted, would bring LEC-II's common share ownership to 50%. On March 1, 1994, Capital acquired the assets of WOI-TV for $12.7 million. WOI-TV is an ABC affiliate and serves the Des Moines, Iowa market. Lombardo Communications, Inc. II, controlled by Philip J. Lombardo, has the remaining share interest in Capital.
Operations. Revenues of a local television station depend to some extent upon its relationship with an affiliated network. In general, the affiliation contracts of WHBF-TV and WOI-TV with CBS and ABC, respectively, provide that the network will offer to the affiliated station the programs it generates, and the affiliated station will transmit a number of hours of network programming each month. The programs transmitted by the affiliated station generally include advertising originated by the network, for which the network is compensated by its advertisers.
The affiliation contract provides that the network will pay to the affiliated station an amount which is determined by negotiation, based upon the market size and rating of the affiliated station. Typically, the affiliated station also makes available a certain number of hours each month for network transmission without compensation to the local station, and the network makes available to the affiliated station certain programs which will be broadcast without advertising, usually public information programs. Some network programs also include "slots" of time in which the local station is permitted to sell spot advertising for its own account. The affiliate is permitted to sell advertising spots preceding, following, and sometimes during network programs.
A network affiliation is important to a local station because network programs, in general, have higher viewer ratings than non-network programs and help to establish a solid audience base and acceptance within the market for the local station. Because network programming often enhances a station's rating, a network-affiliated station is often able to charge higher prices for its own advertising time.
In addition to revenues derived from broadcasting network programs, local television stations derive revenues from the sale of advertising time for spot advertisements, which vary from 10 seconds to 120 seconds in length, and from the sale of program sponsorship to national and local advertisers. Advertising contracts are generally short in duration and may be canceled upon two-weeks notice. WHBF-TV and WOI-TV are represented by a national firm for the sale of spot advertising to national customers, but have local sales personnel covering the service area in which each is located. National representatives are compensated by a commission based on net advertising revenues from national customers.
Competition. WHBF-TV and WOI-TV compete for revenues with local television and radio stations, cable television, and other advertising media, such as newspapers, magazines, billboards and direct mail. Generally, television stations such as WHBF-TV and WOI-TV do not compete with stations in other markets.
Other sources of competition include community antenna television ("CATV") systems, which carry television broadcast signals by wire or cable to subscribers who pay a fee for this service. CATV systems retransmit programming originated by broadcasters, as well as providing additional programming that is not originated on, or transmitted from, conventional broadcasting stations. In addition, some alternative media operators, such as multipoint distribution service owners, provide for a fee and on a subscription basis, programming that is not a part of regular television service. Additional program services are provided by low-power television stations and direct broadcast satellites provide video services as well.
Federal Regulation. Television broadcasting is subject to the jurisdiction of the FCC under the Communications Act of 1934, as amended (the "Communications Act"). The Communications Act, and/or the FCC's rules, among other things, (i) prohibit the assignment of a broadcast license or the transfer of control of a corporation holding a license without the prior approval of the FCC; (ii) prohibit the common ownership of a television station and an AM or FM radio station or daily newspaper in the same market, although AM-FM station combinations by itself are permitted; (iii) prohibit ownership of a CATV system and television station in the same market; (iv) restrict the total number of broadcast licenses which can be held by a single entity or individual or entity with attributable interests in the stations and prohibits such individuals and entities from operating or having attributable interests in most types of stations in the same service area (loosened in the 1996 Act); and (v) prohibit a corporation from holding an FCC license if any of its officers or directors are aliens or if more than one-fifth of its capital stock is owned of record or voted by aliens or their representatives or by a international government or representative thereof, or by any corporation organized under the laws of a international country. See Regulatory Environment under A. above for a description of certain provisions of the 1996 Act including in particular those which would remove the regulations over non-basic cable service in three years and permit telephone service providers to provide cable service. In calculating media ownership interests, Registrant's interests may be aggregated under certain circumstances with certain other interests of Mr. Mario J. Gabelli, Chairman and Chief Executive Officer of the Registrant, and certain of his affiliates.
Television licenses are issued for terms of seven years and are renewable for terms of seven years. The current licenses for WHBF-TV and WOI-TV expire on December 1, 1997 and February 1, 1998, respectively.
Other
On December 1, 1995, Clear Video LLC, a 60% owned subsidiary of Registrant acquired 23 cable television systems in northeast Kansas serving approximately 4,500 subscribers for $5.2 million. Certain of the systems cluster with local telephone exchanges owned by J.B.N. Telephone. Registrant also owns a small cable system in Kansas.
Registrant also has the right to market direct broadcasting TV services via satellite to approximately 21,200 households in New Mexico and Wisconsin and had approximately 1,350 customers at December 31, 1996. Operating results have not been material to date.
C. Personal Communications Services ("PCS").
Subsidiaries of Registrant are 49.9% limited partners in five partnerships (the "C-Block Partnerships"). In the FCC's C-Block auction (restricted to small businesses and certain other qualifying bidders) of 30 megahertz personal communications services licenses, which concluded in 1996, the "C-Block" Partnerships won 31 licenses in 17 states covering a population of approximately 7 million people. The licenses had an aggregate purchase price of $216 million after a 25% bidding credit.
Under FCC rules, the "C-Block Partnerships made a down payment equal to 10% of the cost (net of bidding credits) of the licenses ($21.6 million). The Government is providing 10 year financing, interest only for the first six years at an interest rate of 7% per annum (Registrant argues strenuously that the interest rate should have been 6.51%, the applicable treasury rate at the time the licenses were awarded), for the remaining 90% of the cost of the licenses. Registrant's subsidiaries have agreements to loan the C-Block Partnerships an aggregate of $41.8 million, $20.4 million of which has been utilized at December 31, 1996, to fund the down payments on the licenses, and the remainder is to be utilized for interest payments on the Government loans and certain other partnership expenses. These loans carry an annual commit- ment fee of 20% and an interest rate of 15% which are payble when the loans mature in 2003. The 50.1% general partners have no obligation to provide loans or additional funds to the C-Block Partnerships. In late March 1997, the FCC approved a possible combining of the five C-Block Partnerships into a single partnership.
Another subsidiary of Registrant, Lynch PCS Corporation F ("LPCSF"), is a 49.9% limited partner in Aer Force Communications B, L.P. ("Aer Force").In the FCC's F-Block Auction (restricted to small businesses and certain other qualifying bidders) of 10 megahertz PCS licenses, Aer Force won five licenses in four states covering a population of approximately 20 million people. The licenses have an aggregate purchase price of $19 million after a 25% bidding credit. The grant of licenses won in the F-Block Auction is subject to the FCC's application and review process, in which other bidders and the FCC have the right to challenge Aer Force's qualifications.
Under FCC rules, Aer Force has to make a down payment equal to 20% of the cost (net of bidding credits) of the licenses ($3.8 million), 50% of which was made on January 23, 1997 with the remaining 50% due shortly after the award of the licenses. The Government is providing 10 year financing, interest only for two (2) years, for the remaining 80%. Registrant's subsidiary has agreed to loan Aer Force $11.8 million for five years, of which $1.9 million was used for the first half of the down payment and another $1.9 million would be used for the second half of the down payments with the remainder to be used for interest and certain other partnership expenses. The 50.1% general partner has no obligation to provide loans or additional funds to Aer Force. To fund LPCSF's loan obligation, Registrant has borrowed $11.8 million from Gabelli Funds, Inc. ("GFI"), of which $10 million has been repaid. Registrant expects to reborrow $1.9 million for the remaining 50% of the down payment. The GFI loan is due August 12, 1997, and is secured by the note to LPCSF from Aer Force, LPCSF's 49.9% partnership interest in Aer Force and the stock of certain of Registrant's subsidiaries. The loan from GFI includes a special fee payable to GFI equal to 10% of the net profits (after an assumed cost of capital) on LPCSF's investment in Aer Force. Another subsidiary of Registrant has an agreement with Rivgam Communicators L.L.C. ("Rivgam"), a subsidiary of GFI, which won licenses in the FCC's D and E Block Auctions for 10 megahertz PCS licenses, to provide certain services to it and to receive a fee equal to 10% of the profits of Rivgam (after an assumed cost of capital). Rivgam won twelve licenses in seven states covering a population of 33 million, with an aggregate cost of $84.9 million. Registrant is examining the possibility of spinning off Lynch PCS Corporation F to Registrant's shareholders. There are certain matters to be examined in connection with a possible spin-off, and there is no assurance that such a spin-off will be effected.
FCC rules impose build-out requirements that require PCS licensees to provide adequate service to at least one-third of the population in the licensed area within five years from the date of grant and two-thirds within ten years. There are also substantial restrictions on the transfer of control of PCS licenses in the C and F blocks.
There are many risks relating to PCS, including without limitation, the high cost of PCS licenses, the fact that it involves start-up businesses, raising the substantial funds required to pay for the licenses and the build out, determining the best way to develop the licenses and which technology to utilize, the small size and limited resources of the C-Block Partnerships and Aer Force compared to other potential competitors, existing and changing regulatory requirements, additional auctions of wireless telecommunications spectrum and actually building out and operating new businesses profitably in a highly competitive environment (including already established cellular telephone operators and other new PCS licensees). There can be no assurance that any licenses granted to the C-Block Partnerships, Aer Force, or Rivgam can be successfully financed, developed and/or operated, with Registrant's subsidiaries recovering their debt and equity investments.
II. SERVICES A. The Morgan Group, Inc..
The Morgan Group Inc. ("Morgan") is the Registrant's only service subsidiary. On July 22, 1993, Morgan completed an initial public offering ("IPO") of 1,100,000 shares of its Class A common Stock, $.015 par value, at $9.00 per share. As a result of this offering, Lynch's equity ownership in Morgan was reduced from 90% to 47%, represented by its ownership of 1,200,000 shares of Class B common stock. In December 1995, Lynch acquired from Morgan 150,000 shares of Class A common stock (plus $1.3 million in cash plus accrued dividends) in exchange for its 1,493,942 shares of Series A Preferred Stock of Morgan. At December 31, 1996, Lynch's equity ownership in Morgan is approximately 50%. Because the Class B common stock is entitled to two votes per share, its voting interest in Morgan is approximately 66% and, therefore, Lynch continues to consolidate Morgan's results in its financial statements. Morgan Class A Common Stock is listed on the American Stock Exchange under the symbol "MG."
Morgan is the leading provider of outsourcing transportation services to the manufactured housing and recreational vehicle ("RV") and commercial truck industries in the United States and has been operating since 1936. Morgan provides outsourcing transportation services through a national network of approximately 1,720 independent owner-operators and 1,300 drive-away drivers. Morgan dispatches its drivers from 115 locations in 35 states. Morgan's largest customers include Fleetwood Enterprises, Inc., Oakwood Homes Corporation, Winnebago Industries, Inc., Champion Enterprises, Inc., Cavalier Homes, Inc., Schult Homes, Clayton Homes, Skyline Corporation and Ryder Systems. Morgan's services also include arranging for transporting other products, including commercial vehicles and office trailers.
In May 1995, Morgan acquired the assets of Transfer Drivers, Inc. ("TDI"), which focuses on relocating rental equipment for companies such as Ryder Systems, Budget Rentals and Penske Truck Leasing and also delivery of new equipment from manufacturers including Utilimaster, Grumman Olson and Bluebird Bus. TDI had revenues of $8.4 million in 1996 and $5.3 million in 1995. On December 30, 1996, Morgan acquired the operating assets of Transit Homes of America ("Transit") which had more than 400 independent contract drivers and serves a number of leading producers in the manufactured housing industry. Transit had revenues of $29.5 million in 1996.
As of December 31, 1996, Morgan's owned transportation equipment included 32 tractors, 74 drop deck trailers, 15 car carrier trailers, 22 tent camper trailers, and 112 lowboy and miscellaneous trailers. The transportation equipment, except for 26 tractors, are being held for sale in conjunction with the sale or discontinuance of the "truckaway" operation (see below).
Morgan also provides certain insurance and financing services to its owner-operators. Morgan currently provides physical damage insurance and certain other insurance protection to the owners of equipment under lease to the Company through a captive insurance subsidiary. In addition, Morgan provides financing and certain guarantees of equipment loans through its finance subsidiary.
Morgan has decided to discontinue the "truckaway" operation of the Specialized Transport Division. Morgan recorded in the fourth quarter of 1996, special charges of $3,500,000 before taxes relating to exiting the truckaway operation and a write down of properties in accordance with the SFAS 121. Truckaway is a line of business which focused on the transportation of van conversions, tent campers, and automotive product utilizing Company-owned equipment. In addition to the above identified equipment being held for sale in conjunction with the sale or discontinuance of the "truckaway" operation, there are 13 tractors and 9 tent camper trailers currently financed under operating leases. At December 31, 1996, there were approximately 110 owner operators and 19 company drivers assigned to the truckaway operation. The truckaway operation had revenues of $12,900,000, $14,400,000, and $20,600,000 and estimated losses of $1,800,000, $1,200,000 and estimated profits of $1,200,000 for the years ended December 31, 1996, 1995, and 1994, respectively.
