-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, FfZTGmspSru305QejixYBBCfPilzB9xYP43nxubc4kA8zTaSwMYlbTyOaElalGmx 9yHa9qwkeQsPTW87DPAwoQ== 0000950133-98-001177.txt : 19980401 0000950133-98-001177.hdr.sgml : 19980401 ACCESSION NUMBER: 0000950133-98-001177 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 19 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980331 SROS: AMEX FILER: COMPANY DATA: COMPANY CONFORMED NAME: LYNCH CORP CENTRAL INDEX KEY: 0000061004 STANDARD INDUSTRIAL CLASSIFICATION: TRUCKING (NO LOCAL) [4213] IRS NUMBER: 381799862 STATE OF INCORPORATION: IN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-00106 FILM NUMBER: 98582272 BUSINESS ADDRESS: STREET 1: 8 SOUND SHORE DR STE 290 CITY: GREENWICH STATE: CT ZIP: 06830 BUSINESS PHONE: 2036293333 MAIL ADDRESS: STREET 1: 8 SOUND SHORE DRIVE STREET 2: SUITE 290 CITY: GREENWICH STATE: CT ZIP: 06830 10-K405 1 FORM 10-K405 1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 [ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED] For the fiscal year ended December 31, 1997 Commission file number 1-106 ----------------- ----- OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the transition period from to ----------------------- ----------------------- LYNCH CORPORATION - -------------------------------------------------------------------------------- (Exact name of Registrant as specified in its charter) Indiana 38-1799862 - ------------------------------ ------------------------------------ State of other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization 8 Sound Shore Drive, Suite 290, Greenwich, CT 06830 - --------------------------------------------- -------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (203) 629-3333 -------------------- Securities registered pursuant to Section 12(b) of the Act: Name of each exchange Title of each class on which registered ------------------- --------------------- Common Stock, No Par Value American Stock Exchange Securities registered pursuant to section 12(g) of the Act: None ---- Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- ---- Indicate by mark if disclosure of delinquent filers pursuant to Item 405 of Regulations S-K is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K, or any amendment to this Form 10-K. [X] The aggregate market value of voting stock held by non-affiliates of the Registrant (based upon the closing price of the Registrant's Common Stock on the American Stock Exchange on March 23, 1998 of $103.875 per share) was $112,428,587. (In determining this figure, the Registrant has assumed that all of the Registrant's directors and officers are affiliates. This assumption shall not be deemed conclusive for any other purpose.) The number of outstanding shares of the Registrant's Common Stock was 1,418,248 as of March 23, 1998. DOCUMENTS INCORPORATED BY REFERENCE: Part II: Certain portions of Registrant's Annual Report to Shareholders for the year ended December 31, 1997. Part III: Certain portions of Registrant's Proxy Statement for the 1998 Annual Meeting of Shareholders. 2 FORWARD LOOKING INFORMATION This Form 10-K contains certain forward looking information, including without limitation examining the possibility of a spin-off (pg.2), Item 1-I.A "Regulatory Environment" and possible changes thereto and "Competition" (pgs. 4-6), Item 1-I.C "Personal Communications Services ("PCS")", including possible write downs of Registrant subsidiary's investment in Fortunet (pgs. 9-10), Item 1-II. Morgan "Growth Strategy" (p.12), Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations," and Notes to Financial Statements (Item 14(a) below). It should be recognized that such information are estimates or forecasts based upon various assumptions, including the matters referred to therein, as well as meeting the Registrant's internal performance assumptions regarding expected operating performance and the expected performance of the economy and financial markets as it impacts Registrant's businesses. As a result, such information is subject to uncertainties, risks and inaccuracies. PART I 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, but are expected to become 401 Theodore Fremd Avenue, Rye, New York 10580-1430 in April 1998. Its current telephone number is 203-629-3333. Registrant's business development strategy is to expand its existing operations through internal growth and acquisitions. It may also, from time to time, consider the acquisition of other assets or businesses that are not related to its present business. For the year ended December 31, 1997, multimedia operations provided 10% of the Registrant's consolidated revenues; services operations provided 32% of the Registrant's consolidated revenues; and manufacturing operations provided 58% of the Registrant's consolidated revenues. As used herein, the Registrant includes subsidiary corporations. Registrant is pursuing segmentation of its business, through a spin-off of 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 (Registrant expects to file a ruling request in the second quarter of 1998 with the Internal Revenue Service with respect thereto) and there is no assurance that the ruling request will be filed, and if filed, granted in a form acceptable to Registrant or 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 -2- 3 through the selective acquisition of local exchange telephone companies serving rural areas and by offering additional services to existing customers. From 1989 through 1997, Registrant has acquired ten telephone companies, five of which have indirect minority ownership of 2% to 19%, whose operations range in size from less than 500 to over 9,500 access lines. As of December 31, 1997, total access lines were 36,525, 100% 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, 1997, the Registrant owned minority interests in certain entities that provide wireless cellular telephone service in several Rural Service Areas ("RSA's") in New Mexico and North Dakota, covering areas with a total population of approximately 393,133, of which the Registrant's proportionate interest is approximately 15,116. Operating results through 1997 have not been significant to date. Inter-Community Telephone Company's participation in the Defense Commercial 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.
YEAR ENDED DECEMBER 31, ----------------------- 1997 1996 1995 ---- ---- ---- Telephone Operations Access lines* . . . . . . . . . . . . . . . . . 36,525 28,984 15,586 % Residential . . . . . . . . . . . . . . . . 75% 74% 78% % Business (nonresidential) . . . . . . . . . 25% 26% 22% Total revenues ($000's) . . . . . . . . . . . . 43,824 28,608 23,328 % Local service . . . . . . . . . . . . . . . 17% 14% 13% % Network access and long distance. . . . . . 73% 73% 69% % Other . . . . . . . . . . . . . . . . . . . 10% 13% 17%
- ------------ * 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, 1997, Lynch has acquired ten telephone companies serving a total of -3- 4 approximately 30,950 access lines at the time of these acquisitions for an aggregate consideration totaling approximately $135 million. 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 11,600 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 the spring of 1997, Registrant acquired the stock of Upper Peninsula Telephone Company ("UPTC") for approximately $26.5 million. UPTC serves approximately 6,600 access lines located primarily in the Upper Peninsula of Michigan. 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 fostering 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 intrastate 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. -4- 5 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. 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. Although the FCC has completed numerous regulatory proceedings required to implement the 1996 Act, the FCC is still in the process of promulgating new regulations covering these and related matters. For certain issues, the FCC bifurcated the proceedings between price cap and rate-of-return companies or in the case of the Universal Service Fund (USF) between rural and non-rural companies. In several cases, the regulations for the price-cap (or non-rural) local exchange carriers (LECs) have been or are being determined first, followed by separate proceedings for rate-of-return (or rural) companies. Since all of the Registrant's telephone subsidiaries are rural, rate-of-return companies for the interstate jurisdiction, many of the issues are yet to be resolved by the FCC for the Registrant's subsidiaries. Current or anticipated proceedings, which could have significant revenue impacts for rural, rate-of-return companies, include changes in access charge regulations, jurisdictional separations rules and permanent USF procedures. In May 1997, the FCC adopted interim USF procedures effective January 1, 1998 which continue to use actual embedded costs for rural companies. The interim procedures transferred the Weighted DEM and Long-Term Support (LTS) to the USF and required all telecommunications companies (including the Registrant's telephone subsidiaries) to contribute to the fund. In addition, a cap was implemented on the amount of corporate expense allowable for the computation of USF. The interim -5- 6 rules will be in effect until January 1, 2001, when the rural companies will begin transitioning to USF revenues based on forward-looking economic costs. The transition is currently scheduled to be complete January 1, 2004 at which time the USF revenue would be exclusively computed based on forward-looking economic costs. It is impossible to determine the impact of these proposed changes on the Registrant's ten telephone companies at this time. In May 1997, the FCC also ordered several changes for price cap companies to the rules applicable to interstate access charges which long distance telephone carriers pay to local exchange companies. It is anticipated that the FCC may commence a proceeding in early 1998 to propose that rate-of-return companies adopt those same changes. In October 1997, the FCC initiated a proceeding where companies provided comments to the FCC regarding how costs should be allocated between the state and interstate jurisdictions. In October 1998, the FCC is expected to begin the process of determining a forward-looking economic cost model for determining permanent USF procedures for rural telephone carriers. The FCC is currently in the process of determining USF procedures for non-rural carriers. Since interstate revenues constituted approximately 51% of the revenues of the Registrant's ten telephone companies in 1997, modifications to access charges, separations, and/or USF could have a material effect. Registrant cannot predict the effect of the 1996 Act, state initiatives and new proposed Federal and state 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; although there can be no assurance that this will continue. However, as a result of the 1996 Act, FCC and state regulatory authority initiatives 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 New York, Michigan, Wisconsin and Kansas passed or amended telecommunications bills intended to introduce more competition among providers of local services and reduce regulation. 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. 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. In addition, cellular radio or similar radio-based services, including personal communication services ("PCS"), and internet based service could provide an alternative local telephone exchange service as well as possible competition from electric companies. B. BROADCASTING 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 -6- 7 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 Ames/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 audience ratings, 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 -7- 8 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) limit foreign ownership of FCC licenses under certain circumstances. 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 eight years and are renewable for terms of eight years. The current licenses for WHBF-TV and WOI-TV expire on December 1, 2005 and February 1, 2006, respectively. OTHER On December 1, 1995, CLR 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 Haviland, Kansas. Registrant also has the right to market direct broadcasting TV services via satellite to approximately 5,398 households in New Mexico and had approximately 1,390 customers at December 31, 1997. Operating results have not been material to date. -8- 9 C. PERSONAL COMMUNICATIONS SERVICES ("PCS"). A subsidiary of Registrant is a 49.9% limited partner in Fortunet Communications, L.P. ("Fortunet"). Fortunet is the successor to five partnerships that won 30 megahertz personal communications services licenses in the FCC's C-Block auction (restricted to small businesses and certain other qualifying bidders), which concluded in 1996. Fortunet 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, Fortunet made a down payment equal to 10% of the cost (net of bidding credits) of the licenses ($21.6 million). The Government provided 10 year installment financing, interest only for the first six years at an interest rate of 7% per annum. Registrant's subsidiary has loaned Fortunet an aggregate of $24.0 million to fund the down payments and the first interest payment on the licenses. The 50.1% general partner has no obligation to provide loans or additional funds to Fortunet. Due to changed circumstances there may probably be no obligation of the limited partner to provide additional loans or funds. Certain C-Block licensees, including Fortunet, have experienced substantial financial problems in connection with servicing the FCC installment debt and/or building out the licenses. At least two major C-Block licenses have filed for protection under the Federal Bankruptcy Act. As a result, the FCC in March 1997, suspended interest payments on the FCC installment debt while it examined the situation. In September 1997 the FCC gave C-Block licensees four choices (one of which was the resumption of principal and interest payments) with respect to their licenses. The three other options, as modified in March 1998, are (i) giving up all C-Block licenses in any Metropolitan Trading Areas ("MTA"); for licenses returned, the licensee may either opt (a) to rebid on those licenses in the reauction and forfeit 100% of the down payment or (b) to forego the opportunity to rebid on those licenses and receive a credit of 70% of the down payment to be used to prepay any licenses retained, (ii) using 70% of the down payments (100% in the case of licenses to be paid up) to prepay licenses in any MTA while giving up the licenses not prepaid, and (iii) giving up 15 MHZ of the 30 MHZ licenses in any MTAs for forgiveness of 50% of the debt; a licensee who elects to resume installment payments on the remaining portion would be entitled to a credit towards debt service equal to 40% of the down payments on the spectrum given up while a licensee who elects to prepay the retained licenses would receive a credit towards prepayment equal to 70% of the down payments on the spectrum given up. The FCC has not yet given a specific date for licensees to make their elections, but it will not be before late May 1998. Fortunet has not yet determined what election it intends to make. In the third quarter of 1997, Registrant provided a reserve of 30% of its subsidiary's investment in Fortunet ($4.6 million after-tax). Depending on the election made, Registrant may have to write-down substantially all of its investment in Fortunet. Another subsidiary of Registrant, Lynch PCS Corporation F ("LPCSF"), was 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. In December 1997, East/West Communications, Inc. ("East/West") succeeded to the assets and liabilities of Aer Force with LPCSF receiving 49.9% of the common stock. Immediately thereafter, Registrant spun off 39.9% of the common stock of East/West -9- 10 to Registrant's shareholders and transferred 10% of East/West stock to Gabelli Funds, Inc. ("GFI") in satisfaction of an obligation to pay it 10% of the net profits of Aer Force (after an assumed cost of capital). Registrant also has 7,800 shares ($7,800,000 par and liquidation value) of 5% payment-in-kind preferred stock of East/West redeemable in 2009, subject to earlier payment in certain circumstances. East/West has certain financial and operating hurdles to overcome in the near term. Another subsidiary of the Registrant, Lynch PCS Corporation G ("LPCSG") has an agreement with Rivgam Communications L.L.C. ("Rivgam"), a subsidiary of GFI, which won licenses in the FCC's D and E Block PCS Auctions for 10 megahertz PCS licenses, to receive a fee equal to 10% of the realized net profits of Rivgam (after an assumed cost of capital) in return for providing bidding and certain other services. Rivgam won 12 licenses in seven states covering a population of 33 million, with an aggregate cost of $85.1 million. For a variety of reasons, and subject to any limitations of law and FCC regulation, East/West might enter into joint venture and/or working or other arrangements with Rivgam. LPCSG also has an agreement with Bal/Rivgam LLC (in which GFI has a 49.9% equity interest), which won licenses in FCC's Wireless Communications Services ("WCS") Auction in 1997, to receive a fee equal to 5% of the realized net profits of Bal/Rivgam (after an assumed cost of capital), in return for providing bidding and certain other services to Bal/Rivgam. Bal/Rivgam won 5 WCS licenses covering a population of approximately 42 million with an aggregate cost of $0.7 million. LPCSG also has an agreement to provide BCK\Rivgam L.L.C., in which GFI has a 49.9% equity interest, with similar services in connection with the FCC's Local Multipoint Distribution Services ("LMDS") Auction ended on March 25, 1998. Subject to final grant, BCK\Rivgam won 3 licenses covering a population of 1.3 million with an aggregate cost of $6.1 million. LPCSG has an agreement to receive 5% of the net profits of BCK\Rivgam (after an assumed cost of capital). 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, as well as build out requirements for WCS and LMDS licenses. Neither Fortunet nor East/West has begun any build out of their licenses. There are also substantial restrictions on the transfer of control of C and F Block PCS licenses, WCS licenses and LMDS licenses. There are many risks relating to PCS communications 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 Fortunet and East/West 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 are also similar risks as to WCS and LMDS licenses. There can be no assurance that any licenses granted to Fortunet or East/West can be successfully sold or financed or developed, with Registrant's subsidiaries recovering their debt and equity investments. II. SERVICES -10- 11 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, 1997, Lynch's equity ownership in Morgan is approximately 51%. 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 1,560 independent owner-operators and 1,350 drive-away drivers. Morgan dispatches its drivers from 123 locations in 35 states. Morgan's largest customers include Fleetwood Enterprises, Inc., Oakwood Homes Corporation, Winnebago Industries, Inc., Champion Enterprises, Inc., Cavalier Homes, Inc., 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 $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, 1997, Morgan owned transportation equipment consisted of 23 tractors, having disposed of all of its trailers in conjunction with the sale and 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 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. In the first half of 1997, Morgan discontinued the "truckaway" operation of the Specialized Transport Division taking a special charge to income in the fourth quarter of 1996. Truckaway is a line of business which focused on the transportation of van conversions, tent campers, and automotive product utilizing Company-owned equipment. The truckaway operation had revenues of $12,900,000, -11- 12 $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 was essentially flat in 1997, while the recreational vehicle industry was down in 1997. 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 66%, 58.8% and 58.6% of its revenues in 1997, 1996, and 1995. 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. -12- 13 Selected Operating Information. The following table sets forth certain operating information for each of the five years ended December 31, 1997.
YEARS ENDED DECEMBER 31 1993 1994 1995 1996 1997 --------------------------------------------------------------- (Revenues in thousands) MANUFACTURED HOUSING GROUP: Shipments . . . . . . . 95,184 121,604 135,750 144,601 178,533 Revenues. . . . . . . . $ 39,930 $ 53,520 $ 63,353 $ 72,616 $ 93,092 DRIVER OUTSOURCING: Shipments . . . . . . . 30,978 32,060 49,885 58,368 45,857 Revenues. . . . . . . . $ 13,416 $ 15,197 $ 19,842 $ 23,090 $ 20,163 SPECIALIZED TRANSPORT: Shipments . . . . . . . 38,618 41,934 44,406 41,255 34,457 Revenues . . . . . . . $ 25,835 $ 28,246 $ 29,494 $ 26,169 $ 19,173 OTHER SERVICE REVENUES $ 3,612 $ 4,917 $ 9,614 $ 10,333 $ 13,726 --------- -------- -------- --------- -------- Total operating Revenues . . . . . . . $ 82,793 $101,880 $122,303 $132,208 $146,154 ======== ======== ======== ======== ========
INDUSTRY PARTICIPATION. The following tables set forth participation in the two principal industries the company operates in where industry information is available:
1993 1994 1995 1996 1997 --------------------------------------------------------------- MANUFACTURED HOMES: Industry production(1). . 374,126 451,646 505,819 553,133 558,435 Shipments . . . . . . . . 76,188 98,181 114,890 121,136 154,389 Shares of units shipped . 20.4% 21.7% 22.7% 21.9% 27.6% RECREATIONAL VEHICLES: Industry productions(2) . 406,300 426,100 380,300 376,400 362,700 Units moved(3) . . . . . 71,792 67,502 64,303 57,703 39,102 Shares of units shipped(3) 17.7% 15.8% 16.9% 15.3% 10.8%
- ----------------------------- (1) Based on reports of Manufactured Housing Institute ("MHI"). To calculate shares of homes shipped, Morgan assumes two unit shipments for each multi-section home. (2) Based on reports of Recreational Vehicle Industry Association ("RVIA"), excluding van campers, truck campers, pick-up truck conversions, and sport utility vehicles conversions. RVIA began reporting truck and sport utility vehicle conversions in their industry shipment data in 1994. (3) Shares of units shipped calculation includes travel trailers, two types of motor homes, van conversions, and tent campers and truck conversions in 1994 - 1997. Morgan's share of units shipped are based on units moved compared to industry production rather than shipped are based on units moved compared to industry production rather than shipments because certain RV shipments include more than one unit per move. -13- 14 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 $25 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 $25 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. -14- 15 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. In 1997, 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 publicly traded. 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 March 1, 1998, Registrant owned 2,237,203 shares of Spinnaker Common Stock, approximately 62% of the outstanding, and 2,259,063 shares of Class A Common Stock, approximately 63% of the outstanding. In June 1994, Spinnaker entered into an agreement with Boyle, Fleming, Inc. ("BF"), for BF to provide operating and strategic management to Spinnaker and for Messrs. Boyle and Fleming to become Chairman and President. In addition to a management fee, BF received a warrant to purchase 678,945 shares of Spinnaker -15- 16 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 and December 1995 and the August 1996 Common 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. All BF warrants have now been exercised. 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 1997 net sales: industrial sealing tape (51.6%) and adhesive-backed label stock (46.0%). For the fiscal year ended December 31, 1997, Spinnaker had net sales of $232 million. Spinnaker has four 100% owned subsidiaries: Spinnaker Coating, Inc., (formerly called Brown-Bridge Industries, Inc.) ("Spinnaker Coating"), 80.1% of which was acquired in September 1994, Central Products Company ("Central Products"), acquired in October 1995, Spinnaker Coating-Maine, Inc. ("Coating-Maine"), 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 Spinnaker Coating (plus management stock options), which were owned by the management of Spinnaker Coating, BF and Registrant. Spinnaker Coating and Coating - Maine are in the adhesive-backed label stock industry. Central Products manufactures industrial sealing tape. Entoleter manufactures a line of industrial process equipment and a line of air pollution equipment. In March 1998, Coating-Maine acquired the Pressure Sensitive Business of S.D. Warren Company ("Warren") for an aggregate purchase price of approximately $51.8 million plus the assumption of certain liabilities (excluding substantially all trade payables). The Pressure Sensitive Business manufactures standard pressure sensitive products that are primarily used for EDP labels and consumer products labels that are sold to major forms manufacturers and distributors. The Pressure Sensitive Business operates at S.D. Warren's Westbrook, Maine facility and had sales of approximately $62.1 million for its fiscal year ended October 1, 1997. The purchase price was paid by the issuance of a 10% subordinated convertible note (the "Note") to Warren, in the original principal amount of $7.0 million, and the remainder with funds available under Spinnaker's asset-backed working capital revolving credit facility with BT Commercial Corporation (The "Revolving Credit Facility"), which was concurrently amended to increase the aggregate facility amount to $60 million. The principal amount outstanding under the Note is prepayable by Spinnaker at any time without penalty. The Note has a payment-in-kind ("PIK") feature that allows Spinnaker to pay interest accrued during the first year with an additional subordinated note having substantially similar terms as the Note, and Spinnaker may also issue such a PIK note if at a future interest payment date a default or event of default exists, or would be caused by the payment of interest in cash, under the Revolving Credit Facility. Payments of principal and interest are subject to restrictions contained in, and in any event are junior and subordinate in right of payment to, the payment of indebtedness outstanding under the Revolving Credit Facility and Spinnaker's 10 3/4% Senior Secured Notes due 2006. The Note matures on January 31, 2002, however it is expected to be prepaid earlier if certain conditions or events occur. Prepayments of principal in an amount equal to 30% and 70% of the original principal amount are due on March 31, 1999 and on March 31, 2000, respectively, subject to there being sufficient unused availability and no existing default or event of default under the Revolving Credit Facility. The Note is convertible for shares of Spinnaker's common stock, no par value ("Common Stock"), on the basis of 40 shares per $1,000 of the outstanding principal amount of the Note (or $25 per share), subject to adjustment as set forth in the Note. Upon conversion of the Note, the holder thereof will be entitled to certain registration rights with respect to the shares of Common Stock received upon such conversion. 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. -16- 17 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. SPINNAKER COATING Spinnaker Coating 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. Spinnaker Coating is a major supplier of adhesive-back label stock for use in United States postage stamps. Spinnaker Coating'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 -17- 18 products used primarily for marking, identification and promotional labeling. Spinnaker Coating'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 1997, pressure sensitive products constituted approximately 87% of Spinnaker Coating's net sales of adhesive-backed label stock products. 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 1997, 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. Spinnaker Coating 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 Spinnaker Coating's facilities in Troy, Ohio. However, to broaden its market penetration, Spinnaker Coating also contracts with seven regional processors throughout the United States, with whom Spinnaker Coating stores product until sold. Generally, these processors perform -18- 19 both slitting and distribution services for Spinnaker Coating. 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% 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. Spinnaker Coating has installed at its Troy, Ohio, facilities a new production line for silicone coating. See Item 2 below for a description of manufacturing and distribution facilities. Competition The adhesive-backed materials industry is highly competitive, and Spinnaker competes with both national and regional suppliers. As a result of the competitive environment in the markets in which Spinnaker operates, Spinnaker faces (and will continue to face) pressure on sales prices of its products. As a result of such pricing pressures, Spinnaker may in the future experience reductions in the profit margins on its sales, or may be unable to pass future raw material price increases to its customers (which would also reduce profit margins). Spinnaker operates in markets characterized by a few large diversified companies selling products under recognized trade names and a number of smaller public and privately-held companies selling to the market. In addition to branded products, some companies in the industry produce private-label products to enhance supply relationships with large buyers. Central Products competes with other manufacturers of carton sealing tape products as well as manufacturers of alternative carton closure products. Competition in the carton sealing market is based primarily on price and quality, although other factors may enhance a company's competitive position, including product performance characteristics, technical support, product literature and customer support. There are a wide range of participants in the carton sealing industry, including large diversified corporations (principally in pressure sensitive) and small private companies (principally in water sensitive tape). -19- 20 Central Products is one of the leading manufactures of water sensitive tape. 3M Corporation is the largest manufacturer of pressure sensitive tape in the carton sealing market in the United States. The adhesive-backed label stock market is fragmented. Spinnaker Coating competes with several national manufacturers, including Avery-Dennison, Bemis, 3M Corporation and a number of smaller regional manufacturers. Spinnaker believes that Avery-Dennison, Bemis and 3M Corporation are the only competitors with national production facilities and Avery-Dennison and 3M Corporation are the only competitors with nationally recognized brand names. Environmental Regulations Spinnaker's operations are subject to environmental laws and regulations governing emissions to the air, discharges to waterways, and generation, handling, storage, transportation, treatment and disposal of waste materials. Spinnaker is also subject to other federal and state laws and regulations regarding health and safety matters. Environmental laws and regulations are constantly evolving and it is impossible to predict the effect that these laws and regulations will have on Spinnaker in the future. While Spinnaker believes it is currently in substantial compliance with all such environmental laws and regulations, there can be no assurance that it will at all times be in complete compliance with all such requirements. In addition, although Spinnaker believes that any noncompliance is unlikely to have a material adverse affect on Spinnaker, it is possible that such noncompliance could have a material adverse affect on Spinnaker. Spinnaker has made and will continue to make capital expenditures to comply with environmental requirements. As is the case with manufacturers in general, if a release of hazardous substances occurs on or from Spinnaker's properties or any associated offsite disposal location, or if contamination from prior activities is discovered at any of Spinnaker's properties, Spinnaker may be held liable and the amount of such liability could be material. Patents and Trademarks Patents are held by Spinnaker with respect to the manufacture of certain of its products, but its management does not consider such patents to be important to Spinnaker's operations. The patents expire over various lengths of time with the last patent expiring in about 10 years. Spinnaker has registered several of its trade names and trademarks for adhesive-backed materials. International Sales Spinnaker's international sales were $14.2 million, $11.5 million and $10.4 million 1997, 1996, and 1995, respectively. Of the $14.2 million in 1997 international sales, approximately 85% were represented by exports of Spinnaker Coating and Central Products adhesive-backed materials. The substantial majority of these sales were to Canadian customers and, consequently, Spinnaker believes that the risks commonly associated with doing business in international countries are minimal. The profitability of foreign sales is substantially equivalent to that of domestic sales. Because international sales are transacted in United States dollars, payments in many cases are secured by irrevocable letters of credit. -20- 21 Backlog The Company's backlog believed to be firm was $7.1 million at December 31, 1997, as compared to $9.2 million at December 31, 1996. Industrial Process Equipment Business Through its Entoleter subsidiary, the Company engineers, manufactures and markets a line of industrial process equipment and a line of air pollution control equipment. Entoleter's net sales consist entirely of sales to commercial and industrial customers. Spinnaker is exploring strategic alternative with respect to Entoleter, including a possible spin-off of the Entoleter stock to its shareholders. There can be no assurance, however, that any transaction involving Entoleter will occur. Employees As of December 31, 1997, Spinnaker employed approximately 945 persons, of which 542 were Central Products employees, 357 were Spinnaker Coating employees, and 36 were Entoleter employees. All employees other than management are paid on an hourly basis. A majority of its hourly employees are not represented by unions. Central Products has a labor agreement expiring in 1998 with the United Paperworkers International Union AFL-CIO covering 184 hourly employees at the Menasha, Wisconsin plant. Entoleter's 15 hourly-paid production employees are members of the United Electrical, Radio and Machine Workers of America Union. The current collective bargaining agreement expires on April 30, 1999. Spinnaker believes that its relations with its employees are good; however, there can be no assurance that the Company will not experience work stoppages or slowdowns in the future. B. LYNCH SYSTEMS, INC. (FORMERLY CALLED LYNCH MACHINERY, INC.) Lynch Systems, Inc. ("LS"), a 90% owned subsidiary of Registrant and the initial part of the Lynch Display Technologies group, designs, develops, manufactures and markets a broad range of manufacturing equipment for the electronic display and consumer glass industries. LS also produces replacement parts for various types of packaging and glass container-making machines which LS does not manufacture. CRT Display and Consumer Glass Manufacturing Technologies. LS manufactures glass-forming presses and electronic controls to provide high-speed automated systems to form different sizes of face panels and tubes for television screens and computer monitors. LS produces an HDTV model press to build large-screen televisions for the HDTV (high definition television) market. LS manufactures and installs presses to form table ware such as glass tumblers, plates, cups, saucers and commercial optical glass. LS also manufactures and installs electronic controls and retrofit systems for CRT display and consumer glass presses. LS shipped 6 controls and retrofit systems amounting to approximately $2.8 million in 1997. -21- 22 The production of glass pressware entails the use of machines which heat glass and, using great pressure, form an item by pressing it into a desired shape. Because of the high cost of bringing the machine and materials up to temperature, a machine for producing glass pressware must be capable of running 24 hours a day, 365 days a year. During 1997, LS delivered 9 glass press machines, compared to 4 machines in 1996; however, revenues are recognized on a percentage of completion basis. At December 31, 1997, LS had orders for, and had in various stages of production, 9 glass press machines, at a total sales price of approximately $17.4 million, which are scheduled for delivery in 1998 and beyond. One order for $16 million of machines with an Asian purchaser, permits the purchaser to cancel the order on the payment of a $2.4 million penalty. The customer has currently put a hold on this order and LS does not expect significant production during 1998. There can be no assurance that LS can obtain orders for additional large glass pressing orders to replace its existing orders. LS believes that it is the largest supplier to glass companies that do not manufacture their own pressware machines in the worldwide pressware market. Competitors include various companies in Italy, Japan, France, Germany and elsewhere. While several of the largest domestic and international producers of glass pressware frequently build their own glass-forming machines and produce spare parts in-house, nearly all pressware producers have made purchases of machines and/or spare parts from LS. Packaging Machinery. Effective in January 1996, LS discontinued the manufacturing of automated case packers and related equipment. In mid-1996, LS discontinued and sold its Tri-Can International operation, which manufactured packaging machines. In connection therewith, LS recognized a charge to income in 1996 of approximately $0.8 million (after tax). International Sales. During 1997, approximately 81% of LS's sales were made to international customers, and 100% of its large glass pressing machine orders were from international customers in Asia. The profitability of international sales is equivalent to that of domestic sales. Because many international orders require partial advance deposits, with the balance often secured by irrevocable letters of credit from banks in the international country, the Registrant believes that some of the credit risks commonly associated with doing business in international countries are minimized. The Registrant avoids currency exchange risk by transacting all international sales in United States dollars. LS is unable to predict how great an adverse impact the current East Asia financial crisis will have on its international business. Backlog. LS had an order backlog of approximately $18.6 million at December 31, 1997, compared with approximately $6.6 million at December 31, 1996. LS includes as backlog those orders which are subject to written contract, written purchase orders and telephone orders from long standing customers who maintain satisfactory credit ratings. LS has historically experienced only insignificant cancellations of the orders included in its backlog; however, see above for the right of a purchaser to cancel an order upon the payment of a penalty. -22- 23 Raw Materials. Raw materials are generally available to LS in adequate supply from a number of suppliers. C. M-TRON INDUSTRIES, INC. ("M-TRON") M-tron, a 91% owned subsidiary of the Registrant, is a manufacturer and importer of quartz crystal products and clock oscillator modules used for clocking digital circuits, precision time base references and telecommunications equipment. A quartz crystal is an oscillating component which performs the clocking function in a circuit. Crystals and clock oscillator modules are used primarily in microprocessor-related equipment and telecommunications equipment. Frequency and time related products essentially use crystals or clock oscillators, with the addition of electronic circuitry vertically integrating the product. Crystal and clock oscillators are sold to original equipment manufacturers, both directly and through commissioned representatives and distributors. For 1997, 1996, and 1995, M-tron's sales consisted of (in thousands):
1997 1996 1995 ------- ------- ------- Crystals............................ $12,611 $10,594 $13,778 Oscillator Modules.................. 10,217 7,839 6,434 ------- ------ ------ Total $22,828 $18,433 $20,212 ======= ======= =======
Competition. Quartz crystals and clock oscillators are sold in a highly competitive industry. There are numerous domestic and international manufacturers who are capable of providing quartz crystals and clock oscillators comparable in quality and performance to M-tron's products. International competitors, particularly from the Far East, continue to dominate the United States market. M-tron seeks to manufacture smaller specialty orders of crystals and oscillators, which it believes it can competitively fill based upon price, quality and order response time. M-tron also performs quality control tests on all products it imports from the Far East and resells domestically and internationally. International Sales. M-tron's international sales in 1997 were approximately 43% of total sales and were concentrated in Canada and Western Europe. The profitability of international sales has been substantially equivalent to that of domestic sales. M-tron is unable to predict what effect the East Asian financial crisis will have on its business. However, because sales are ordinarily spread over a number of customers in a number of developed countries with no individually significant shipments, the Registrant believes that risks commonly associated with doing business in international countries are minimized. Backlog. M-tron had backlog orders of approximately $5,215,000 at December 31, 1997, compared with $5,049,000 at December 31, 1996. M-tron includes as backlog those orders which are subject to specific production release orders under written contracts, verbal and written orders from distributors with which M-tron has had long-standing relationships, as well as written purchase orders from sales representatives. M-tron believes that all of the backlog at December 31, 1997, will be shipped during 1998. -23- 24 Raw Material. To the extent possible, M-tron's raw materials are purchased from multiple sources. Of primary significance are quartz crystal bars and the bases used for mounting certain finished crystals. M-tron currently has at least two qualified vendors for each of these items. No shortages have occurred in the recent past nor are any anticipated in the near future. IV. OTHER INFORMATION While the Registrant holds licenses and patents of various types, Registrant does not believe they are critical to its overall operations, except for (1) the television-broadcasting license of WHBF-TV and WOI-TV; (2) Registrant's telephone subsidiaries franchise certificates to provide local-exchange telephone service within its service areas; (3) Western's FCC licenses to operate point-to-point microwave systems; (4) licenses held by partnerships and corporations in which Western and Inter-Community own minority interests to operate cellular radio systems covering areas in New Mexico and North Dakota, (5) CLR Video's franchises to provide cable television service within its service areas and (6) personal communications services licenses held by companies in which Lynch subsidiaries have investments. The Registrant conducts product development activities with respect to each of its major lines of manufacturing business. Currently, such activities are directed principally toward the improvement of existing products, the development of new products and/or diversification. The cost of such activities, which have been funded entirely by the Registrant, amounted to approximately $1,022,000 in 1997, $1,627,000 in 1996, and $1,673,000 in 1995. The capital expenditures, earnings and competitive position of Registrant have not been materially affected by compliance with current federal, state, and local laws and regulations relating to the protection of the environment; however, Registrant cannot predict the effect of future laws and regulations. The Registrant has not experienced difficulties relative to fuel or energy shortages but substantial increases in fuel costs or fuel shortages could adversely affect the operations of Morgan. Registrant has initiated a comprehensive review of its computer systems to identify the systems that could be affected by the "Year 2000" issue and is developing an implementation plan to resolve the issue. The Year 2000 problem is the result of computer programs being written using two digits (rather than four) to define the applicable year. Any of the Registrant's programs or programs utilized by vendors to the Registrant that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a major system failure or miscalculations. Of Registrant's subsidiaries, the most potential exposure exists at the telephone companies, both with the switching equipment and third party billing vendors, and at Morgan. Registrant presently believes that, with modifications to existing software and converting to new software, the Year 2000 problem will not pose significant operational problems for Registrant's computer systems as so modified and converted. However, if such modifications and conversions are not completed timely, the Year 2000 problem may have a material impact on the operations of Registrant. Registrant cannot yet estimate the cost of such modifications or conversions. -24- 25 No portion of the business of the Registrant is regarded as seasonal, except that, in the case of Morgan, fewer shipments are scheduled during the winter months in those parts of the country where weather conditions limit highway use. There were no customers in 1997 or 1996 that represents 10% or more of consolidated revenues. The Registrant does not believe that it is dependent on any single customer. Excluding the following for The Morgan Group, Inc.: approximately 1,560 independent owner-operators and 1,350 drive-away drivers, the Registrant had a total of 1,881 employees at December 31, 1997 and 1,910 employees at December 31, 1996. Additional information with respect to each of the Registrant's lines of business is included in Note 14 to the Consolidated Financial Statements included as Item 14(a) below. V. EXECUTIVE OFFICERS OF THE REGISTRANT Pursuant to General Instruction G (3) of Form 10-K, the following list of executive officers of the Registrant is included in Part 1 of this Annual Report on Form 10-K in lieu of being included in the Proxy Statement for the 1998 Annual Meeting of Shareholders. Such list sets forth the names and ages of all executive officers of Registrant indicating all positions and offices with the Registrant held by each such person and each such person's principal occupations or employment during the past five years.