Industry Information. Morgan's business is substantially dependent upon the manufactured housing and recreational vehicle industries. Both of these industries are subject to broad production cycles. The manufactured housing industry continued to experience growth during 1996, while the recreational vehicle industry was down in 1996.
Growth Strategy. Morgan's strategy is to (i) capitalize on its stronger market position in the manufactured housing business, growing internally and through acquisitions and (ii) emphasize the Company's role in the large outsourcing transport industry which encompasses arranging for deliveries of numerous types of consumer and commercial vehicles.
Morgan's initiatives for improved margins are to exit lines of business which are unrewarding, reducing corporate overhead, and improving the Company's safety record. There is no assurance that such strategy and initiatives will be successful in light of changing economics market and competitive conditions.
Morgan is continuously reviewing and negotiating potential acquisitions. There can be no assurance that any future acquisitions will be effected or, if effected, that they can be successfully integrated with Morgan's business.
Customers and Marketing. Morgan's ten largest customers accounted for approximately 69% of its revenues in the previous three years.
Competition. All of Morgan's activities are highly competitive. In addition to fleets operated by manufacturers, Morgan competes with several large national interstate carriers and numerous small regional or local interstate and intrastate carriers. Morgan's principal competitors in the manufactured housing and RV marketplaces are privately owned. In the commercial transport market, Morgan competes with large national interstate carriers, many of whom have substantially greater resources than Morgan. Morgan also competes for certain services with railroad carriers. No assurance can be given that Morgan will be able to maintain its competitive position in the future.
Competition among carriers is based on the rate charged for services, quality of service, financial strength, insurance coverage and the geographic scope of the carrier's authority and operational structure. The availability of tractor equipment and the possession of appropriate registration approvals permitting shipments between points required by the customer may also be influential.
Selected Operating Information. The following table sets forth certain operating information for each of the five years ended December 31, 1996.
Risk Management, Safety and Insurance. The risk of substantial losses arising from traffic accidents is inherent in any transportation business. Morgan carries insurance to cover such losses up to $20 million per occurrence with a deductible of up to $250,000 per occurrence for personal injury and property damage. The frequency and severity of claims under the Company's liability insurance affect the cost, and potentially the availability, of such insurance. If Morgan is required to pay substantially greater insurance premiums, or incurs substantial losses above $20 million or substantial losses below its $250,000 deductible, its results of operations can be materially adversely affected. There can be no assurance that Morgan can continue to maintain its present insurance coverage on acceptable terms.
Interstate Indemnity Company ("Interstate"), a wholly-owned insurance subsidiary of the Company, makes available physical damage insurance coverage for the Company's owner-operators. Interstate also writes performance surety bonds for Morgan Drive Away, Inc.
Regulation. Morgan's interstate operations are subject to regulation by the Federal Highway Administration, which is an agency of the United States Department of Transportation ("D.O.T."). Effective August 26, 1994, essentially all motor common carriers were no longer required to file individually determined rates, classifications, rules or practices with the Interstate Commerce Commission ("I.C.C.") Effective January 1, 1995, the economic regulation of certain intrastate operations by various state agencies was preempted by federal law. The states will continue to have jurisdiction primarily to insure that carriers providing intrastate transportation services maintain required insurance coverage, comply with all applicable safety regulations, and conform to regulations governing size and weight of shipments on state highways. Most states have adopted D.O.T. safety regulations and conform to regulations governing size and weight of shipments on state highway, and actively enforce them in conjunction with D.O.T. personnel.
Carriers normally are required to obtain authority from the I.C.C. or its successor as well as various state agencies. Morgan is approved to provide transportation from, to, and between all points in the continental United States.
Morgan provides contract and non-contract transportation services to the shipping public pursuant to governing rates and charges maintained at its corporate and various dispatching offices. A contract carrier provides transportation services pursuant to a written contract designed to meet a customer's specific shipping needs or by dedicating equipment exclusively to a given customer for the movement of a series of shipments during a specified period of time.
Federal regulations govern not only operating authority and registration, but also such matters as the content of agreements with owner- operators, required procedures for processing of cargo loss and damage claims, and financial reporting. Morgan believes that it is in substantial compliance with all material regulations applicable to its operations.
The D.O.T. regulates safety matters with respect to the interstate operations of Morgan. Among other things, the D.O.T. regulates commercial driver qualifications and licensing; sets minimum levels of carrier liability insurance; requires carriers to enforce limitations on drivers' hours of service; prescribes parts, accessories and maintenance procedures for safe operation of freight vehicles; establishes noise emission and employee health and safety standards for commercial motor vehicle operators; and utilizes audits, roadside inspections and other enforcement procedures to monitor compliance with all such regulations. Recently, the D.O.T. has established regulations which mandate random, periodic, pre-employment, post-accident and reasonable cause drug testing for commercial drivers. The D.O.T. has also established similar regulations for alcohol testing. Morgan believes that it is in substantial compliance with all material D.O.T. requirements applicable to its operations.
From time to time, tax authorities have sought to assert that owner operators in the trucking industry are employees, rather than independent contractors. No such tax claim has been successfully made with respect to Morgan. Under existing industry practice and interpretations of federal and state tax laws, as well as Morgan's current method of operation, Morgan, based on the advice of counsel, maintains that its owner operators are not employees. Whether an owner operator is an independent contractor or employee is, however, generally a fact-sensitive determination and the laws and their interpretations can vary from state to state. There can be no assurance that tax authorities will not successfully challenge this position, or that such tax laws or interpretations thereof will not change. If the owner operators were determined to be employees, such determination could materially increase Morgan's employment tax and workers' compensation exposure.
Interstate, Morgan's insurance subsidiary, is a captive insurance company incorporated under Vermont law. It is required to report annually to the Vermont Department of Banking, Insurance & Securities and must submit to an examination by this Department on a triennial basis. Vermont regulations require Interstate to be audited annually and to have its loss reserves certified by an approved actuary. Morgan believes Interstate is in substantial compliance with Vermont insurance regulations.
III. MANUFACTURING
A. Spinnaker Industries, Inc. ("Spinnaker")
Spinnaker's Common Stock and Class A Common Stock are traded in the over-the-counter market under the symbol "SPNI" and SPNI-A, respectively, and are listed in the National Association of Securities Dealers Automated Quotations System (NASDAQ). In August 1996, Spinnaker changed the name of its existing Common Stock to Class A Common Stock and declared a stock dividend of one share of a new Common Stock for each share of Class A Common Stock outstanding. At December 31,1996, Registrant owned 2,237,203 shares of Spinnaker Common Stock, approximately 72.8% of the outstanding, and 2,259,063 shares of Class A Common Stock, approximately 73.5% of the outstanding.
In June 1994, Spinnaker entered into an agreement with Boyle, Fleming, George & Co., Inc. ("BF"), for BF to provide operating and strategic management to Spinnaker. In addition to a management fee, BF received a warrant to purchase 678,945 shares of Spinnaker Class A Common Stock and Common Stock (20%) at a price of $2.67 for one share of both Common Stock and Class A Common Stock (adjusted for the 3 for 2 stock splits in December 1994, December 1995 and the August 1996 Common Stock Dividend). In April 1996, BF exercised warrants to purchase 187,476 shares of Common Stock and Class A Common (adjusted for the August 1996 Stock Dividend). In August 1996, the Management Agreement with BF was terminated and Messrs. Richard J. Boyle and Ned Fleming III became employees of Spinnaker.
Spinnaker is in discussion with potential underwriters concerning a possibly offering of Spinnaker common stock, although there can be no assurance that an offering will be accomplished on terms satisfactory to Spinnaker.
Spinnaker is a leading manufacturer and marketer of adhesive carton sealing tape and adhesive-backed label stock, primarily for the carton sealing tape and pressure sensitive label stock markets. Spinnaker's products are grouped into two principal businesses that accounted for the following percentages of 1996 net sales: pressure and water sensitive carton sealing tape (51%) and adhesive-backed label stock (46%). For the fiscal year ended December 31, 1996, Spinnaker had net sales of $246.5 million.
Spinnaker has three 100% owned subsidiaries: Brown-Bridge Industries, Inc.("Brown-Bridge"), 80.1% of which was acquired in September 1994, Central Products Company ("Central Products"), acquired in October 1995 and Entoleter, Inc. ("Entoleter"), which it has owned since Registrant acquired Spinnaker in 1987. In October 1996, Spinnaker acquired the remaining 19.9% of outstanding stock of Brown-Bridge (plus management stock options), which were owned by the management of Brown-Bridge, BF and Registrant. Brown-Bridge is in the adhesive-coated paper industry. Central Products manufactures carton sealing tape. Entoleter manufactures a line of industrial process equipment and a line of air pollution equipment.
Central Products
Central Products' carton sealing tape is used for the packaging of goods for shipment by manufacturing, retail or distribution companies. Central Products manufactures pressure sensitive tape with all three primary adhesive technologies: acrylic, hot melt and natural rubber. It also offers three types of water sensitive tape: paper tape, fiberglass reinforced tape and box tape. Central Products believes it is the only United States supplier to manufacture both pressure sensitive tape and water sensitive tape, and is the only company to produce pressure sensitive tape utilizing all three pressure sensitive adhesive technologies.
Pressure Sensitive Tape. Pressure sensitive tape is manufactured primarily through the coating of plastic film with a thin layer of acrylic, hot melt or natural rubber adhesive. The adhesive is applied to various grades of high-quality, low-stretch polypropylene film for use in most applications as well as PVC and polyester films which are used for certain specialized applications. Acrylic adhesives, which are noted for their clarity, non-yellowing properties, good temperature resistance and low application cost, are best suited for manual applications on light and medium carton sealing situations. Hot melt adhesives, noted for their quiet release and easy unwind during application, are the most widely used pressure sensitive adhesives because they satisfy 90% of all carton sealing requirements. Natural rubber adhesives are unique because of their aggressive adhesion properties and, although they are ideal for recycled content cartons and cartons requiring hot, humid or cold packing, transportation and storage, they can be used for a wide variety of surface conditions and extreme temperature tolerances. Central Products' pressure sensitive tapes are sold under the trade names Alltac and Central .
Water Sensitive Tape. Water sensitive tape is generally manufactured through the application of a thin layer of water sensitive adhesive to gumming kraft paper. It is offered as either non-reinforced (paper) tape or fiberglass reinforced tape. Non-reinforced tape is made by applying an adhesive to a single layer of high tensile strength kraft paper coated with Central Products' patented starch-based adhesive. Non-reinforced tapes are totally biodegradable and are used in light to medium carton sealing applications. Fiberglass reinforced tape contains a layer of fiberglass yarn placed between two layers of kraft paper, and is typically used to seal heavy packages or on cartons that will be subject to a high level of abuse during shipping and is also favored in shipping high value goods due to its strong sealing qualities. Both non-reinforced tape and fiberglass reinforced tape are available in light, medium and heavy grades. Central Products' water sensitive carton sealing tapes are sold under the trade names Glasseal , Central , Green Core and Tru-Seal .
Central Products also supplies tape dispensing equipment manufactured by other companies. It currently offers a broad line of carton sealing equipment for pressure sensitive tape, which ranges from hand held dispensers to automatic random sizing equipment. Central Products also offers two types of table top dispensers for water sensitive tape a manual dispenser and a more expensive electric dispenser.
Brown-Bridge
Brown-Bridge develops, manufactures and markets adhesive-backed label stock that is converted by printers and industrial users into products that are utilized for marking, identifying, labeling and decorating applications and products. Brown-Bridge's products are offered in three primary adhesive categories: pressure sensitive, water sensitive and heat sensitive.
Pressure Sensitive. Pressure sensitive products, which are activated by the application of pressure, are manufactured with a three element construction consisting of face stock, adhesive coating and silicone coated release liner. The adhesive product is sold in roll or sheet form for further conversion into products used primarily for marking, identification and promotional labeling. Brown-Bridge's pressure sensitive products are sold under the trade names Strip Tac and Strip Tac Plus . Roll pressure sensitive products are generally sold to label printers that produce products used primarily for informational labels (shipping labels, price labels, warning labels, etc.), product identification and postage stamps. Sheet pressure sensitive products are sold to commercial sheet printers, who provide information labels and other products (such as laser printer stock). During fiscal 1996, pressure sensitive products constituted approximately 87% of Brown-Bridge's net sales.