NAME OFFICES AND AGE ---- POSITIONS HELD --- -------------- Mario J. Gabelli Chairman and Chief Executive Officer (since May 1986); Chairman and Chief Executive Officer (since March 1980) of Gabelli Funds Inc. (successor to The Gabelli Group, Inc.), holding Company for subsidiaries engaged in various aspects of the securities business. 55 Robert E. Dolan Chief Financial Officer (since February 1992) and Controller (since May 1990). 46
-25- 26 Robert A. Hurwich Vice President-Administration, Secretary & General Counsel (since February 1994); Private Law Practice (1991-1993); Vice President, Secretary & General Counsel of Moore McCormack Resources, Inc. (1975-1989). 56
The executive officers of the Registrant are elected annually by the Board of Directors at its organizational meeting in May and hold office until the organizational meeting in the next subsequent year and until their respective successors are chosen and qualified. ITEM 2. PROPERTIES Effective April 1998, Lynch will lease space containing approximately 4,000 square feet for its executive offices in Rye, New York. LS's operations are housed in two adjacent buildings situated on 3.19 acres of land in Bainbridge, Georgia. In January 1997, LS 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, 2000, with options to extend the lease to 2006. Spinnaker's corporate headquarters is located in Dallas, Texas, where it shares office space with an affiliate of its principal executive officers. Spinnaker Coating 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 two manufacturing facilities, one in Menasha, Wisconsin and the other in Brighton, Colorado. The Menasha facility contains approximately 160,000 square feet and the Brighton facility 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. -26- 27 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. In connection with Spinnaker's acquisition of the Pressure Sensitive Business of S.D. Warren in March 1998, the parties entered into the Site Lease, which provides for Warren's lease of a portion of its Westbrook, Maine facility to Spinnaker. Such lease is for a term of 99 years, provides for nominal rent of $1.00 per year, and permits Spinnaker to lease additional space for expansion at the site. During 1997 and 1996, Registrant's manufacturing facilities (except for LS) 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, 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 for driver training and commercial driver licensing, testing and certification. Most of Morgan's 93 regional and 110 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 five years, at monthly rental ranging from $100 to $11,048. The Elkhart facility is currently mortgaged to one of Morgan's lenders. In total, Morgan owns 69 acres of land throughout the United States, including the Elkhart facilities. Western New Mexico Telephone Company owns a total of 16.9 acres at fourteen 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 38 other sites under permits or easements at which it has installed various equipment either in small company-owned buildings (totaling 2,403 square feet) or under protective cover. Western also owns 3,248 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 ("RUS"). -27- 28 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 1,743 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 Company 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 Telephone 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 22 miles of fiber optic cable. All of Cuba City's and Belmont's property described herein are encumbered under mortgages held by the RUS 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 1,186 miles of buried copper cable and 186 miles of buried fiber optic cable. All properties described herein are encumbered under mortgages held by the RUS. 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. In 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 16.4 acres at 5 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 4 other smaller facilities housing garage, warehouse and central office switching equipment and over 62 miles of buried copper cable and 21 miles of fiber optic cable. Upper Peninsula Telephone Company owns a total of approximately 25 acres at 19 sites located principally in the Upper Peninsula of Michigan. Its host central office switching equipment, administrative and commercial offices consisting of 11,200 square feet is located in Carney, Michigan. In addition, Upper Peninsula owns 25 other smaller facilities housing garage, warehouse and central office switching equipment and over 2,100 miles of buried copper cable and 95 miles of fiber optic cable. All properties described herein are encumbered under mortgages held by the RUS and Co-Bank. CLR Video has its headquarters in leased space in Wetmore, Kansas. It also -28- 29 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. LEGAL PROCEEDINGS Registrant is a party to certain lawsuits in the ordinary course of business. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The information required by this Item 5 is incorporated herein by reference to "Market Price Information and Common Stock Ownership" in Registrant's Annual Report to Shareholders for the year ended December 31, 1997. ITEM 6. SELECTED FINANCIAL DATA The information required by this Item 6 is incorporated herein by reference to "Five Year Summary Selected Financial Data" in Registrant's Annual Report to Shareholders for the year ended December 31, 1997. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information required by this Item 7 is incorporated herein by reference to "Management Discussion and Analysis of Financial Condition and Results of Operations" in Registrant's Annual Report to Shareholders for the year ended December 31,1997. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK Not applicable. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Report of Independent Auditors and the following Consolidated Financial -29- 30 Statements of the Registrant are incorporated herein by reference to Registrant's Annual Report to Shareholders for the year ended December 31, 1997. Consolidated Balance Sheets - December 31, 1997, and 1996. Consolidated Statements of Operations - Years ended December 31, 1997, 1996, and 1995. Consolidated Statements of Shareholders' Equity - Years ended December 31, 1997, 1996, and 1995. Consolidated Statements of Cash Flows - Years ended December 31, 1997, 1996, and 1995. Notes to Consolidated Financial Statements ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE On August 25, 1997, Registrant's majority-owned subsidiary Spinnaker Industries, Inc. ("Spinnaker") dismissed Deloitte & Touche LLP, independent accountants ("DT"), as the principal accountant for Central Products Company, a wholly owned subsidiary of Spinnaker ("Central Products"), and expanded the auditing responsibility of Registrant's and Spinnaker's principal accountants, Ernst & Young LLP ("EY"), to include Central Products operations. EY has served as the Registrant's and Spinnaker's principal independent accountant since at least 1988. EY referred to DT's audits of Central Products' financial statements as of December 31, 1995 and 1996 and for the year ended December 31, 1996 and the three months ended December 31, 1995, in its reports regarding its audits of the financial statements of Registrant and Spinnaker. Spinnaker's Audit Committee, with the knowledge of Registrant's Audit Committee, recommended the foregoing change in accountants to Spinnaker's Board of Directors, who approved such action on August 12, 1997. The Spinnaker Audit Committee's recommendation was based upon its desire to consolidate its annual audit process under one independent accounting firm. The reports of DT on Central Products' financial statements as of December 31, 1996 and 1995 and for the year ended December 31, 1996 and the three months ended December 31, 1995, have not contained an adverse opinion or a disclaimer of an opinion, nor were they qualified or modified as to uncertainty, audit scope, or -30- 31 accounting principles. There were no disagreements with DT or any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure during those two periods and in the subsequent interim periods, which, if they had not been resolved to the satisfaction of DT, would have caused it to make reference to such disagreement in its report on Central Products' financial statements. Spinnaker filed a Form 8-K dated August 25, 1997, with respect to such change. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this Item 10 is included under the captions "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 1998, which information is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION The information required by this Item 11 is included under the captions "Compensation of Directors," "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 1998, which information is incorporated herein by reference. The Performance Graph in the Proxy Statement shows that Registrant's Common Stock underperformed the American Stock Exchange Market Value Index and a combined peer group index (telephone communications, except radio telephone operations; converted paper and paperboard; and trucking except local) in 1993 and out performed said indices through 1994, 1995, 1996, and 1997. 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 1998, which information is included herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item 13 is included under the caption "Executive Compensation", and "Transactions with Certain Affiliated Persons" in the Registrant's Proxy Statement for its Annual Meeting of Shareholders for 1998, which information is included herein by reference. -31- 32 PART IV 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 incorporated herein by reference to the Registrant's Annual Report to Shareholders for the year ended December 31, 1997, as noted on Page 29-30 in Item 8 hereof: Consolidated Balance Sheets - December 31, 1997 and 1996 Consolidated Statements of Operations - Years ended December 31, 1997, 1996, and 1995 Consolidated Statements of Shareholders' Equity - Years ended December 31, 1997, 1996, and 1995 Consolidated Statements of Cash Flows - Years ended December 31, 1997, 1996, and 1995 Notes to Consolidated Financial Statements (2) Financial Statement Schedules: Schedule I - Condensed Financial Information of Registrant Schedule II - Valuation and Qualifying Accounts Other Financial Statement Schedules have been excluded because they are not required. -32- 33 SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT LYNCH CORPORATION CONDENSED STATEMENT OF OPERATIONS
Year Ended December 31 ------------------------------ 1997 1996 1995 ---- ---- ---- (In Thousands of Dollars) Interest, Dividends & Gain on Sales of Marketable Securities $ 377 $ 649 $ 232 Interest, Dividend & Other Income from Subsidiaries 35 621 715 Gain on Sale of Subsidiary and Affiliate Stock: Brown-Bridge Industries, Inc. - 203 - ----- ------ ------ TOTAL INCOME 412 1,473 947 Costs and Expenses: Unallocated Corporate Administrative Expense $ 1,436 $ 2,312 $ 2,869 Interest Expense 1,257 669 448 Interest Expense to Subsidiaries 741 249 -- ------- ------- ------- TOTAL COST AND EXPENSES 3,434 3,230 3,317 ------- ------- ------- LOSS BEFORE INCOME TAXES, EQUITY IN NET INCOME (LOSS) OF SUBSIDIARIES (3,022) (1,758) (2,370) Income Tax Benefit 1,142 515 779 Equity in Net Income (Loss) of Subsidiaries (998) 3,939 6,736 -------- ------- ------- NET INCOME $(2,878) $ 2,696 $ 5,145 ======= ======= =======
NOTES TO CONDENSED FINANCIAL STATEMENTS NOTE A - DIVIDENDS FROM SUBSIDIARIES Cash dividends paid to Lynch Corporation from the Registrant's consolidated subsidiaries were $1,195,000 in 1997, $1,811,000 in 1996, and $1,166,000 in 1995. No other dividends were received from subsidiaries or investees. NOTE B - SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR ADDITIONAL INFORMATION -33- 34 SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT LYNCH CORPORATION CONDENSED BALANCE SHEET
Year Ended December 31 1997 1996 ---- ---- (In Thousands of Dollars) ASSETS CURRENT ASSETS Cash and Cash Equivalents $ 290 $ 68 Marketable Securities and Short Term Investments 755 573 Deferred Income Tax Benefits 348 738 Other Current Assets 47 11 ------ ------- Total Current Assets 1,440 1,390 OFFICE EQUIPMENT (Net of Depreciation) 22 26 OTHER ASSETS (Principally Investment in and Advances to Subsidiaries) $69,255 $61,836 ------- ------- Total Assets $70,717 $63,252 ======= ======= LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES $28,602 $18,965 LONG TERM DEBT 2,190 2,090 DEFERRED INCOME TAX LIABILITIES 1,478 1,585 DEFERRED CHARGES 1,996 1,689 TOTAL SHAREHOLDERS' EQUITY $36,451 $38,923 ------- ------- Total Liabilities and Shareholders' Equity $70,717 $63,252 ======= =======
-34- 35 SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT LYNCH CORPORATION CONDENSED STATEMENTS OF CASH FLOWS
Year Ended December 31 1997 1996 1995 ---- ---- ---- (In Thousands of Dollars) Cash Provided From (Used In) Operating Activities $ (25) $ 469 $(1,158) -------- ------- ------- INVESTING ACTIVITIES: Investment in Lynch Manufacturing 1,135 1,683 781 Investment and Advances to Brighton Communications (17) (2,053) - Loan to Spinnaker Industries, Inc. - 1,330 -- Investment in Brown-Bridge Industries, Inc. - 407 - Investment in and Advances to Lenco II - - 2,535 Investment in and Advances to The Morgan Group, Inc. 7 60 1,300 Investment in and Advances to Pcs Partnerships (8,628) (14,315) (7,010) Other (101) 607 (13) ------- ------- ------- NET CASH PROVIDED FROM (USED IN) INVESTING ACTIVITIES (7,604) (12,281) (2,407) ------- ------- ------- FINANCING ACTIVITIES: Net Borrowings Lines of Credit 7,179 8,627 3,709 Issuance of Long Term Debt - 2,000 -- Sale of Treasury Stock 672 754 - Other - 1 248 ------ ------ ------ NET CASH PROVIDED FROM FINANCING ACTIVITIES 7,851 11,382 3,957 ------ ------ ------- TOTAL INCREASE (DECREASE)IN CASH AND CASH EQUIVALENTS 222 (430) 392 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 68 498 106 ------ ------ ------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 290 $ 68 $ 498 ====== ====== =======
-35- 36 SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS LYNCH CORPORATION AND SUBSIDIARIES YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E ADDITIONS BALANCE AT CHARGED TO CHARGED TO BEGINNING COSTS AND OTHER ACCOUNTS DEDUCTIONS BALANCE AT DESCRIPTION OF PERIOD EXPENSES -DESCRIBE -DESCRIBE PERIOD YEAR ENDED DECEMBER 31, 1997 ALLOWANCE FOR UNCOLLECTIBLE $1,525,000 $ 742,000 $ 0 $ 819,000(B) $1,448,000 YEAR ENDED DECEMBER 31, 1996 ALLOWANCE FOR UNCOLLECTIBLE $1,732,000 $1,900,000 $ 75,000(A) $2,182,000(B) $1.525.000 YEAR ENDED DECEMBER 31, 1995 ALLOWANCE FOR UNCOLLECTIBLE $ 737,000 $ 987,000 $1,160,000(A) $1,152,000(B) $1,732,000
(A) ALLOCATION OF PURCHASE PRICE OF ACQUIRED COMPANY. (B) UNCOLLECTIBLE ACCOUNTS WRITTEN OFF ARE NET OF RECOVERIES. -36- 37 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 Page 2 above re Forward Looking Information. (3) Exhibits: See the Exhibit Index on pages 40 - 43 of this Form 10-K Annual Report. The following Exhibits listed in the Exhibit Index are filed with this Form 10-K Annual Report: 10(o) - Directors Stock Plan 10(u)(i)(a) - Correction to Loan Agreement 10(y) - Letter Agreement dated as of January 20, 1998, between Lynch PCS Corporation G and BCK/Rivgam, L.L.C. 10(z) - Employment Agreement dated February 2, 1998 between Registrant and Mark Feldman 13 - Annual Report to Shareholders for the year ended December 31, 1997 (only those portions of the Annual Report expressly incorporated by reference herein shall be deemed filed) 21 - Subsidiaries of the Registrant 23 - Consents of Independent Auditors - Ernst & Young LLP - Arthur Andersen LLP - McGladrey & Pullen, LLP(2) - Deloitte & Touche, LLP - Johnson Mackowiak Moore & Myott, LLP - Frederick & Warriner, L.L.C. 24 - Powers of Attorney 27 - Financial Data Schedules 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, 1995. - Report of McGladrey & Pullen, LLP on the Financial Statements of Capital Communications Corporation for the years ended December 31, 1996 and 1995. - Report of McGladrey & Pullen, LLP on the Financial Statements of Coronet Communications Corporation for the years ended December 31, 1996 and 1995. - Report of Deloitte & Touche LLP on the Financial Statements of Central Products Company for the year ended December 31, 1996 and the three months ended December 31, 1995. - Report of Johnson Mackowiak Moore & Myott, LLP on the Consolidated Financial Statements of Dunkirk & Fredonia Telephone Company for the period November 26, 1996 through December 31, 1996. - Report of Frederick & Warinner, L.L.C. on the Financial Statements of CLR Video, Inc. for the year ended December 31, 1996. -37- 38 (b) Reports on Form 8-K: Reports on Form 8-K were filed as of (i) October 15, 1997, and December 8, 1997, to report under Item 5 on letters to Hector Communications, Inc. with respect to shares of stock of Hector . (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) -38- 39 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.
SIGNATURE CAPACITY DATE --------- -------- ---- * MARIO J. GABELLI Chairman of the Board of - ------------------- Directors and Chief MARIO J. GABELLI Executive Officer March 30, 1998 (Principal Executive Officer) * E. VAL CERUTTI Director March 30, 1998 - ------------------ E. VAL CERUTTI * PAUL J. EVANSON Director March 30, 1998 - ------------------ PAUL J. EVANSON * JOHN C. FERRARA Director March 30, 1998 - ----------------- JOHN C. FERRARA * DAVID C. MITCHELL Director March 30, 1998 - ------------------- DAVID C. MITCHELL * SALVATORE MUOIO Director March 30, 1998 - ----------------- SALVATORE MUOI0 * RALPH R. PAPITTO Director March 30, 1998 - ------------------ RALPH R. PAPITTO s/ROBERT E. DOLAN Chief Financial Officer - ------------------ (Principal Financial ROBERT E. DOLAN and Accounting Officer) March 30, 1998 *s/ROBERT A. HURWICH - -------------------- ROBERT A. HURWICH Attorney-in-fact
-39- 40 EXHIBIT INDEX Exhibit No. Description - ----------- ----------- 3 (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 October 23, 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 -40- 41 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 (exhibit omitted) (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).+ (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 -41- 42 *(p) Phantom Stock Plan (incorporated by reference to Exhibit 10(p) to Registrant's Form 10-Q for the year ended March 31, 1997). (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) (incorporated by reference to Exhibit 10(v) to Registrant's Form 10-K for the year ended December 31, 1995).+ (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) (incorporated by reference to Exhibit 10(w) to Registrant's Form 10-K for the year ended December 31, 1995.. (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, 1996, between Gabelli Funds, Inc. and Registrant (incorporated by reference to Exhibit 10(u)(i) of Registrant's Form 10-K for the year ended December 31, 1996. (u)(a) Correction to Loan Agreement. (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 (incorporated by reference to Exhibit 10(u)(ii) to Registrant's Form 10-K for the year ended December 31, 1996). (v) Letter Agreement, dated as of August 12, 1996, between Rivgam Communicators, L.L.P. and Lynch PCS Corporation G (incorporated by reference to Exhibit 10(u)(ii) to Registrant's Form 10-K for the year ended December 31, 1996). (w) Loan Agreement, dated as of August 12, 1996 between Lynch PCS Corporation F and Aer Force Communications B, L.P. (incorporated by reference to Exhibit 10(u)(ii) to Registrant's Form 10-K for the year ended December 31, 1996). 10(x) Letter Agreement between Lynch PCS Corporation G and Bal/Rivgam, L.L.C. (incorporated by reference to Exhibit 10(x) to Registrant's Form 10-Q for the Quarter ended September 30, 1997). 10(y) Letter Agreement, dated January 20, 1998, between Lynch PCS Corporation G and BCK/Rivgam, L.L.C. *10(z) Employment Agreement, dated February 2, 1998, between Registrant and Mark Feldman. 13 Annual Report to Shareholders for the year ended December 31, 1997 (only -42- 43 those portions of the Annual Report expressly incorporated by reference herein shall be deemed filed.) 16 Letter Re: Change in Certifying Accountant (incorporated by reference to Exhibit 16 to Registrant's Form 8-K, dated March 19, 1996). 21 Subsidiaries of the Registrant. 23 Consents of Independent Auditors. - Ernst & Young LLP - Arthur Andersen LLP - McGladrey & Pullen, LLP(2) - Deloitte & Touche, LLP - Johnson Mackowiak Moore & Myott, LLP - Frederick & Warinner, L.L.C. 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, 1995. - Report of McGladrey & Pullen, LLP on the Financial Statements of Capital Communications Corporation for the years ended December 31, 1996 and 1995. - Report of McGladrey & Pullen, LLP on the Financial Statements of Coronet Communications Corporation for the years ended December 31, 1996 and 1995. - Report of Deloitte & Touche LLP on the Financial Statements of Central Products Company for the year ended December 31, 1996 and the three months ended December 31, 1995. - Report of Johnson Mackowiak Moore & Myott, LLP on the Consolidated Financial Statements of Dunkirk & Fredonia Telephone Company for the period November 26, 1996 through December 31, 1996. - Report of Frederick & Warinner, L.L.C. on the Financial Statements of CLR Video, Inc. for the year ended December 31, 1996. - ---------------------- * Management contract or compensatory or arrangement. + Registrant agrees to furnish a supplemental copy of any omitted schedule to the Securities and Exchange Commission upon request. 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. -43- EX-10.O 2 DIRECTORS STOCK PLAN 1 EXHIBIT 10(0) LYNCH CORPORATION DIRECTORS STOCK PLAN (THE "PLAN") 1. Each person who is a director of Lynch Corporation (the "Corporation") (but is not an employee of the Corporation) on the first business day of each year (except that the date of grant for 1996 shall be February 1, 1996) shall be granted as of said business day a number of shares of common stock of the Corporation ("Common Stock") equal to $15,000 divided by the average closing price of the Common Stock on the American Stock Exchange for the 30 trading days preceding the date of grant of the shares (January 2, 1996 in the case of the 1996 grant) (whether or not the Common Stock traded on said day), but the number of shares of Common Stock shall not be less than 200. Any person who becomes such a director after the first business day of a year may, at the option of the Board of Directors, be granted a number of shares of Common Stock for that year up to the number of shares awarded to other directors for that year. Unless otherwise determined by the Board of Directors, if a director receiving a grant in a particular year is not a director on March 31, June 30, September 30 and December 31 of said year, the director shall 2 promptly transfer to the Corporation 100%, 75%, 50%, or 25%, respectively, of the shares received for that year. Certificates issued by the Corporation may contain (i) an appropriate legend as to the foregoing obligation and (ii) an appropriate securities laws legend. 2. The Plan may be amended in any respect or discontinued at any time by action of the Board of Directors of the Corporation; provided, however, that any such action shall not affect any shares of Common Stock previously granted and provided further that the Plan provisions may not be amended more than once every six months, other than to comply with changes in the Internal Revenue Code, the Employee Retirement Income Security Act or the rules therewith. Adoption of the Plan does not create any limitation on the power of the Board of Directors to create other plans or programs for directors. EX-10.U.I.A 3 CORRECTION TO LOAN AGREEMENT 1 EXHIBIT 10(u)(i)(a) CORRECTION TO LOAN AGREEMENT ("LOAN AGREEMENT") DATED AS OF AUGUST 12, 1996 BY AND BETWEEN LYNCH CORPORATION, AS "BORROWER" AND GABELLI FUNDS, INC., AS "LENDER" Whereas the Borrower and the Lender agree that the Section 2.01(d), as originally executed, was incorrect and desire to correct said provision; Now Therefore, the Borrower and Lender agree that Section 2.01(d) shall be corrected in its entirety to read as follows: "(d) Special Fee. If Borrower has not prepaid the Loan in full within five Business Days after the end of the F-Block Auction, Borrower shall pay Lender a special fee equal to 20.04008% of the Net Profits of PCSF's 49.9% partnership interest in Bidder (i.e., a 10% interest in Bidder), from time to time as and when realized. Net Profits shall not include any amounts received by PCSF pursuant to the Bidder Loan Agreement and shall be net of any losses of PCSF under the Bidder Loan Agreement. For purposes of computing Net Profits, capital contributions by PCSF to Bidder shall be deemed to be loans to Bidder under the Bidder Loan Agreement and interest under the Bidder Loan Agreement shall include deemed commitment fees and interest on such capital contributions. Net Profits shall mean and shall be deemed to be realized at the time of (i) any profits received by PCSF from the sale, directly or indirectly, of all or a substantial portion of the assets of Bidder and the distribution of the proceeds to the partners (after payments of the principal and interest under the Bidder Loan Agreement), (ii) any payments or distributions by Bidder to Borrower or its Affiliates, including loans (other than principal, interest and other amounts as contemplated in the Bidder Loan Agreement and the Expenses Agreement referred to therein) including loans, (iii) the proceeds from any sale, directly or indirectly, including a merger or similar transaction, by Borrower of any of its partnership interest in Bidder, and/or (iv) the net proceeds from any sale of the stock of PCSF, whether by the existing stockholder or an Affiliate, to a person or entity that is not its Affiliate of PCSF. The term "Affiliate" shall have the meaning in Rule 12b-2 under the Securities Exchange Act of 1934, as amended. Any dispute under this Section 2(d), including without limitation the amount of profit, the value of any non-cash items or 2 other matters, if the parties cannot otherwise agree, shall be submitted to binding arbitration under the rules of the American Arbitration Association." IN WITNESS WHEREOF, the Borrower and the Lender have executed this Correction effective as of August 12, 1996. LYNCH CORPORATION GABELLI FUNDS, INC. By: By: ------------------- ----------------------- Robert E. Dolan Chief Financial Officer EX-10.Y 4 LETTER AGREEMENT DATED JANUARY 20, 1998 1 EXHIBIT 10(y) BCK/RIVGAM, L.L.C. 19 SPECTACLE LANE WILTON, CT 06897 January 20, 1998 Lynch PCS Corporation G 8 Sound Shore Drive Greenwich, CT 06830 Gentlemen: This will confirm the agreement between BCK/Rivgam, L.L.C. ("BCK/R") and Lynch PCS Corporation G ("LPCG") with respect to BCK/R's participation in the Federal Communications Commission ("FCC")'s auctions for licenses for local multipoint distribution service ("LMDS"). 1. LPCG Services. LPCG will provide certain services as follows: (i) LPCG will be responsible for submitting bids in the LMDS auctions on behalf of BCK/R, subject to the control and as authorized by BCK/R; (ii) LPCG will be responsible, in consultation with BCK/R, for recommending certain strategies for any LMDS licenses won; and (iii) LPCG will provide such other ancillary services as agreed to between LPCG and BCK/R. 2. Compensation. In return for LPCG's providing such services, BCK/R will (a) reimburse LPCG for all out-of-pocket expenses incurred by LPCG in connection with providing such services provided BCK/R is the winning bidder on any LMDS Licenses; and (b) pay LPCG 5% of the Net Profits of BCK/R from time to time as and when realized. With respect to any capital contributions by Marie Balitsos, Nara 2 Cadorin, and Rivgam LMDS, L.L.C. ("Rivgam") or any Affiliate of such person, to BCK/R up to an aggregate maximum of 25% of the cost (net of any bidding credits) of LMDS Licenses won by BCK/R in the LMDS auctions (the "Equity Investment"), there shall be deemed to be, for purposes of computing Net Profits, an interest expense equal to 20% plus the higher of the prime rate (as set forth in the Wall Street Journal) or 7% (reset annually on each January 1), compounded annually. Interest, commitment fees and other payments on loans by Rivgam (or its Affiliate) to BCK/R (the "Rivgam Loan") pursuant to the Loan Agreement (the "Rivgam Loan Agreement") dated as of February 1, 1998, shall be deemed to be costs at the rates stated therein in computing Net Profits, but the special fee (the "Special Fee") provided for in Section 2.01(e) of the Rivgam Loan Agreement shall not be deemed to be a cost for purposes of computing Net Profits. Net Profits shall mean and shall be deemed to be realized at the time of (i) any profits received by BCK/R from the sale, directly or indirectly, of all or a substantial portion of the assets of BCK/R (assuming the payment of the principal and deemed interest expense on the Equity Investment), (ii) any payments or distributions by BCK/R, including loans, to the members of BCK/R or their Affiliates (other than payments of principal and deemed interest expense on the Equity Investment, payments (other than the Special Payment) pursuant to the Rivgam Loan Agreement and payments pursuant to the Expenses Agreement referred to in the Rivgam Loan Agreement), (iii) the proceeds from any sale, directly or indirectly, including a merger or similar transaction, by any Members of BCK/R of any of their interest in BCK/R and/or (iv) the proceeds from any sale or transfer of any interest in any member of BCK/R, whether by an existing shareholder or an Affiliate, to a person that is not an Affiliate of BCK/R. The term "Affiliate" shall have the meaning in Rule 12b-2 under the Securities Exchange Act of 1934, as amended. Any recipient of any distributions or proceeds from sale shall be responsible, in addition to BCK/R, for the payment of any amounts due under clause (b) above. 3. Other. (a) The agreement shall be binding on any successors to LPCG, BCK/R and any Members of BCK/R. (b) BCK/R shall not conduct any business other than LMDS. -2- 3 (c) This Agreement shall be construed in accordance with the internal law of the State of Connecticut (without reference to choice of law provisions). (d) Any dispute hereunder shall be subject to arbitration in New York City or Stamford, Connecticut, in accordance with the rules of the American Arbitration Association. IN WITNESS WHEREOF, the parties have duly executed and delivered this Letter Agreement as of January 20, 1998. LYNCH PCS CORPORATION G BCK/Rivgam, L.L.C. By: By: ------------------- ---------------------------- Robert E. Dolan Marie Balitsos President Managing Member of BCK/R AGREED TO: ---------------------------- Marie Balitsos A Member of BCK/R ---------------------------- Nara Cadorin A Member of BCK/R Rivgam LMDS, L.L.C. A Member of BCK/R By: ------------------------ -3- EX-10.Z 5 EMPLOYMENT AGREEMENT 1 EXHIBIT 10(z) February 2, 1998 Mr. Mark M. Feldman 27 Hampton Road Scarsdale, NY 10583 Dear Mark: This letter will memorialize the understanding between Lynch Corporation and Mark M. Feldman (respectively, "Lynch" and Feldman"; collectively the "Parties") regarding the employment of Feldman by Lynch as Executive Vice President - Corporate Development. This letter accurately sets forth the understanding of the Parties; upon its execution it will be a binding contract between them. I Feldman will: A. Report to the Chief Executive Officer of Lynch. B. Be responsible for the implementation or effectuation of transactions that were approved by Lynch that either may be requested of him ("Delegated Transaction") or may be identified, or otherwise originated, and introduced by him ("Introduced Transaction"). Without intending to limit the scope of any such transactions: 1. Examples of Delegated Transactions are transactions intended to rationalize the asset bases of Lynch and its subsidiaries and affiliates (but excluding Mario J. Gabelli and his affiliates), including, but not limited to, effectuating sales, mergers equity offering, or spin-offs of operations, acquisitions or dispositions of individual assets, the raising of capital for operating purposes, and any other transaction that is not an Introduced Transaction; and 2 2. Examples of Introduced Transactions are acquisitions and investments for Lynch and its subsidiaries and affiliates (but excluding Mario J. Gabelli and his affiliates) and raising pools of investment capital (i.e., where Lynch raises and manages investment funds for third parties), that may be so identified, or otherwise originated, and introduced by him. C. Provide such other services as may be reasonably requested by the Chief Executive Officer of Lynch that are consistent with Feldman's background and training. II Lynch will: A. Make Feldman a corporate officer with the title of Executive Vice President - Corporate Development. B. Pay Feldman an annual salary of $250,000, reimburse his reasonable out-of-pocket expenses in accordance with company policies, and provide him with such insurance, retirement, and vacation benefits as are customarily provided by Lynch to its senior officers. C. Provide Feldman with twenty percent (20%) interests in the future net gain or profits (after an allowance for Lynch's customary return on capital for acquisitions and similar investments) generated by all such Introduced Transactions that are actually consummated. The form and terms of each such interest to be determined on a case-by-case basis depending on the structure and characteristics of the particular underlying transaction. Feldman shall not transfer any such interests received, without Lynch's consent in the sole discretion. Any such interest shall not have any voting, approval, election, inspection, fiduciary or other similar ownership rights, except to the extent required by law, in which case Feldman hereby grants to Lynch an irrevocable proxy and power of attorney (which is coupled with an interest) to exercise such rights as Lynch deems appropriate in its sole discretion. If, in Lynch's sole discretion, a Feldman interest would adversely affect a transaction which Lynch desires to undertake, Feldman shall be required to agree to do with his interest what Lynch in its sole discretion 3 elects. Otherwise, Lynch shall have the right, upon notice to Feldman, to acquire any such interest for cash at fair market value. If the parties are unable to agree on fair market value, the determination of fair value shall be submitted to a binding arbitration in accordance with the rules of the American Arbitration Association; D. Pay Feldman, at the sole discretion of Lynch, an annual bonus, part of Lynch's management bonus pool, based on Feldman's successful implementation or consummation of Designated Transactions or for any reason determined solely by Lynch; E. Provide Feldman with an office with his own Internet access and computer in the corporate headquarters of Lynch in Greenwich, Connecticut, or in Rye, New York. III The term of this agreement shall be from February 2, 1998, through December 31, 1999. This agreement shall be terminable for cause at any time and it shall be terminable without cause after October 31, 1998, on three months notice. Upon termination, Feldman shall have the right to retain all equity interest earned herein as provided in paragraph IIC, above, and Lynch shall have the right to retain all pending Introduced Transactions, provided that (a) it shall elect such right in writing within thirty (30) days of Feldman's termination; and (b) it shall compensate Feldman in the manner described in paragraph IIC for any Introduced Transactions on which he spent substantial time prior to his termination and consummated within 6 months after termination on terms comparable to those discussed prior to termination of employment. Lynch shall have no other obligation to Feldman in connection with any termination of employment. IV As originally proposed by Lynch, Feldman shall be allowed to conduct his financial advisory business as long as it does not conflict with his obligations hereunder. As originally proposed by Feldman, he will not undertake any significant new business without bringing it to the attention of Lynch. Feldman presently is a director of Baron Asset Fund and SNL Securities, Inc., and he represents that there is not present conflict between either such directorship and the functions herein contemplated. In the event that such a 4 conflict develops, however, Feldman will immediately resign the conflicting directorship. Dated as of February 2, 1998. Lynch Corporation Mark M. Feldman By: L/S: --------------------- --------------------- EX-13 6 PORTIONS OF 1997 ANNUAL REPORT TO SHAREHOLDERS 1 EXHIBIT 13 LYNCH CORPORATION - ------------------------------------------------------------------------------ ANNUAL REPORT--1997 - ------------------------------------------------------------------------------ 2 LYNCH--PAST HISTORY - - Lynch Glass Machinery Company, predecessor of Lynch Corporation, was organized in 1917. The Company emerged in the late twenties as a successful manufacturer of glass-forming machinery. In 1928, Lynch Corporation was incorporated in the State of Indiana. To better reflect its broader markets and corporate strategy, in 1997 Lynch Display Technologies was formed to be the parent of Lynch Machinery and to focus resources on growth opportunities in the electronic display industry. In 1998, Lynch Machinery's name was changed to Lynch Systems, Inc. - - In 1946, Lynch was listed on the "New York Curb Exchange" the predecessor to the American Stock Exchange. - - In 1964, Curtiss-Wright Corporation purchased a controlling interest in Lynch. - - In 1976, M-tron Industries, Inc., a manufacturer of quartz crystals was acquired. LYNCH--1985 - 1996 - - In 1985, companies affiliated with Gabelli Funds, Inc. acquired a majority interest in Lynch's Common Stock, including the entire interest of Curtiss-Wright Corporation. Mario J. Gabelli was elected Chairman of the Board and Chief Executive Officer in 1986. The price: $11.00/share. - - In July 1986, Lynch issued $23 million of 8% Convertible Subordinated Debentures as the first step in an acquisition program designed to broaden Lynch's business base. Conversion price - $31/share. - - In 1987, Lynch expanded the scope of its operations into the financial services and entertainment industries with the start-up of Lynch Capital Corporation, a securities broker dealer, and Lynch Entertainment Corporation, a joint venture partner with a 20% interest in WHBF-TV, the CBS television network affiliate in Rock Island, Illinois. Later in the year, the Company acquired Tremont Partners, Inc., a Connecticut-based investment management consulting firm. In December, Lynch added to its manufacturing sector with the acquisition of an 83% interest in Safety Railway Service Corporation, whose sole operating subsidiary, Entoleter, Inc., is a manufacturer of industrial processing and air pollution control equipment. - - In 1988, Lynch entered the service sector with the acquisition of Morgan Drive Away, Inc., the largest independent service provider to the manufactured housing and recreational vehicle industry. - - 1989 was highlighted by Lynch's entry into the telecommunications industry. The acquisition of Western New Mexico Telephone Company, an independent local telephone company servicing southwestern New Mexico, was an important first step. - - Lynch's second telecommunications acquisition, Inter-Community Telephone Company of Nome, North Dakota, was completed in April 1991, followed in October of that year with the acquisitions of Cuba City Telephone Exchange Company and Belmont Telephone Company. - - During 1992, Lynch acquired Bretton Woods Telephone Company of New Hampshire; and completed a rights offering to its shareholders which resulted in the Tremont investment advisory firm becoming a publicly traded company (OTC:TMAVA) with Lynch initially retaining a 37% interest. - - 1993 saw the launching of The Morgan Group, Inc., as a public company with an initial public offering of 1.1 million Class A Common Shares at $9 per share. Lynch retained a 47% equity interest and a 64% voting interest. Lynch also acquired J.B.N. Telephone Company in Kansas from GTE Corporation. Lynch Systems acquired Tri-Can Systems of Aslip, IL, a manufacturer of packaging machinery. - - 1994 saw the rebirth of Safety Railway Service Corporation into Spinnaker Industries, Inc. under the stewardship of the Boyle, Fleming & Company, Inc., with the acquisition of Brown-Bridge Industries, a manufacturer of adhesive coated stocks from Kimberly-Clark. In 1998, Brown-Bridge was renamed Spinnaker Coating, Inc. In addition, Lynch completed the acquisition of a 50% interest in station WOI-TV in Ames, IA, and the purchase of Haviland Telephone Company of Kansas. Finally, all the remaining 8% Convertible Subordinated Debentures that were issued in 1986 were redeemed. - - 1995 unfolded with Lynch making dynamic progress. In multimedia, we partnered with CLR Video, a cable operator in Kansas, bought 340 telephone lines from Sprint and commercialized DirectTV. Morgan bought TDI and positioned itself to develop critical mass in the outsourcing business. Spinnaker further reinforced its adhesive strategy by purchasing Alco Standard's Central Products, which manufactures and markets a wide variety of carton sealing tapes and related equipment. - - 1996 was another vigorous year for Lynch. On the telephony front, we consummated the affiliation with the Maytum family and Dunkirk & Fredonia and completed the purchase of 1,400 lines from U.S. West. Morgan closed on Transit Homes of America, Inc., an innovative leader in manufactured housing transport under the aegis of Larry Kling, further consolidating its role as the leader in the still fragmented manufactured housing outsourcing business. We streamlined the balkanized financial structure at Spinnaker with the issuance of $115 million Senior Secured Notes Due 2006 through Bankers Trust. We also refinanced our investment in television station WOI. Finally, partnerships including Lynch subsidiaries, organized and bid on Personal Communications Services licenses in the so-called "C-Block" and "F-Block" auctions. LYNCH--1997 - - Completed the acquisition of Upper Peninsula Telephone Company. - - Signed a contract at Spinnaker to acquire the pressure sensitive business from. S.D. Warren. The transaction was closed on March 17, 1998 under a newly formed subsidiary, Spinnaker Coating-Maine, Inc. - - Spun-off interest in East/West Communications, Inc., a F-Block PCS licensee with licenses covering a population of 20 million. - - Lynch wrote-off approximately 30% of its subsidiary's investment in the C-Block licenses. The net of tax write-off was $4.6 million, or $3.27 per share. 3 FINANCIAL HIGHLIGHTS (IN THOUSANDS OF DOLLARS, EXCEPT FOR SHARE AMOUNTS)
December 31, ------------------------------------------------------------------------- 1997 1996 1995 1994 1993 - --------------------------------------------------------------------------------------------------------------------- Sales and Revenues: Multimedia $ 47,908 $ 28,608 $ 23,597 $ 20,144 $ 16,206 Services 146,154 132,208 122,303 101,880 82,829 Manufacturing 273,474 291,064 187,727 61,217 27,986 ---------- ----------- ----------- ----------- ----------- Total $ 467,536 $ 451,880 $ 333,627 $ 183,241 $ 127,021 ========== =========== =========== =========== =========== - --------------------------------------------------------------------------------------------------------------------- Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA): Multimedia $ 24,134 $ 15,331 $ 12,342 $ 10,858 $ 8,965 Services 2,090 (1,765) 4,635 4,349 3,013 Manufacturing 21,171 22,751 17,047 4,693 1,915 ---------- ----------- ----------- ----------- ----------- EBITDA 47,395 $ 36,317 $ 34,024 $ 19,900 $ 13,893 Corporate Expenses-Net (1,563) (2,396) (2,928) (1,521) (1,366) ---------- ----------- ----------- ----------- ----------- Total $ 45,832 $ 33,921 $ 31,096 $ 18,379 $ 12,527 ========== =========== =========== =========== =========== - --------------------------------------------------------------------------------------------------------------------- Depreciation/Amortization: Multimedia $ 12,183 $ 8,660 $ 7,350 $ 5,651 $ 4,400 Services 1,075 1,498 1,264 915 803 Manufacturing 7,787 6,823 2,662 931 690 ---------- ----------- ----------- ----------- ----------- Total $ 21,045 $ 16,981 $ 11,276 $ 7,497 $ 5,893 ========== =========== =========== =========== =========== - --------------------------------------------------------------------------------------------------------------------- Capital Expenditures $ 21,828 $ 25,518 $ 19,569 $ 11,598 $ 4,356 - --------------------------------------------------------------------------------------------------------------------- Net Income (Loss)- Total $ (2,878) $ 2,696 $ 5,145 $ 2,328 $ 2,953 - Per Share - Basic (2.03) 1.94 3.73 1.75 2.41 - Diluted (2.03) 1.92 3.66 1.72 2.29 - --------------------------------------------------------------------------------------------------------------------- Working Capital $ 55,951 $ 41,632 $ 25,626 $ 22,713 $ 47,529 Current Ratio 1.6 to 1 1.4 to 1 1.3 to 1 1.3 to 1 3.3 to 1 Total Assets $ 423,638 $ 392,620 $ 302,439 $ 185,910 $ 129,972 Shareholders' Equity $ 36,451 $ 38,923 $ 35,512 $ 30,531 $ 24,316 Per Share $ 25.72 $ 27.98 $ 25.76 $ 22.15 $ 19.84 - --------------------------------------------------------------------------------------------------------------------- Price Per Share: High $ 109 3/4 $ 92 1/2 $ 84 3/4 $ 32 7/8 $ 26 3/8 Low 69 1/2 56 30 22 20 3/4 At December 31 Stock Price 83 70 1/2 58 1/2 30 23 - --------------------------------------------------------------------------------------------------------------------- Shares O/S 1,417,048 1,391,034 1,378,663 1,378,658 1,225,677 - ---------------------------------------------------------------------------------------------------------------------
1 4 CHAIRMAN'S LETTER TO OUR SHAREHOLDERS: Lynch's 1996 Annual Report started with the following statement, "By all standards, Lynch ended 1996 on a solid note." I cannot say that for 1997. The best analogy I may make is to say that 1997 was akin to walking through knee-high mud. Our stock closed on December 31, 1997 at $83.00 per share, an 18% increase over the $70.50 per share price of the prior year. In addition, each shareholder received one share of East/West Communications, Inc. for each share of Lynch--on which the accountants placed a value of about $0.10 per Lynch share. Our telephone operations prospered. After a five-year "love-making fest," we paired-up with the Upper Peninsula Telephone Company of Michigan. On the sour side was the malaise associated with our PCS license involvement--the so-called "C-Block"--I'll explain more later. Also, on the sour side, was the inability to hit pay dirt at either Lynch Display Technologies or at M-tron. Spinnaker and Morgan treaded water--so to speak. The net result was that we were unable to add to the intrinsic value of our enterprise from internal initiatives. Any progress on this all important bench mark is only traceable to the dynamics of "the deal world" where merger fervor lifted and is lifting the multiples accorded transactions, and, thereby, lifting our own "intrinsic valuation." Let's step back and look at these comments in a more graphic format. [LYNCH PUBLIC STOCK PRICE CHART] [LYNCH STOCK CHART] [INTRINSIC VALUE GOAL CHART] THE ECONOMY IN THE U.S.--HOW IT UNFOLDED Again in our 1996 Annual Report, we stated "The outlook for the U.S. economy continues to be of steady economic growth, low inflation and abundant financial liquidity." Indeed, we ended 1997 on a vigorous economic note. For 1998, we believe that the progress will continue with GDP rising 2 - 21/2%, inflationary pressures, particularly on the labor front, contained by increased productivity gains and lingering ripple effects of the Asian economic and currency turmoil. Yet not all is bright. On our "bear watch," (we referred to these as "potential gremlins at work" ) we include the following: - - Will the Asian problems that we see at the time of this writing prove to be the tip of a very deep iceberg that will march throughout the world, including China/Hong Kong and, more importantly, impact major trade partners of the United States such as Brazil and Mexico. - - Will the U.S. leadership that provided the backdrop for sustained gains in economic activity, employment and financial assets, be changed. Simply stated, will Clinton become an early lame duck or resign, and will the financial equivalent of Ruth and Gehrig (Rubin and Greenspan) be as persistent and diligent in providing financial stewardship. - - Will the Republicans maintain their control of the legislature to provide the continued policy of checks and balances to liberal, left-winged social initiatives that Clinton seems to be preparing. - - Will upward pressure on wages not be checked by productivity gains and eventually lead to an increase in the Federal Funds rate. 2 5 - - Will a synchronized worldwide economic upswing lead to pressure on interest rates. Equally, the emergence of trade barriers could cause a political backlash. - - Of course, there is always the potential for a disruption in the flow of oil from the Mid-east. - - Last, but certainly not least--the level of the market. Valuations are high by most measures and the overall equity market does not appear to have a margin of safety.
- ---------------------------------------------------------- REPORT CARD FOR 1997 Lynch Corporation - ---------------------------------------------------------- Growth in EBITDA C Acquisitions B Financing D Financial Incomplete Creativity A - ----------------------------------------------------------
TO DO LIST IN 1998 AND BEYOND
Your Chairman Management Other ------- ---------- ---- - - Restart Growth in Intrinsic Value X X X - - Raise Capital Efficiently X - Monetize our holding in Spinnaker X - Consolidate debt and restructure our balkanized telco holdings X - Split Lynch into two parts (Project Dolly) X X X
- - Marry M-tron's customer base and manufacturing know how with technical skill sets in high end frequency, initially, surface acoustic wave ("SAW") technology. - - Launch Lynch Display Technology by buttressing traditional "big screen" TV capability (including HDTV) into all forms of equipment for PC (including plastic and liquid display) and TV production. - - Use Morgan as platform for growth either into collateral aspects of mobile home business--including insurance, financing and lease/rental business--or into new businesses. For Lynch, our mantra remains the same: "Lets grow intrinsic value by 25%" and lets do this by duplicating ourselves in the next ten years, our Project Dolly. LYNCH--LOOKING THROUGH THE REARVIEW MIRROR As we go forward, we should examine each of the building blocks of our intrinsic value. First, by looking at the interplay in 1997 and, then, looking forward. - - Telephony--take our systems and create C-LECs, ISP, LD resellers. In other words, capitalize on the myriad opportunities opening up from new technology and the deregulation of telecommunications. During 1997, revenues in the multimedia group increased 67% to $47.9 million from $28.6 million in the previous year reflecting the inclusion of Dunkirk & Fredonia Telephone Company and Upper Peninsula Telephone Company. EBITDA at the telephone companies surged 57% to $24.1 million from $15.3 million reported in 1996, also primarily due to these acquisitions. 3 6
- -------------------------------------------------------------------------------------------------------------------- Access Lines/Subscribers Population Telephony - -------------------------------------------------------------------------------------------------------------------- Total Telephony Alarm Minutes of Operation Wireline Cable ISP Systems DirectTV Cellular PCS Use - -------------------------------------------------------------------------------------------------------------------- Western New Mexico 5,941 500 1,390 8,182 - -------------------------------------------------------------------------------------------------------------------- Inter-Community 2,634 110 7,334 - -------------------------------------------------------------------------------------------------------------------- Cuba City 1,698 - -------------------------------------------------------------------------------------------------------------------- Belmont 806 - -------------------------------------------------------------------------------------------------------------------- Bretton Woods 491 56 - -------------------------------------------------------------------------------------------------------------------- J.B.N. 2,698 80 - -------------------------------------------------------------------------------------------------------------------- Haviland 4,043 194 207 - -------------------------------------------------------------------------------------------------------------------- Dunkirk & Fredonia 11,634 2,553 569 - -------------------------------------------------------------------------------------------------------------------- Upper Peninsula 6,580 - -------------------------------------------------------------------------------------------------------------------- CLR Video 4,466 - -------------------------------------------------------------------------------------------------------------------- Fortunet* 7,297,743 - -------------------------------------------------------------------------------------------------------------------- 1997 TOTAL 36,525 4,660 3,506 569 1,390 15,516 7,297,743 16,709M - -------------------------------------------------------------------------------------------------------------------- 1996 TOTAL 28,630 4,454 971 536 1,355 - -------------------------------------------------------------------------------------------------------------------- Growth 97/96 27.6% 4.6% 261% 6.2% 2.6%
* A Lynch subsidiary is a 49.9% limited partner in Fortunet. - - Services--Revenues at The Morgan Group rose nearly 11% to $146.2 million from $132.2 million. The revenue growth reflects the acquisition of Transit Homes of America on December 31, 1996, offset by a decrease in revenues associated with Morgan's unprofitable Truck-away operation which was disposed of during the second quarter of 1997. Stripping out the effects of certain special charges associated with Truckaway and a change in accounting for certain components of driver pay, EBITDA rose 56% to $2.7 million from $1.7 million. - - Manufacturing--Our manufacturing group's results were disappointing and well below our expectations with revenues dropping 6% to $273.5 million from the $291.1 million recorded in 1996. EBITDA dropped to $21.2 million from $22.8 million. a) Spinnaker Industries, Inc. revenues declined by 6% to $232.0 million from $246.5 million as a decline in revenues per unit shipped offset volume gains, notably at Central Products Company. Continuing efficiencies resulted in a margin increase, allowing a 9% increase in EBITDA to $17.8 million from $16.3 million. b) Timing delays in the manufacturing of extra-large glass presses under a significant long-term contract hampered Lynch Machinery results. Revenues and EBITDA fell by $7.4 million and $3.2 million, respectively, from the previous year. c) The bright spot was M-tron. Bolstered by significant sales to telecommunications equipment manufacturers, M-tron's revenues and EBITDA grew by 24% and almost 25%, respectively, for 1997. Continued growth in the telecommunications marketplace should result in continued favorable comparisons. More importantly, M-tron is accelerating plans to move into surface acoustic wave (SAW) technology. FINANCIAL HIGHLIGHTS--1997 - - EBITDA (earnings before interest, taxes, depreciation and amortization) before corporate expenses increased 31% to a record of $47.4 million in 1997 from $36.3 million in 1996. - - Revenues rose 3% to a record of $467.5 million from $451.9 million reported in 1996. - - Capital expenditures were $21.8 million in 1997--as we continued to build our telecommunications and manufacturing infrastructure--compared to $25.5 million in 1996. Roughly $23 million is projected for 1998. 4 7 - - Of note: at December 31, 1997, Lynch owned the following:
Control % of Company Shares 12/31/96 Price 12/31/97 Price - ----- ---------- -------- --------- ---------- Spinnaker Industries, Inc. 63% Common (SPNI) 2,237,203 30 Bid 201/8 Bid Class A (SPNIA) 2,259,000 40 Bid 221/2 Bid The Morgan Group, Inc. 51% Class A Common (MG) 155,900 71/2 Close 91/4 Close Class B Common 1,200,000 * * Non-Control - --------- Hector Communications, Inc. 6% Preferred** 124,000 ** ** Common 20,700 71/4 Close 91/4 Close CommNet Cellular, Inc. .02% Common 2,853 277/8 Close 359/16 Close Pegasus Communications Inc. .2% Class A Common 15,275 13.75 Close 20.75 Close Tremont Advisers, Inc. 3% Class B Common 116,189 2.50 Bid 4.75 Bid East/West Communications, Inc. -- 7,800 $1000 par value per share***
- ------------ * Class B does not trade, but is convertible into Common on a 1:1 basis. ** Preferred does not trade, but is convertible into Common on a 1:1 basis. ***Preferred does not trade. NOW BACK TO THE FUTURE OUR FUTURE--PROJECT "DOLLY" [PRE-DOLLY CHART] [POST-DOLLY CHART] 5 8 FIRST TWELVE YEARS "SOWING" To understand our guidelines for the future, let's look at 1997 and the past transactions we structured for Lynch. When we took command of the company in 1985, there were 1,364,110 shares outstanding and shareholder equity was $14.3 million. At the end of 1997, there were 1,417,048 shares outstanding and shareholder equity was $36.5 million. More importantly, EBITDA was $45.8 million versus $0.1 million in 1985. Thus, during this timeframe, we have grown revenues at 37% CAGR and EBITDA at 61% CAGR. We accomplished this with limited financial resources and virtually no increase in shares outstanding. We also have spun off two potentially lucrative companies to shareholders, Tremont and East/West.
1985 1997 CAGR - -------------------------------------------------------------------------------------------------------------------- (000) (000) Revenues $10,699 $467,536 37% EBITDA $ 147 $ 45,832 61% Shareholder Equity $14,348 $ 36,451 8% Number of Shares 1,364,110 1,417,048 .3% Intrinsic Value (Pre-tax) $12 $200+/- 26% Stock Price $11 $83 18%
IT'S TIME TO HARVEST OR IS IT STILL TIME TO SOW In examining our goals for the year in our stewardship at Lynch, we expect to continue to find ways to grow our intrinsic value at the 25% hurdle rate that we set as our benchmark for growth in assets. While we continue to be creative and opportunistic, we will continue husbanding resources that are at our disposal. As your Chairman, I personally own 254,034 shares of the company, approximately 18%. As the saying goes, "we eat our own cooking." Our "prism" for the future is ever changing--should we bid/partner our interest in PCS--should we do an IPO for M-tron--should we sell convertible/debt/equity to broaden our base of accessibility--should we accelerate penetration of telephone/cable/broadcast. 6 9 Before ending, and of special note, I would like to thank both Morris Berkowitz and Paul Woolard, who will no longer be on the Lynch Board in an official capacity effective December 31, 1997 (though I am not letting them get off that easy, they will be serving as Directors Emeritus for some time to come). [PHOTO] [PHOTO] MORRIS BERKOWITZ PAUL P. WOOLARD Paul Woolard has served Lynch Corporation as a Director for 30 years. He came to the Board in 1968 when Lynch was under the auspices of Curtiss Wright. At that time, Lynch consisted solely of its glass machinery operation. Accordingly, Paul has been party to the Lynch story from the beginning with the acquisition of M-tron Industries in 1977 through the announcement of S.D. Warren in 1997. After ably serving our country as a pilot in the U.S. Army Air Force during World War II, Paul received a Bachelor of Arts degree from Columbia College. His career began as a Field Sales Trainee for Prince Matchabelli, Inc. and culminated 36 years later as President of Revlon, Inc. worldwide cosmetics and fragrances operations. Over the years, Paul devoted much time and effort to the March of Dimes, Boy Scouts, United Cerebral Palsy and continues to be active as a founding trustee of the Inner City Scholarship Fund. Paul served as Chairman of Lynch's Compensation Committee and provided significant guidance to Lynch's Audit Committee. Morris Berkowitz, who like Paul, during World War II served in the U.S. Army Air Force, holds a B.B.A. from C.C.N.Y. and J.D. from N.Y.U. He is a C.P.A. and is licensed to practice as an attorney. He spent his first 15 business years in the accounting firm of Martin Podoll & Company, ten years as a partner. He later became Vice President of Finance at Random House, Inc. and Vice President of Finance of LIN Broadcasting Corporation, steering that company through years of tremendous growth. Morris has been a Lynch Director for over ten years and has been especially helpful in Lynch's broadcasting ventures. Additionally, he is the proto-typical Chairman of an Audit Committee. As always, we will be cognizant of the needs of our "stakeholders"--our equity owners, our staff, our partner/employees, our debtholders, and our communities in which we are job creators. Mario J. Gabelli Chairman of the Board and Chief Executive Officer March 30, 1998 7 10 PROPORTIONAL OWNERSHIP Another way to look at the company is to examine each of our businesses and to look at what share of those businesses we own. This methodology is known as "proportional ownership." Simply stated, what are the businesses Lynch owns, what are the revenues, EBITDA, debt and values. Those of us who are knowledgeable of cable TV are familiar with the concept.