Water Sensitive. Water sensitive products, which are activated by the application of water, include a broad range of paper and cloth materials, coated with a variety of adhesives. The adhesive coated products are sold in roll or sheet form for further conversion to postage and promotional stamps, container labels, inventory control labels, shipping labels and splicing, binding and stripping tapes. The water sensitive line is sold under the trade name Pancake and consists of three product groups: dry process, conventional gummed and industrial. Dry process is sold primarily for label and business form uses. Conventional gum products serve many of the same end uses for hand applied labels as dry process stock. A major portion of these products is sold for government postage and promotional stamp uses. Industrial products are sold in several niche markets, such as electrical and other specialty markets.
Heat Sensitive. Heat sensitive products, which are activated by the application of heat, are manufactured by coating a face stock with either a hot melt coating or an emulsion process adhesive. The heat sensitive product line is sold primarily for labeling end uses, such as pharmaceutical bottles, meat and cheese packages, supermarket scales, cassettes and bakery packages. The adhesive coated product is sold in roll or sheet form for further conversion. Brown-Bridge's heat sensitive products are sold under the trade name Heat Seal.
Marketing and Customers
Spinnaker markets its broad range of products to a variety of customers. During 1996, no single customer accounted for more than 10% of Spinnaker's net sales.
Central Products' marketing and sales strategy emphasizes supplying a full line of both water sensitive and pressure sensitive tape products to the carton sealing tape industry. Central Products sells its products directly to over 1,500 paper distributors (customers), who in turn resell these tape products to the end user markets. In addition, Central Products sells private-brand carton closure tapes direct to large customers who in turn distribute the products under their name to end users. Central Products provides its distributor customers with a high level of product education to enable them to better sell the Company's products.
Brown-Bridge generally markets its products through its own sales representatives to regional and national printers, converters and merchants. The majority of sales represent product sold and shipped from Brown-Bridge's facilities in Troy, Ohio. However, to broaden its market penetration, Brown-Bridge also contracts with seven regional processors throughout the United States, with whom Brown-Bridge stores product until sold. Generally, these processors perform both slitting and distribution services for Brown-Bridge.
Manufacturing and Raw Materials
Spinnaker produces all adhesive technologies for carton sealing tape and adhesive-backed label stock. It produces carton sealing tapes and label stock for a variety of standard and custom applications requiring water, pressure and heat sensitive technologies. Spinnaker believes its strong manufacturing capabilities enable it to maintain high product quality and low operating costs and respond to customers' needs quickly and efficiently.
Raw materials are the most significant cost component in Spinnaker's production process. The material component accounts for approximately 65% to 70% of the total cost of its products, with the most important raw materials being paper (gumming kraft and face stock), adhesive materials, fiberglass, and polypropylene resin. These materials are currently readily available and are procured from numerous suppliers.
Among Spinnaker's manufacturing strengths at its Central Products water sensitive tape operation are fully integrated, computerized coating and laminating machines, fully automated slitting, rewinding and packaging machines and a state of the art print shop. At its pressure sensitive tape operation, they include an in-house film line for production of polypropylene film and an advanced computerized coating machine for each of the three adhesive technologies.
See Item 2
ITEM 2. PROPERTIES
Lynch leases space containing approximately 3,400 square feet for its executive offices in Greenwich, Connecticut.
LM's operations are housed in two adjacent buildings situated on 3.19 acres of land in Bainbridge, Georgia. In January 1997, LM completed an expansion of its manufacturing capacity at this site, which added approximately 15,000 square feet, bringing total manufacturing space to approximately 73,000 square feet. Finished office area in the two buildings totals approximately 17,000 square feet. All such properties are subject to security deeds relating to loans.
M-tron's operations are housed in two separate facilities in Yankton, South Dakota. These facilities contain approximately 34,000 square feet in the aggregate. One facility owned by M-tron contains approximately 18,000 square feet and is situated on 5.34 acres of land. This land and building are subject to a mortgage executed in support of a bank loan. The other Yankton facility containing approximately 16,000 square feet is leased, which lease expires on September 30, 1997.
Spinnaker's corporate headquarters is located in Dallas, Texas, where it shares office space with an affiliate of its principal executive officers.
Brown-Bridge owns two manufacturing facilities, Plant One and Plant Two, in Troy, Ohio. Plant One is a 200,000 square foot complex located on approximately five acres of land adjacent to the Miami River and Plant Two is a 98,000 square foot facility located on approximately five aces of land nearby. There are approximately five undeveloped acres of land adjacent to Plant Two that are available for expansion. Both facilities house manufacturing, administrative and shipping operations.
Central Products owns one manufacturing facility in Menasha, Wisconsin and leases another in Brighton, Colorado. The Menasha facility contains approximately 160,000 square feet and the Brighton facility whose lease expires in 2014, contains approximately 210,000 square feet. The corporate office and center for administrative services are located in a 20,000 square foot facility adjacent to the Menasha plant. Central Products also maintain two leased distribution centers in Neenah, WI (90,000 square feet), and Denver, CO (100,000 square feet).
Entoleter owns a manufacturing plant containing 72,000 square feet located on approximately 5 acres of land in Hamden, Connecticut. The land and building are subject to a mortgage and security agreement executed in support of a bank loan. Entoleter also owns approximately 6 unimproved acres located in Hamden, Connecticut adjacent to its property.
During 1996 and 1995, Registrant's manufacturing facilities operated in the aggregate at a relatively high level of capacity utilization.
Morgan owns approximately 24 acres of land with improvements in Elkhart, Indiana. The improvements include a 23,000 square foot office building used as Morgan's principal office, a 7,000 square foot leased building containing additional offices leased to one of its customers, a 9,000 square foot building used for Morgan's safety and driver service departments and also for storage and an 8,000 square foot building used as a garage to service company-owned vehicles. Most of Morgan's 11 regional and 127 dispatch offices are situated on leased property. Morgan also owns and leases property for parking and storage of equipment at various locations throughout the United States, usually in proximity to manufacturers of products moved by Morgan. The property leases have lease term commitments of a minimum of thirty days and a maximum of three years, at monthly rental ranging from $100 to $9,750. The Elkhart facility is currently mortgaged to one of Morgan's lenders. In total, Morgan owns 73 acres of land throughout the United States, including the Elkhart facilities. Morgan is in the process of selling 38 acres located at four property locations, two of which are associated with exiting the "truckaway" operation.
Western New Mexico Telephone Company owns a total of 16.4 acres at twelve sites located in southwestern New Mexico. Its principal operating facilities are located in Silver City, where Western owns a building comprising a total of 6,480 square feet housing its administrative offices and certain storage facilities. In Cliff, Western owns five buildings with a total of 14,055 square feet in which are located additional offices and storage facilities as well as a vehicle shop, a wood shop, and central office switching equipment. Smaller facilities, used mainly for storage and for housing central office switching equipment, with a total of 8,384 square feet, are located in Lordsburg, Reserve, Magdalena and five other localities. In addition, Western leases 1.28 acres on which it has constructed four microwave towers and a 120 square-foot equipment building. Western has the use of 34 other sites under permits or easements at which it has installed various equipment either in small company-owned buildings (totaling 4,757 square feet) or under protective cover. Western also owns 3,221 miles of buried copper cable and 421 miles of buried fiber optic cable running through rights-of-way within its 15,000 square-mile service area. All Western's properties described herein are encumbered under mortgages held by the Rural Utilities Service.
Inter-Community Telephone Company owns 12 acres of land at 10 sites. Its main office at Nome, ND, contains 4,326 square feet of office and storage space. In addition, it has 4,400 square feet of garage space and 5,035 square feet utilized for its switching facilities. Inter-Community has 1,728 miles of buried copper cable and 172 miles of buried fiber optic cable. All of Inter-Community's properties described herein are encumbered under mortgages held by the National Bank for Co-Operatives ("Co-Bank").
Cuba City Telephone is located in a 3,800 square foot brick building on 0.4 of an acre of land. The building serves as the central office, commercial office, and garage for vehicle and material storage. The company also owns a cement block storage building of 800 square feet on 0.1 of an acre. In Madison, Wisconsin, Cuba City leases 900 square feet for administrative headquarters and financial functions. Belmont company is located in a cement block building of 800 square feet on .5 acre of land in Belmont, Wisconsin. The building houses the central office equipment for Belmont. The companies own a combined total of 217 miles of buried copper cable and 26 miles of fiber optic cable. All of Cuba City's and Belmont's property described herein are encumbered under mortgages held by the REA and Rural Telephone Bank, respectively.
J.B.N. Telephone Company owns a total of approximately 2.25 acres at fifteen sites located in northeast Kansas. Its administrative and commercial office consisting of 2,820 square feet along with a 1,600 square feet garage and warehouse facility are located in Wetmore, Kansas. In addition, J.B.N. owns thirteen smaller facilities housing central office switching equipment and over 947 miles of buried copper cable. All properties described herein are encumbered under mortgages held by the Rural Utilities Service.
Haviland Telephone Company owns a total of approximately 3.9 acres at 20 sites located in south central Kansas. Its administrative and commercial office consisting of 4,450 square feet is located in Haviland, Kansas. Its addition, Haviland owns 19 smaller facilities housing garage, warehouse, and central office switching equipment and over 1,500 miles of buried copper cable. All properties described herein are encumbered under a mortgage to Co-Bank.
Dunkirk & Fredonia Telephone Company (including its subsidiaries) own a total of approximately 9 acres at 10 sites located in western New York. Its host central office switching equipment, administrative and commercial offices consisting of 18,297 square feet is located in Fredonia, New York. In addition, Dunkirk & Fredonia owns nine other smaller facilities housing garage, warehouse and central office switching equipment and over 111 miles of buried copper cable and 19 miles of fiber optic cable.
CLR has its headquarters in leased space in Wetmore, Kansas. It also owns one small parcel of land and leases 22 small sites, which it uses for its cable receiving and transmission equipment. All properties described herein are encumbered under a mortgage to Co-Bank.
It is the Registrant's opinion that the facilities referred to above are in good operating condition and suitable and adequate for present uses.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Registrant is a party to certain lawsuits in the ordinary course of business.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET PRICE INFORMATION AND COMMON STOCK OWNERSHIP
The Common Stock of Lynch Corporation is traded on the American Stock Exchange under the symbol "LGL." The market price high and lows in consolidated trading of the Common Stock during the past two years is as follows:
The Registrant did not declare any dividends in 1996 or 1995. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations below.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Notes:
(a) Includes results of Inter-Community Telephone Company from April 2, 1991, Cuba City Telephone Exchange and Belmont Telephone Company from October 31, 1991, Bretton Woods Telephone Company from February 4, 1992, J.B.N. Telephone Company for November 30, 1993, the assets of Station WOI-TV from March 1, 1994, the assets of Brown Bridge Division from September 19, 1994, Haviland Telephone Company from September 26, 1994, Central Products Company from October 4, 1995 and Dunkirk and Fredonia Telephone Company from November 26,1996. (b) EBITDA is earnings before interest, taxes, depreciation and amortization. (c) Operating Profit (Loss) is sales and revenues less operating expenses, which excludes investment income, interest expense, share of operations of affiliated companies, minority interests and taxes. (d) Discontinued operations of Lynch Tri-Can International. (e) Gain (Loss) on repurchase or redemption of Company's 8% convertible subordinated debentures for years 1994, 1993, and 1992 and early extinguishment of debt at Spinnaker in 1996. (f) On January 1, 1993, Lynch adopted the provisions of Statement of Financial Accounting Standard No., 109, "Accounting for Income Taxes." (See Note 9 to the Consolidated Financial Statements.) As a result of this adoption, for the years ended December 31, 1994 and 1993, Operating Profit was lower by $766,000 due to the higher depreciation and amortization as a result of increased write-ups in assets acquired in prior business combinations. The adoption of this statement had no effect on net income, other than the above noted "Cumulative Effect of Accounting Change Adjustment" for that period. (g) Based on weighted average number of common shares outstanding. (h) No dividends have been declared over the period.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
RESULTS OF OPERATIONS
YEAR 1996 COMPARED TO 1995
Revenues increased to $451.9 million in 1996 from $333.6 million in 1995, a 35.5% increase. Acquisitions made during late 1995, principally in the manufacturing segment, were the most significant contributors to the increase. In the manufacturing segment, revenues increased by $103.4 million to $291.1 million versus $187.7 million in 1995, or 55%. Central Products Company, which was acquired on October 4, 1995, contributed $126.4 million in 1996 versus $30.6 million in 1995. 1996's manufacturing revenues also reflect $26.1 million from Lynch Machinery, Inc., a decrease of $6.2 million when compared with 1995 results. This decline was a result of lower production activities associated with extra-large glass presses versus 1995. Three extra-large glass presses were shipped in 1996 versus eleven in 1995. The services segment, which represents 29.3% of total revenue, increased by $9.9 million from 1995 or 8%. In the multimedia segment, which represents 6.3% of total revenue, revenues increased by $5.0 million. The inclusion of CLR Video for the full year($1.4 million), increased revenues at Western New Mexico($1.8 million) and the acquisition of Dunkirk & Fredonia Telephone ($.9 million) were the major factors contributing to the growth in the multimedia segment.
Earnings before interest, taxes, depreciation and amortization (EBITDA) increased to $33.9 million in 1996 from $31.1 million in 1995, a $2.8 million, or a 9% increase. Operating segment EBITDA (prior to corporate management fees and expenses) grew to $37.3 million from $35.0 million, a 7% increase. The manufacturing segment represented 67% of EBITDA or $22.8 million, an increase of $5.7 million versus 1995. The full year inclusion of Central Products whose EBITDA contribution was $10.9 million in 1996 versus $2.7 million in 1995 accounted for $8.2 million of the increase. This increase was offset by lower EBITDA at Lynch Machinery of $2.6 million when compared to 1995 results due to lower sales volume of the extra-large glass presses. The services segment had negative EBITDA of ($1.8) million versus $4.7 million in 1995. The decline was attributable to (a)a $3.5 million loss reserve taken by Morgan relating to the closing of the Truckaway Division and related real estate and (b) a decrease in recreational vehicle margins due to reduced demand and higher driver pay and insurance claims. The multimedia segment contributed $15.3 million or 45.0% of total EBITDA versus $12.3 million in 1995.
Operating profits for 1996 were $16.9 million in 1996, a decrease of $2.9 million or 15% versus 1995. Operating profits in the services segment declined by $6.6 million due to the same factors impacting EBITDA. This decline was partially offset by improvements in the manufacturing, multimedia and corporate segments of $1.5 million, $1.7 million and $.5 million, respectively.
Investment income decreased by $.9 million to $2.2 million in 1996 versus 1995. The decrease was related to lower dollar investments in generating current income.
Interest expense increased by $6.2 million in 1996 when compared to 1995. The increase is due primarily to the full year effect of financing the acquisition of CPC in late 1995.
Gain on sales of subsidiary and affiliate stock increased by $5.1 million in 1996. This increase is the result of the conversion of a $6.0 million Spinnaker Note into Spinnaker Common Stock in 1996 and other transactions.
The 1996 tax provision of $3.0 million, included federal, state and local taxes and represents an effective rate of 40.8% versus 39.2% in 1995.
Results of discontinued operations reflect the disposal Tri-Can International, a manufacturer of packaging machinery. The assets sold consisted primarily of inventory and intangibles. As a result of this disposal, a loss of $.5 million net of taxes and minority interest was recorded. In addition, the operating results of Tri-Can have been classified as discontinued operations and result in net operating losses of $.3 million in 1996 versus $.3 million in 1995.
Loss on early extinguishment of debt, net of taxes and minority interest, resulted in an extraordinary charge to income of $1.3 million in 1996. The early extinguishment of debt is the result of Spinnaker Industries issuing $115 million of Senior secured debt due in 2006. The debt proceeds were used to extinguish substantially all bank debt, bridge loans and lines of credit at Spinnaker and its major operating subsidiaries.
YEAR 1995 COMPARED TO 1994
Revenues increased to $333.6 million in 1995 from $183.2 million in 1994, an 82% increase. Acquisitions made during 1995 and 1994, principally in the manufacturing segment, were the most significant contributors to the increase. In the manufacturing segment, where revenues increased by $126.5 million to $187.7 million in 1995 from $61.2 million in 1994, or 207%. The acquisition of Brown-Bridge Industries, Inc. on September 19, 1994, contributed $97.2 million in revenues for 1995 versus $26.8 million in 1994. This represents 56% of the total manufacturing increase. The acquisition of Central Products Company on October 4, 1995, contributed $30.6 million, or 24% of the segment's revenues increase. 1995's manufacturing revenues also reflect $32.3 million from Lynch Machinery, Inc. compared to $15.1 million in 1994, 14% of the segment's revenue increase. The production of extra-large glass presses from orders contracted for in 1994 and 1995 resulted in this additional revenue. Fifteen glass presses were shipped in 1995, compared to eight in 1994. Of the presses shipped in 1995, eleven were advanced technology extra-large presses. As a result of the shipment of these presses in 1995, Lynch Machinery glass press backlog was reduced by $11.5 million to $13.3 million at December 31, 1995 from $24.8 million at December 31, 1994. While Lynch Machinery is in the process of bidding for additional glass press contracts, it is not anticipated that the level of production in 1996 will equal 1995 levels. The services segment, which represents 37% of total revenue, increased by $20.4 million from 1994 or 20%. The Morgan Group, Inc.'s results increased due to continued strength in manufactured housing shipments (industry shipments up 12%) and the acquisition of Transfer Drivers, Inc. in May 1995. In the multimedia segment, which represents 7% of total revenue, revenues increased by $3.5 million from 1994, or 17%. Haviland Telephone Company, which was acquired on September 26, 1994, contributed 74% of the increase. The inclusion of Central Products for the full year plus additional acquisitions contracted for in 1995 and anticipated to close in 1996 are projected to increase reported revenues by about 40% in 1996 from 1995.
Earnings before interest, taxes, depreciation and amortization (EBITDA) increased to $31.1 million in 1995 from $18.4 million in 1994, a $12.7 million, or 69% increase. Operating segment EBITDA (prior to corporate management fees and expenses) grew to $ 35.0 million from $20.6 million, a 70% increase. The manufacturing segment was the largest contributor to EBITDA with $17.1 million, or 55% in 1995, as compared to $4.7 million, or 26% in 1994. Spinnaker's EBITDA grew to $8.0 million from $1.1 million, a $6.9 million increase. The inclusion of Brown-Bridge for the full year accounted for $3.9 million of the increase in 1995. Central Products' EBITDA of $2.7 million in the fourth quarter primarily accounted for the remaining increase. Lynch Machinery accounted for 32% of the total increase in manufacturing EBITDA. Profit margins associated with the production of extra-large glass were the cause of the significant improvement. The services segment contributed $4.6 million, or 15%, compared to $4.3 million, or 24% in 1994. This increase was directly the result of the increased revenues offset by a product mix shift and increases in certain operating costs. The multimedia segment contributed 40% of total EBITDA in 1995, or $12.3 million, as compared to $10.9 million, or 59% of total EBITDA in 1994. The inclusion of Haviland represents 79% of this increase. The inclusion of Central Products for the full year plus additional acquisitions made in 1995 and anticipated to close in 1996 are projected to increase reported EBITDA by about 50% in 1996 from 1995.
Operating profits increased to $19.8 million in 1995 from $10.9 million in 1994, $8.9 million or 82% increase. The breakdown of the increases and the primary causes are the same as the above discussion regarding EBITDA.
Investment income increased in 1995 from 1994 primarily reflecting additional net gains in marketable securities.
Interest expense increased during 1995 primarily as a result of the debt incurred for acquisition needs in 1995 and 1994 for Central Products and Brown-Bridge.
The full year effect of the financing for the Central Products acquisition is expected to significantly increase interest expense.
The 1995 income tax provision of $4.9 million, included federal, state and local taxes and represents an effective rate of 39.2% versus 40.1% in 1994. The rate is effected by a provision for the repatriating of earnings by subsidiaries that are not consolidated for income tax purposes (Morgan), a change in its deferred tax reserve associated with income (1995) and losses (1994) related to the Company's equity investee, a reduction in taxes attributable to a special election available to Morgan's captive insurance company. It should be noted that Morgan is consolidated for financial statement purposes, but in accordance with FASB 109 "Accounting for Income Taxes", a deferred tax liability is recognized for the difference between the financial reporting basis and the tax basis of the investment in Morgan created by current earnings.
Income before extraordinary items and discontinued operations was $5.5 million, or $3.89 per share in 1995 as compared to $2.7 million or $2.02 in 1994. These amounts include the gain on the sale of affiliate stock which contributed $35,000 to net income, or $.02 per share in 1995 and $190,000, or $0.14 per share in 1994. Results of discontinued operations reflect the operating results of Tri-Can which has been re-classified as discontinued. During 1994, the Company recorded an extraordinary item which represented the loss on the redemption of the Company's 8% Convertible Subordinated Debentures. This loss was $264,000, or $0.20 per share.
FINANCIAL CONDITION
As of December 31, 1996, the Registrant had current assets of $140.1 million and current liabilities of $98.5 million. Working capital was therefore $41.6 million as compared to $25.6 million at December 31, 1995, primarily due to the decline in current maturities of long-term debt as a result of the high yield offering at Spinnaker Industries and acquisitions made during 1995.
Within the elements of current assets, cash and cash equivalents increased by $18.0 million, primarily due to the sale of marketable securities and short-term investments of $9.4 million, inclusion of Dunkirk and Fredonia ($4.4 million) and an increase of approximately $6.5 million at Spinnaker due to changes in working capital demands offset by a reduction of $1.5 million at Lynch Machinery (see Consolidated Statement of Cash Flow for additional elements). Inventories increased by $3.6 million primarily due to increases at Central Products and Brown Bridge. Within current liabilities, notes due to banks increased by $7.8 million, primarily due to borrowing under the holding company's line of credit. Cash flow from operations as presented in the Consolidated Statement of Cash Flow increased by $1.9 million, primarily due to increased EBITDA from the Company's operating entities, and net sales of trading securities offset by an increase in other net working capital components.
Capital expenditures were $25.5 million in 1996 and $19.6 million in 1995 due to significant deployment of enhanced technology by our telephone operations, installation of the silicone paper coating machine at Brown-Bridge and the inclusion of Central Products for the full year in 1996. This increased level of capital expenditures is expected to decline in 1997 in the multimedia segment as upgrade programs wind down and absence of large machine investments in manufacturing. Overall 1997 capital expenditures are expected to be approximately 15% - 20% below the 1996 level.
At December 31, 1996, total debt was $260.8 million, which was $73.4 million more than the $187.4 million at the end of 1995. Total debt was significantly impacted by: the acquisition of Dunkirk and Fredonia Telephone Company, with a total of $25.8 million of debt incurred and assumed and Registrant's investment in PCS partnerships of $27.1 million, with the remainder attributable principally to Spinnaker. Debt at year end 1996 included $234.9 million of fixed interest rate debt, at an average cash interest rate of 9.1% and $25.8 million of variable interest rate debt at an average interest rate of 8.2 %. Additionally, the Company had $50.8 million in unused short-term lines of credit of which $39.3 million was attributed to Spinnaker, and $4.2 million of which was attributable to Morgan. As of December 31, 1996, the Parent Company borrowed $11.9 million under a $12.0 million short-term line of credit facility. These funds were primarily used to fund the bids by affiliated partnerships in the PCS Auctions. This short- term line of credit expires April 15, 1997. Management anticipates that this line will be renewed for one year but there is no assurance that it will be.
Backlog in the manufactured products segment at December 31, 1996 was $20.9 million versus $34.0 million at the end of 1995. Backlog at Lynch Machinery was $6.6 million at December 31, 1996, and $16.9 million at December 31, 1995. The lack of significant orders coupled with the elimination of product lines caused the decrease. Orders of $9 million were booked in early 1997, somewhat compensating for the decline in 1996. Backlog at Brown-Bridge declined by $2.6 million in 1996 to $3.1 million at December 31, 1996. Backlog at Central Products increased by $1.4 million in 1996 to $4.5 million at December 31, 1996.
Since 1987, the Board of Directors of Lynch has authorized the repurchase of 300,000 common shares. At December 31, 1996, Lynch's remaining authorization is to repurchase an additional 69,139 shares of common stock.
The Board of Directors has adopted a policy not to pay dividends; and such policy is reviewed annually. This policy takes into account the long term growth objectives of the Company; especially its acquisition program, shareholders' desire for capital appreciation of their holdings and the current tax law disincentives for corporate dividend distributions. Accordingly, no cash dividends have been paid since January 30, 1989 and none are expected to be paid in 1997.
Lynch Corporation maintains an active acquisition program and generally finances each acquisition with a significant component of debt. This acquisition debt contains restrictions on the amount of readily available funds that can be transferred to Lynch Corporation from its subsidiaries.