1997 DATA Traditional Proportional Accounting Ownership (000) (000) - --------------------------------------------------------------------------------------------------------------------- Revenues-- Telecommunications $ 47,908 $ 43,080 Broadcasting -- 5,194 Services 146,154 74,465 Manufacturing 273,474 208,439 -------- -------- $467,536 $331,178 ======== ======== EBITDA--Before Corporate Expenses and Special Charges Telecommunications $ 24,134 $ 21,700 Broadcasting -- 1,595 Services 2,090 1,116 Manufacturing 21,171 16,420 -------- -------- $ 47,395 $ 40,831 ======== ======== Cash-- Telecommunications $ 26,554 $ 22,808 Broadcasting -- 542 Services 380 194 Manufacturing 6,497 4,856 -------- -------- $ 33,431 $ 28,400 ======== ======== Debt-- Telecommunications $132,013 $121,384 Broadcasting -- 8,409 Services 4,460 2,272 Manufacturing 119,900 88,633 -------- -------- $256,373 $220,698 ======== ========
The proportional ownership amounts noted above, represents Lynch's proportional share of the reported revenues, EBITDA ("earnings before interest, taxes, depreciation and amortization"), cash (including marketable securities) and debt of the subsidiaries included in Lynch Corporation's consolidated financial statements and other significant minority-owned entities accounted for in the consolidated financial statements under the equity method. Accordingly, the above proportional ownership amounts represent Lynch's percentage interest in the entities full reported amounts for the respective period or date. That is, the proportional ownership of revenues and EBITDA represents the entity's reported results for the year ended December 31, 1997, multiplied by Lynch's ownership of that entity as of December 31, 1997. Proportional ownership of cash and debt represents cash and debt of that entity at December 31, 1997, multiplied by Lynch's ownership of that entity at December 31, 1997. The cash and debt amounts above exclude cash and debt at the Parent Company of $1.1 million and $24.9 million, respectively. 8 11 REPORT BY THE CHIEF FINANCIAL OFFICER OBJECTIVE The stated and steadfast goal of Lynch Corporation is to grow the intrinsic value of the company by 25% annually. Integral to this strategy, we provide our shareholders with opportunities for direct participation in focused stand-alone entities, armed with the financial platform for continued growth. While Safety Railway and its success is the model, other examples of this strategy are the rights offering for Tremont Advisors, Inc. in 1992, the initial public offering of The Morgan Group, Inc. in 1993 and the dividend of East/West Communications, Inc. in 1997. The concept of intrinsic value is a long-term prescription for managing an enterprise based on the cash flow generating ability of a business and the collateral value of its assets. Lynch looks to achieve its growth goal via acquisitions, both strategic and opportunistic, and development of internal opportunities. We also look to optimize growth by structuring transactions in the most tax efficient manner and utilizing financial engineering skills. ACQUISITIONS STRATEGY We look for value oriented investments and apply strict rate of return criteria to all potential acquisitions. An appropriate level of financial leverage is imperative to minimize our net investment and maximize returns. We will only participate in "friendly" transactions that will enable us to employ our management/shareholder partnership philosophy. We actively seek potential acquisitions that generally have the following characteristics: - - domestic operations; - - basic business--no high technology, unless is related to what we know, or high research and development; - - a franchise with a protected and/or dominant market position; - - dependable and growing free cash flow; - - no turnarounds or start-up companies; and - - good management in place willing to continue with the business. On occasion, we will consider an acquisition which does not meet the foregoing criteria. OPERATING PHILOSOPHY Once an acquisition is made, we cement a management/shareholder partnership by providing local management teams with an opportunity to acquire an interest in their respective business. It is our belief that managerial independence promotes efficiency and longevity of financial success. Incentive compensation plans coupled with stand-alone financing, reward management for operating the company entrepreneurially. As a result, operating expenses and capital expenditures are incurred only as prudently necessary. Moreover, each unit is self-motivated to attain high levels of customer satisfaction achieved through significant interaction between the operation and the consumer. Such satisfaction not only increases the value of local management investment, but also adds to the value of Lynch. Despite the managerial independence which our subsidiaries enjoy, it is essential that Lynch and each operating unit strive to achieve the same goals: to increase intrinsic value and shareholder wealth. Therefore, we maintain constant communication with each of our operating units as to the direction of the overall economy and, more specifically, the future of the industry in which they operate. Each business is empowered with the ability to leverage off its current operations and accelerate growth. The people at corporate allocate cash, provide long-term strategic vision to these businesses, support the efforts of these business to grow via acquisitions and provide overall financial guidance. 9 12 OUR STRUCTURE TODAY Lynch consists of an array of entrepreneurial operating entities, aligned as follows:
MULTIMEDIA SERVICES MANUFACTURING - ---------- -------- ------------- Telecommunications The Morgan Group, Inc. Spinnaker Industries, Inc. PCS Lynch Display Technologies, Inc. Broadcasting M-tron Industries, Inc.
TELECOMMUNICATIONS Lynch Interactive has investments of 80% to 100% in eleven rural telephone properties throughout the United States and a 60% investment in one cable television operation. Lynch companies consist of 37,000 access lines, 4,700 cable television subscribers, 16,000 cellular POPs and 1,400 Direct Satellite TV subscribers. Pro forma for the full year inclusion of Upper Peninsula Telephone Company revenues and EBITDA for the telecommunications group were $50.1 million and $25.4 million for the year end December 31, 1997. At December 31, 1997, the Group had cash of $26.6 million and debt of $132.0 million. Lynch Interactive will look to continue to acquire and consolidate rural telephone companies throughout the United States as well as leverage off its operational and technical infrastructure and grow the company through the development of complementary revenue streams. PERSONAL COMMUNICATIONS SERVICES ("PCS") C-BLOCK LICENSES In late 1995, Lynch initiated the first leg of its personal communications services or "PCS," strategy. Through five separate 49.9%-owned limited partnerships, which were subsequently combined into one partnership, Fortunet, Lynch subsidiaries participated in the FCC's "C-Block" Auction of 30 MHZ of PCS spectrum (the so-called C-Block Auction). As a result of that auction, these partnerships acquired the rights to provide PCS service to selective geographic areas within the United States, covering a population of over seven million. The cost of these licenses was $216.2 million, or $30.76 per POP. The prices of the "C-Block" significantly exceeded expectations. As discussed below, petitions were filed with the FCC by the largest C-Block holders, including Fortunet, to restructure the terms of the license. As a result of petitions on September 26, 1997, the FCC provided a four option plan to provide the current C-Block holders with avenues to restructure their ownership interests. The FCC had originally provided that the C-Block licensees were required to decide which option they would choose by January 18, 1998. This date has been extended. On March 24, 1998, the FCC somewhat modified the four options and extended the deadline for bidders to choose an option until at least late May 1998. Our partners at Fortunet in consultation with Lynch's subsidiary are currently still deciding which option it will choose. F-BLOCK LICENSES A Lynch subsidiary also participated in the subsequent F-Block Auction through a different 49.9% limited partnership. This partnership was high bidder in licenses that hold the right to provide PCS services of 10MHz of spectrum to selective geographic areas in the United States, covering a population of 20 million, including Los Angeles and Santa Barbara, California, Reno, Nevada, Washington, D.C., and Sarasota, Florida. The cost of these licenses was $18.9 million, or $0.95 per POP. A 39.9% interest in these properties were subsequently spun off to our shareholders, via a newly created entity called East/West Communications, Inc. The Lynch subsidiary provided $3.5 million of cash in the form of a subordinated loan to the partnership to acquire these licenses. A portion of this loan, including accrued interest and commitment fees, was contributed to the partnership and the remainder converted to a redeemable preferred stock with a par value of $7.8 million payable in 2009 at face plus pay in kind accrued dividends at 5% per annum. While East/West has certain financial and operating hurdles to overcome in the near term, we believe it is well positioned to take advantage of significant opportunities with its licenses. 10 13 OTHER PCS AND WIRELESS In the D & E Block auctions for PCS spectrum, a Lynch subsidiary provided bidding services and certain other advisory services to Rivgam Communicators, Inc. ("Rivgam"). In exchange for these services, the subsidiary will receive a 10% carried interest after a specific financial hurdle rate for the capital provided to Rivgam, in the future profitability of these licenses. In these auctions, Rivgam acquired 12 Licenses of 10 MHZ each covering a population of 33.1 million, for a total cost of $84.9 million, or $2.39 per POP including Los Angeles, California, Philadelphia, Pennsylvania, Washington, D.C., San Diego, California, Baltimore, Maryland (20 MHZ), and Buffalo, New York. In a subsequent Wireless Communications ("WCS") Auction, the Lynch subsidiary provided similar services to Bal/Rivgam for which it will receive a 5% carried interest after specific financial hurdle. This auction was for 10 MHZ of spectrum to be used for more advanced wireless voice and data communications to pin point a subscriber to any given locale. Bal/Rivgam acquired licenses covering a population of 42.1 million. In the current LMDS Auction, the Lynch subsidiary is providing similar services to BCK/Rivgam. The auction is for 1,300 GHz of spectrum and licenses will afford licensees the opportunity to offer a variety of services such as multichannel video programming, telephony, video communications and data services. The auction closed on March 25, 1998 and BCK/Rivgam was high bidder in licenses for Las Vegas, (1,300 GHz) and Reno (1,150 GHz), Nevada covering a population of 1.3 million for a net purchase price of $6.1 million. Subject to final grant Lynch will receive a 5% carried interest after specific financial hurdle in these licenses. While Lynch did not invest any funds to acquire these interests, we created these "hidden values" within Lynch Corporation by capitalizing on our experience gained in the C and F Block auctions. BROADCASTING Lynch owns 50% (fully diluted) and 20% net interest in Stations WOI-TV and WHBF-TV, two network affiliated television stations, ABC and CBS, respectively. In recent transactions, network affiliates have been sold at a multiple of 12 to 14 times broadcast cash flow. In 1997, WOI's full year revenues and broadcasting cash flow were $8.2 million and $2.5 million, respectively. At December 31, 1997, it had a total cash and accounts receivable of $2.3 million and outstanding debt of only $11 million. WHBF's full year revenues and broadcasting cash flow in 1997 were $7.3 million and $3.0 million, respectively. At December 31, 1997, it had total cash and accounts receivable of $1.2 million and outstanding debt of only $15 million. THE MORGAN GROUP, INC. Morgan is an outsourcer of services to the manufactured housing and recreational vehicle industries. Morgan Common Stock is listed on the American Stock Exchange. There are 2.6 million common shares outstanding, of which, Lynch Corporation owns 1.36 million, or 51%. Excluding all special charges, revenues and EBITDA in 1997 were $146.2 million and $2.7 million, respectively. At December 31, 1997, Morgan held cash and cash equivalents of $0.4 million and had $4.5 million debt outstanding. SPINNAKER INDUSTRIES, INC. Spinnaker is a consolidator of manufacturing companies in the adhesive-backed industry. Lynch owns 4.5 million of the 7.1 million common shares outstanding. Pro forma 1997 revenues and EBITDA, including full year results of S.D. Warren and other pro forma adjustments were $294 million and $26.2 million, respectively, and pro forma at December 31, 1997, it had cash and cash equivalents of $6.0 million and total debt outstanding of $168.1 million. 11 14 LYNCH DISPLAY TECHNOLOGIES Lynch Display Technologies, Inc., through Lynch Machinery, currently produces glass presses and packaging machinery. For the three years ended December 1997, average revenues and EBITDA were $25.7 million and $4.8 million, respectively. M-TRON INDUSTRIES, INC. M-tron Industries, Inc. produces quartz crystals and oscillators. For the three years ended December 31, 1997, average revenues and EBITDA were $20.5 million and $2.0 million, respectively. PROJECT DOLLY We are in the process of creating two entities at Lynch. Lynch Interactive Corporation will consist of telecommunications, PCS, broadcasting and Morgan, and Lynch Corporation will continue to hold the manufacturing operations, though we will probably transfer 15% of the shares of Spinnaker Common Stock to Interactive. Each Lynch shareholder would receive one share of the spin-off company, Lynch Interactive Corporation, while maintaining each share of the remaining company. The spin-off would enable each group (Telecommunications and Manufacturing) to focus on its unique markets and growth opportunities and more effectively access capital. Each of these industries has different requirements for management, operations, infrastructure, capital, internal development and acquisitions. Each in turn captures different valuations, research and analysis from the financial and investment community. While growth opportunities in other aspects within Lynch have slowed the tax rulings necessary to implement the spin-off, if all conditions are satisfied, we expect to move forward with this plan, enabling our shareholders to maintain equity in both our manufacturing and telecommunications holdings. Both groups will continue to pursue and develop significant high growth opportunities with strong returns on equity. FINANCIAL CHALLENGE Perhaps the most significant challenge facing Lynch over the coming year is developing additional financial resources for us to continue to grow. We will explore the use of various financial tools to provide efficient funding. Harvesting of current investments, access to public markets at the holding company and subsidiaries, and strategic and financial joint ventures with our PCS interests, will all be explored. One such strategy is a high yield debt offering for our telecommunications group. While such an offering would increase the cash cost of debt by 100 to 200 basis points, it would provide us with significantly more flexibility to allocate financial resources within the telecommunication group to the areas where they would most effectively grow the company. Additionally, it would significantly ease our access to additional debt instruments and/or markets. CLOSING As we have traditionally done, our managing partners will share their insight into what they are doing to enhance and grow their individual operations and build toward the future. It's truly a pleasure to work with these individuals as well as all the talented and dedicated associates within the Corporation. Robert E. Dolan Chief Financial Officer 12 15 LYNCH INTERACTIVE CORPORATION Before I go on to the operations of Lynch Interactive, with great sadness, I note the passing of a significant contributor to the Lynch family of companies. During 1997, Jack C. Keen, our first partner in the telephone business, died. After spending over 30 years at various telephone companies, including Southwestern Bell and Contel, in 1973 J.C. branched out on his own and acquired Mogollan Mountains Telephone Company, a decrepit rural telephone system that served fewer than 600 subscribers through four exchanges strung out in the mountains north of Silver City, New Mexico. J.C. took that system and, virtually from scratch, built the state-of-the-art digital telecommunications system serving almost 6,000 subscribers and covering over 15,000 square miles. Through that time, he successfully piloted the company through many dramatic and challenging changes in both the regulatory and technological environment. [PHOTO] JACK C. KEEN J.C. was an extremely well respected industry player and was well known in Washington, D.C., as an articulate and outspoken advocate for the nation's small, independent telephone companies and their rural subscribers. In this capacity, he chaired and served on numerous committees over the years.Today, Western New Mexico Telephone Company is ably managed by Jackie Keen and Mary Beth Baxter, (J.C.'s daughter) but we will sorely miss his counsel. STATISTICS--VIDEO, VOICE & DATA--DECEMBER 31, 1997
- --------------------------------------------------------------------------------------------------------------------- Access Lines/Subscribers Population Telephony - --------------------------------------------------------------------------------------------------------------------- Total Telephony Alarm Minutes of Operation Wireline Cable ISP Systems DirectTV Cellular PCS Use - --------------------------------------------------------------------------------------------------------------------- Western New Mexico 5,941 500 1,390 8,182 - --------------------------------------------------------------------------------------------------------------------- Inter-Community 2,634 110 7,334 - --------------------------------------------------------------------------------------------------------------------- Cuba City 1,698 - --------------------------------------------------------------------------------------------------------------------- Belmont 806 - --------------------------------------------------------------------------------------------------------------------- Bretton Woods 491 56 - --------------------------------------------------------------------------------------------------------------------- J.B.N. 2,698 80 - --------------------------------------------------------------------------------------------------------------------- Haviland 4,043 194 207 - --------------------------------------------------------------------------------------------------------------------- Dunkirk & Fredonia 11,634 2,553 569 - --------------------------------------------------------------------------------------------------------------------- Upper Peninsula 6,580 - --------------------------------------------------------------------------------------------------------------------- CLR Video 4,466 - --------------------------------------------------------------------------------------------------------------------- Fortunet* 7,297,743 - --------------------------------------------------------------------------------------------------------------------- 1997 TOTAL 36,525 4,660 3,506 569 1,390 15,516 7,297,743 16,709M - --------------------------------------------------------------------------------------------------------------------- 1996 TOTAL 28,630 4,454 971 536 1,355 - --------------------------------------------------------------------------------------------------------------------- Growth 97/96 27.6% 4.6% 261% 6.2% 2.6%
* A Lynch subsidiary is a 49.9% limited partner in Fortunet. Lynch Interactive experienced growth in all its units in 1997. The traditional wireline business, referred to as Incumbent Local Exchange Carriers ("ILECs"), enjoyed a 4.3% increase in customer lines which grew to 36,525 from 35,020, pro forma for the acquisition of Upper Peninsula Telephone Company. Internet service is now available to 92% of our customers. The growth of this service in the last 12 months has been significant. 2,856 new customers have been added in 1997 for a growth rate of 439%. All units of Lynch Interactive are exploring new opportunities for growth especially in the area of Long Distance Reselling and Competitive Local Exchange Companies (CLEC's). I am pleased with the managements' positive attitude towards seeking out new ventures and fitting them into Lynch Interactive's overall strategy. On May 23, 1997, Lynch acquired all the remaining shares of Upper Peninsula Telephone Company ("UPTC") for a total purchase price of $26.5 million. UPTC is an ILEC which serves 6,580 access lines 13 16 predominantly in the upper peninsula of Michigan. It's an outstanding company that serves several towns in the Lower and Upper Peninsula of Michigan such as Carney and Drummond Island. Full year 1996 revenues of UPTC were $8.5 million and EBITDA was $5.0 million. In addition to its landline telecommunications operation, UPTC owned two minority positions in cellular partnerships operating in Michigan. As a result of this transaction, UPTC was required to sell these properties to certain of its other partners for $6.3 million, net of income taxes. Accordingly, adjusting for cash on hand at the acquisition date, debt obligation assumed, and the net proceeds from the sale of the cellular interests, Lynch acquired UPTC for 3.5 times 1996 revenues and 1.3 times historical book value. But most importantly, we established ties with L.G. Matthews and his family who have operated in the upper portion of Michigan for over 35 years. The Matthews' helped pioneer the provision of telecommunication services to the communities in the upper peninsula of Michigan through the acquisition and development of telephone, cable, cellular and paging operations. Lynch is proud to welcome all of the employees of UPTC to our extended telephone family. Upon the retirement of L.G. Matthews, Calvin, his son, was appointed President of UPTC. Calvin has close to 30 years in the telephone business and will continue the strong tradition of providing outstanding service to UPTC customers. As explained more fully below, we liquified our investment in our DirectTV business in Wisconsin for cash and shares of Pegasus Communications, Inc. Additionally, our two telephone companies JBN and Haviland were merged in 1997 to form the Lynch Kansas Telephone Company. We believe the synergies between the two companies, operating in the same state and will provide efficiencies and lead to increased profitability of each company. After the completion of the merger, Robert Ellis, General Manager of Haviland retired at his request. Robert served the company with distinction and its his experience and leadership that has prepared Haviland to enter the 21st century as a leading edge communications provider. Gene Morris, General Manager of JBN, assumed the responsibility for both companies and was appointed President, Lynch Kansas Telephone Company. 1998 will be the year when special emphasis will be devoted to growing the core business. CLEC's and Long Distance reselling should enhance the revenue growth with a minimum capital investment. We are looking forward to placing these two services in our overall product portfolio. "One-Stop-Shopping" remains our primary goal.
- --------------------------------------------------------- ACCESS LINES COMPANY 1996 1997 - --------------------------------------------------------- Western New Mexico 5,596 5,941 Inter-Community 2,555 2,634 Cuba City/Belmont 2,442 2,504 Bretton Woods 360 491 Kansas Telephone JBN 2,658 2,698 Haviland 3,890 4,043 Dunkirk & Fredonia 11,129 11,634 Upper Peninsula 6,390 6,580 --------- --------- 35,020 36,525 - ---------------------------------------------------------
Eugene P. Connell Chairman 14 17 ACQUISITION OF UPPER PENINSULA TELEPHONE COMPANY [UPPER PENINSULA MAP] [LOWER PENINSULA MAP] On March 18, 1997, Lynch Corporation acquired Upper Peninsula Telephone Company from the Matthews family, who have operated the company since the early 1950s. Upper Peninsula serves approximately 5,100 access lines in the Upper Peninsula and 1,500 access lines in the Lower Peninsula of Michigan. HISTORY OF UPPER PENINSULA TELEPHONE COMPANY Upper Peninsula Telephone Company ("UPTC"), Carney, Michigan, was incorporated on January 22, 1927 by various farming families in Menominee County, Michigan as three separate entities known as Nadeau Township Telephone Company, Faithorn Telephone Company, and Wallace Telephone Company. In the early 1950s, the Matthews family purchased the Wallace Telephone Company from local residents. Wallace Telephone Company at that time provided service to approximately 50 customers in the village of Wallace, Michigan. The company's second acquisition was in Marenisco, Michigan in the western portion of the Upper Peninsula. In the late 1950s, the Matthews family purchased the Nadeau Township and Faithorn Telephone Companies, and the names were changed to Upper Peninsula Telephone Company. After receiving funding from the Rural Electrification Administration (REA) in 1963, the company was able to purchase the Felch and Watson Exchanges. By the end of 1965, all six exchanges were provided with underground cable plant and converted from magneto to dial equipment switching. In 1967, the Matthews family formed the Drummond Island Telephone Company by purchasing the Drummond Island Exchange from General Telephone Company. The company grew to six exchanges by the end of 1972, serving two resort communities, one exchange on Lake Huron, and three forestry and farming communities. In September of 1983, the Drummond Island Telephone Company properties were merged with UPTC's to form a company with 18 exchanges. The company's latest acquisition consists of the previously unserved area known as Manistee River, located 90 miles south of Mackinaw City, Michigan, with digital service initiated in October 1992. These 56 residents went from using two-way and CB radios to 100% digital service. The company was basically formed by acquiring franchises for previously unserved areas which the Michigan Bell Telephone Company and General Telephone Company operating companies did not have an interest in due to a small customer base or lack of business entities. Today the company serves fifteen exchanges in the Upper Peninsula and four in the Lower Peninsula of Michigan, ranging in size from our Scott Point Exchange with 18 customers to the Chester Exchange with 1,056 customers, and provides telephone service to approximately 6,580 customers. UPTC's service areas cover 2,995 square miles, with 2,195 route miles of mainline facilities. The company serves three exchanges on the Wisconsin-Michigan border and one exchange which is on the Canadian border. The company was the first independent in the State of Michigan to provide service via the placement of underground facilities. UPTC has continued to strive to improve its communications services. We are proud to be serving all customers via American-made digital switching equipment manufactured by Redcom Laboratories, Inc. of Victor, New York. These facilities are providing 100% one-party service capabilities, Equal Access and E911 emergency services where availability of that service offering exists. Our cable plant facilities are 100% underground, and we are deploying local exchange fiber optic backbone and AFC subscriber facilities in four service areas. 15 18 UPTC is headquartered in the Village of Carney, Michigan, and provides all of its corporate services from this location. UPTC has service personnel stationed in five outlying areas to serve the customers' needs. We would like to note that many of our employees serve in various capacities within the local community on a voluntary basis, including the rescue squad, Boy Scouts of America, township government and fire department. We welcome the following associates to the Lynch family: ASSOCIATES Richard Bingham, Robert Cocco, Richard DeVriendt, Joe Dombrowski, Louis DuPont, Vicki Fullerton, Blaine Gadda, Bart Hall, Linda Jeschke, Jeff Johnson, Rose Ann Klatt, Gordon Leese, Dirk Macco, Dolores Marklein, Calvin Matthews, Mandy Matthews, Caren Miller, Debbie Moreau, Mark Moreau, Dana Nakkula, Tammy Parrett, Tena Parrett, Tiffany Poupore, Linda Rhode, Becky Schetter, John Skufca, Val Sohr, Cathy Starzynski, Lori Thiry, Al Treiber, Mary Urbanc, Mike Warrner, Ron Wells, Lori Wolsker, Scott Zimmerman and Judi Zini. 16 19 WESTERN NEW MEXICO TELEPHONE COMPANY Western New Mexico Telephone Company ("Western") had another year of excellent access line growth and significant earnings. Western's regulated customer base grew 5.3% in 1997 to end the year with 5,941 access lines. Management anticipates that access line growth and earnings will continue to be strong. In 1997, Western began providing its customers the option of choosing their long distance provider by converting to equal access for both interstate and intrastate long distance services. Western continues to upgrade central office and outside plant facilities in order to accommodate our customer's telecommunications needs. Western strives to make certain our customers are not excluded from the information superhighway. Management has worked closely with the schools in our area to provide broadband capabilities. In addition, Western helped develop an action plan for the schools to participate in the new federal Universal Service Fund for schools and libraries. The new fund should help assure that schools serving rural areas, such as Western's, can provide students the same services as in the urban, metropolitan areas. Western's non-regulated operation, WNM Communications Inc. ("WNMC"), is rapidly expanding in the internet, paging and DBS satellite businesses. The DBS satellite business ended the year with 1,390 customers. WNMC began actively marketing internet access service in the latter part of 1997 and ended the year with 500 customers. Internet access service shows good promise for growth and expansion. WNMC began selling pagers and offering paging service late in 1997 and ended the year with approximately 40 paging customers. WNMC also expanded its full service offering by locating GTE Mobilenet, Lynch's cellular partner, inside WNMC's building. Although WNMC is still in its infancy, it will provide Western a strong presence in the Silver City market. This could be leveraged to provide competitive local exchange services or other competitive telecommunication offerings. Western's management is in the process of evaluating the business opportunities in these exciting service arenas. Western's management believes the future to be excellent in all phases of the telecommunications business and is actively pursuing its long-term growth objectives in both the regulated and non-regulated operations. Jack K. Keen Chairman INTER-COMMUNITY TELEPHONE COMPANY The Inter-Community Telephone Companies serve 2,634 subscribers in southeastern North Dakota. We made several significant strides in 1997 toward building Inter-Community into a leading telecommunications player in its region. Some of our accomplishments were as follows: - - Our nine exchanges are now linked together with 165 miles of fiber-optic cable using a Northern Telecom DMS-10 host-remote configuration. - - All exchanges have SS7 and CLASS capability. - - All exchanges have converted to Equal Access. - - We established an Internet Service Provider not only to serve our current customer base, but extending to Valley City, a town with a population of three times our service area, whose telephone service is provided by US West. For 1998, we plan to construct another 30 miles of fiber-optic cable through Valley City, providing broadband capabilities to Sanborn and Tower City exchanges, as well as SONET capabilities to our customers, and interactive TV for several area schools in the region and laying the ground work for a CLEC operation in the near future. Keith Andersen General Manager 17 20 BELMONT TELEPHONE COMPANY CUBA CITY TELEPHONE EXCHANGE COMPANY The year 1997 again proved to be a good one for both companies in several categories. Subscriber access lines grew 3% reaching a combined total of 2,504 at year end. During the fall of 1997, the two companies entered the final phase of their four year system upgrade. The project will be completed in the spring of 1998. The final phase of the Cuba City switch upgrade includes the addition of new subscriber services for enhanced calling features, voice mail, caller identification and added subscriber capacity. Concurrently, the Belmont central office is being converted to a remote switch functioning off Cuba City as a host. In 1996 and 1997, the company worked closely with the Cuba City High School in providing new technologies. The company donated a fiber optic communications link between the high school and elementary school and the classroom facilities for high school participation in "distance learning" which allows ten schools to share curriculum. In 1993, Lafayette County Satellite TV, Inc. was established as a sister company to both Cuba City and Belmont Telephone Company. Lafayette County acquired the right to provide DirectTV service to Lafayette County Wisconsin with a population of approximately 16,062 for $45,000. After three years of growing the business and attaining a level of 353 Subscribers, we made a decision to sell the operation to Pegasus Communications, Inc. for a combination of cash and stock with a total valuation of $373,000. Although we are optimistic about the future of the DirectTV business, the economies of running a small stand-alone operation plus the opportunity to generate financial resources to reinvest in other opportunities that are more complementary to our telephone operations led us to this decision to sell. The two companies are looking forward to the spring of 1998 when we will begin marketing new calling services. Richard A. Kiesling President BRETTON WOODS TELEPHONE COMPANY Bretton Woods Telephone Company serves the Bretton Woods Resort Area in New Hampshire, location of the Mt. Washington Hotel, Bretton Woods Ski Areas, The Mt. Washington Cog Railway and approximately 255 condominiums. A Centrex system provides telephone service at the Ski Areas and the Mt. Washington Hotel's facilities, in a fully integrated property-wide system, thereby simplifying communication to all facilities. Total access lines have increased approximately 36% in 1997 to 491 from 360, due to the installation of these Centrex systems, as well as further condominium development. 1997 has seen the greatest increase in access lines in the history of Bretton Woods Telephone Company. Currently, we are renegotiating our infrastructure-sharing agreements with NYNEX/Bell Atlantic. These negotiations, and the total impact of the Telecommunications Act of 1996, are issues that, hopefully, will be resolved in 1998. The New Hampshire Public Utilities Commission has actively supported competition but, thus far, interconnection is a reality in NYNEX/Bell Atlantic serving areas only. We look forward to 1998 and anticipate further "Resort" telecommunications requirements for the Mt. Washington Hotel, should a proposed gambling bill pass. Bretton Woods Telephone Company's policy is to anticipate our customers' requirements and meet their expectations with a network and staff that provides state-of-the-art features and services. Nancy Hubert General Manager 18 21 LYNCH KANSAS TELEPHONE COMPANY [MAP OF KANSAS SERVICE AREAS] JBN TELEPHONE COMPANY During 1997, JBN Telephone Company increased its access lines by an additional 1.5% to 2,698 from 2,658. That growth can be attributed to a casino in our serving area that is in operation 24 hours a day. JBN began providing local Internet access to its 15 exchanges in the fourth quarter 1997. Due to an EAS route from one of our exchanges, we will also provide local Internet to a neighboring town served by another local exchange carrier. Due to fiber optic cable placement in a neighboring community outside the JBN service area, we are able to provide local Internet to the city's residents and school, in addition to industrial customers who have expressed interest in changing from their current Internet provider. Revenues in 1997 increased by $671,000, or 22% over the same period in 1996. Additionally, JBN converted all its offices to Equal Access and SS7 in February and March, and minutes billed to the interexchange carries have increased over 45% in 1997, further driving our increase in revenues. EBITDA increased by $771,000, or 38% to $2.8 million from $2.0 million. JBN is currently in discussions with Kinnet and three other independent telephone companies adjacent to JBN in northeast Kansas to explore the possibilities and advantages to fiber inter-connectivity between all companies. JBN Telephone Company's goal in 1998 is to increase our marketing efforts in order to better inform our customers of services currently available, as well as increase our scope of service. We believe 1998 will be another exciting and profitable year. HAVILAND TELEPHONE COMPANY During 1997, Haviland Telephone Company added 153 additional access lines, an increase of approximately 4%. That growth can be attributed to the Eastern exchanges, which are benefitting from industrial and population growth coming out of Wichita. Additionally, the Company began offering local Internet access, and presently there are 207 Internet subscribers, some of which have requested second lines. Revenues at December 31, 1997 have increased by $119,000, or 3.3% over the same period in 1996. This increase is attributable to increased minutes of use billed to Interexchange Carriers, and an increase in local rates as part of the new Kansas Universal Service Fund. Gene Morris President 19 22 DUNKIRK & FREDONIA TELEPHONE COMPANY Dunkirk & Fredonia Telephone Company began 1997 with strong emphasis on marketing ourselves as the total communications supplier. Working with The Schutte Group, we have changed the name of our parent company to DFT Communications Corporation (hereafter DFT), and have moved away from the name that tied us to a particular geographic area. We have also changed our logo to reflect a uniform advertising campaign that identifies all of our services with DFT. The operation continues to include Dunkirk & Fredonia Telephone Company and wholly-owned subsidiaries, Cassadaga Telephone Corporation and Comantel, Inc., as well as the services they provide: Local Service, Long Distance, Cellular, Telephone and Security Systems, Paging, Internet and 2-way Radio Sales and Service. New products and services were added during 1997. Those services included a new dealer contract for Cellular service with Cellular One Sygnet and the addition of DFT Long Distance in which two CIC codes were opened for all of the Lynch companies to use. DFT Long Distance is expected to begin operation within our franchised area in the summer of 1998. Nineteen ninety seven also saw the expansion of our Comlink paging service into the Olean, NY market, as well as the addition of several dealers for Comlink Paging. DFT has experienced strong growth in several areas throughout the year. Netsync, the Internet Service of DFT, which was started in April of 1996, has seen an increase in subscribers of 1,582 during 1997. We enjoyed a positive swing in EBITDA of $189,000 going from a loss of $148,000 in 1996 to a profit of $41,000 in 1997. Access lines have also experienced growth at almost twice the normal rate. Dunkirk & Fredonia telephone lines increased by 4.0% and Cassadaga lines increased by 3.8% for a total combined growth of 505 access lines. In conjunction with the marketing program, a new product brochure was developed to aid customers with the products and services offered by DFT. 1998 is also the 100th anniversary of Dunkirk & Fredonia Telephone Company. A full color brochure was added to our 1997-98 Telephone Directory advertising our services and proud history. A newly remodeled building, at 38 Temple Street, was completed during 1997, and is located next to our Central Office. The building currently houses our Eagle Radio Technologies Group as well as some Sales offices. 1998 promises to be a busy year for DFT. Our 100th Anniversary celebration kicks off in January with sales promotions and continues with scheduled events throughout the year. One event planned for July will be an Open House for the community and invited guests. New service offerings will continue to be brought forward including DFT Long Distance and the addition of CLASS services beginning in June of 1998. DFT will also continue to work toward providing our customers a combined bill, reinforcing our position as a one stop source for all communication needs and making our billing more simplified for the customer. DFT is also in the process of assisting one of our sister companies, Bretton Woods Telephone, with developing and providing billing service which should begin in August of 1998. The Internet continues to be an area of growth opportunity for Netsync as we continue to exceed our projections. We will seek to expand subscribers through acquisition and provisioning of service to other companies both within and outside New York State. Another highlight of 1998 will be for DFT to negotiate a contract extension with the State University College at Fredonia. DFT currently provides approximately 1,700 lines to the College. The College wishes to add additional lines and Centrex service is currently provided via an Individual Case Basis (ICB). Industry perspectives are changing and DFT will have to position itself to be ready to compete in the market as a Competitive Local Exchange Carrier (CLEC) or embrace competition through interconnection agreements. Partnering to provide service may become more of a necessity than an option as regulatory issues, such as Access Reform, Universal Service, Lifeline and other FCC and PSC changes, continue to erode revenues. Greater diversity and new revenue opportunities through new services or enhancement of services will help shape the customers' perception of keeping DFT a major player in the provisioning of communications services. Robert A. Maytum President & CEO 20 23 UPPER PENINSULA TELEPHONE COMPANY Upper Peninsula Telephone Company is the newest member of the Lynch telecommunications family, purchased on March 18, 1997. The company serves 19 exchanges covering 2,995 square miles between upper and lower Michigan. All of the exchanges have digital switching provided by Redcom Laboratories, Inc. of Victor, New York. As of December 31, 1997, the company serves 6,580 access lines, and increased its customer base by 3.1% during the year. Exchanges served are generally rural in nature with the exception of three exchanges which serve resort areas with fishing and/or PGA type quality golf courses. The economy in Michigan has seen a steady growth in recent years, and is projected to continue through the next few years. As families migrate from metropolitan areas to our rural location, our company should experience even more growth in its customer base. Our company continues to increase its investments, purchasing the latest technology to provide its customer base with state-of-the-art communications services. During 1997, plant investments consisted of 22 miles of fiber optic cable and 40 miles of copper cable plant, upgrading our Fence River and Grace Harbor Exchanges, along with the placement of AFC digital loop carrier systems. At year end, the company's investments resulted in the elimination of all multi-party services. From an industry and regulatory standpoint, 1997 offered many challenges and opportunities to increase the company's working experience. The Management of the company makes every effort to stay abreast of regulatory and industry changes which may affect the operation of the business. With many changes looming in 1998, the company is confident that it has the expertise to navigate these anticipated changes during 1998 and beyond. The company's Management will see another busy year from the standpoint of enhancing the services it offers its customers. We are looking forward to formulating a partnership to provide Internet access, increasing our customers' awareness of existing service offerings to generate revenue, and working with a consortium of telephone companies within the Upper Peninsula area for offering sky paging and toll related services. In addition, many companies operating within the state of Michigan are also involved in providing a state-wide network for various telecommunications services. As a member of this network, we're analyzing the viability of this relationship as it would meet the needs of our customers and continued profitability. The Management and staff at Upper Peninsula Telephone Company are proud of our many accomplishments during 1997, including our excellent customer service and ability to provide our customers a safe haven in an ever changing marketplace. Calvin E. Matthews Vice President CLR VIDEO, L.L.C. CLR Video, L.L.C. completed 1997 operations in a better position than had been expected, both financially and in customer-base growth. We believe this was accomplished by adhering to our business plan, which had been developed around our belief in commitment, responsive customer and field service, improved system maintenance and system improvements. These actions helped to solidify our position with franchise authorities and customers. A very successful marketing effort stopped the customer attrition and netted a 5.1% gain in customer base, a major improvement over 1996, when we experienced a 4.6% loss. CLR's adherence to the business plan, coupled with a slight modification in 1997 capital expenditures, has facilitated continued improvements in operations. Revenues for 1997 have exceeded budget estimates. Expenses were slightly lower than budgeted, producing an improved bottom line and annual contribution to cash flow of $170 per customer, a 4.9% increase from the 1996 per customer contribution of $162. Forecasted 1998 cash flow per customer is expected to increase by 10%, to $187. Robert C. Carson President 21 24 FORTUNET COMMUNICATIONS, L.C. PERSONAL COMMUNICATIONS SERVICES Personal Communications Services ("PCS") is a second generation low-cost digital wireless service utilizing voice, video or data devices that allow people to interact at anytime and virtually anywhere. Over the past three years, the Federal Communications Commission ("FCC") auctioned off approximately two thousand PCS licenses, a total of 120 MHZ of spectrum, falling within six separate frequency blocks labeled A through F. Frequency blocks C and F were designated by the FCC as "entrepreneurial blocks." Certain qualifying small businesses were afforded bidding credits in the auctions as well as government financing of the licenses acquired. For auction purposes, the FCC segmented the United States utilizing two different service areas based on Rand McNally's major trading areas ("MTAs") and basic trading areas ("BTAs"). MTAs divide the country into 51 contiguous, non-overlapping areas and were used in the A and B block auctions. BTAs divided the country in 493 contiguous, non-overlapping areas and were utilized in the C, D, E, and F block auctions. Under the FCC rules, one-third of the population covered by these licenses must be constructed within five years of the award of the licenses; and, two-thirds must be served within ten years. Failure to comply, could result in loss of the license. Starting December 1994, the FCC held its first simultaneous multiple round auctions for 99 licenses to provide broadband PCS over 30 MHZ of spectrum over the 51 major trading areas, A and B blocks. The auction concluded on March 13, 1995. In the spring of 1996, the FCC finalized the auction of 493 BTA licenses of 30 MHZ of spectrum on frequency block C, and in January 1997, the FCC concluded auctions for 1,479 BTA licenses for 10 MHZ of spectrum on frequency blocks D, E, & F. [GRAPHIC] RESULTS OF AUCTION Lynch subsidiaries, as a limited partner in five small business entities, participated in the entrepreneurial C-Block auction. These partnerships were eligible for 25% bidding credits and ten year government financing at long-term Treasury rates. Lynch subsidiaries held a 49.9% equity interest in each of these partnerships and funding commitments for which they are to receive interest and commitment fees at stated rates. In the auction, these partnerships won a total of 31 licenses in 17 states covering a population of 7,029,291 million. Areas under license include the state capital cities, Tallahassee, Florida; Hartford, Connecticut; Des Moines, Iowa; and Cheyenne, Wyoming as well as selected areas of Georgia, Illinois, Idaho, Kansas, Maryland, Minnesota, New Hampshire, New Mexico, New York and Pennsylvania, Oregon, Texas, Virginia, and Wisconsin. These licenses were subsequently rolled into one partnership, Fortunet Communications, L.P., of which a Lynch subsidiary will has a 49.9% interest. The total cost of these licenses was $216.2 million, or $30.76 per 30 MHZ POP, after the 25% bidding credit. In addition, the FCC provided 10 year financing (principal amortizing quarterly in years seven through ten) at an interest rate of 7% (though the FCC staff has yet to figure out that the appropriate interest rate should be 6.51% of $194.6 million, or 90%, of the cost of the licenses acquired). AFTERMATH OF THE AUCTION-REPRINTED VERBATIM FROM LYNCH'S THIRD QUARTER REPORT TO SHAREHOLDERS Before the conclusion of the C-Block auction, the FCC announced it would auction off significant additional spectrum. These subsequent and unforeseen, ill-conceived and ill-timed auctions have created the perception of a huge inventory of spectrum available to the marketplace, far beyond current needs. From Wall Street's point of view, the FCC's actions created the specter of unlimited supply of spectrum. These considerations, as well as other externally driven technological and market forces, have made financing of the build-out of these licenses through the capital markets much more difficult than previously anticipated. Indeed, the second largest acquirer of spectrum in the C-Block auction, Pocket Communications, which acquired licenses covering a population of 33.6 million at a cost of $1.4 billion, or $42.44 per POP, has filed for bankruptcy. In addition, on October 20, 1997, 22 25 General Wireless Inc., the third largest acquirer of spectrum in the C-Block auction which acquired licenses covering a population of 17.9 million at a cost of $1.1 billion, or $59.05 per POP, also filed for bankruptcy of its PCS subsidiaries. Other license holders are also reported to be in financial difficulty. Fortunet, as well as many of the license holders from this auction, had petitioned the FCC for relief in terms of (a) resetting the interest rate to the appropriate rate at that time; (b) further reducing or delaying the required debt payments in order to afford better access to capital markets; and (c) relaxing the restrictions with regard to ownership structure and alternative arrangements in order to afford these small businesses the opportunity to more realistically restructure and build-out their systems. The response from the FCC, which was announced on September 26, 1997, afforded licenses holders a choice of four options, but, in our opinion, provided little, if any, concrete relief to the license holders. YOUR CHAIRMAN'S OBSERVATIONS In the bidding evaluation process for spectrum, certain assumptions were made regarding the future supply of spectrum that would be available for voice and data. These were compiled with other financial, tax and operating assumptions. Certain of the assumptions proved incorrect--particularly regarding the tax deductions available to Lynch and, more importantly, the actual supply of spectrum the FCC would permit in the marketplace. The FCC's action on September 26, 1997, failed to address the linkage between the capital market and the fundamental supply/demand issue. We believe the prudent action for our shareholders is to stop any further cash drain. The philosophical jousting among the regulators and the liquidity confusion in the marketplace is unlikely to be resolved by January 15, 1998, the current deadline for C-Block holders to select an option offered under the current FCC plan. In addition, we believe the "reauction" of the C-Block PCS licenses, currently scheduled for Spring 1998, will create lingering uncertainty. REMAINING INVESTMENT IN FORTUNET Lynch's subsidiary has a net book value associated with its remaining investment in, loans to, and deferred costs associated with Fortunet of $20.3 million. Under the FCC's response on September 26, 1997, four courses of action were provided to the C-Block license holders, one of them being resumption of principal and interest payments. The ramifications of choosing the other three courses of action could result in Fortunet ultimately forfeiting either 30%, 50%, or 100% of its current investment in these licenses. While Fortunet is still examining what action, if any, it will take with respect to these options and will continue to look for ways to finance and build out this spectrum, the management of Lynch felt it prudent to provide for a 30% reserve of its investment at this time, as this represents management's estimate of the impairment of this investment given the available alternatives. At the same time, we must point out that the "New FCC" (four of the five current FCC Commissioners have been appointed since the September 26th action) may determine it appropriate to take a fresh look at this issue. UPDATE On March 24, 1998, the FCC modified the four options that had been previously provided. As part of this modification, the FCC provided the C-Block licensee somewhat more flexibility in choosing the application of these options to the licenses awarded. The deadline for the C-Block licensees to submit their choices, though not yet established, will most likely be in late May 1998. The modification to these options does not impact our previously provided for reserve for impairment and, Fortunet, in concert with the Lynch subsidiary, is still evaluating what options it will choose. 23 26 BROADCASTING Lynch currently has ownership interests in two network affiliated television stations; Station WOI-TV and Station WHBF-TV. Station WOI-TV is an ABC affiliate which serves the Des Moines, Iowa media market, the 72rd largest in the United States with 372,000 households. Station WHBF-TV is a CBS affiliate which serves the Quad-Cities media market in Rock Island and Moline, Illinois, and Davenport and Bettendorf, Iowa, the 88th largest market in the United States with 299,000 total households. Philip J. Lombardo is our partner in both these ventures. Phil is a well known industry player with over thirty-five years of experience in operating broadcasting properties. STATION WOI-TV In 1994, Capital Communications Corporation acquired the assets of Station WOI-TV from Iowa State University. Lynch Corporation owns 49% of the common shares outstanding and a convertible preferred share, which when converted, will bring Lynch's common share ownership to 50%. Lynch's initial investment in Station WOI-TV was $13.25 million in the form of Senior Debt, Subordinated Notes, Preferred Stock, Convertible Preferred Stock and Common Stock. Less than one year later, all funds were returned to Lynch, including interest at the stated rates, save for the $250,000 anticipated long-term investment in the common and convertible preferred. Reflecting lower prime time ratings by ABC versus the other networks, WOI reported lower revenues and EBITDA versus the previous year. Revenues during 1997 were $8.2 million and broadcast cash flow was $2.5 million. The 1996 amounts were $8.9 million and $2.9 million, respectively. As evidenced in television history, the networks success in prime time has always cycled up and down and we firmly believe, under the guidance of the Walt Disney Company, ABC will begin an up trend in the near future. In addition, WOI has recently enacted several management changes, which is expected to support the anticipated network upswing with improved local results. From a broader perspective, we continue to believe this station is well positioned both geographically and operationally. STATION WHBF-TV In 1986, Lynch made an initial investment in Station WHBF-TV of $7.0 million in the form of subordinated notes and a 20% partnership equity interest. Over the years, due to the success of the station, the majority of the subordinated notes were repaid along with the stated interest. In 1997, as part of a major refinancing, the remaining principal and interest associated with the subordinated notes was repaid, leaving Lynch with a net $250,000 remaining investment in our original partnership interest. Revenues during 1997 were $7.3 million and broadcast cash flow was $3.0 million, in line with the 1996 amounts of $7.1 million and $3.0 million, respectively. PERSPECTIVE We have long believed in the intrinsic value of local network-affiliated television stations. This belief caused us to make substantial investments in both these properties at the time of their initial acquisition. Their subsequent success resulted in the return of substantially all of our initial investment at reasonable rates of return. Today we reap the benefit of our commitments; we hold investments in two extremely valuable properties at a minimal cost basis to Lynch. Under current accounting rules, these values are not reflected in our reported financial statements, but represent a significant "hidden value" within Lynch Corporation. 24 27 THE MORGAN GROUP, INC. The Morgan Group, Inc. ("Morgan") and its wholly owned subsidiaries, Morgan Drive Away, Inc., Interstate Indemnity Company and Morgan Finance Company realized a profit rebound in 1997. Aided by the December 1996 acquisition of Transit Homes of America, a major manufactured housing transporter, and the disposition of its money-losing, capital intensive Truckaway division, Morgan's EBITDA rose 56% to $2.7 million in 1997, up from $1.7 million in 1996, prior to special charges in both years. (After special charges, 1997 EBITDA rose to $2.1 million, up from a loss of $1.8 million in 1996). Despite this significant improvement in earnings, we are far from satisfied with Morgan's level of profitability. We have worked to build a company that is a leader in its chosen market niches--we arrange for almost 30% of the nation's manufactured housing deliveries from manufacturer to dealer--and have moved aggressively into outsourcing transportation services for recreational and commercial vehicles manufacturers, modular office producers, semi-trailer manufacturers and lessors, retailers, and other private fleet operators. As a market leader, serving the growing dominant producers and providing those customers with the best service, highest insurance protection and a national network of offices, we expect to continue to build our business--and expand our margins. Since 1992 we have grown our top line from $67 million to $146 million--a respectable 17% per year. Our margins have not kept a steady pace, however, and bettering our profitability will be a continuing focus in the years immediately ahead. We plan to accomplish this by continuing to implement our three platform strategy: (1) Consolidation: Morgan is the long-time industry leader in its market, arranging for the shipment of manufactured houses. We have built a number one market share over the years by forging a reputation for quality service, and we will continue to leverage that by acquisitions and by growing with our current customers who dominate their markets--companies such as Oakwood Homes, Fleetwood Enterprises, Winnebago, Champion Enterprises, Redman Homes, Palm Harbor, and Cavalier Homes. We also are building toward a number one market share in semi-trailer delivery and selected driver outsourcing markets. (2) Restructuring: As we sharpen our focus in manufactured housing and outsourcing, and having completed the closing/selling of Truckaway, we not only cut out a drag on operating income but also generated positive cash flow from the sale of assets. Now, we have set upon a path to cut our centralized overhead, including our selling, general, and administrative costs, and are determined to pare duplicative field expenses as well. While Year 2000 issues present a challenge, our information systems can be made more efficient and less costly. (3) Outsourcing: We intend to capitalize on the growing trend toward manufacturers' outsourcing the arrangement of transporting their vehicles. This is an estimated $500.0 million market, involving the annual shipment of some 750,000 new commercial and recreational vehicles - buses, vans, garbage trucks, motor homes, fire engines, UPS and FedEx vehicles and the like. Increasingly, manufacturers are turning to outside specialists to deliver their products to the point of sale or worksite. This, like manufactured housing shipment, is a highly fragmented industry, marketed by dozens of small companies and only a few national competitors capable of providing full service to the largest manufacturers. Our experience and network of terminals around the country provide an outstanding opportunity for developing this market. INDUSTRY OVERVIEW AND OUTLOOK The Morgan Drive Away core operation is the leading provider of outsourcing transportation for the manufactured housing, recreational vehicle and commercial truck industries in the United States. Morgan Drive Away also facilitates the moving of a variety of other goods such as commercial vehicles, motor homes, modular offices, semi-trailers and the like. We believe that a combination of factors bode well for the long-term health of the industries we serve. High quality new products, attractive demographics, healthy consumer confidence levels, and, a relatively short supply of rental apartments are favorable trends in manufactured housing. The national trend toward outsourcing in many American industries fits into our strategy of providing services to some of the most rapidly growing companies in the country.Having cut away unprofitable operations and focusing on our areas of leading market position and growth, we believe Morgan's future is bright. The industries served are expanding, our most important customers are the leaders within those industries, and the company's financial wherewithal and commitment to maximizing shareholder value should result in above-average operating gains in 1998 and beyond. Charles C. Baum Chairman 25 28 SPINNAKER INDUSTRIES, INC. 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. Our strategy is to focus on the growing pressure sensitive markets for industrial tape and label stock applications, while pursuing acquisitions within the adhesive-backed materials industry that complement its existing businesses. Three businesses are grouped into two principal categories that accounted for the following percentages of net sales for the year ended December 31, 1997: industrial tape 53% and adhesive-backed label stock 47%. Spinnaker's industrial tape business is conducted through its Central Products subsidiary, which was founded in 1917. Central Products, is a leading manufacturer of carton sealing tape and offers the broadest line. It estimates that it has a greater than 50% share of the water sensitive carton sealing tape market, where its revenues are more than twice those of its next largest competitor. In the pressure sensitive carton sealing tape market, it is one of the three largest manufacturers for carton sealing tape applications, and believes that it is the only manufacturer of all pressure sensitive technologies (acrylic, hot melt and natural rubber), which provides Central with a competitive advantage by allowing it to meet the broadest range of application requirements of its customers. Its branded and private label products are used primarily for commercial packaging applications and are sold through its national sales force to over 1,500 paper and office products distributors nationwide, including the largest national distributors of paper products, for resale to over 20,000 end users. Spinnaker maintains particularly strong relationships with Unisource Worldwide, Inc. ("Unisource") and xpedx (a division of International Paper Co.), formerly known as ResourceNet International, which are among the largest distributors of paper and office products in the United States. Central supplies each of Unisource and xpedx with a full line of their own private label carton sealing tape products. Spinnaker believes that its arrangements with key customers are evidence of its leading position in the carton sealing tape market, which is due in part to Spinnaker being the only one-stop manufacturer of private label products in the carton sealing tape market. Spinnaker's adhesive-backed label stock business is conducted through Spinnaker Coating, Inc. (formerly known as Brown-Bridge Industries, Inc.) which was founded in 1928. With the recent acquisition of the Pressure Sensitive Business from S.D. Warren Company, Spinnaker Coating is the fifth largest manufacturer of adhesive-backed label stock in the United States. It is the only manufacturer of all adhesive-backed paper technologies (pressure, water and heat sensitive), which enables Spinnaker Coating to provide a broad range of standard and custom coating solutions that meet the design specifications of its customers. Spinnaker Coating primarily manufactures custom, low-volume, pressure sensitive products used for speciality applications, whereas the Pressure Sensitive Business manufactures standard, high volume, pressure sensitive products, which complements its product line. Spinnaker Coating, on a pro forma basis, offers a full line of more than 2,000 variations of adhesive-backed label stock and sells its products in roll and sheet form to over 1,000 printers, paper merchants, industrial users and major forms manufacturers and distributors. These major forms manufacturers and distributors purchase high volumes of standard pressure sensitive products manufactured by the Pressure Sensitive Business. Customers convert its label stock into labels used for a broad range of end use applications, including bar-coding, mailing and shipping, packaging for pharmaceutical, food and other consumer products, office identification and business forms, postage stamps stock, decorative labels and other specialty industrial uses. Spinnaker Coating is the largest supplier of pressure sensitive postage stamp stock for use by the United States Postal Service. Spinnaker expects to benefit from strong growth in the adhesive-backed materials industry, particularly in pressure sensitive applications in its principal markets for carton sealing tape and adhesive-backed label stock. Despite lower than expected industry growth during 1997, according to independent studies, demand for pressure sensitive tape for packaging and sealing applications is projected to grow at an average rate of approximately 6.3% per year, and demand for pressure sensitive label stock is projected to increase at an average rate of approximately 8.3% per year. Spinnaker also manufactures and markets industrial process equipment and air pollution control scrubbers through its Entoleter, Inc. ("Entoleter") subsidiary. Spinnaker is exploring strategic alternatives with respect to Entoleter to improve shareholder value, including the possible sale or spin-off of Entoleter. Richard J. Boyle Chairman 26 29 LYNCH DISPLAY TECHNOLOGIES, INC Lynch Corporation formed Lynch Display Technologies in 1997 to focus resources on growth opportunities in the electronic display industry. Electronic displays involve rapidly-changing technologies in the fields of flat panel and cathode ray tubes for televisions, computer screens, electronic signs, automobile panels and numerous other applications. Lynch Display Technologies concentrates in the capital equipment and components sector of this global market. The long-term strategy of Lynch Display Technologies is to acquire and develop a group of growth companies in the electronic display industry. The company is continually evaluating investment and strategic opportunities from a broad and growing field of technology firms. To ensure that the company is focused on emerging technologies with the highest growth potential, Lynch Display Technologies has created a Scientific Advisory Board chaired by Dr. Samuel Musa, PhD., executive director of the University of Michigan's Center for Display Technology. The other member at this time is Dr. Christopher Summers, PhD, director of the Center for Phosphor Excellence at Georgia Tech in Atlanta. Lynch Display Technologies currently has one operating company, Lynch Machinery in Bainbridge, Georgia. To reflect the broader range of services and products offered by the company, Lynch Machinery has been renamed Lynch Systems, Inc. Lynch Systems designs, manufactures and markets a sophisticated array of glass-forming equipment and industrial controls systems for cathode ray tube and non-display glass manufacturers. The company exports in excess of 95% of its products outside the United States, with the vast majority produced for customers in China, Korea, Indonesia and India. Although Lynch Systems requires that all transactions be conducted in U.S. dollars, the company has been affected by the significant economic upheaval and downturn in key Asian markets, most importantly Korea and Indonesia. Financial and currency issues have caused customers in these markets to postpone capital expenditure programs involving the purchase of glass-pressing and industrial control systems from Lynch Systems. As a result, company revenues and operating income declined from 1996. Revenues declined from $26. 1 million in 1996 to $18.7 million in 1997. EBITDA dropped from $4.9 million in 1996 to $1.9 million in 1997. After-tax earnings declined from $1.9 million in 1996 to $.9 million in 1997. Lynch Systems has launched several strategic initiatives to increase revenues and profitability in 1998 and beyond. The company is focusing on developing long-term supply and service relationships with every major producer of cathode ray tube glass in the world. These services include design, engineering, manufacturing, installation management and maintenance of capital equipment and controls. Lynch Systems has also launched key product development initiatives to regain technological dominance in its historic markets of non-display glass forming equipment for consumer and commercial glass. Lynch Systems currently has less than a two percent share of this global market and expects to increase its share significantly with new product and marketing initiatives. In December, the company accepted the resignation of Bob Pando as President and Chief Executive Officer of Lynch Systems. Lynch thanks Bob for his ten years of service in Bainbridge. Mark L. Cushing, President and CEO of Lynch Display Technologies and assistant to the Chairman of Lynch Corporation, was named acting President/CEO of Lynch Systems. A search is underway for a permanent President. Mark L. Cushing Assistant to the Chairman 27 30 M-TRON INDUSTRIES HIGHLIGHTS - M-tron continued to pursue and grow its share in the telecommunications and wireless communications marketplace with it applications specific products. - The implementation of the Team Concept has developed to the point that the next phase is being organized and will be put into effect in the immediate future. This procedure has significantly increased M-tron's ability to meet market demands for competitive, on time delivery. - Several new products were introduced and an advanced research and development project was initiated primarily applicable to the telecommunications market sector. THE ORGANIZATION The sales organization was restructured into three managerial directives: OEM (Original Equipment Manufacturers) and Contract Manufacturing. With contract manufacturing of ever increasing importance and design-ins at the OEM level critical. Telecommunications. Fast becoming the major sales area, M-tron's top customers are telecommunications companies. Much of the product development that is currently taking place, and will continue to be so, is for this market segment. This area requires a special technical knowledge of the marketplace, its product requirements and the customers' technical direction. Distribution. M-tron has contracts with several of the top distributors in the country along with some second tier area distributors. Unlike OEM/Contract Manufacturing, or Telecommunications, distribution requires a different set of disciplines to sell in this market segment. Once purchasing in high volume and selling in low volume, distributors now operate almost the same as manufacturer's representatives. In confirmation of this sales approach, OEM new orders grew 20%, distribution grew 23%, telecommunications grew 28%, and contract manufacturing grew 39% in 1997 over 1996 new orders in like category. In addition, the M-tron Hong Kong office, in its third year, has shown significant gains selling primarily to contract manufacturers in the Pacific Rim countries who assemble products primarily of United States OEM's origin. This office also does its own quality control and is successfully incorporating off shore purchasing for the Hong Kong office and for M-tron USA. These activities include purchasing of standard product to M-tron's specifications and the research and purchase of new product offerings developed in the Far East as well as to coordinate and find new quality sources in the Far East, including China. PRODUCT DEVELOPMENT The principle product area that resulted in significantly increased sales was that of manufactured oscillators. This manufactured product is expected to grow approximately 40% in 1998 primarily driven by new products introduced in 1997 principally directed at the telecommunications market sector. In addition, M-tron initiated the development of a technologically advanced product that is being coordinated by M-tron's Chief Scientist and a globally recognized expert in telecommunication frequencies for application in PCS and cellular base stations, multiple channel multipoint distribution systems, wireless LAN systems and wireless meter reading for such applications as gas, water, and electrical wireless systems. These new product characteristics and specifications exceed that of known SAW (Surface Acoustical Wave) device applications for such markets. 