Registrant has a minority position in several entities to which it has funding commitments. These entities participated in two of the auctions conducted by the Federal Communications Commission for 30 megahertz and 10 megahertz of broadband spectrum to be used for personal communications services, the so-called "C" and "F" Block Auction, respectively. In the C-Block Auction, such entities acquired 30 licenses to provide personal communications services to geographic areas of the United States with a total population of 7.0 million. The cost of these licenses was $216.2 million, $194.0 million of the cost of these licenses was funded via a loan from the United States Government. The loan requires quarterly interest payments at 7% (Registrant argues strenuously that the interest rate should have been 6.51%, the applicable treasury rate at the time the licenses were awarded), and with quarterly principal amortization in years 7, 8, 9, and 10. As of December 31, 1996, Registrant invested $598,000 in partnership equity and $20.4 million in loans and has funding commitments to provide an additional $20.2 million in loans, including funding quarterly interest on the Government debt of $3.4 million. In the F-Block Auction, an entity in which Lynch holds a minority position acquired five licenses to provide personal communications services in geographic areas of the United States with a total populations of 20 million. The cost of these licenses was $19.9 million. $16.5 of the cost of the licenses will be financed with a loan from the United States Government. The interest rate on the loan will be the long- term Government rate at the date of issuance and with quarterly principal amortization in years 3 to 10. As of December 31, 1996 Registrant has invested $99,000 in partnership equity and provided the entity with a loan of $11.8 million funded by a short-term secured borrowing by the Registrant. $10 million of this loan was returned in January 1997; however, Registrant continues to have a funding commitment to provide $10 million in loans to the entity. Registrant is currently seeking alternatives to minimize or raise funds for its funding commitments to the entities, but currently expects to fund required interest payments. There are many risks associated with personal communications services. In addition, funding aspects of acquisition of licenses and the subsequent mandatory build out requirements plus the amortization of the license, could significantly and materially impact the Registrant's reported net income over the next several years. Of note, under the current structure the ramifications of this should not impact reported revenues and EBITDA in the future.
In mid-March 1997, Registrant acquired 60% of the stock of Upper Peninsula Telephone Company for approximately $15.3 million with a short-term secured bridge financing. Registrant is currently seeking permanent financing to replace the bridge financing and to finance the acquisition of the remaining stock of Upper Peninsula.
In December, 1996, the Registrant's Board of Directors announced that it is examining the possibility of splitting, through a "Spin-off", either its communications operations or its manufacturing operations. A spin-off could improve management focus, facilitate and enhance financings and set the stage for future growth, including acquisitions. A split could also help surface the underlying values of the company as the different business segments appeal to differing "value" and "growth" cultures in the investment community. There are a number of matters to be examined in connection with a possible spin-off, including tax consequences, and there is no assurance that such a spin-off will be effected.
Lynch Corporation has a significant need for resources to fund the operation of the holding company, and meet its current funding commitments, including those related to personal communications services, and fund future growth. Lynch is currently considering various alternative long and short-term financing arrangements. One such alternative would be to sell a portion or all of certain investment in operating entities. Additional debt and/or equity financing vehicles are also being considered. While management expects to obtain adequate financing resources to enable the company to meet its obligations, there is no assurance that such can be readily obtained or at reasonable costs.
See Item 1.V above re Forward Looking Information.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Item 14(a).
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
In March 1994, The Morgan Group, Inc., a publicly traded subsidiary of the Registrant, approved Arthur Andersen LLP to replace Ernst & Young as its auditors for 1994 and 1995. For 1996, Ernst & Young, Registrant's auditors, replaced Arthur Andersen LLP as auditors for The Morgan Group, Inc. See Registrant's Form 8-K dated March 19, 1996 which is incorporated herein by reference.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item 10 is included under the caption "Executive Officers of the Registrant" in Item 1 hereof and included under the captions "Election of Directors" and "Section 16(a) Reporting" in Registrant's Proxy Statement for its Annual Meeting of Shareholders for 1997, which information is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item 11 is included under the caption "Compensation of Directors," under the captions "Executive Compensation," "Executive Compensation and Benefits Committee Report on Executive Compensation" and "Performance Graph" in Registrant's Proxy Statement for its Annual Meeting of Shareholders for 1997, which information is incorporated herein by reference. The Performance Graph in the Proxy Statement shows that Registrant's Common Stock under performed the American Stock Exchange Market Value Index and the American Stock Exchange Service Industry Index in 1993 and over performed said indices in 1992, 1994, 1995 and 1996.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item 12 is included under the caption "Security Ownership of Certain Beneficial Owners and Management," in the Registrant's Proxy Statement for its Annual Meeting of Shareholders for 1997, which information is included herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item 13 is included under the caption "Executive Compensation", "Transactions with Certain Affiliated Persons" and "Compensation Committee Interlocks and Insider Participants" in the Registrant's Proxy Statement for its Annual Meeting of Shareholders for 1997, which information is included herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Form 10-K Annual Report:
(1) Financial Statements:
The Report of Independent Auditors and the following Consolidated Financial Statements of the Registrant are included herein:
Consolidated Balance Sheets - December 31, 1996 and 1995
Consolidated Statements of Income - Years ended December 31, 1996, 1995, and 1994.
Consolidated Statements of Shareholders' Equity - Years ended December 31, 1996, 1995, and 1994
Consolidated Statements of Cash Flows - Years ended December 31, 1996, 1995, and 1994
Notes to Consolidated Financial Statements
(2) Financial Statement Schedules:
Schedule I - Condensed Financial Information of Registrant
NOTES TO CONDENSED FINANCIAL STATEMENTS NOTE A - DIVIDENDS FROM SUBSIDIARIES Cash dividends paid to Lynch Corporation from the Registrant's consolidated subsidiaries were $1,811,000 in 1996, $1,166,000 in 1995, and $277,000 in 1994. No other dividends were received from subsidiaries or investees.
NOTE B - SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR ADDITIONAL
INFORMATION SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT LYNCH CORPORATION CONDENSED BALANCE SHEETS
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT LYNCH CORPORATION CONDENSED STATEMENTS OF CASH FLOWS
Schedule II - Valuation and Qualifying Accounts
SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS LYNCH CORPORATION AND SUBSIDIARIES YEARS ENDED DECEMBER 31, 1996, 1995, AND 1994
(A) UNCOLLECTIBLE ACCOUNTS WRITTEN OFF ARE NET OF RECOVERIES.
(B) RECLASSES ($43,000) AND AMOUNT RECORDED AS PART OF THE ALLOCATION OF PURCHASE PRICE OF ACQUIRED COMPANIES ($197,000).
(C) ALLOCATION OF PURCHASE PRICE OF ACQUIRED COMPANY.
All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions, or are inapplicable, and therefore have been omitted.
See Item 1.V above re Forward Looking Information.
(3) Exhibits:
See the Exhibit Index of this Form 10-K Annual Report below. The following Exhibits listed in the Exhibit Index are filed with this Form 10-K Annual Report:
10(u)(i) Loan Agreement, dated as of August 12, 1996, between Gabelli Funds, Inc. and Registrant.
10(u) (ii) Pledge and Security Interest Agreement, dated as of August 12, 1996, by and between Gabelli Funds, Inc. Registrant and certain subsidiaries of Registrant.
10(v) Letter Agreement, dated as of August 12, 1996, between Rivgam Communicators, L.L.P. and Lynch PCS Corporation G.
10(w) Loan Agreement, dated as of August 12, 1996, between Lynch PCS Corporation F and Aer Force Communications B, L.P.
11 - Computation of Per Share Earnings.
21 - Subsidiaries of the Registrant.
23 - Consents of Independent Auditors. - Ernst & Young LLP - Arthur Andersen LLP - McGladrey & Pullen, LLP(2) - Deloitte & Touche, LLP - Frederick & Warinner, LLC - Johnson MacKowiak Moore & Myott, LLP 24 - Powers of Attorney.
27 - Financial Data Schedule
99 - Reports of Independent Auditors.
- Report of Arthur Andersen LLP on the Consolidated Financial Statements of The Morgan Group, Inc. for the year ended December 31, 1995. - Report of McGladrey & Pullen, LLP on the Financial Statements of Capital Communications Corporation for the year ended December 31, 1996. - Report of McGladrey & Pullen, LLP on the Financial Statements of Coronet Communications Company for the year ended December 31, 1996. - Report of Deloitte & Touche, LLP on the Financial Statements of Central Products Company for year ended December 31, 1996. - Report of Frederick & Warinner LLC on the Financial Statements of CLR Video, LLC for the year ended December 31, 1996. - Report of Johnson MacKowiak Moore & Myott, LLP on the Consolidated Financial Statements of Dunkirk & Fredonia Telephone Company for the period November 26, 1996 to December 31, 1996. (b) Reports on Form 8-K: A Reports on Form 8-K was filed as of (i) October 23, 1996 to report on a financing by Registrant's subsidiary, Spinnaker Industries, Inc. (ii) November 25, 1996 to report on the completion of the Dunkirk & Fredonia Telephone Company acquisition and the examining by Registrant of the possibility of splitting, through a spin-off, either its multimedia operations or its manufacturing operations, and (iii) as of December 30, 1996 to report on the acquisition of Transit Homes of America, Inc.
(c) Exhibits:
Exhibits are listed in response to Item 14(a)(3)
(d) Financial Statement Schedules:
Financial Statement Schedules are listed in response to Item 14(a)(2)
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
LYNCH CORPORATION
By:s/ROBERT E. DOLAN ROBERT E. DOLAN Chief Financial Officer (Principal Financial and Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
ANNUAL REPORT ON FORM 10-K
ITEM 14(a)(1) AND (2),(c) AND (d)
FINANCIAL STATEMENTS
CERTAIN EXHIBITS
FINANCIAL STATEMENTS SCHEDULES
YEAR ENDED DECEMBER 31, 1996
LYNCH CORP0RATION AND SUBSIDIARIES
Audited Consolidated Financial Statements
Lynch Corporation and Subsidiaries
Years ended December 31, 1996, 1995 and 1994 with Report of Independent Auditors
Lynch Corporation and Subsidiaries
Audited Consolidated Financial Statements
Years ended December 31, 1996, 1995 and 1994
Contents
Report of Independent Auditors 1 Audited Consolidated Financial Statements Consolidated Balance Sheets 2 Consolidated Statements of Income 4 Consolidated Statements of Shareholders' Equity 5 Consolidated Statements of Cash Flows 6 Notes to Consolidated Financial Statements 7
Lynch Corporation and Subsidiaries
See accompanying notes.
See accompanying notes.
See accompanying notes.
PAGE
Lynch Corporation and Subsidiaries
Consolidated Statements of Shareholders' Equity
See accompanying notes.
PAGE
See accompanying notes. PAGE
Lynch Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 1996
1. Accounting and Reporting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of Lynch Corporation ("Company" or "Lynch") and entities in which it has majority voting control. Investments in affiliates in which the Company does not have majority voting control are accounted for in accordance with the equity method. All material intercompany transactions and accounts have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
The Company has a significant need for resources to fund the operation of the holding company, and meet its current funding commitments, including those related to personal communications services, and fund future growth. The Company is currently considering various alternatives long and short-term financing arrangements. One such alternative would be to sell a portion or all of certain investments in operating entities. Additional debt and/or equity financing vehicles are also being considered. While management expects to obtain adequate financing resources to enable the Company to meet its obligations, there is no assurance that such can be readily obtained or at reasonable costs.
Cash Equivalents
Cash equivalents consist of highly liquid investments with a maturity of less than three months when purchased.
At December 31, 1996 and 1995, assets of $14.4 million and $7.9 million, which are classified as cash and cash equivalents, are invested in United States Treasury money market funds for which affiliates of the Company serve as investment managers to the respective Funds.
Marketable Securities and Short-Term Investments
On January 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS" No. 115). Under Statement No. 115, the accounting for investments depends on the classification of such securities as either held-to-maturity, available-for-sale, or trading.
Marketable securities and short-term investments consist principally of U.S. Treasury obligations, and preferred and common stocks and bonds. At December 31, 1996, all marketable securities and United States Treasury money market funds classified as cash equivalents were classified as trading, with the exception of an equity security with a carrying value of $.9 million which was classified as available-for-sale. Trading and available-for-sale securities are stated at fair value with unrealized gains or losses on trading securities included in earnings and unrealized gains or losses on available-for-sale securities included in a separate component of shareholders' equity. Unrealized gains (losses) of $628,000, $408,000 and ($214,000) on trading securities has been included in earnings for the year ended December 31, 1996, 1995, and 1994, respectively. There was no adjustment to shareholders' equity for the available-for-sale security at December 31, 1996 and 1995, respectively.
The cost of marketable securities sold is determined on the specific identification method. Realized gains of $102,000, $529,000 and $293,000, and realized losses of $112,000, $108,000 and $233,000 are included in other income for the years ended December 31, 1996, 1995, and 1994, respectively
Lynch Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
1. Accounting and Reporting Policies (continued)
Properties and Depreciation
Property, plant and equipment are recorded at cost and include expenditures for additions and major improvements. Maintenance and repairs are charged to operations as incurred. Depreciation is computed for financial reporting purposes using the straight-line method over the estimated useful lives of the assets which range from 3 years to 35 years. For income tax purposes, accelerated depreciation methods are used.
Excess of Cost Over Net Assets of Companies Acquired
Excess of cost over net assets of companies acquired (goodwill) is being amortized on a straight-line basis over periods not exceeding forty years. The Company periodically reviews goodwill to assess recoverability, and impairments would be recognized in operating results if a permanent diminution in value were to occur. The Company measures the potential impairment of recorded goodwill by the undiscounted value of expected future cash flows in relation to its net capital investment in the subsidiary. Based on its review, the Company does not believe that an impairment of its goodwill has occurred.
Multimedia
Multimedia revenues include local and intrastate telephone company service revenues which are subject to review and approval by state public utility commissions, and long distance network revenues, which are based upon charges to long distance carriers through a tariff filed by the National Exchange Carriers Association with the Federal Communications Commission. Revenues are based on cost studies for the Company's exchanges, and have been estimated pending completion of final cost studies.
Services
Service revenues and related estimated costs of transportation are recognized when transportation of the manufactured housing, recreational vehicle or other product is completed.
Liability insurance is maintained with a deductible amount for claims resulting from personal injury and property damage. Provisions are made for the estimated liabilities for the self-insured portion of such claims as incurred.
Manufacturing
Manufacturing revenues, with the exception of certain long-term contracts discussed below, are recognized on shipment.
Research and Development Costs
Research and development costs are charged to operations as incurred. Such costs approximated $1,626,870 in 1996, $1,673,000 in 1995 and $1,231,000 in 1994.
Lynch Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
1. Accounting and Reporting Policies (continued)
Earnings Per Share
Earnings per common and common equivalent share amounts are based on the average number of common shares outstanding during each period, assuming the exercise of all stock options having an exercise price less than the average market price of the common stock using the treasury stock method. Fully diluted earnings per share reflect the effect, where dilutive, of the debentures when outstanding and the exercise of all stock options having an exercise price less than the greater of the average or the closing market price of the Common Stock of the Company at the end of the period using the treasury stock method.
Accounting for Long-Term Contracts
Lynch Machinery, Inc., a 90% owned subsidiary of the Company is engaged in the manufacture and marketing of glass forming machines and specialized manufacturing machines. Certain sales contracts require an advance payment (usually 15% of the contract price) which is accounted for as a customer advance. The contractual sales prices are paid either (i) as the manufacturing process reaches specified levels of completion or (ii) based on the shipment date. Guarantees by letter of credit from a qualifying financial institution are required for most sales contracts.
Because of the specialized nature of these machines and the period of time needed to complete production and shipping, Lynch Machinery accounts for these contracts using the completed contract method.
Impairments
Effective January 1, 1996, the Company adopted SFAS No. 121 "Accounting for the Impairment of Long-Lived Assets to be Disposed Of". The Company periodically assesses the net realizable value of its long-lived assets and evaluates such assets for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. For assets to be held, impairment is determined to exist if estimated undiscounted future cash flows are less than the carrying amount. For assets to be disposed of, impairment is determined to exist if the estimated net realizable value is less than the carrying amount.
Stock Based Compensation
During 1996, the Company adopted SFAS No. 123, "Accounting for Stock Based Compensation". SFAS No. 123 establishes a fair value method of accounting and reporting standards for stock based compensation plans. However as permitted by SFAS No. 123, the Company has elected to continue to apply the provisions of Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees" and related interpretations. Under APB No. 25, because the exercise price of the Company's employee stock options were not less than the market price of the underlying stock on the date of grant, no compensation expense is recognized. The Company is required to disclose the pro forma net income (loss) and net income (loss) per share as if the fair value method defined in SFAS No. 123 had been applied to all grants made on or after January 1, 1995. See Note 10 for pro forma disclosures.
Lynch Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
1. Accounting and Reporting Policies (continued)
Fair Value of Financial Instruments
Cash and cash equivalents, trade accounts receivable, short-term borrowings, trade accounts payable and accrued liabilities are carried at cost which approximates fair value due to the short-term maturity of these instruments. The carrying amount of the Company's borrowings under its revolving lines of credit approximates fair value, as the obligations bear interest at a floating rate. The fair value of all other long-term obligations approximate cost based on discounted cash flows using the Company's incremental borrowing rate for similar instruments.
Reclassifications
Certain amounts in the 1994 and 1995 financial statements have been reclassified to conform to the 1996 presentation.
2. Acquisitions
On December 30, 1996, The Morgan Group, Inc., 51% owned by Lynch, acquired the operating assets of Transit Homes of America, Inc., a provider of transportation services to a number of producers in the manufactured housing industry. The purchase price was approximately $4.4 million, including assumed obligations.
On November 26, 1996, Lynch Telephone Corporation VIII, a wholly-owned subsidiary of Lynch, acquired all of the outstanding shares of Dunkirk & Fredonia Telephone Company, a local exchange company serving portions of western New York. The total cost of this transaction was $27.7 million. As a result of this transaction, the Company recorded $13.8 million in goodwill which is being amortized over 25 years.
On June 3, 1996, Inter-Community Telephone, a Lynch Telephone Corporation II subsidiary acquired four telephone exchanges in North Dakota containing approximately 1,400 access lines from U.S. West Communications, Inc. for approximately $4.7 million.
On October 4, 1995, Central Products Acquisition Corp., a wholly-owned subsidiary of Spinnaker Industries, Inc. ( a 73% owned subsidiary of Lynch) acquired from Alco Standard Corporation ("Alco"), the assets and stock of Central Products Company, a manufacturer of carton sealing tapes and related equipment. The cost of the acquisition was $80.0 million. As a result of this transaction, the Company recorded $27.2 million in goodwill which is being amortized over 25 years.
On September 26, 1994, Lynch Telephone Corporation VII, a wholly-owned subsidiary of Lynch, acquired all of the outstanding shares of Haviland Telephone Company, Inc., a local exchange Company in Kansas, from Interdigital Communications Corporation. The total cost of this transaction was $13.4 million. As a result of this transaction, the Company recorded $8.2 million in goodwill which is being amortized over 25 years.
On September 19, 1994, Brown-Bridge Industries, Inc., a wholly-owned subsidiary of Spinnaker Industries, Inc., acquired from Kimberly Clark Corporation the net assets associated with its Brown-Bridge operation, a manufacturer of adhesive coated stock for labels and related applications. The cost of the transaction was $29.1 million, plus $6.9 million in current liabilities assumed.
Lynch Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. Acquisitions (continued)
On March 1, 1994, Capital Communications Corporation, 49% owned by Lynch, acquired certain assets associated with the operations of Station WOI-TV from Iowa State University. Station WOI is an ABC affiliate serving the Des Moines, Iowa market. The total cost of the transaction was $13.0 million.
All of the above transactions were accounted for as purchases, and accordingly, the assets acquired and liabilities assumed were recorded at their estimated fair market values.
The operating results of the acquired companies are included in the Consolidated Statements of Income from their respective acquisition dates. The following unaudited combined pro forma information shows the results of the Company's operations presented as though the purchase of Transit Homes and Dunkirk and Fredonia were made at the beginning of 1995, and Central Products, Haviland, Brown-Bridge, and Station WOI-TV had been made at the beginning of 1994.
Year ended December 31
On March 18, 1997, the Company acquired approximately 60% ($15.3 million) of the stock of Upper Peninsula Telephone Co., a local exchange company in Michigan, with 6,200 access lines, with the intent of acquiring the rest of the company.
3. Discontinued Operations
Morgan Drive Away, a 50.1% owned subsidiary of the Company, recorded in the fourth quarter of 1996, special charges of $3,500,000 before taxes relating to exiting the truckaway operation and a write down of properties in accordance with SFAS 121. In addition in the fourth quarter, Morgan recorded a pre-tax charge of $750,000 of increased insurance reserves and insurance costs primarily related to 1996 accidents. These charges have been included in the Company's results of continuing operations.
The Board of Directors of Lynch Machinery, a 90% owned subsidiary of the Company, decided to discontinue the operations of Tri-Can International, Ltd. ("Tri-Can) and sell the assets of the operation. The sale of Tri-Can was completed in August, 1996. Accordingly, Tri-Can is reported as a discontinued operation for the years ended December 31, 1996, 1995 and 1994. Tri-Can which was previously reported in the manufacturing segment due to the insignificance tothe Company's financial statements, is treated as a discontinued operation as its products and customers are different than those of Lynch Machinery.
Lynch Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
3. Discontinued Operations (continued)
As a result of this disposal, the Registrant recorded a provision for loss of $487,000 after-taxes, to reflect the writedown of certain assets and costs estimated to be incurred prior to disposal and a provision of $263,000 after-tax for operating losses prior to the sale. The operating results of Tri-Can are summarized as follows (dollars in thousands):
Components of net assets (liabilities) of discontinued operations included in the Balance Sheet is as follows:
4. Inventories
Inventories are stated at the lower of cost or market value. Inventories valued using the last-in, first-out (LIFO) method comprised approximately 53% and 58% of consolidated inventories at December 31, 1996 and 1995. Inventories at Brown-Bridge, 42% and 38% of inventories at December 31, 1996 and 1995, are valued using the specific identification method. The balance of inventories are valued using the first-in first-out (FIFO) method.
Lynch Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
4. Inventories (continued)
Current cost exceeded the LIFO value of inventories by $973,457 and $905,000 at December 31, 1996 and 1995, respectively.
5. Personal Communications Services
Lynch subsidiaries through limited partnerships participated in the auctions conducted by the Federal Communications Commission ("FCC") for 30 megahertz and 10 megahertz of broadband spectrum to be used for personal communications services, the "C-Block" and "F-Block" Auctions, respectively. These two auctions, which were part of six auctions conducted by the FCC for a total 90 megahertz of spectrum, were specially designated by the FCC to encourage small businesses to participate in the wireless telecommunications industry, so-called "entrepreneurial blocks." To effectuate this, the FCC provided certain designated bidders a 25% bidding credit to be used during the auction as well as long-term financing for a substantial portion of the cost of the licenses acquired. The licenses represent the right to provide wireless communications services to territorial areas of the United States. Under FCC regulations, service must be provided to one-third of the population within the area of the license within five years of the date of the award and two-thirds of the population within ten years of the date of award. Failure to comply may result in the forfeiture of the license. The subsidiaries hold a 49.9% limited partnership interest position in each of these partnerships and have committed to funding the government interest and certain other expenses up to a specified amount as discussed below.
Lynch subsidiaries are limited partners in five separate partnerships which participated in the C-Block auction, which ended in May 1996. Such partnerships acquired 31 licenses at a net cost, after the bidding credit, of $216 million. These licenses were awarded in September 1996. The FCC provided 90% of the financing of the cost of these licenses at an interest rate of 7% per annum with interest due quarterly for years one through six and principal amortization and interest due quarterly in years seven through ten. Lynch subsidiaries have agreements to provide a total of $41.8 million of funding to such partnerships, of which $20.4 million was funded through December 31, 1996. There loans carry an annual commitment fee of 20% and an interest rate of 15% which are payable when the loans mature in 2003. For accounting purposes, all cost and expenses, including interest expense, associated with the licenses are currently being capitalized until service is provided. The proforma combined balance sheet of these partnerships at December 31, 1996 is as follows (in thousands):
Lynch Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
5. Personal Communications Services (continued)
A Lynch subsidiary is a limited partner in Aer Force Communications B, L.P., which participated in the "F-Block Auction" which began in August 1996. Under the auction rules, in order for a bidder to bid on a designated area, it had to have on deposit with the FCC, $0.60 for each person within that designated area. Aer Force put $12 million on deposit with the FCC. The bidding concluded during January 1997 and Aer Force was high bidder for five licenses at a net bid of $19.0 million. These licenses have not yet been awarded. Once the licenses are awarded, the FCC will finance 80% of the cost of the licenses with interest only due quarterly in years one and two and principal amortization and interest due quarterly in years three through ten. The interest rate will be determined on the date of the award based on the long-term treasury rate at that time. $11.8 million of the $12 million deposited with the FCC was financed from a facility from Gabelli Funds, Inc. ("GFI"), an affiliate of the Chairman and CEO of the Company (see Note 8 for the description of the terms of this loan). In January, $10.0 million of this loan was repaid with monies returned from the FCC. Currently, Aer Force has on deposit with the FCC $1.9 million, or 10% of the cost of the licenses for which it was high bidder. Once the licenses have been awarded, Aer Force will be required to make the remaining 10% down payment, which is expected to be financed through a draw-down by Lynch on the facility with GFI. Lynch subsidiaries have committed a total of $11.8 million, based on the award of licenses for which Aer Force is currently high bidder. The balance sheet of Aer Force at December 31, 1996 is as follows (in thousands):
A wholly-owned Lynch subsidiary will also receive a 10% net profit interest (after a capital charge) in certain PCS Licenses won by Rivgam Communications, L.L.C. in compensation for certain services during the PCS "D and E" block auctions. Rivigam is a subsidiary of GFI.
Lynch Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
6. Investments in Affiliated Companies
Lynch Entertainment Corporation ("LENCO"), a wholly-owned subsidiary of the Company, has a 20% investment in Coronet Communications Company ("Coronet"), which operates television station WHBF-TV, a CBS affiliate in Rock Island, Illinois. Lynch Entertainment Corporation II ("LENCO II"), a wholly-owned subsidiary of the Company, has a 49% investment in Capital Communications Company ("Capital"), which operates television station WOI-TV, an ABC affiliate in Des Moines, Iowa.