1997 OPERATIONS PERFORMANCE Continuing efforts in 1997 as expressed in the 1996 Annual Report, M-tron realized an increase in new orders from $16.2 million to $23.0 million or 42%, while sales increased from $18.4 million in 1996 to $22.8 million in 1997, or 24%. Net income increased from $677,000 in 1996 to $1,006,000 in 1997, or 49%, while EBITDA increased from $ 1.7 million in 1996 to $2.2 million in 1997, or 25%. M-tron will continue its team development, introduce new products, both sourced in the Far East and designed at its Yankton facility, and emphasize its efforts in the Telecommunications and Wireless Communications markets. By doing so, and capturing an increased share of its major customers business, M-tron expects that it will continue its growth path in 1998 and beyond. In so doing, M-tron expects to incorporate a major amount of automation into its processes in the coming year. M-tron would like to take this opportunity to thank its employees, its suppliers, the Yankton Community and, of course, its most valued customers, for the understanding and support that resulted in M-tron's 1997 performance which has laid the groundwork for profitable growth in the years to come. Martin J. Kiousis President 28 31 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS YEAR 1997 COMPARED TO 1996 Revenues increased to $467.5 million in 1997 from $451.9 million in 1996, a 4% increase. Acquisitions made during late 1996 and early 1997 in the multimedia and service segments were the most significant contributors to this increase. In the multimedia segment, revenues increased by $19.3 million to $47.9 million from $28.6 million in the previous year. Dunkirk and Fredonia Telephone Company, which was acquired on November 26, 1996, contributed $10.3 million compared to $0.9 million in 1996. Upper Peninsula Telephone Company, control of which was acquired on March 18, 1997, contributed $7.2 million to this segment's revenue increase. In the services segment, revenues of $21.2 million resulting from the acquisition of Transit Homes of America, Inc. on December 31, 1996, offset by lower "Truckaway" revenues, was the primary contributor to the revenue increase at The Morgan Group, Inc. In the manufacturing segment, revenues decreased by $17.6 million reflecting order short-fall at Lynch Systems, Inc. (formerly known as Lynch Machinery, Inc.), of $7.4 million; revenue short-fall at all three units of Spinnaker of $14.5 million; and partially offset by improved revenues at M-tron of $4.4 million. Earnings before interest, taxes, depreciation and amortization (EBITDA) increased to $45.8 million in 1997 from $33.9 million in 1996, a $11.9 million, or a 35% increase. Operating segment EBITDA (prior to corporate management fees and expenses) grew to $47.4 million from $36.3 million, a 31% increase. The manufacturing segment represented 46% of EBITDA, or $21.2 million, a decrease of $1.6 million versus 1996. While all of the other components of the manufacturing segment had increases, they were more than offset by lower EBITDA at Lynch Systems of $3.2 million when compared to 1996 results due to lower sales volume of the extra-large glass presses. The services segment had EBITDA of $2.1 million versus negative EBITDA of $1.8 million in 1996 predominately due to special charges recorded at Morgan of $3.5 million in 1996 and $.6 million in 1997. The multimedia segment contributed $24.1 million or 52.7% of total EBITDA versus $15.3 million in 1996 due to the effects of the acquisition of Dunkirk & Fredonia Telephone Company and Upper Peninsula Telephone Company. Operating profits for 1997 were $24.8 million, an increase of $7.8 million, or 46.3%, versus 1996. Operating profits in the services segment increased by $4.3 million due to the same factors impacting EBITDA. There were also increases in the multimedia and corporate segments operating profits of $5.2 million and $.9 million offset by a decline in the manufacturing segment of $2.5 million. Investment income decreased by $.2 million to $2.0 million in 1997 versus 1996. The decrease was related to lower dollar investments generating current income. Interest expense increased by $6.5 million in 1997 when compared to 1996. The increase is due primarily to the full year effect of financing the acquisitions of Dunkirk and Fredonia Telephone Company, the acquisition of Upper Peninsula Telephone Company and the Subordinated Notes issued by Spinnaker in October 1996. In 1997, Lynch provided a reserve of 30% of the investment in, loans to, and deferred costs associated with its subsidiary's 49.9% equity ownership in Fortunet Communications, L.P. ("Fortunet"), a partnership formed to acquire, construct and operate licenses for the provision of personal communications services ("PCS") in the so-called C-Block Auction. Such write-off amounted to $7.0 million, or $4.6 million after tax benefit. In May 1996, the FCC concluded the C Block Auction for 30-megahertz of broadband spectrum across the United States to be used for PCS. PCS is the second generation of low-cost digital wireless service utilized for voice, video and data devices. In the C-Block Auction, certain qualified small businesses were afforded bidding credits as well as access to long-term government financing for a substantial portion of the cost of the licenses acquired. As a result of this auction, Fortunet acquired 31 licenses in 17 states covering a population ("POP") of 7.0 million. The total cost of these licenses was $216 million, or $30.76 per POP, after the 25% bidding credit. The U.S. Government lent licensees 90% of the net cost of the licenses. Events during and subsequent to the auction, as well as other externally driven technologies and market forces, have made financing of the Government installment debt and the development of these licenses through the capital markets much more difficult than previously anticipated. 29 32 Fortunet, as well as many of the license holders from this auction, has petitioned the FCC for relief in terms of (1) resetting the interest rate to the appropriate rate at the time; (2) further reducing or delaying the required debt payments in order to afford better access to capital markets; and (3) relaxing the restrictions with regard to ownership structure and alternative arrangements in order to afford these small businesses the opportunity to more realistically restructure and build-out their systems. The response from the FCC which was announced on September 26, 1997, and modified on March 26, 1998, afforded license holders a choice of four options, one of which was the resumption of current debt payments which had been suspended earlier this year. The ramifications of choosing the other three courses of action could result in Fortunet ultimately forfeiting either 30%, 50%, or 100% of its current investment in these licenses. While Fortunet is still examining what action, if any, it will take with respect to these options and will continue to look for ways to finance and develop this spectrum, the management of the Company provided for a 30% reserve of its investment at this time, as this represents management's estimate of the impairment of this investment given the current available alternatives. The 1997 tax benefit of $.7 million, includes federal, state and local taxes and represents an effective rate of 21.4% versus 40.8% effective tax provision rate in 1996. The difference in the effective rates is primarily due to the effects of state income taxes and the amortization of goodwill. 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 Systems, 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 $36.3 million from $34.0 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 Systems 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 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 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. 30 33 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 of 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. FINANCIAL CONDITION As of December 31, 1997, the Company had current assets of $152.8 million and current liabilities of $96.8 million. Working capital was therefore $56.0 million as compared to $41.6 million at December 31, 1996 and increased primarily due to the acquisition of Dunkirk & Fredonia Telephone Company and Upper Peninsula Telephone Company. Capital expenditures were $21.8 million in 1997 and $25.5 million in 1996 as 1996 included the installation of a silicone paper coating machine at Spinnaker Coating. Overall 1998 capital expenditures are expected to be approximately $2.0 million to $3.0 million above the 1997 level. At December 31, 1997, total debt was $281.1 million, which was $20.3 million more than the $260.8 million at the end of 1996, primarily due to the acquisition of Upper Peninsula during 1997. Debt at year end 1997 included $231.2 million of fixed interest rate debt, at an average cash interest rate of 8.9% and $49.9 million of variable interest rate debt at an average interest rate of 8.7%. Additionally, at December 31, 1997 the Company had $48.1 million in unused short-term lines of credit of which $34.5 million was attributed to Spinnaker, and $3.3 million of which was attributable to Morgan. Subsequent to year end, Spinnaker increased its working capital facility from $40.0 to $60.0 million and $45.0 million of the facility was drawn down to fund the acquisition of S.D. Warren's pressure sensitive business. Certain restrictive covenants within the debt facilities at both Spinnaker and Morgan limit their ability to provide the parent company with significant funding. As of December 31, 1997, the Parent Company had borrowed $22.7 million under two short-term lines of credit facilities. The lines currently total $24.5 million. These funds were primarily used to fund the bids by partnerships in the PCS Auctions and fund a portion of the purchase price of Upper Peninsula Telephone Company. These short-term lines of credit expire May 15, 1998 ($14.5 million) and December 29, 1998 ($10.0 million). Management anticipates that these lines will be renewed for one year but there is no assurance that they will be. Backlog in the manufactured products segment at December 31, 1997 was $30.9 million versus $20.9 million at the end of 1996. Backlog at Lynch Systems was $18.6 million at December 31, 1997, and $6.6 million at December 31, 1996. Included in the current backlog is a $16 million glass press order from a international customer. The customer has currently alerted the Company not to proceed with construction on these presses until notified and Lynch Systems does not expect significant production during 1998. Since 1987, the Board of Directors of Lynch has authorized the repurchase of 300,000 common shares. At December 31, 1997, Lynch's remaining authorization is to repurchase an additional 69,000 shares of common stock. The Board of Directors has adopted a policy not to pay cash 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 1998. 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. 31 34 On March 17, 1998, Spinnaker Coating-Maine, Inc. acquired the pressure sensitive adhesive-backed label stock business of S.D. Warren ("Pressure Sensitive Business" or "the Acquisition"). The Pressure Sensitive Business manufactures and markets label stock primarily for the EDP segment of the label stock market and generated $62.1 million of net sales and operating profit of $5.8 million on a historical basis for the fiscal year ended October 1, 1997. The purchase price was approximately $52 million, plus the assumption of certain liabilities and was funded by issuing the seller a subordinated note of $7.0 million and from Spinnaker's amended $60 million revolving credit facility. The subordinated note bears interest at 10% per annum and 30% is due on March 31, 1999 with the remainder due March 31, 2000, subject to certain postponement and acceleration provisions. The note is convertible into Spinnaker common stock at a price of $25.00 per share, subject to certain adjustments. A subsidiary of the Company has a minority position in an entity, Fortunet Communications, Inc. ("Fortunet") to which it has funding commitments. Fortunet participated in the auction conducted by the Federal Communications Commission for 30 megahertz and broadband spectrum to be used for personal communications services, the so-called "C-Block" Auction. In this auction, Fortunet 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, $194.6 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% (the Company 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 through 10. As of December 31, 1997, the subsidiary had invested $598,000 in partnership equity and $24.0 million in loans; as well as possible funding commitments to provide an additional $17.6 million in loans. The subsidiary is currently evaluating its funding alternatives and options in light of the current FCC proposals (see below) and has not yet determined how it will go forward with regard to the funding commitments. There are many risks associated with personal communications services. In addition, funding aspects of acquisition and development of licenses plus the amortization of the license, could significantly and materially impact the Company's reported net income over the next several years. Fortunet, as well as many of the license holders from this auction, has petitioned the FCC for relief in terms of (1) resetting the interest rate to the appropriate rate at the time; (2) further reducing or delaying the required debt payments in order to afford better access to capital markets; and (3) relaxing the restrictions with regard to ownership structure and alternative arrangements in order to afford these small businesses the opportunity to more realistically restructure and build-out their systems. The response from the FCC, which was announced on September 26, 1997, afforded the license holders a choice of four options, one of which was the resumption of current debt payments which had been suspended earlier this year. The ramifications of choosing the other three courses of action could result in the Company's subsidiary ultimately forfeiting either 30%, 50%, or 100% of its current investment in these licenses. On March 24, 1998, the FCC modified the four options, with a date not earlier than late May 1998, for the "C-Block" license holders to notify the FCC of its choice of options. While Fortunet is still examining what action, if any, it will take with respect to these options, and will continue to look for ways to finance and develop this spectrum, the Company provided for a 30% reserve of its investment at this time, as this represents management's estimate of the impairment of this investment given the current available alternatives. The Company has initiated a comprehensive review of its computer systems to identify the systems that could be affected by the "Year 2000" issue and is developing an implementation plan to resolve the issue. The Year 2000 problem is the result of computer programs being written using two digits (rather than four) to define the applicable year. Any of the Company's programs or programs utilized by vendors to the Company that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a major system failure or miscalculations. Of the Company's subsidiaries, the most potential exposure exists at the telephone companies, both with the switching equipment and third party billing vendors, and at Morgan. The Company presently believes that, with modifications to existing software and converting to new software, the Year 2000 problem will not pose significant operational problems for the Company's computer systems as so modified and converted. However, if such modifications and conversions are not completed timely, the Year 2000 problem may have a material impact on the operations of the Company. The Company cannot yet estimate the cost of such modifications or conversions. 32 35 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 spin-off 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. The Company has a significant need for resources to fund the operation of the parent company, meet its current funding commitments 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 investments in operating entities either directly or through an exchange debt instrument. Additional debt and/or equity financing vehicles at the parent company and/or subsidiaries 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. 33 36 LYNCH CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
December 31 1997 1996 ------- ------- ASSETS CURRENT ASSETS: Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 33,557 $ 33,946 Marketable securities and short-term investments . . . . . . . . . . . . . . . . . . 985 2,156 Trade accounts receivable, less allowances of $1,448 and $1,525 in 1997 and 1996, respectively includes $1,776 and $9,624 of costs in excess of billings at 1997 and 1996, respectively . . . . . . . . . . . . . . . . . . . . . . 54,480 52,963 Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35,685 36,859 Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17,993 5,571 Other current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,059 8,598 -------- -------- TOTAL CURRENT ASSETS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 152,759 140,093 PROPERTY, PLANT AND EQUIPMENT: Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,742 1,367 Buildings and improvements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25,272 21,334 Machinery and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 190,579 157,025 -------- -------- 217,593 179,726 Accumulated depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (60,064) (46,707) -------- -------- 157,529 133,019 EXCESS OF COSTS OVER FAIR VALUE OF NET ASSETS ACQUIRED . . . . . . . . . . . . . . . . . 73,257 69,206 INVESTMENTS IN AND ADVANCES TO PCS ENTITIES . . . . . . . . . . . . . . . . . . . . . . . 25,448 34,116 OTHER ASSETS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14,645 16,186 -------- -------- TOTAL ASSETS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $423,638 $392,620 ======== ========
See accompanying notes. 34 37 LYNCH CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (CONTINUED) (IN THOUSANDS)
December 31 1997 1996 ---------- ---------- LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Notes payable to banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 29,021 $ 19,158 Trade accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21,381 20,998 Accrued interest payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 886 1,230 Accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33,969 28,663 Customer advances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,249 6,382 Current maturities of long-term debt . . . . . . . . . . . . . . . . . . . . . . . . 9,302 22,030 -------- -------- TOTAL CURRENT LIABILITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96,808 98,461 LONG-TERM DEBT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 242,776 219,579 DEFERRED INCOME TAXES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33,764 22,389 MINORITY INTERESTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13,839 13,268 SHAREHOLDERS' EQUITY: Common Stock, no par or stated value: Authorized 10 million shares Issued 1,471,191 shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,139 5,139 Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,644 8,417 Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23,414 26,472 Treasury stock of 54,143 and 80,157 shares, at cost . . . . . . . . . . . . . . . . . (746) (1,105) -------- -------- TOTAL SHAREHOLDERS' EQUITY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36,451 38,923 -------- -------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY . . . . . . . . . . . . . . . . . . . . . . . $423,638 $392,620 ======== ========
See accompanying notes. 35 38 LYNCH CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Year ended December 31 1997 1996 1995 ----------- ------------ ----------- SALES AND REVENUES: Multimedia . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 47,908 $ 28,608 $ 23,597 Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . 146,154 132,208 122,303 Manufacturing . . . . . . . . . . . . . . . . . . . . . . . . . . 273,474 291,064 187,727 ----------- ------------ ----------- 467,536 451,880 333,627 ----------- ------------ ----------- COSTS AND EXPENSES: Multimedia . . . . . . . . . . . . . . . . . . . . . . . . . . . 35,363 21,435 17,889 Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . 135,431 127,236 111,672 Manufacturing . . . . . . . . . . . . . . . . . . . . . . . . . . 227,621 241,683 147,497 Selling and administrative . . . . . . . . . . . . . . . . . . . 44,334 44,586 36,722 ----------- ------------ ----------- OPERATING PROFIT . . . . . . . . . . . . . . . . . . . . . . . . . . 24,787 16,940 19,847 ----------- ------------ ----------- Other income (expense): Investment income . . . . . . . . . . . . . . . . . . . . . . . . 2,048 2,203 3,070 Interest expense . . . . . . . . . . . . . . . . . . . . . . . . (23,461) (17,011) (10,844) Share of operations of affiliated companies . . . . . . . . . . . 154 119 398 Reserve for impairment of investment in PCS license holders . . . (7,024) -- -- Gain on sales of subsidiary and affiliate stock . . . . . . . . . 169 5,146 59 ----------- ------------ ----------- (28,114) (9,543) (7,317) ----------- ------------ ----------- INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES, MINORITY INTERESTS AND EXTRAORDINARY ITEM . . . . . . . . . . . . . . . . . . . . . . . (3,327) 7,397 12,530 Benefit (provision) for income taxes . . . . . . . . . . . . . . . . 713 (3,021) (4,906) Minority interests . . . . . . . . . . . . . . . . . . . . . . . . . (264) 418 (2,155) ----------- ------------ ----------- INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE EXTRAORDINARY ITEM . . . . . . . . . . . . . . . . . . . . . . . (2,878) 4,794 5,469 Discontinued operations: Loss from operations of discontinued Lynch Tri-Can International (less applicable income taxes of $149 and $220 and minority interest effects of $29 and $36 in 1996 and 1995, respectively) -- (263) (324) Loss on disposal of Lynch Tri-Can International (less applicable income taxes of $167 and minority interest effect of $54) . . . -- (487) -- ----------- ------------ ----------- INCOME (LOSS) BEFORE EXTRAORDINARY ITEM . . . . . . . . . . . . . . . (2,878) 4,044 5,145 Loss on early extinguishment of debt, net of income tax benefit of $953 and minority interest effect of $495 . . . . . . . -- (1,348) -- ----------- ------------ ----------- NET INCOME (LOSS) . . . . . . . . . . . . . . . . . . . . . . . . . . $ (2,878) $ 2,696 $ 5,145 ----------- ------------ ----------- Weighted average shares outstanding . . . . . . . . . . . . . . . . . 1,415,000 1,388,000 1,379,000 =========== ============ =========== Basic earnings per share: Income (loss) from continuing operations before extraordinary item . . . . . . . . . . . . . . . . . . . . . . $ (2.03) $ 3.45 $ 3.96 Loss from discontinued operations . . . . . . . . . . . . . . . . . . -- (.54) (.23) Extraordinary item . . . . . . . . . . . . . . . . . . . . . . . . . -- (.97) -- ----------- ------------ ----------- NET INCOME (LOSS) . . . . . . . . . . . . . . . . . . . . . . . . . . $ (2.03) $ 1.94 $ 3.73 =========== ============ =========== Diluted earnings per share: Income (loss) from continuing operations before extraordinary item . . . . . . . . . . . . . . . . . . . . . . $ (2.03) $ 3.41 $ 3.89 Loss from discontinued operations . . . . . . . . . . . . . . . . -- (.53) (.23) Extraordinary item . . . . . . . . . . . . . . . . . . . . . . . -- (.96) -- ----------- ------------ ----------- NET INCOME (LOSS) . . . . . . . . . . . . . . . . . . . . . . . . . . $ (2.03) $ 1.92 $ 3.66 =========== ============ ===========
See accompanying notes. 36 39 LYNCH CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)
Year ended December 31 1997 1996 1995 --------- ------- --------- OPERATING ACTIVITIES Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . $ (2,878) $ 2,696 $ 5,145 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization . . . . . . . . . . . . . . . . . 21,045 16,981 11,276 Amortization of deferred financing charges . . . . . . . . . . 632 -- -- Extraordinary charge on early extinguishment of debt . . . . . -- 1,348 -- Net effect of purchases and sales of trading securities . . . . 1,171 9,276 2,079 Deferred taxes . . . . . . . . . . . . . . . . . . . . . . . . (3,751) 2,082 201 Share of operations of affiliated companies . . . . . . . . . . (154) (119) (398) Minority interests . . . . . . . . . . . . . . . . . . . . . . 264 (500) 2,119 Morgan special charge . . . . . . . . . . . . . . . . . . . . . -- 3,500 -- Gain on sale of stock by subsidiaries . . . . . . . . . . . . . (169) (5,146) (59) Reserve for impairment in investment in PCS license holders . . 7,024 -- -- Changes in operating assets and liabilities, net of effects of acquisitions: Receivables . . . . . . . . . . . . . . . . . . . . . . (1,357) 407 (3,704) Inventories . . . . . . . . . . . . . . . . . . . . . . 1,174 (3,374) 1,539 Accounts payable and accrued liabilities . . . . . . . . (1,342) 3,743 10,417 Other . . . . . . . . . . . . . . . . . . . . . . . . . 2,426 (1,810) (1,437) --------- ------- --------- NET CASH PROVIDED BY OPERATING ACTIVITIES . . . . . . . . . . . . . . 24,085 29,084 27,178 --------- ------- --------- INVESTING ACTIVITIES Acquisitions (total cost less debt assumed and cash equivalents acquired): Personal Communications Services Partnerships . . . . . . 1,644 (27,106) (7,010) Dunkirk and Fredonia . . . . . . . . . . . . . . . . . . . -- (17,788) -- Central Products Company . . . . . . . . . . . . . . . . . -- -- (85,072) Upper Peninsula Telephone Company . . . . . . . . . . . . (24,968) -- -- Other . . . . . . . . . . . . . . . . . . . . . . . . . . . -- (7,813) (8,048) Capital expenditures . . . . . . . . . . . . . . . . . . . . . . (21,828) (25,518) (19,569) Investment in Coronet Communications Company . . . . . . . . . . 2,995 -- -- Investment in Capital Communications, Inc. . . . . . . . . . . . -- -- 3,000 Sale of investments in Cellular partnerships . . . . . . . . . . 8,576 -- -- Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . (31) (1,597) (1,349) --------- ------- --------- NET CASH USED IN INVESTING ACTIVITIES . . . . . . . . . . . . . . . . (33,612) (79,822) (118,048) --------- ------- ---------
See accompanying notes. 37 40 LYNCH CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) (DOLLARS IN THOUSANDS)
Year ended December 31 1997 1996 1995 ------- ------ ------ FINANCING ACTIVITIES Issuance of long-term debt . . . . . . . . . . . . . . . . . . . 25,027 166,358 90,167 Payments to reduce long-term debt . . . . . . . . . . . . . . . . (26,634) (101,708) (4,720) Net borrowings, lines of credit . . . . . . . . . . . . . . . . 9,863 7,797 3,718 Deferred financing costs . . . . . . . . . . . . . . . . . . . . -- (7,139) -- Sale of treasury stock . . . . . . . . . . . . . . . . . . . . . 672 755 -- Sale of minority interests . . . . . . . . . . . . . . . . . . . -- 3,642 (220) Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 210 (942) (164) ------- -------- -------- NET CASH PROVIDED BY FINANCING ACTIVITIES . . . . . . . . . . . . . . 9,138 68,763 88,781 ------- -------- -------- Net increase (decrease) in cash and cash equivalents . . . . . . . . (389) 18,025 (2,089) Cash and cash equivalents at beginning of year . . . . . . . . . . . 33,946 15,921 18,010 ------- -------- -------- Cash and cash equivalents at end of year . . . . . . . . . . . . . . $33,557 $ 33,946 $ 15,921 ======= ======== ========
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(DOLLARS IN THOUSANDS) Common Additional Stock Common Paid-in Retained Outstanding Stock Capital Earnings ------------- --------- ----------- ----------- Balance at December 31, 1994 . . . . . . . . . . . . . . . 1,378,658 $5,139 $8,037 $18,631 Issuance of treasury stock . . . . . . . . . . . . . . 5 -- -- -- Capital transactions of the Morgan Group Inc. . . . . . -- -- (164) -- Net income for the year . . . . . . . . . . . . . . . . -- -- -- 5,145 ----------- -------- ---------- ----------- Balance at December 31, 1995 . . . . . . . . . . . . . . . 1,378,663 5,139 7,873 23,776 Issuance of treasury stock . . . . . . . . . . . . . . 12,371 -- 584 -- Capital transactions of the Morgan Group Inc. . . . . . -- -- (40) -- Net income for the year . . . . . . . . . . . . . . . . -- -- -- 2,696 ----------- -------- ---------- ----------- Balance at December 31, 1996 . . . . . . . . . . . . . . . 1,391,034 5,139 8,417 26,472 Capital transactions of the Morgan Group, Inc. . . . . -- -- (86) -- Issuance of treasury stock . . . . . . . . . . . . . . 26,014 -- 313 -- Dividend of East/West Communications, Inc. . . . . . . -- -- -- (180) Net loss for the year . . . . . . . . . . . . . . . . . -- -- -- (2,878) ----------- -------- ---------- ----------- Balance at December 31, 1997 . . . . . . . . . . . . . . . 1,417,048 $5,139 $8,644 $23,414 =========== ======== ========== ===========
See accompanying notes. 38 41 LYNCH CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997 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 operations of the holding company, meet its current funding commitments (see Note 5) and fund future growth. The Company is currently considering various alternative long and short-term financing arrangements. One such alternative would be to sell a portion or all of certain investments in operating entities either directly or through an exchangeable debt instrument. 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, 1997 and 1996, assets of $19.9 million and $14.4 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 Marketable securities and short-term investments consist principally of U.S. Treasury obligations, and preferred and common stocks and bonds. At December 31, 1997 and 1996, all marketable securities and United States Treasury money market funds classified as cash equivalents were classified as trading, with the exception of certain equity securities in 1997 and 1996 with carrying values of $1.0 million and $.9 million, respectively, which were 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 of $169,000, $628,000 and $408,000 on trading securities has been included in earnings for the years ended December 31, 1997, 1996, and 1995, respectively. There was no adjustment to shareholders' equity for the available-for-sale securities at December 31, 1997, 1996 and 1995, respectively. The cost of marketable securities sold is determined on the specific identification method. Realized gains of $229,000, $102,000 and $529,000, and realized losses of $9,000, $112,000 and $108,000 are included in investment income for the years ended December 31, 1997, 1996, and 1995, respectively. 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. 39 42 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 were $1,022,000 in 1997, $1,627,000 in 1996 and $1,673,000 in 1995. Earnings Per Share In 1997, the Financial Accounting Standards Board issued Statement ("SFAS") No. 128, Earnings per Share. SFAS No. 128 replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants, and convertible securities. Diluted earnings per share is very similar to the previously reported fully diluted earnings per share. All earnings per share amounts for all periods have been presented in accordance with, and where appropriate, restated to conform to the SFAS No. 128 requirements. Accounting for Long-Term Contracts Lynch Systems, 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 Systems accounts for these contracts using the percentage-of-completion accounting method as costs are incurred. Impairments Effective January 1, 1996, the Company adopted SFAS No. 121 "Accounting for the Impairment of Long-Lived Assets and for 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, if the exercise price of the Company's employee stock options was 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. 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 other long-term obligations approximates cost based on borrowing rates for similar instruments, excluding the Spinnaker senior-secured debt with a carrying value of $115 million and a fair value of approximately $119 million at December 31, 1997, based on quoted market prices for similar securities. Reclassifications Certain amounts in the 1996 and 1995 financial statements have been reclassified to conform to the 1997 presentation. Recent Accounting Pronouncements In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income, which is effective beginning in 1998. SFAS No. 130 establishes standards for reporting and display for comprehensive income and its components. Comparative periods are required to be reclassified to reflect the provisions of the Statement. The adoption of this Statement will not affect earnings as previously reported. In June 1997, the FASB also issued SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information. This new Statement requires disclosure of selected financial and descriptive information for each operating segment based on management's internal organizational decision-making structure. Additional information is required on a company-wide basis for revenues by product or service, revenues and identifiable assets by geographic location and informa- 40 43 tion about significant customers. The Company will begin presenting any additional information as required by SFAS No. 131 in its financial statements for the year ending December 31, 1998. 2. ACQUISITIONS On March 18, 1997, Lynch Michigan Telephone Holding Company, a wholly-owned subsidiary of Lynch acquired approximately 60% of the outstanding shares of Upper Peninsula Telephone Company for $15.2 million. The Company completed the acquisition of the remaining 40% on May 23, 1997. The total cost of the acquisition was $26.5 million. As a result of this transaction, the Company recorded $7.4 million in goodwill which is being amortized over 25 years. 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, DFT Communications, Inc. (Formerly known as 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 63% 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. 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 Operations 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 Upper Peninsula Telephone Company was made at the beginning of 1996 and the purchase of Transit Homes and Dunkirk and Fredonia were made at the beginning of 1995.
For the year ended December 31 1997 1996 1995 ---------- ---------- ---------- (In thousands except per share data) Sales . . . . . . . . . . . $469,912 $500,915 $467,720 Income (loss) from continuing operations . . . . (2,711) 8,056 4,843 Loss from discontinued operations . . . . . . . . . -- (750) (324) Extraordinary item . . . . . . . -- (1,348) -- ---------- ---------- ---------- Net income (loss) . . . . . . . . $ (2,711) $ 5,958 $ 4,519 ========== ========== ========== Basic earnings per share: Income (loss) from continuing operations . . . $ (1.92) $ 5.80 $ 3.51 Loss from discontinued operations . . . . . . . . -- (.54) (.23) Extraordinary item . . . . . -- (.97) -- ---------- ---------- ---------- Net income (loss) per share . . . $ (1.92) $ 4.29 $ 3.28 ========== ========== ========== Diluted earnings per share: Income (loss) from continuing operations . . . $ (1.92) $ 5.73 $ 3.44 Loss from discontinued operations . . . . . . . . -- (.53) (.23) Extraordinary item . . . . . -- (.96) -- ---------- ---------- ---------- Net income (loss) per share . . . $ (1.92) $ 4.24 $ 3.21 ========== ========== ==========
3. SPECIAL CHARGES/DISCONTINUED OPERATIONS Morgan Drive Away, a 51% 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. Morgan recorded a special charge for 1997 of $624,000 before taxes comprised of gains in excess of the net realizable value associated with exiting the truckaway operation of $361,000, offset by charges related to driver pay of $985,000. These charges have been included in the Company's results of continuing operations. The Board of Directors of Lynch Systems, 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 and 1995. Tri-Can which was previously reported in the manufacturing segment due to the insignificance to the Company's financial statements, is treated as a discontinued operation as its products and customers are different than those of Lynch Systems. 41 44 As a result of this disposal, Lynch 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):
For the Year ended December 31 1996 1995 ----- ----- Sales . . . . . . . . . . . . . . . . . . $2,797 $4,539 ====== ====== Loss before tax benefit . . . . . . . . . $ (441) $ (580) Income tax benefit . . . . . . . . . . . 149 220 Minority interest . . . . . . . . . . . . 29 36 ------ ------ Loss from operations . . . . . . . . . . (263) (324) ------ ------ Loss on disposal before income tax benefit . . . . . . . . . . . . . . . . (708) -- Income tax benefit . . . . . . . . . . . 167 -- Minority interest . . . . . . . . . . . . 54 -- ------ ------ Loss on disposal . . . . . . . . . . . . (487) -- ------ ------ Total loss on discontinued operations . . $ (750) $ (324) ====== ======
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 48% and 50% of consolidated inventories at December 31, 1997 and 1996. Inventories at Spinnaker Coating, 43% and 42% of inventories at December 31, 1997 and 1996, are valued using the specific identification method. The balance of inventories are valued using the first-in first-out (FIFO) method.