At December 31, 1996 and 1995, LENCO's net investment in Coronet is $1,214,000 and $995,000, respectively. Long-term debt of Coronet, at December 31, 1996, is comprised of $13.2 million due to a third party lender and $2.9 million due to LENCO. All of this debt was repaid on February 3, 1997 from the proceeds of a $16.1 million term loan from a third party lender which is due quarterly through December 31, 2003. The Company recorded interest income on the LENCO debt of $287,000, $276,000, and $265,000 for the years ended December 31, 1996, 1995, and 1994, respectively. LENCO guaranteed $3.75 million of $16.1 million of Coronet's third party debt.
At December 31, 1996 and 1995, LENCO II's investment in Capital is carried at zero as its share of net losses recognized to date would have exceeded in net investment. LENCO II also owns $10,000 of Preferred Stock B of Capital, which is convertible at any time into the Common Stock of Capital in a sufficient amount to bring LENCO II's ownership to 50%.
7. Excess of Costs Over Fair Value of Net Assets Acquired Intangible assets include acquisition intangibles of $69.2 million and $53.1 million, net of accumulated amortization of $7.9 million and $5.5 million, at December 31, 1996 and 1995, respectively.
Lynch Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
8. Notes Payable and Long-term Debt
Long-term debt consists of (all interest rates are at December 31, 1996):
On October 23, 1996, Spinnaker Industries, Inc. completed the issuance of $115,000,000 of 10.75% senior-secured debt due 2006. The debt proceeds were used to extinguish substantially all existing bank debt, bridge loans and lines of credit at Spinnaker and its two major operating subsidiaries, Central Products and Brown-Bridge. The early extinguishment of debt resulted in an extraordinary charge to fourth quarter earnings of $1,348,000 net of applicable taxes and minority interest. In addition, Spinnaker established a $40 million asset-backed senior-secured revolving credit facility. Financing costs were incurred by Spinnaker in conjunction with the issuance of the 10.75% senior secured notes. These financing costs are deferred and amortized over the term of the related debt. Unamortized financing costs of approximately $6,200,000 at December 31, 1996 are included in other assets.
Lynch Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
8. Notes Payable and Long-term Debt (continued)
RUS debt of $13.4 million bearing interest at 2% has been reduced by a purchase price allocation of $3.0 million reflecting an imputed interest rate of 5%. Unsecured notes issued in connection with the telephone company acquisitions are predominantly held by members of management of the telephone operating companies.
The Company maintains lines of credit with banks which aggregate $47.0 million, of which $11.1 million was unused at December 31, 1996. These lines along with the long-term debt facilities are secured by the operating assets of the related subsidiaries as well as pledges of stock of certain subsidiaries. The line of credit agreements expire in 1997, are renewable annually, and are at interest rates ranging from LIBOR plus 1.25%, to prime plus .25%. The Company's outstanding balances under these lines of credit totaled $17.4 million and standby letters of credit totaled approximately $3.6 million at December 31, 1996, securing various insurance obligations and customer advances. Several of the credit agreements contain restrictive covenants. Due to certain of these restrictive covenants and working capital requirements of the subsidiaries, cash distributions from these subsidiaries are limited. At December 31, 1996 and 1995, $8.4 million and $5.6 million, respectively, of subsidiaries' retained earnings were restricted under these agreements.
Spinnaker's subsidiaries have unused short-term credit facilities available for future use, including revolving credit agreements with a maximum aggregate availability of $40,000,000. Borrowings under these credit lines totaled $686,000 at December 31, 1996. Interest on the outstanding balances under these credit facilities are at variable rates with an interest rate in effect at December 31, 1996 of 10.0%. Spinnaker is required to comply with various covenants including a limitation on capital expenditures, and minimum levels of current ratio, interest coverage, and net worth, as well as various other financial covenants. Spinnaker's line of credit agreement expires in 2001.
In conjunction with the "F-Block" auction discussed in Note 5, a deposit of $12.0 million was deposited with the FCC. Lynch borrowed $11.8 million of this deposit from GFI on August 12, 1996 which is due and payable in one year. The interest rate on this loan is fixed at 10% and in addition a commitment fee of 1% per annum is being charged on the principal amount of GFI's commitment ($11.8 million) including funds actually borrowed. GFI will also receive 10% of Lynch's subsidiary's share of net profits of Aer Force Communications B, L.P. In January, 1997, $10.0 million of this loan was repaid with monies returned from the FCC.
In July 1986, the Company issued $23.0 million principal amount of 8% convertible subordinated debentures. These debentures were unsecured obligations of the Company and were convertible into Common Stock at a price of $31 per share prior to maturity. Through September 21, 1994, the Company had either purchased on the open market or redeemed $11.2 million of the original issuance. At that date, in accordance with the terms of the debenture indenture, the Company called for redemption all of the remaining debentures outstanding, at 101.6% of their face amount plus accrued interest. The redemption was completed on October 24, 1994, and $10,195,000 of the debentures were redeemed and $1.6 million were converted into 52,881 shares of Common Stock at $31 per share before allocation of related expenses. As a result of the redemption, the Company recognized in 1994 an extraordinary loss of $264,000, net of taxes.
Cash payments for interest were $16.7 million, $10.6 million and $6.2 million for the years ended December 31, 1996, 1995 and 1994, respectively.
Aggregate principal maturities of long-term debt for each of the next five years are as follows: 1997--$23.8 million; 1998--$6.2 million, 1999--$5.8 million, 2000--$13.5 million and 2001--$5.7 million.
Lynch Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
9. Minority Interests and Related Party Transactions
On June 13, 1994, Spinnaker entered into a management agreement (the "Management Agreement") with Boyle, Fleming & Co., Inc. ("BF"), of whom a former Director of the Company is a principal, to assume the management of Spinnaker. Effective August 31, 1996, the Management Agreement was terminated at which time Messrs. Boyle, and Fleming became employees of Spinnaker and continued to be Chairman and Chief Executive Officer and President, respectively, of Spinnaker. Spinnaker and BF also entered into a Warrant Purchase Agreement in 1994, pursuant to which BF received warrants to purchase common stock of Spinnaker (equating to a 20% ownership of Spinnaker) at any time on or before June 30, 1999, subject to certain restrictions. As of December 31, 1996 there were approximately 490,000 warrants outstanding to purchase one share each of Class A Common Stock and common stock at a total price of $2.67 per warrant exercise (adjusted for the 3 for 2 stock splits in December 1995 and 1994, and a stock dividend in August 1996).
On May 5, 1996, Alco converted a $6.0 million convertible note issued in connection with the purchase of CPC, into Spinnaker Common Stock. In accordance with the Company's policy, as a result of this and other transactions the Company recognized a gain on sales of subsidiary and affiliate stock of $5.1 million in 1996.
On October 23, 1996, concurrent with the issuance of the $115 million senior notes (see Note 8), Spinnaker acquired the remaining 25% minority interest in its Brown-Bridge subsidiary. The terms of the acquisition involved a cash payment of approximately $2.3 million and the issuance of 9,613 shares of Spinnaker Common Stock. In addition, as part of the consideration for the shares of capital stock of Brown-Bridge, the minority shareholders received the right to a contingent payment, which is exercisable at any time during the period beginning October 1, 1998 and ending September 30, 2000. The value of the contingent payment is equal to the percentage of the capital stock of the former Brown-Bridge entity owned by such stockholder at the time of the merger multiplied by 75% of the fair market value of the capital stock of Brown-Bridge, as determined in accordance with certain economic assumptions, as of the date such right is exercised, less the consideration received at closing. The contingent price is payable through the issuance of Common Stock of Spinnaker, unless Spinnaker elects to pay the contingent price in cash. If such paymebts are made in cash, they could raise to a default under the Senior Notes, unless there is sufficient availability under provisions regarding restricted payments contained in the Senior Notes.
In connection with the purchase of the Brown-Bridge minority interest, all the Brown-Bridge options were accelerated and in turn certain key executives of Brown-Bridge management exercised those options to purchase 71,065 shares of Brown-Bridge common stock at various prices between $7.16 and $14.69 per share, for a total of approximately $670,000. The options were originally granted in 1994 and were issued at not less than 100% of the fair market value of the common stock at the date of grant.
The Company, pursuant to Indiana law and the Company's Articles of Incorporation, has reimbursed its Chairman and Chief Executive Officer, for $392,000 of legal fees incurred in connection with a regulatory inquiry. Relating to this reimbursement, the Company charged results of operations for the year ended December 31, 1994 in the amount of $317,000.
On January 19, 1994 and March 12, 1996, Lynch sold 100,000 and 10,373, respectively, shares of common stock held in its treasury to its Chairman and Chief Executive Officer at the market price per share, the closing price in trading of Lynch common stock on The American Stock Exchange on those dates was $22.875 and $60.25, respectively. The January 19, 1994 transaction was approved by the Company's shareholders at its annual meeting held on May 5, 1994.
Lynch Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
10. Stock Option Plans
On June 4, 1993, the Board of Directors of Morgan approved the adoption of a stock option plan which provides for the granting of incentive or non-qualified stock options to purchase up to 200,000 shares of Class A Common Stock to officers, including members of Morgan's Board of Directors, and other key employees. No options may be granted under this plan at less than the fair market value of the Common Stock at the date of the grant, except for certain nonemployee directors. Three nonemployee directors were granted non-qualified stock options to purchase a total of 24,000 shares of Class A Common Stock at prices ranging from $6.80 to $9.00 per share. Although the exercise period is determined when options are actually granted, an option shall not be exercised later than 10 years and one day after it is granted. Stock options granted will terminate if the grantee's employment terminates prior to exercise for reasons other than retirement, death, or disability. Morgan employees have been granted non-qualified stock options to purchase 175,500 shares of Class A Common Stock, net of cancellations and exercises, at prices ranging from $7.38 to $8.75 per share. Stock options vest over a four year period pursuant to the terms of the plan. As of December 31, 1996, there were 88,375 options to purchase shares granted to employees and non-employees directors which were exercisable based upon the vesting terms, and 4,000 shares had option prices less than the closing price of $7.50.
In accordance with the Company's directors stock option plan, the Company may grant stock options to directors who are not employees of the Company. Effective February 15, 1996, Spinnaker granted 30,000 stock options for the purchase of one share each of Spinnaker Class A Common Stock and Spinnaker Common Stock at a total price of $40 per option exercise (adjusted for the stock dividend in August 1996) to qualifying directors. The options vest over a two year period with 15,000 options becoming exercisable one year after the grant date and the remaining 15,000 options becoming exercisable two years after the grant date. The options expire on the fifth anniversary after the grant date or 30 days after the director ceaswes to be a director.
The Company has adopted the provisions of SFAS No. 123, "Accounting for Stock Based Compensation" and as permitted by SFAS No. 123, the Company and its subsidiaries have elected to account for all of the above option plans under APB No. 25 and as such no compensation expense was recorded. Pro forma information regarding net income and earnings per share is required by SFAS No. 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions: risk-free interest rates of 5.58%; dividend yields of 0%; volatility factors of the expected market price of the Company's common stock of .50; and a weighted-average expected life of the options of three years. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The estimated weighted-average fair value per option is approximately $5.20. The pro forma effect on the Company's 1996 operations is as follows:
Lynch Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
11. Shareholders' Equity
In December 1996, the Company's Board of Directors announced that it is examining the possibility of splitting, through a "spin-off", either its communications operations or its manufacturing operations. A spin-off could improve management focus, facilitate and enhance financings and set the stage for future growth, including acquisitions. A split could also help surface the underlying values of the Company as the different business segments appeal to differing "value" and "growth" cultures in the investment community. There are a number of matters to be examined in connection with a possible spin-off, including tax consequences, and there is no assurance that such a spin-off will be effected.
In 1987, 1988 and 1992, the Board of Directors authorized the purchase of up to 300,000 shares of Common Stock. Through December 31, 1996, 230,861 shares had been purchased at an average cost of $13.15 per share.
In January 1994, an officer was granted stock options to purchase up to 24,516 shares of Lynch common stock at an exercise price of $23.125, the closing price on the American Stock Exchange on January 18, 1994. These options were exercised in January, 1997.
On February 1, 1996, the Company adopted a plan to provide a portion of the compensation for its directors in common shares of the Company. The amount of common stock is based upon the market price at the end of the previous year. In February 1996 and January 1997, the Company awarded 1,428 and 1,284, respectively, shares under this program.
On February 29, 1996, the Company adopted a Phantom Stock Option Plan for certain employees. To date, 39,100 of Phantom Stock Options ("PSO") have been granted at a prices ranging from $63 to $70 per share. Upon the exercise of a PSO, the holder is entitled to receive an amount equal to the amount by which the market value of the Company's common stock on the exercisable date exceeds the exercise price of the PSO.