December 31 1997 1996 ----- ----- (In Thousands) Raw materials and supplies . . . . . . . . $10,493 $10,987 Work in process . . . . . . . . . . . . . . 3,544 3,950 Finished goods . . . . . . . . . . . . . . 21,648 21,922 ------- ------- TOTAL . . . . . . . . . . . . . . . . . . . $35,685 $36,859 ======= =======
Current cost exceeded the LIFO value of inventories by $925,000 and $973,000 at December 31, 1997 and 1996, 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 held a 49.9% limited partnership interest in each of these partnerships and had committed to funding the government interest and certain other expenses up to a specified amount as discussed below. In the C-Block auction, which ended in May 1996, Lynch's subsidiary was a limited partner in Fortunet Communications, L.P. ("Fortunet"), which 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's subsidiary had agreements to provide a total of $41.8 million of funding to such partnership, of which $24.0 million was funded through December 31, 1997. These 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. Events during and subsequent to the auction, as well as other externally driven technological and market forces, have made financing the development of these licenses through the capital markets much more difficult than previously anticipated. Fortunet, as well as many of the license holders from this auction, has petitioned the FCC for relief in terms of (1) resetting the interest rate to the appropriate rate at the time; (2) further reducing or delaying the required debt payments in order to afford better access to capital markets; and (3) relaxing the restrictions with regard to ownership structure and alternative arrangements in order to afford these small businesses the opportunity to more realistically restructure and build-out their systems. The response from the FCC, which was announced on September 26, 1997, afforded license holders a choice of four options, one of which was the resumption of current debt payment which had been suspended earlier this year. The ramifications of choosing the other three courses of action could result in Lynch's subsidiary ultimately forfeiting either 30%, 50%, or 100% of its current investment in these licenses. On March 24, 1998, the 42 45 FCC modified the four options. While Fortunet is still examining what action, if any, it will take with these options, it is expected that a decision will be required to be made during the second quarter of 1998. Lynch has provided for a 30% reserve of its investment at this time, as this represents management's estimate of the impairment of this investment given the current available alternatives. The balance sheets of Fortunet at December 31, 1997 and 1996 are as follows (in thousands):
December 31 1997 1996 ------ ------ ASSETS Cost of license acquired . . . . . . . . . . $243,693 $223,076 -------- -------- Total assets . . . . . . . . . . . . . . . . $243,693 $223,076 ======== ======== LIABILITIES AND DEFICIT Due to the Department of Treasury . . . . . . $208,188 $198,486 Due to Lynch Subsidiary . . . . . . . . . . . 49,513 31,574 Partnership Deficit . . . . . . . . . . . . . (14,008) (6,984) -------- -------- Total liabilities and deficit . . . . . . . . $243,693 $223,076 ======== ========
Included in "Due to Lynch Subsidiary" and "Cost of license acquired" are interest and other financing fees aggregating $25.5 million and $10.9 million at December 31, 1997 and 1996, respectively. In the F-Block Auction, East/West Communications, Inc. ("East/West"), incorporated in August 1997 as a successor to Aer Force Communications B, L.P. minority owned by a subsidiary of Lynch, acquired five licenses to provide personal communications services in geographic areas of the United States with a total population of 20 million. 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. $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 a description of the terms of this loan). In January 1997, $10.0 million of this loan was repaid with monies returned from the FCC upon completion of the auction. On May 12, 1997, four of the five licenses were awarded and on July 14, 1997, the fifth license was awarded. $15.2 million of the cost of the licenses is financed with a loan from the United States Government. The interest rate on the loan is 6.25% with quarterly principal amortization in years 3 to 10. As of November 30, 1997, Lynch's subsidiary had invested $225,000 in partnership equity and provided the partnership with a loan of $3.5 million funded by a short-term secured borrowing and had a funding commitment of $8.3 million to East/West. On December 4, 1997, East/West succeeded to the assets and liabilities of Aer Force with Lynch's subsidiary receiving 49.9% of the common stock. Immediately thereafter, Lynch spun off 39.9% of the common stock of East/West to Lynch's shareholders and transferred 10% of East/West stock to GFI in satisfaction of an obligation to pay it 10% of the net profits (after a capital charge) of Aer Force. Prior to the succession, Lynch's subsidiary contributed a portion of the debt (including interest and commitment fees) owed to it as a contribution to Aer Force B's capital and immediately after the succession the remaining debt owed to it ($4.5 million book value) was deemed paid by the issuance by East/West of 7,800 shares ($7,800,000 liquidation preference) of Redeemable Preferred Stock and termination of Lynch's subsidiary's obligation to make further loans. The Redeemable Preferred Stock has a 5% payment-in-kind dividend and is redeemable in 2009 subject to earlier payment in certain circumstances. A 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. Rivgam is a subsidiary of GFI. During 1997, the FCC held an auction for 2.3 GHZ of spectrum to be used for Wireless Communications Services. A wholly-owned Lynch subsidiary will receive a 5% net profit interest (after a capital charge) in certain WCS licenses won by Bal/Rivgam Communications in that auction for certain services performed during the auction. GFI has a minority interest in Bal/Rivgam. 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 Ames/Des Moines, Iowa. At December 31, 1997 and 1996, LENCO's net investment in Coronet is a negative ($1,612,000) and $1,214,000, respectively. In 1997, Coronet repaid a $2.9 million loan to LENCO plus accrued interest. Long-term debt of Coronet, at December 31, 1997, is comprised of $14.8 million due to a third party lender which is due quarterly through December 31, 2003. The Company recorded interest income on the LENCO debt of $30,000, $287,000 and $276,000 for the years ended December 31, 1997, 1996, and 1995, respectively. LENCO guaranteed $3.8 million of $14.8 million of Coronet's third party debt. 43 46 At December 31, 1997 and 1996, LENCO II's investment in Capital is carried at zero as its share of net losses recognized to date has exceeded its 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 Excess of costs over fair value of net assets acquired include acquisition intangibles of $73.3 million and $69.2 million, net of accumulated amortization of $11.2 million and $7.9 million, at December 31, 1997 and 1996, respectively. 8. NOTES PAYABLE AND LONG-TERM DEBT Long-term debt consists of (all interest rates are at December 31, 1997):
December 31 1997 1996 ------ ------ (In Thousands) Spinnaker Industries, Inc. 10.75% Senior Secured Notes due 2006 . . . . . . . $115,000 $115,000 Rural Electrification Administration and Rural Telephone Bank notes payable in equal quarterly installments through 2027 at fixed interest rates ranging from 2% to 7.5% (4.7% weighted average), secured by assets of the telephone companies of $102.6 million . . . 47,109 34,734 Bank credit facilities utilized by certain telephone and telephone holding companies through 2009, $35.1 million at a fixed interest rate averaging 9.1% and $19.5 million at variable interest rates averaging 8.5% . . . . . . . . . . . 54,633 41,513 Unsecured notes issued in connection with telephone company acquisitions; $28.0 million at fixed interest rates averaging 9% . . . . . . . . . . . . . . . 28,049 29,783 Gabelli Funds, Inc. loan issued in connection with FCC F-Block Auction at fixed rate of 10% due in 1997 . . . . . -- 11,800 Other . . . . . . . . . . . . . . . . . . . . . 7,287 8,779 -------- -------- 252,078 241,609 Current maturities . . . . . . . . . . . . . . . . (9,302) (22,030) -------- -------- $242,776 $219,579 ======== ========
On October 23, 1996, Spinnaker Industries, Inc. completed the issuance of $115.0 million 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 Spinnaker Coating. 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 $5.7 million and $6.2 million at December 31, 1997 and 1996, respectively, are included in other assets. The notes are redeemable, in whole or in part, at the option of Spinnaker on or after October 15, 2001, at the redemption prices beginning at 105.375% of the principal amount declining to 100% of the principal amount on October 15, 2005, plus accrued and unpaid interest. In addition, at any time or from time to time on or prior to October 15, 1999, Spinnaker, at its option, may redeem up to 33-1/3% of the aggregate principal amount of the Notes with net cash proceeds from public equity offerings at a redemption price equal to 110.75% of the principal amount plus accrued and unpaid interest. The Notes are unconditionally guaranteed, jointly and severally, by Spinnaker Coating, Inc. (formerly known as Brown-Bridge Industries, Inc.) and CPC. REA 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. On a consolidated basis, at December 31, 1997, Lynch maintains short-term and long-term lines of credit facilities totaling $88.9 million, of which $48.1 million was available. Lynch (Parent Company) maintains a $26.0 million short-term line of credit facility, of which $3.3 million was available at December 31, 1997. One facility decreased from $16.0 million to $14.0 in February 1998. The line of credit agreement expires in May 1998 and is subject to renewal. Spinnaker Industries, Inc. maintains lines of credit at its subsidiaries which total $40.0 million, of which $34.5 million was available at December 31, 1997 (see Note 17). The Morgan Group maintains lines of credit totaling $10.0 million, $3.3 million was available at December 31, 1997. In March 1998, the Morgan Group replaced this facility with a $15.0 million revolving line of credit that matures in April 2001. Additionally, a letter of credit facility was obtained which expires in April 1999. These facilities, as well as facilities at other subsidiaries of Lynch, generally limit the credit available under the lines of credit to certain variables, such as inventories and receivables, and are secured by the operating assets of the subsidiary, and include various restrictive financial covenants. Due to certain of these restrictive covenants and working capital requirements of the subsidiaries, cash distributions from the subsidiaries are limited. At December 31, 1997, $48.9 million of these total facilities expire within one year. 44 47 In general, the long-term debt credit facilities are secured by property, plant and equipment, inventory, receivables and common stock of certain subsidiaries and contain certain covenants restricting distributions to Lynch. At December 31, 1997 substantially all net assets of operating subsidiaries are restricted. 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 was due and payable in one year. The interest rate on this loan was fixed at 10% and in addition a commitment fee of 1% per annum was being charged on the principal amount of GFI's commitment ($11.8 million) including funds actually borrowed. GFI also received 20% 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. The remaining note was paid in August 1997. Cash payments for interest were $23.1 million, $16.7 million and $10.6 million for the years ended December 31, 1997, 1996 and 1995, respectively. Aggregate principal maturities of long-term debt for each of the next five years are as follows: 1998--$9.3 million; 1999--$8.0 million; 2000--$15.8 million; 2001--$12.0 million and 2002--$11.8 million. 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 that time) at any time on or before June 30, 1999, subject to certain restrictions. As of December 31, 1997 there were 228,499 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). All the remaining warrants were exercised in January 1998. On May 5, 1996, Alco converted a $6.0 million 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 Spinnaker Coating. 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 Spinnaker Coating, 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 Spinnaker Coating entity owned by such stockholder at the time of the merger multiplied by 75% of the fair value of the capital stock of Spinnaker Coating, 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 payments are made in cash, they could give rise 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 Spinnaker Coating minority interest, all the Spinnaker Coating options were accelerated and in turn certain key executives of Spinnaker Coating management exercised those options to purchase 71,065 shares of Spinnaker Coating 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. On March 12, 1996, Lynch sold 10,373, 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 this date was $60.25. In March, 1997, GFI and an affiliate made a secured loan to the Company of $10 million, which was used by the Company to close the acquisition of 60% of the stock of Upper Peninsula Telephone Company. The loan bore interest at the prime rate with a commitment fee of 1% of the principal amount. The loan was repaid in June 1997. 45 48 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 non-employee directors. 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. Stock options vest over a four year period pursuant to the terms of the plan, except for stock options granted to a non-employee director, which are immediately vested. Morgan employees have been granted non-qualified stock options to purchase 118,000 shares of Class A Common stock, net of cancellations and exercises, at prices ranging from $7.38 to $9.38 per share. Non-employee directors have been granted non-qualified stock options to purchase 49,000 shares of Class A Common stock, net of cancellations and exercises, at prices ranging from $6.20 to $9.00 per share. As of December 31, 1997, there were 110,625 options to purchase shares granted to Morgan's employees and non-employee directors which were exercisable based upon the vesting terms, of which all shares had option prices less than the December 31, 1997 closing price of $9.25. In accordance with Spinnaker's directors stock option plan, Spinnaker may grant stock options to directors who are not employees of Spinnaker. In February 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 ceases to be a director. In January of 1997, under the same terms, Spinnaker issued 10,000 stock options for the purchase of one share of Common Stock at an exercise price of $27 per share. As permitted by SFAS No. 123, Spinnaker elected to account for these options under APB No. 25 and as such no compensation expense was recorded because the option exercise price was not less than the market price at the date of grant. Pro forma information regarding net income and earnings per share is required by SFAS No. 123, and has been determined as if Spinnaker had accounted for its director 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 6.09%-5.58%; dividend yields of 0%, volatility factors of the expected market price of the Spinnaker's common stock of .50; and a weighted-average expected life of the options of 3 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 $14.62 and $10.40 for the 1997 and 1996 options, respectively. The pro forma effect on Lynch's 1997 and 1996 operations is as follows (In Thousands, except for per share amounts):
1997 1996 ---------- ------- As reported: Net Income (loss) . . . . . . $(2,878) $2,696 Per share: Basic . . . . . . . . . . . (2.03) $1.94 Diluted . . . . . . . . . . (2.03) $1.92 Pro forma: Net Income (loss) . . . . . . $(2,950) $2,607 Per share: Basic . . . . . . . . . . . (2.08) $1.88 Diluted . . . . . . . . . . (2.08) $1.86
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, 1997, 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 and shares were issued from Treasury. 46 49 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. Through March 1998, 4,126 shares have been awarded under this program. On February 29, 1996, the Company adopted a Phantom Stock Option Plan for certain employees. To date, 43,000 of Phantom Stock Options ("PSO") have been granted at prices ranging from $63 to $85 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. The resulting expenses were $439,000 and $46,000 in 1997 and 1996, respectively. 12. INCOME TAXES Deferred income taxes for 1997 and 1996 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, 1997 and 1996 are as follows:
December 31, 1997 December 31, 1996 Deferred Tax Deferred Tax Asset Liability Asset Liability ------ ------ ----- ------ (In Thousands) Inventory reserve . . . . . . $ 474 -- $ 435 -- Fixed assets written up under purchase accounting and tax over book depreciation . -- $18,514 -- $14,818 Discount on long-term debt . -- 1,184 -- 1,286 Basis difference in subsidiary and affiliate stock . . . . . . . . . -- 3,378 -- 3,486 Partnership tax losses in excess of book losses, including PCS impairment reserve . . . 6,109 8,040 -- 1,669 Other reserves and accruals . 5,459 -- 2,536 -- Net operating loss carryforwards of subsidiary companies . . 4,056 -- 2,568 -- Other . . . . . . . . . . . . 1,895 2,648 194 1,130 ------- ------- ------ ------- 17,993 33,764 5,733 22,389 Valuation allowance . . . . . -- -- (162) -- ------- ------- ------ ------- Total deferred income taxes . . . . . . $17,993 $33,764 $5,571 $22,389 ======= ======= ====== =======
The provision (benefit) for income taxes is summarized as follows:
1997 1996 1995 ------ ------ ------ (In Thousands) Current payable taxes: Federal . . . . . . . . $2,359 $ 695 $4,420 State and local . . . . 679 193 992 ------ ------ ------ 3,038 888 5,412 ------ ------ ------ Deferred taxes: Federal . . . . . . . . (3,722) 1,495 (446) State and local . . . . (29) 638 (60) ------ ------ ------ (3,751) 2,133 (506) ------ ------ ------ $ (713) $3,021 $4,906 ====== ====== ======
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 and extraordinary item, follows:
1997 1996 1995 ---- ----- ---- (In Thousands) Tax at statutory rate . . . . . $(1,131) $2,515 $4,260 Increases (decreases): State and local taxes, net of federal benefit . 429 543 615 Amortization of excess of acquired net assets over cost, net . . . . . . . . 443 132 64 Unremitted earnings of domestic subsidiary . . . . (108) (65) 91 Reduction attributable to special election by captive insurance company . . . . . . . . . . (155) (216) (223) Other . . . . . . . . . . . . . (191) 112 99 ------- ------ ------ $ (713) $3,021 $4,906 ======= ====== ======
Net cash payments for income taxes were $.7 million, $3.5 million and $4.2 million for the years ended December 31, 1997, 1996 and 1995, 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. 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 $39 million in 1997, $25 million in 1996 and $41 million in 1995. 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 47 50 television stations. The services segment includes transportation and related services. $13.5 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. 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, $932,000 and $965,000 during the years ended December 31 1997, 1996 and 1995, 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.
Year ended December 31 1997 1996 1995 -------- -------- ------ (In Thousands) REVENUES Multimedia . . . . . . . . . . $ 47,908 $ 28,608 $ 23,597 Services . . . . . . . . . . . 146,154 132,208 122,303 Manufacturing . . . . . . . . 273,474 291,064 187,727 -------- -------- -------- $467,536 $451,880 $333,627 ======== ======== ======== OPERATING PROFIT Multimedia . . . . . . . . . . $ 11,845 $ 6,611 $ 4,938 Services . . . . . . . . . . . 1,015 (3,263) 3,371 Manufacturing . . . . . . . . 13,384 15,928 14,412 Unallocated corporate expense . . . . . . . . . . (1,457) (2,336) (2,874) -------- -------- -------- $ 24,787 $ 16,940 $ 19,847 ======== ======== ======== CAPITAL EXPENDITURES Multimedia . . . . . . . . . . $ 10,914 $ 11,056 $ 14,051 Services . . . . . . . . . . . 919 1,007 2,135 Manufacturing . . . . . . . . 9,991 13,438 3,373 General corporate . . . . . . 4 17 10 -------- -------- -------- $ 21,828 $ 25,518 $ 19,569 ======== ======== ======== DEPRECIATION AND AMORTIZATION Multimedia . . . . . . . . . . $ 12,183 $ 8,660 $ 7,350 Services . . . . . . . . . . . 1,075 1,498 1,264 Manufacturing . . . . . . . . 7,787 6,823 2,662 -------- -------- -------- $ 21,045 $ 16,981 $ 11,276 ======== ======== ======== ASSETS Multimedia . . . . . . . . . . $197,881 $168,354 $102,998 Services . . . . . . . . . . . 32,746 33,066 30,796 Manufacturing . . . . . . . . 180,292 186,299 162,819 General corporate . . . . . . 12,719 4,901 5,826 -------- -------- -------- $423,638 $392,620 $302,439 ======== ======== ========
15. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) The following is a summary of the quarterly results of operations for the years ended December 31, 1997 and 1996 (in thousands, except per share amounts):
1997--Three Months Ended --------------------------------------------- March 31 June 30 Sept. 30 Dec. 31 --------- ---------- --------- ---------- Sales and revenues . . . . . . . . . . . $108,779 $121,426 $118,717 $118,614 Operating profit . . . . . . . . . . . . 4,236 8,116 6,287 6,148 Income (loss) from continuing operations . . . . . . . (512) 1,250 (4,274)(a) 658 Net income (loss) . . . . . . . . . (512) 1,250 (4,274)(a) 658 Basic earnings per share: Net income (loss) . . . . . . . . . (.36) .88 (3.02) .46 Diluted earnings per share: Net income (loss) . . . . . . . . . (.36) .88 (3.02) .46
1996--Three Months Ended --------------------------------------------- March 31 June 30 Sept. 30 Dec. 31 --------- ---------- --------- --------- Sales and revenues . . . . . . . . . . . $109,475 $113,493 $117,321 $111,591 Operating profit . . . . . . . . . . . . 5,938 5,383 6,714 (1,095) Income (loss) from continuing operations before discontinued operations and extraordinary items . . . . . . . . 1,224 3,215 1,249 (894) Discontinued operations . . . . . . . . . (23) (720) -- (7) Extraordinary item . . . . . . . . . . . -- -- -- (1,348) Net income (loss) . . . . . . . . . 1,201 2,495 1,249 (2,249) Basic earnings per share: Net income (loss) . . . . . . . . . .87 1.79 .90 (1.62) Diluted earnings per share: Net income (loss) . . . . . . . . . .86 1.77 .89 (1.62)
Note: a) Includes $7.0 million before tax for reserve for impairment of investment in PCS license holders. 48 51 16. EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share from continuing operations:
Year ended December 31 1997 1996 1995 ------- ------- ------- Numerator: Income (loss) from continuing operations before extraordinary item . . . . $(2,878,000) $4,794,000 $5,469,000 Numerator for diluted earnings per share . . . . (2,878,000) 4,794,000 5,469,000 Denominator: Denominator for basic earnings per share-- weighted-average shares . . 1,415,000 1,388,000 1,379,000 Effect of dilutive securities: Stock options . . . . . . . . . -- 17,000 30,000 ----------- ---------- ---------- Dilutive potential common shares . . . . . . . . . . -- 17,000 30,000 Denominator for diluted earnings per share - adjusted weighted- average shares . . . . . . 1,415,000 1,405,000 1,409,000 =========== ========== ========== Basic earnings (loss) per share . . . . . . . . . . . $(2.03) $3.45 $3.96 =========== ========== ========== Diluted earnings (loss) per share . . . . . . . . . . . $(2.03) $3.41 $3.89 =========== ========== ==========
17. SUBSEQUENT EVENTS Effective March 17, 1998, Spinnaker Coating-Maine, Inc. closed the acquisition of the pressure sensitive adhesive-backed label stock business of S.D. Warren ("Pressure Sensitive Business" or "the Acquisition"). S.D. Warren is a large pulp and paper producer owned by an indirect wholly owned subsidiary of SAPPI, Ltd., a public South African conglomerate. Spinnaker Coating-Maine is a wholly owned subsidiary of Spinnaker Coating, Inc. and was formed to acquire the Pressure Sensitive Business which manufactures and markets label stock primarily for the EDP segment of the label stock market. The Pressure Sensitive Business' EDP products are used in various labeling end uses, including form printing and product marking and identification. The purchase price under the agreement was approximately $52 million, plus the assumption of certain liabilities and was funded by issuing the seller a subordinated note of $7.0 million and the remainder from Spinnaker's revolving credit facility which was expanded subsequent to December 31, 1997 from $40.0 million to $60.0 million. The subordinated note bears interest at 10% per annum and 30% is due on March 31, 1999 with the remainder due March 31, 2000, subject to certain postponement and acceleration provisions. The note is convertible into Spinnaker common stock at a price of $25.00 per share, subject to certain adjustments. The Pressure Sensitive Business generated $62.1 million of net sales and, on a historical basis, and $5.8 million of operating income for the fiscal year ended October 1, 1997. The Pressure Sensitive Business was renamed Spinnaker Coating-Maine, Inc. effective with the acquisition. - ------------------------------------------------------------------------------- FORWARD LOOKING INFORMATION This Annual Report contains certain forward looking information, including without limitation information in the Chairman's Letter, the summary reports of the Company's various businesses, personal communications service matters, Management's Discussion and Analysis of Financial Condition and Results of Operations, particularly Financial Condition, and Notes to Financial Statements. It should be recognized that such information are estimates or forecasts based upon various assumptions, including the matters referred to therein, as well as meeting the Company's internal performance assumptions regarding expected operating performance and the expected performance of the economy and financial markets as it impacts the Company's businesses. As a result, such information is subject to uncertainties, risks and inaccuracies. 49 52 REPORT OF INDEPENDENT AUDITORS Shareholders and Board of Directors Lynch Corporation We have audited the accompanying consolidated balance sheets of Lynch Corporation and subsidiaries ("Lynch Corporation") as of December 31, 1997 and 1996, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the 1996 and 1995 financial statements of Central Products Company, a wholly-owned subsidiary of Spinnaker Industries, Inc. (a 73% and 83% owned subsidiary of Lynch Manufacturing as of December 31, 1996 and 1995, respectively, a wholly-owned subsidiary of Lynch Corporation), which statements reflect total assets of $97,300,000 as of December 31,1996, and total revenues of $126,383,000 and $30,581,000 for the year ended December 31, 1996 and the three month period ended December 31, 1995, respectively, the 1996 financial statements of Dunkirk and Fredonia Telephone Company, a wholly-owned subsidiary of DFT Communications, Inc. (formerly Lynch Telephone VIII, a wholly-owned subsidiary of the Company) which statements reflect total assets of $17,715,373 as of December 31, 1996 and total revenues of $575,000 for the two month period ended December 31, 1996, the 1996 financial statements of CLR Video, L.L.C., a wholly-owned subsidiary of Lynch Multimedia (a wholly-owned subsidiary of the Company) which statements reflect total assets of $5,834,000 as of December 31, 1996 and total revenues of $1,399,000 for the year ended December 31, 1996, the 1995 financial statements of The Morgan Group, Inc. and subsidiaries, a subsidiary in which the Company has a 64% voting interest, which statements reflect total revenues of $122,303,000 for the year ended December 31, 1995, and the 1996 and 1995 financial statements of Coronet Communications Company and of Capital Communications Company, Inc. (corporations in which the Company has a 20% and 49% interest, respectively). Those statements were audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to data included for Central Products Company in 1996 and 1995, Dunkirk and Fredonia in 1996, CLR Video, L.L.C. in 1996, The Morgan Group, Inc. and subsidiaries in 1995, Coronet Communications Company and Capital Communications Company, Inc. in 1996 and 1995, is based solely on the reports of the other auditors. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the reports of other auditors provide a reasonable basis for our opinion. In our opinion, based on our audits and the reports of other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Lynch Corporation and subsidiaries at December 31, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. Ernst & Young LLP Stamford, Connecticut March 24, 1998 50 53 LYNCH CORPORATION FIVE YEAR SUMMARY SELECTED FINANCIAL DATA (IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
Year Ended December 31 (a) ------------------------------------------------------------ 1997 1996 1995 1994 1993 ------- ------- ------- ------- ------- Revenues (a) . . . . . . . . . . . . . . . . . . . $467,536 $451,880 $333,627 $183,241 $127,021 --------- --------- --------- --------- --------- Operating Profit (b) . . . . . . . . . . . . . . . 24,787 16,940 19,847 10,942 6,634 Net Financing Activities . . . . . . . . . . . . . (21,259) (14,689) (7,376) (4,333) (3,643) Reserve for Impairment, of Investment in PCS License Holders . . . . . . . . . . . . . . . . (7,024) -- -- -- -- Gain on Sales of Subsidiary and Affiliate Stock . . 169 5,146 59 190 4,326 --------- --------- --------- --------- --------- Income (Loss) from Continuing Operations Before Income Taxes and Minority Interests . . . . . . . . . . . . (3,327) 7,397 12,530 6,799 7,317 Provision for Income Tax . . . . . . . . . . . . . 713 (3,021) (4,906) (2,726) (2,454) Minority Interests . . . . . . . . . . . . . . . . (264) 418 (2,155) (1,372) (737) --------- --------- --------- --------- --------- Income (Loss) from Continuing Operations Before Extraordinary Items and Cumulative Effect of Accounting Change . . . . . . . . . . (2,878) 4,794 5,469 2,701 4,126 Discontinued Operations (c) . . . . . . . . . . . . -- (750) (324) (109) (10) Extraordinary Item (d) . . . . . . . . . . . . . . -- (1,348) -- (264) (206) Cumulative Effect to January 1, 1993 of Change in Accounting for Income Taxes(e) . . . -- -- -- -- (957) --------- --------- --------- --------- --------- Net Income (Loss) . . . . . . . . . . . . . . . . . $ (2,878) $ 2,696 $ 5,145 $ 2,328 $ 2,953 ========= ========= ========= ========= ========= Per Common Share (f) Income (Loss) from Continuing Operations: Basic . . . . . . . . . . . . . . . . . . . $ (2.03) $ 3.45 $ 3.96 $ 2.03 $ 3.37 Diluted . . . . . . . . . . . . . . . . . . (2.03) 3.41 3.89 1.95 2.98 Net Income (Loss): Basic . . . . . . . . . . . . . . . . . . . $ (2.03) $ 1.94 $3.73 $ 1.75 $ 2.41 Diluted . . . . . . . . . . . . . . . . . . (2.03) 1.92 3.66 1.72 2.29 Cash, Securities and Short-Term Investments . . . . $ 34,542 $ 36,102 $ 27,353 $ 31,521 $ 45,509 Total Assets (a) . . . . . . . . . . . . . . . . . 423,638 392,620 302,439 185,910 129,523 Long-term Debt . . . . . . . . . . . . . . . . . . 242,776 219,579 138,029 62,745 65,768 Shareholders' Equity (g) . . . . . . . . . . . . . $ 36,451 $ 38,923 $ 35,512 $ 30,531 $ 24,316