12. Income Taxes
Deferred income taxes for 1996 and 1995 are provided for the temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities. Cumulative temporary differences and carryforwards at December 31, 1996 and 1995 are as follows:
Lynch Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
12. Income Taxes (continued)
The provision for income taxes is summarized as follows:
A reconciliation of the provision for income taxes from continuing operations and the amount computed by applying the statutory federal income tax rate to income before income taxes, minority interest, extraordinary item, and cumulative effect of accounting change follows:
Net cash payments for income taxes were $3.5 million, $4.2 million and $2.3 million for the years ended December 31, 1996, 1995 and 1994, respectively.
13. Contingencies
Lynch has pending claims incurred in the normal course of business. Management believes that the ultimate resolution of these claims will not have a material adverse effect on the consolidated liquidity, financial position or results of operations of Lynch.
Lynch Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
13. Contingencies (continued)
Pursuant to the CPC acquisition agreement, CPC assumed sponsorship of a defined benefit pension plan for union employees per their collective bargaining agreement and also agreed to establish a new defined benefit plan for non-union employees hired by CPC. The seller retained the defined benefit pension obligation for non-union retirees as of September 30, 1995 and any non-union employees not hired by CPC.
The acquisition agreement required the seller to transfer assets to the CPC plans equal to the present value of accrued benefits as of September 30, 1995 as defined in the agreement plus a defined rate of interest to the transfer date. The assets were transferred by the seller to the CPC union and non-union plans in January 1997.
14. Segment Information
The Company is principally engaged in three business segments: multimedia, services and manufacturing. All businesses are located domestically, and export sales were approximately $25 million in 1996, $41 million in 1995 and $16.5 million in 1994. The Company does not believe it is dependent on any single customer. The multimedia segment includes local telephone companies, the investment in PCS entities and investments in two network-affiliated television stations. The services segment includes transportation and related services. $11.6 million of the Company's accounts receivable are related to the services segment and are principally due from companies in the mobile home and recreational vehicle industry located throughout the United States, including several located in the Midwest and Southeast. Services provided to one major mobile home manufacturer accounted for approximately $24.3 million, $29.4 million and $27.5 million in revenues of the services segment for the years ended December 31, 1996, 1995, and 1994, respectively. The manufacturing segment includes the manufacture and sale of adhesive coated stock for labels and related applications, glass forming, impact milling, adhesive tapes, and other machinery and related replacement parts, as well as quartz crystals and oscillators. There were no intersegment sales or transfers.
Operating profit (loss) is equal to revenues less operating expenses, excluding unallocated general corporate expenses, interest and income taxes. The Company allocates a portion of its general corporate expenses to its operating segments. Such allocation was $932,000, $965,000 and $790,000 during the years ended December 31 1996, 1995 and 1994, respectively. Identifiable assets of each industry segment are the assets used by the segment in its operations excluding general corporate assets. General corporate assets are principally cash and cash equivalents, short-term investments and certain other investments and receivables.
Lynch Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
14. Segment Information (continued)
PAGE
Lynch Corporation and Subsidiaries
Notes to Consolidated Financial Statements (continued)
15. Quarterly Results of Operations (unaudited)
The following is a summary of the quarterly results of operations for the years ended December 31, 1996 and 1995 (in thousands, except per share amounts):
EXHIBIT INDEX
Exhibit No. Description
(a) Restated Articles of Incorporation of Registrant (incorporated by reference to Exhibit 3(a) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1987).
(b) By-Laws of the Registrant, (incorporated by reference to the Exhibit 3(b) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1987).
4 (a) Loan Agreement and Revolving Loan Note of Lynch Telephone Corporation, dated October 18, 1989, (incorporated by reference to Exhibit 4(d) of the Registrant's Form 10-K for the year ended December 31, 1989).
(b) Purchase Agreement, dated October 18, 1996 (the "Purchase Agreement") among Spinnaker Industries, Inc., a Delaware corporation ("Spinnaker"), Brown-Bridge Industries, Inc., a Delaware corporation ("Brown-Bridge), Central Products Company, a Delaware corporation ("Central Products"), and Entoleter, Inc., ("Entoleter") and together with Brown-Bridge and Central Products, the "Guarantors") and BT Securities Corporation (the "Initial Purchaser") (incorporated by reference to Exhibit 4.1 to Registrant's Form 8-K, dated October 23, 1996).
(c) Indenture dated, October 23, 1996, among Spinnaker, the Guarantors and the Chase Manhattan Bank, as Trustee (incorporated by reference to Exhibit 4.3 to Registrant's Form 8-K, dated April 19, 1996).
(d) Credit Agreement among Central Products, Brown-Bridge and Entoleter, as Borrowers, Spinnaker, as Guarantor, each of the financial institutions listed on Schedule 1 thereto, BT Commercial Corporation, as Agent, Transamerican Business Credit Corporation, as Collateral Agent, and Bankers Trust Company as Issuing Bank (incorporated by reference to Exhibit 99.1 to Registrant's Form 8-K dated April 19, 1996).
The Registrant, by signing this Form 10-K Annual Report, agrees to furnish to the Securities and Exchange Commission a copy of any long-term debt instrument where the amount of the securities authorized thereunder does not exceed 10 percent of the total assets of the Registrant on a consolidated basis.
10 (a) Partnership Agreement, dated March 11, 1987, between Lombardo Communications, Inc. and Lynch Entertainment Corporation (incorporated by reference to Exhibit 10(e) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1987).
*(b) Lynch Corporation 401(k) Savings Plan (incorporated by reference to Exhibit 10(b) to Registrant's Report Form 10-K for the year ended December 31, 1995).
(c) Stock Purchase Agreement, dated May 13, 1993, whereby Registrant acquired J.B.N. Telephone Company, Inc. (incorporated by reference to Exhibit 2(a) of the Registrant's Form 8-K, dated December 13, 1993).
(d) Stock Purchase Agreement, dated January 19, 1994, between Registrant and Mario J. Gabelli (incorporated by reference to Exhibit II of Amendment Number 36 to Schedule 13D filed by Mario J. Gabelli and affiliated companies on January 19, 1994).
(e) Shareholders Agreement among Capital Communications Company, Inc., Lombardo Communications, Inc. and Lynch Entertainment Corporation II (incorporated by reference to Exhibit 10 of Registrant's Form 8-K, dated March 14, 1994).
(f) Acquisition Agreement between Brown-Bridge Acquisition Corporation and Kimberly-Clark Corporation, dated June 15, 1994 (incorporated by reference to Exhibit 10(c) to Registrant's Form 10-Q for the quarter ended June 10, 1994).
*(g) Management Agreement, dated as of June 10, 1994, by and among Boyle, Fleming, George & Co., Inc. and Safety Railway Service Corporation (incorporated by reference by Exhibit 7.1 to the Registrant's Form 8-K, dated June 13, 1994).
(h) Warrant Purchase Agreement, dated as of June 10, 1994, by and among Boyle, Fleming, George & Co., Inc. and Safety Railway Service Corporation (incorporated by reference by Exhibit 7.1 to the Registrant's Form 8-K, dated June 13, 1994).
(i) A Warrant, dated as of June 10, 1994, executed by Safety Railway Service Corporation (incorporated by reference to Exhibit 7.1 to Registrant's Form 8-K, dated June 12, 1994).
(j)(i) Asset Purchase Agreement, dated as of June 15, 1994, between Kimberly-Clark Corporation and Brown-Bridge Acquisition Corp. (Exhibits omitted) (incorporated by reference to Exhibit 10(c) to Registrant's Form 10-Q for the quarter ended June 30, 1994). Registrant agrees to furnish supplementally a copy of any omitted schedule to the Securities and Exchange Commission upon request.
(j)(ii) Amendments Nos. 1-3 to Asset Purchase Agreement by and between Kimberly-Clark Corporation and Brown-Bridge Industries, Inc. (formerly Brown-Bridge Acquisition Corp.) (incorporated by reference to Registrant's Form 8-K, dated September 19, 1994).
(k) Stock Purchase Agreement, dated as of August 26, 1994, among Brighton Communications Corporation, Lynch Telephone Corporation VII, Universal Service Telephone Company and InterDigital Communications Corporation (Exhibits omitted) (incorporated by reference to Exhibit 7.1 to Registrant's Form 8-K, dated September 26, 1994).
*(l) Stock Purchase and Loan Program (incorporated by reference to Exhibit 10(p) to Registrant's Form 10-K for the year ended December 31, 1994).
(m) Shareholders' and Voting Agreement, dated September 16, 1994, among Safety Railway Service Corporation, Brown-Bridge Industries, Inc. and the other stockholders of Brown-Bridge (incorporated by reference to Exhibit 10(q) to Registrant's Form 10-K for the year ended December 31, 1994).
(n) Put Option Agreements, dated September 16, 1994, among Safety Railway Service Corporation, Brown-Bridge Industries, Inc. and certain stockholders of Brown Bridge (incorporated by reference to Exhibit 10(q) to Registrant's Form 10-K for the year ended December 31, 1994).
*(o) Directors Stock Plan (incorporated by reference to Exhibit 10(s) to Registrant's Form 10-K for the year ended December 31, 1995).
*(p) Phantom Stock Plan (incorporated by reference to Exhibit (t) to Registrant's Form 10-K for the year ended December 31, 1995).
(q) Stock and Asset Purchase Agreement, dates as of September 27, 1995, by and among Central Products Acquisition Corp., Unisource Worldwide, Inc. and Alco Standard Corporation (incorporated by reference to Exhibit 7.1 to Registrant's Form 8-K dated October 18, 1995).
(r) Stock Purchase Agreement, dated as of November 1, 1995, among Brighton Communications Corporation, Lynch Telephone Corporation VIII and certain other persons (excluding exhibits).
(s)(i) Loan Agreement, dated as of November 6, 1995, between Lynch PCS Corporation A and Aer Force Communications L.P. (now Fortunet Wireless, L.P.) (four similar loan agreements with Fortunet Wireless, L.P. increase the total potential commitment to $41.8 million).
(s)(ii) Amendment No. 1 to the Loan Agreement, dated as of November 6, 1995, referred to in 10(s)(i) (incorporated by reference to Exhibit 10(a) to Registrant's Form 10-Q for quarter ended March 31, 1996).
(t) Agreement and Plan of Merger (Brown-Bridge Minority Interest), by and among Spinnaker, BB Merger Corp., Brown-Bridge Industries, Inc. and the stockholders of Brown-Bridge Industries, Inc. on Exhibit A thereto (incorporated by reference to Exhibit 99.2 to Registrant's Form 8-K, dated April 19, 1996).
(u)(i) Loan Agreement, dated as of August 12, 1006, between Gabelli Funds, Inc. and Registrant.
(u)(ii) Pledge and Security Interest Agreement, dated as of August 12, 1996, by and between Gabelli Funds, Inc. Registrant and certain subsidiaries of Registrant.
(v) Letter Agreement, dated as of August 12, 1996, between Rivgam Communicators, L.L.P. and Lynch PCS Corporation G.
(w) Loan Agreement, dated as of August 12, 19967, between Lynch PCS Corporation F and Aer Force Communications B, L.P.
11 Computation of Per Share Earnings.
16 Letter Re: Change in Certifying Accountant (incorporated by reference to Exhibit 16 to Registrant's Form 8-K, dated March 19, 1996).
16(a) Registrant's Form 8-K, dated March 19, 1996 (incorporated by reference).
21 Subsidiaries of the Registrant.
23 Consents of Independent Auditors. - Ernst & Young LLP - Arthur Andersen LLP - McGladrey & Pullen, LLP(2) - Frederick & Warinner, LLC - Johnson MacKowiak Moore & Myott, LLP
24 Powers of Attorney.
99 Report of Independent Auditors. - Report of Arthur Andersen LLP on the Consolidated Financial Statements of the Morgan Group, Inc. for the year ended December 31, 1996. - Report of McGladrey & Pullen, LLP on the Consolidated Financial Statements of Capital Communications Corporation for the year ended December 31, 1996. - Report of McGladrey & Pullen, LLP on the Consolidated Financial Statements of Coronet Communications Corporation for the year ended December 31, 1996. - Report of Frederick & Warinner LLC on the Financial Statements of CLR Video, LLC for the year ended December 31, 1996. - Report of Johnson MacKowiak Moore & Myott, LLP on the Consolidated Financial Statements of Dunkirk & Fredonia Telephone Company for the period November 26, 1996 to December 31, 1996.
______________________ *Management contract or compensatory or arrangement.
The Exhibits listed above have been filed separately with the Securities and Exchange Commission in conjunction with this Annual Report on Form 10-K or have been incorporated by reference into this Annual Report on Form 10-K. Lynch Corporation will furnish to each of its shareholders a copy of any such Exhibit for a fee equal to Lynch Corporation's cost in furnishing such Exhibit. Requests should be addressed to the Office of the Secretary, Lynch Corporation, 8 Sound Shore Drive, Greenwich, Connecticut 06830.