NOTES: (a) Includes results of J.B.N. Telephone Company from November 30, 1993, Station WOI-TV from March 1, 1994, the Brown Bridge Division from September 19, 1994, Haviland Telephone Company from September 26, 1994, Central Products Company from October 4, 1995, Dunkirk and Fredonia Telephone Company from November 26,1996, Transit Homes of America from December 30. 1996, and Upper Peninsula Telephone Company from March 18, 1997. (b) 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. (c) Discontinued operations of Lynch Tri-Can International. (d) Gain (Loss) on repurchase or redemption of Company's 8% convertible subordinated debentures for years 1994 and 1993 and early extinguishment of debt at Spinnaker in 1996. (e) On January 1, 1993, Lynch adopted the provisions of Statement of Financial Accounting Standard No., 109, "Accounting for Income Taxes." (See Note 12 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. (f) Based on weighted average number of common shares outstanding--restated to conform to SFAS #128. (g) No cash dividends have been declared over the period. In 1997, for each share of Lynch Common Stock, our shareholders received one share of East/West Communications, Inc., an F-Block PCS licensee with licenses covering a population of 20 million. These shares had a net book value to Lynch of $0.12 per share prior to the dividend. 51 54 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 consolidating trading of the Common Stock during the past two years is as follows:
THREE MONTHS ENDED -------------------------------------------------------------------------- 1997 MARCH 31 JUNE 30 SEPT 30 DEC 31 --- --------- ------- ------- ------ High 109 3/4 98 100 95 Low 69 1/2 83 1/2 87 1/2 77 1996 --- High 72 1/2 92 1/2 90 1/2 77 Low 56 62 67 1/2 63 1/2
At March 16, 1998, the Company had 998 shareholders of record. 52 55
BOARD OF DIRECTORS ---------------------------------------------------------------------------------------------------------- E. VAL CERUTTI DAVID C. MITCHELL Business Consultant Business Consultant PAUL J. EVANSON SALVATORE MUOIO President of Florida Power & Light Company Managing Member of S. Muoio & Co. LLC JOHN C. FERRARA RALPH R. PAPITTO Business Consultant Chairman of AFC Cable Systems MARIO J. GABELLI Chairman of the Board and Chief Executive Officer of DIRECTOR SEMERITUS Lynch Corporation and Chairman and Chief Executive MORRIS BERKOWITZ Officer of The Gabelli Funds Inc. Business Consultant PAUL P. WOOLARD Business Consultant
OFFICERS ------------------------------------------------------------------------------------------------------------------- MARIO J. GABELLI ROBERT E. DOLAN CORPORATE STAFF Chairman of the Board and Chief Financial Officer --------------- Chief Executive Officer ROBERT A. HURWICH MARY J. CARROLL MARK L. CUSHING Vice President of Administration, CARMINE P. CERAOLO Assistant to the Chairman Secretary & General Counsel CAROLE L. RAU MARK M. FELDMAN LYNCH INTERACTIVE CORPORATION Executive Vice President of Eugene P Connell Corporate Development Chairman JOSEPH H. EPEL Treasurer
SUBSIDIARY INFORMATION ------------------------------------------------------------------------------------------------------ WESTERN NEW MEXICO TELEPHONE COMPANY SPINNAKER COATINGS, INC. 314 Yankee Street 518 E. Water Street Silver City, New Mexico 88062 Troy, Ohio 45373 INTER-COMMUNITY TELEPHONE COMPANY SPINNAKER COATING-MAINE, INC. P.O. Box A 225 Warren Avenue Nome, North Dakota 58062 Westbrook, Maine 04092 CUBA CITY TELEPHONE EXCHANGE COMPANY CENTRAL PRODUCTS COMPANY BELMONT TELEPHONE COMPANY 748 Fourth Street 2801 International Lane Menasha, WI 54952 Madison, Wisconsin 53704 ENTOLETER, INC. BRETTON WOODS TELEPHONE COMPANY 251 Welton Street Mount Washington Place Hamden, Connecticut 06517 Bretton Woods, New Hampshire 03575 LYNCH SYSTEMS, INC. J.B.N. TELEPHONE COMPANY 601 Independent Street Second & Kansas Bainbridge, Georgia 31717 Wetmore, Kansas 66550 M-TRON INDUSTRIES, INC. CLR VIDEO, L.L.C. 100 Douglas Avenue 328 Second Street Yankton, South Dakota 57078 Westmore, Kansas 66650 HAVILAND TELEPHONE COMPANY INVESTOR RELATIONS CONTACT 106 N. Main Street Robert E. Dolan Haviland, Kansas 67059 (203) 629-3333 DUNKIRK & FREDONIA TELEPHONE COMPANY 40 Temple Street TRANSFER AGENT & REGISTRAR Fredonia, New York 14063 FOR COMMON STOCK UPPER PENINSULA TELEPHONE COMPANY Chemical Mellon Shareholder Services 397 US 41 New York, New York Carney, Michigan 49812 TRADING INFORMATION THE MORGAN GROUP, INC. American Stock Exchange MORGAN DRIVE AWAY INC. 28651 US 20, West Securities Symbol Elkhart, Indiana 46515 Common Stock LGL SPINNAKER INDUSTRIES, INC. 600 N. Pearl Street Dallas, Texas 75201
FORM 10-K COPIES OF THE CORPORATION'S FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1997 MAY BE OBTAINED, WITHOUT CHARGE, BY WRITING TO LYNCH CORPORATION, 8 SOUND SHORE DRIVE, GREENWICH, CT 06830, ATTENTION: ROBERT E. DOLAN. 56 LYNCH CORPORATION, 8 SOUND SHORE DRIVE, SUITE 290, GREENWICH, CONNECTICUT 06830 TELEPHONE (203) 629-3333 - --------------------------------------------------------------------------------------------------------------------------------
EX-21 7 SUBSIDIARIES OF THE REGISTRANT 1 LYNCH CORPORATION - LIST OF SUBSIDIARIES Exhibit 21 LYNCH CORPORATION (38-1799862)
STATE OF PARENT OWNED BY SUBSIDIARY INCORPORATION COMPANY LYNCH - --------------------------------------------------------------------------------------------------------------------------------- BRIGHTON COMMUNICATIONS CORPORATION DELAWARE 100.0% 100.0% LYNCH TELEPHONE CORPORATION IV DELAWARE 100.0% 100.0% BRETTON WOODS TELEPHONE COMPANY, INC. NEW HAMPSHIRE 100.0% 100.0% WORLD SURFER, INC. NEW HAMPSHIRE 100.0% 100.0% LYNCH-KANSAS TELEPHONE CORPORATION DELAWARE 100.0% 100.0% LYNCH TELEPHONE CORPORATION VI DELAWARE 90.0% 98.0% J.B.N. TELEPHONE COMPANY, INC. KANSAS 100.0% 98.0% J.B.N. FINANCE CORPORATION DELAWARE 100.0% 98.0% GIANT COMMUNICATIONS, INC. KANSAS 100.0% 98.0% LYNCH TELEPHONE CORPORATION VII DELAWARE 100.0% 100.0% USTC KANSAS, INC. KANSAS 100.0% 100.0% HAVILAND TELEPHONE COMPANY, INC. KANSAS 100.0% 100.0% HAVILAND FINANCE CORPORATION DELAWARE 100.0% 100.0% DFT COMMUNICATIONS CORPORATION DELAWARE 100.0% 100.0% DUNKIRK & FREDONIA TELEPHONE COMPANY NEW YORK 100.0% 100.0% CASSADAGA TELEPHONE COMPANY NEW YORK 100.0% 100.0% MACOM, INC. NEW YORK 100.0% 100.0% COMANTEL, INC. NEW YORK 100.0% 100.0% D&F CELLULAR TELEPHONE, INC. NEW YORK 100.0% 100.0% ERIE SHORE COMMUNICATIONS, INC. NEW YORK 100.0% 100.0% DFT LONG DISTANCE CORPORATION DELAWARE 100.0% 100.0% LMT HOLDING CORPORATION MICHIGAN 100.0% 100.0% LYNCH MICHIGAN TELEPHONE HOLDING CORP. MICHIGAN 100.0% 100.0% UPPER PENINSULA TELEPHONE CORP. MICHIGAN 100.0% 100.0% ALPHA ENTERPRISES LIMITED MICHIGAN 100.0% 100.0% UPPER PENINSULA CELL. NORTH, INC. MICHIGAN 100.0% 100.0% UPPER PENINSULA CELL. SOUTH, INC. MICHIGAN 100.0% 100.0% GLOBAL TELEVISION, INC. DELAWARE 100.0% 100.0% HOME TRANSPORT SERVICES, INC. DELAWARE 100.0% 100.0% LYNCH CAPITAL CORPORATION DELAWARE 100.0% 100.0% LYNCH ENTERTAINMENT CORPORATION DELAWARE 100.0% 100.0% LYNCH ENTERTAINMENT CORPORATION II DELAWARE 100.0% 100.0% LYNCH INTERNATIONAL EXPORTS, INC. (B) U.S. VIRGIN ISL. 100.0% 100.0% LYNCH MANUFACTURING CORPORATION DELAWARE 100.0% 100.0% LYNCH DISPLAY TECHNOLOGIES, INC. DELAWARE 100.0% 100.0% LYNCH MACHINERY, INC. (C) DELAWARE 90.0% 90.0% M-TRON INDUSTRIES, INC. SOUTH DAKOTA 94.0% 94.0% M-TRON INDUSTRIES, LTD HONG KONG 100.0% 94.0% SPINNAKER INDUSTRIES, INC. (D) DELAWARE 63.0% 63.0% ENTOLETER, INC. DELAWARE 100.0% 63.0% SPINNAKER COATING, INC. DELAWARE 100.0% 63.0% SPINNAKER COATING-MAINE, INC. DELAWARE 100.0% 63.0% CENTRAL PRODUCTS COMPANY DELAWARE 100.0% 63.0% MAC SAW, INC. DELAWARE 100.0% 100.0%
2
STATE OF PARENT OWNED BY SUBSIDIARY INCORPORATION COMPANY LYNCH - ----------------------------------------------------------------------------------------------------------------------------------- LYNCH MULTIMEDIA CORPORATION DELAWARE 100.0% 100.0% CLR VIDEO, L.L.C. KANSAS 60.0% 60.0% THE MORGAN GROUP, INC. DELAWARE 66.24%(V)/50.95%(O) 66.24%(V)/50.95%(O) MORGAN DRIVE AWAY, INC. INDIANA 100.0% 66.24%(V)/50.95%(O) TRANSPORT SERVICES UNLIMITED, INC. INDIANA 100.0% 66.24%(V)/50.95%(O) INTERSTATE INDEMNITY COMPANY VERMONT 100.0% 66.24%(V)/50.95%(O) MORGAN FINANCE, INC. INDIANA 100.0% 66.24%(V)/50.95%(O) TDI, INC. INDIANA 100.0% 66.24%(V)/50.95%(O) HOME TRANSPORT CORPORATION INDIANA 100.0% 66.24%(V)/50.95%(O) MDA CORPORATION LYNCH PCS COMMUNICATIONS CORPORATION DELAWARE 100.0% 100.0% LYNCH PCS CORPORATION A DELAWARE 100.0% 100.0% LYNCH PCS CORPORATION F DELAWARE 100.0% 100.0% LYNCH PCS CORPORATION G DELAWARE 100.0% 100.0% LYNCH INTERACTIVE CORPORATION DELAWARE 100.0% 100.0% LYNCH TELECOMMUNICATIONS CORPORATION DELAWARE 100.0% 100.0% LYNCH TELEPHONE CORPORATION DELAWARE 83.1% 83.1% WESTERN NEW MEXICO TELEPHONE CO., INC. NEW MEXICO 100.0% 83.1% WNM COMMUNICATIONS CORPORATION DELAWARE 100.0% 83.1% WESCELL CELLULAR, INC. NEW MEXICO 100.0% 83.1% WESCEL CELLULAR OF NEW MEXICO LIMITED PARTNERSHIP COLORADO 51.0% 42.4% WESCEL CELLULAR, INC. II NEW MEXICO 100.0% 83.1% NORTHWEST NEW MEXICO CELLULAR, INC. NEW MEXICO 50.0% 40.6% NORTHWEST NEW MEXICO CELLULAR OF NEW MEXICO LIMITED PARTNERSHIP COLORADO 51.0% 20.7% ENCHANTMENT CABLE CORPORATION DELAWARE 100.0% 80.1% LYNCH TELEPHONE CORPORATION II DELAWARE 83.0% 83.0% INTER-COMMUNITY TELEPHONE COMPANY NORTH DAKOTA 100.0% 83.0% INTER-COMMUNITY TELEPHONE COMPANY II NORTH DAKOTA 100.0% 83.0% INTER-COMMUNITY ACQUISITION CORPORATION DELAWARE 100.0% 83.0% LYNCH TELEPHONE CORPORATION III DELAWARE 81.0% 81.0% CUBA CITY TELEPHONE EXCHANGE COMPANY WISCONSIN 100.0% 81.0% BELMONT TELEPHONE COMPANY WISCONSIN 100.0% 81.0%
EX-23 8 CONSENTS OF INDEPENDENT AUDITORS 1 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in this Annual Report (Form 10-K) of Lynch Corporation of our report dated March 24, 1998 included in the 1997 Annual Report to Shareholders of Lynch Corporation. Our audits also included the financial statement schedules of Lynch Corporation listed in Item 14(a). These schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, based on our audits and the reports of other auditors, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein. We also consent to the incorporation by reference in the Registration Statement (Form S-8 No. 33-46953) pertaining to the Lynch Corporation 401 (k) Savings Plan of our report dated March 24, 1998, with respect to the consolidated financial statements incorporated by reference, and our report included in the preceding paragraph with respect to the financial statement schedules included in this Annual Report (Form 10-K) of Lynch Corporation. /s/ Ernst & Young, LLP Stamford, CT March 25, 1998 2 CONSENT OF INDEPENDENT PUBLIC ACCOUNTS As independent public accountants, we hereby consent to the use of our report dated February 5, 1996 on The Morgan Group, Inc., which is included in The Morgan Group, Inc.'s Form 10-K for the year ended December 31, 1997, and incorporated by reference into The Morgan Group, Inc.'s previously filed Registration Statements on Form S-8 (Registration Nos. 33-72996, 33-72998), as an exhibit in Lynch Corporation's Form 10-K for the year ended December 31, 1997, and into Lynch Corporation's previously filed Registration Statements on Form S-8 (Registration No. 33-46953). It should be noted that we have not audited any financial statements of The Morgan Group, Inc. subsequent to December 31, 1995 or performed any audit procedures subsequent to the date of our report. ARTHUR ANDERSEN LLP Chicago, Illinois March 25, 1998 3 CONSENT OF INDEPENDENT ACCOUNTANTS To the Partners Coronet Communications Company Bronxville, New York We hereby consent to the incorporation by reference in the previously filed Registration Statement on Form S-8 (Registration No. 33-46953) of our report, dated January 24, 1997, except for Note 4, which is as of January 31, 1997, on the financial statements of Coronet Communications Company which appears in this annual report on Form 10-K of Lynch Corporation and subsidiaries, for the year ended December 31, 1997. McGLADREY & PULLEN, LLP New York, New York March 27, 1998 4 CONSENT OF INDEPENDENT ACCOUNTANTS To the Partners Capital Communications Company, Inc. Bronxville, New York We hereby consent to the incorporation by reference in the previously filed Registration Statement on Form S-8 (Registration No. 33-46953) of our report, dated January 29, 1997 on the financial statements of Capital Communications Company, Inc. which appears in this annual report on Form 10-K of Lynch Corporation and subsidiaries, for the year ended December 31, 1997. McGLADREY & PULLEN, LLP New York, New York March 27, 1998 5 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement No. 33-46953 of Lynch Corporation on Form S-8 of our report dated February 21, 1997 relating to the financial statements of Central Products Company (not presented separately herein), appearing in this Annual Report on Form 10-K of Lynch Corporation for the year ended December 31, 1997. DELOITTE & TOUCHE LLP Milwaukee, Wisconsin March 26, 1998 6 CONSENT OF INDEPENDENT ACCOUNTANTS March 26, 1998 To the Board of Directors Dunkirk & Fredonia Telephone Company Fredonia, New York 14063 We hereby consent to the incorporation by reference in the previously filed Registration Statement on Form S-8 (Registration No. 33-46953) of our report, dated January 31, 1997 on the financial statements of Dunkirk & Fredonia Telephone Company which appears in this annual report on Form 10-K of Lynch Corporation and subsidiaries, for the year ended December 31, 1997. JOHNSON, MACKOWIAK, MOORE & MYOTT, LLP 7 CONSENT OF INDEPENDENT ACCOUNTANTS To the Board of Managers CLR Video, L.L.C. Wetmore, Kansas We hereby consent to the incorporation by reference in the previously filed Registration Statement on Form S-8 (Registration No. 33-46953) or our report, dated January 29, 1997, on the financial statements of CLR Video, L.L.C. which appears in this annual report on Form 10-K of Lynch Corporation and subsidiaries, for the year ended December 31, 1997. Frederick & Warinner, L.L.C. Lenexa, Kansas March 30, 1998 EX-24 9 POWERS OF ATTORNEY 1 EXHIBIT 24 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that the undersigned Director of LYNCH CORPORATION, an Indiana corporation, hereby appoints ROBERT E. DOLAN and ROBERT A. HURWICH true and lawful attorneys-in-fact and agents, and each of them (with full power to act without the other) his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign, execute, deliver and file with the Securities and Exchange Commission the Annual Report on Form 10-K of Lynch Corporation for the fiscal year ended December 31, 1997, including any and all amendments thereto, granting unto said attorneys and agents, and each of them, full power to do and perform every act and thing requisite, necessary or desirable to be done in connection therewith, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, or their or his substitutes or substitute, may lawfully do or cause to be done by virtue hereof, and hereby revoking all prior appointments by him, if any, of attorneys-in-fact and agents to sign and file the above-described document, including any and all amendments thereto. IN WITNESS WHEREOF. the undersigned has hereunto set his hand and seal on the date set forth below. DATE: March 17, 1998 s/ David C. Mitchell (L.S.) ------------------------- David C. Mitchell s/ Carole L. Rau - ----------------------------- Notary Public 2 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that the undersigned Director of LYNCH CORPORATION, an Indiana corporation, hereby appoints ROBERT E. DOLAN and ROBERT A. HURWICH true and lawful attorneys-in-fact and agents, and each of them (with full power to act without the other) his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign, execute, deliver and file with the Securities and Exchange Commission the Annual Report on Form 10-K of Lynch Corporation for the fiscal year ended December 31, 1997, including any and all amendments thereto, granting unto said attorneys and agents, and each of them, full power to do and perform every act and thing requisite, necessary or desirable to be done in connection therewith, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, or their or his substitutes or substitute, may lawfully do or cause to be done by virtue hereof, and hereby revoking all prior appointments by him, if any, of attorneys-in-fact and agents to sign and file the above-described document, including any and all amendments thereto. IN WITNESS WHEREOF. the undersigned has hereunto set his hand and seal on the date set forth below. DATE: March 17, 1998 s/ E. Val Cerutti (L.S.) ------------------------- E. Val Cerutti s/ Carole L. Rau - --------------------------- Notary Public 3 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that the undersigned Director of LYNCH CORPORATION, an Indiana corporation, hereby appoints ROBERT E. DOLAN and ROBERT A. HURWICH true and lawful attorneys-in-fact and agents, and each of them (with full power to act without the other) his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign, execute, deliver and file with the Securities and Exchange Commission the Annual Report on Form 10-K of Lynch Corporation for the fiscal year ended December 31, 1997, including any and all amendments thereto, granting unto said attorneys and agents, and each of them, full power to do and perform every act and thing requisite, necessary or desirable to be done in connection therewith, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, or their or his substitutes or substitute, may lawfully do or cause to be done by virtue hereof, and hereby revoking all prior appointments by him, if any, of attorneys-in-fact and agents to sign and file the above-described document, including any and all amendments thereto. IN WITNESS WHEREOF. the undersigned has hereunto set his hand and seal on the date set forth below. DATE: March 17, 1998 s/ Paul J. Evanson (L.S.) ------------------------- Paul J. Evanson s/ Elsa M. Akin - --------------------------- Notary Public 4 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that the undersigned Director of LYNCH CORPORATION, an Indiana corporation, hereby appoints ROBERT E. DOLAN and ROBERT A. HURWICH true and lawful attorneys-in-fact and agents, and each of them (with full power to act without the other) his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign, execute, deliver and file with the Securities and Exchange Commission the Annual Report on Form 10-K of Lynch Corporation for the fiscal year ended December 31, 1997, including any and all amendments thereto, granting unto said attorneys and agents, and each of them, full power to do and perform every act and thing requisite, necessary or desirable to be done in connection therewith, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, or their or his substitutes or substitute, may lawfully do or cause to be done by virtue hereof, and hereby revoking all prior appointments by him, if any, of attorneys-in-fact and agents to sign and file the above-described document, including any and all amendments thereto. IN WITNESS WHEREOF. the undersigned has hereunto set his hand and seal on the date set forth below. DATE: March 17, 1998 s/ Salvatore Muoio (L.S.) ------------------------- Salvatore Muoio s/ Carole L. Rau - -------------------------- Notary Public 5 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that the undersigned Director of LYNCH CORPORATION, an Indiana corporation, hereby appoints ROBERT E. DOLAN and ROBERT A. HURWICH true and lawful attorneys-in-fact and agents, and each of them (with full power to act without the other) his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign, execute, deliver and file with the Securities and Exchange Commission the Annual Report on Form 10-K of Lynch Corporation for the fiscal year ended December 31, 1997, including any and all amendments thereto, granting unto said attorneys and agents, and each of them, full power to do and perform every act and thing requisite, necessary or desirable to be done in connection therewith, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, or their or his substitutes or substitute, may lawfully do or cause to be done by virtue hereof, and hereby revoking all prior appointments by him, if any, of attorneys-in-fact and agents to sign and file the above-described document, including any and all amendments thereto. IN WITNESS WHEREOF. the undersigned has hereunto set his hand and seal on the date set forth below. DATE: March 17, 1998 s/ Ralph R. Papitto (L.S.) -------------------------- Ralph R. Papitto s/ Carole L. Rau - ---------------------------- Notary Public 6 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that the undersigned Director of LYNCH CORPORATION, an Indiana corporation, hereby appoints ROBERT E. DOLAN and ROBERT A. HURWICH true and lawful attorneys-in-fact and agents, and each of them (with full power to act without the other) his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign, execute, deliver and file with the Securities and Exchange Commission the Annual Report on Form 10-K of Lynch Corporation for the fiscal year ended December 31, 1997, including any and all amendments thereto, granting unto said attorneys and agents, and each of them, full power to do and perform every act and thing requisite, necessary or desirable to be done in connection therewith, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, or their or his substitutes or substitute, may lawfully do or cause to be done by virtue hereof, and hereby revoking all prior appointments by him, if any, of attorneys-in-fact and agents to sign and file the above-described document, including any and all amendments thereto. IN WITNESS WHEREOF. the undersigned has hereunto set his hand and seal on the date set forth below. DATE: March 17, 1998 s/ John C. Ferrara (L.S.) ------------------------- John C. Ferrara s/ Carole L. Rau - -------------------------- Notary Public 7 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that the undersigned, Director, Chairman of the Board and Chief Executive Officer (Principal Executive Officer), of LYNCH CORPORATION, an Indiana corporation, hereby appoints ROBERT E. DOLAN and ROBERT A. HURWICH true and lawful attorneys-in-fact and agents, and each of them (with full power to act without the other) his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities (including Director, Chairman of the Board and Chief Executive Officer (Principal Executive Officer)), to sign, execute, deliver and file with the Securities and Exchange Commission the Annual Report on Form 10-K of Lynch Corporation for the fiscal year ended December 31, 1997, including any and all amendments thereto, granting unto said attorneys and agents, and each of them, full power to do and perform every act and thing requisite, necessary or desirable to be done in connection therewith, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, or their or his substitutes or substitute, may lawfully do or cause to be done by virtue hereof, and hereby revoking all prior appointments by him, if any, of attorneys-in-fact and agents to sign and file the above-described document, including any and all amendments thereto. IN WITNESS WHEREOF. the undersigned has hereunto set his hand and seal on the date set forth below. DATE: March 17, 1998 s/ Mario J. Gabelli (L.S.) ---------------------------- Mario J. Gabelli s/ Carole L. Rau - ------------------------- Notary Public EX-27 10 FINANCIAL DATA SCHEDULE
5 12-MOS DEC-31-1997 DEC-31-1997 33,557 985 54,480 1,448 35,685 152,759 217,593 60,064 423,638 96,808 242,776 0 0 5,139 31,312 423,638 467,536 467,536 398,415 442,749 0 7,024 23,461 (3,327) 713 (2,878) 0 0 0 (2,878) (2.03) (2.03)
EX-27.1 11 RESTATED FINANCIAL DATA SCHEDULE
5 This schedule contains summary financial information extracted from Condensed Consolidated Statements of Operations and Condensed ConsolidatedOBalance Sheets and is qualified in its entirety by reference to such Form 10-Q. 6-MOS DEC-31-1997 JUN-30-1997 24,553 1,682 51,228 1,650 38,426 132,502 209,363 54,374 416,708 97,658 240,437 0 0 5,139 35,109 416,708 230,205 230,205 196,850 217,853 0 0 11,277 2,263 902 738 0 0 0 738 .52 .52
EX-27.2 12 RESTATED FINANCIAL DATA SCHEDULE
5 This schedule contains summary financial information extracted from Condensed Consolidated Statements of Operations and Condensed Consolidated Balance Sheets and is qualified in its entirety by reference to such Form 10-Q. 9-MOS DEC-31-1997 SEP-30-1997 25,556 2,919 57,572 1,624 36,643 139,491 213,670 58,012 408,988 91,317 244,952 0 0 5,139 30,822 408,988 348,922 348,922 298,231 330,283 0 7,024 17,178 (3,892) (1,139) (3,536) 0 0 0 (3,536) (2.50) (2.50)
EX-27.3 13 RESTATED FINANCIAL DATA SCHEDULE
5 This schedule contains summary financial information extracted from Condensed Consolidated Statements of Operations and Condensed Consolidated Balance Sheets and is qualified in its entirety by reference to such Form 10-Q. 3-MOS DEC-31-1996 MAR-31-1996 23,204 6,409 52,959 1,286 33,911 127,443 152,395 40,053 308,433 100,074 139,485 0 0 5,139 32,291 308,433 110,930 110,930 94,405 105,020 0 0 3,954 2,452 963 1,201 0 0 0 1,201 .87 .86
EX-27.4 14 RESTATED FINANCIAL DATA SCHEDULE
5 This schedule contains summary financial information extracted from Condensed Consolidated Statements of Operations and Condensed Consolidated Balance Sheets and is qualified in its entirety by reference to such Form 10-Q. 6-MOS DEC-31-1996 JUN-30-1996 21,026 4,035 52,911 1,314 38,431 129,107 163,481 45,660 320,463 106,324 138,444 0 0 5,139 34,765 320,463 222,968 222,968 189,713 211,648 0 0 8,185 8,527 3,426 4,439 743 0 0 3,696 2.66 2.63
EX-27.5 15 RESTATED FINANCIAL DATA SCHEDULE
5 This schedule contains summary financial information extracted from Condensed Consolidated Statements of Operations and Condensed Consolidated Balance Sheets and is qualified in its entirety by reference to such Form 10-Q. 9-MOS DEC-31-1996 SEP-30-1996 16,768 1,971 55,047 1,431 39,188 126,014 172,143 49,103 331,488 114,060 140,039 0 0 5,139 36,011 331,488 340,289 340,289 290,416 322,255 0 0 12,439 11,514 4,666 5,688 743 0 0 4,945 3.56 3.52
EX-27.6 16 RESTATED FINANCIAL DATA SCHEDULE
5 12-MOS DEC-31-1996 DEC-31-1996 33,946 2,156 52,963 1,525 36,859 140,093 179,726 46,707 392,620 98,461 219,579 0 0 5,139 33,784 392,620 451,880 451,880 390,354 434,940 0 0 17,011 7,397 3,021 4,794 832 1,843 0 2,696 1.94 1.92
EX-27.7 17 RESTATED FINANCIAL DATA SCHEDULE
5 12-MOS DEC-31-1995 DEC-31-1995 15,921 11,432 52,306 1,732 33,235 123,648 147,140 36,093 302,439 98,022 138,029 0 0 5,139 30,373 302,439 333,627 333,627 278,703 313,782 0 0 10,844 12,530 4,906 5,469 360 0 0 5,145 3.73 3.66
EX-27.8 18 RESTATED FINANCIAL DATA SCHEDULE
5 This schedule contains summary financial information extracted from Condensed Consolidated Statements of Operations and Condensed Consolidated Balance Sheets and is qualified in its entirety by reference to such Form 10-Q. 3-MOS DEC-31-1997 MAR-31-1997 27,685 1,666 53,466 1,501 35,937 132,316 205,011 50,396 412,326 97,027 0 0 0 5,139 33,929 412,326 108,779 108,779 94,218 104,543 0 0 5,469 (786) 315 (512) 0 0 0 (512) 0.36 0.36
EX-99 19 REPORT OF INDEPENDENT AUDITORS 1 Exhibit 99 Report of Independent Public Accountants To the Shareholders and Board of Directors of The Morgan Group, Inc.: We have audited the accompanying consolidated statements of operations, changes in redeemable preferred stock, common stock and other shareholders' equity and cash flows of The Morgan Group, Inc. (a Delaware Corporation) and Subsidiaries for the year ended December 31, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of The Morgan Group, Inc. and Subsidiaries for the year ended December 31, 1995, in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP Chicago, Illinois February 5, 1996 2 INDEPENDENT AUDITORS' REPORT To the Board of Directors Capital Communications Company, Inc. Bronxville, New York We have audited the accompanying balance sheet of Capital Communications Company, Inc. as of December 31, 1996, and the related statements of operations, stockholders' equity (deficit), and cash flows for each of the two years ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Capital Communications Company, Inc. as of December 31, 1996, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. McGLADREY & PULLEN, LLP New York, New York January 29, 1997 3 INDEPENDENT AUDITOR'S REPORT To the Partners Coronet Communications Company Bronxville, New York We have audited the accompanying balance sheets of Coronet Communications Company as of December 31, 1996, and the related statements of operations, partners' capital (deficit), and cash flows for each of the two years in the period ended December 31, 1996. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Coronet Communications Company as of December 31, 1996, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. McGLADREY & PULLEN, LLP New York, New York January 24, 1997 (Except for Note 4, which is as of January 31, 1997) 4 INDEPENDENT AUDITORS' REPORT To the Board of Directors of Spinnaker Industries, Inc.: We have audited the balance sheet of Central Products Company (a wholly-owned subsidiary of Spinnaker Industries, Inc.) as of December 31, 1996 and the related statements of operations and retained earnings (accumulated deficit) and cash flows for the year ended December 31, 1996 and the three months ended December 31, 1995. These financial statements (not presented separately herein) are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such financial statements present fairly, in all material respects, the financial position of Central Products Company as of December 31, 1996 and the results of its operations and its cash flows for the year ended December 31, 1996 and three months ended December 31, 1995 in conformity with generally accepted accounting principles. Deloitte & Touche LLP Milwaukee, Wisconsin February 21, 1997 5 INDEPENDENT AUDITOR'S REPORT January 31, 1997 To the Board of Directors Dunkirk and Fredonia Telephone Company 40 Temple Street Box 209 Fredonia, New York 14063 We have audited the accompanying consolidated balance sheet of Dunkirk and Fredonia Telephone Company (a wholly owned subsidiary of Lynch Telephone Corporation, VIII) and subsidiaries as of December 31, 1996 and the related consolidated statements of income, retained earnings and cash flows for the period November 26, 1996 through December 31, 1996. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards and the Government Auditing Standards, issued by the Comptroller General of the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Dunkirk and Fredonia Telephone Company and subsidiaries as of December 31, 1996 and the results of their operations and their cash flows for the period then ended in conformity with generally accepted accounting principles. The accompanying statements present only the operation of Dunkirk and Fredonia Telephone Company and its subsidiaries since the date of sale of 100% of its stock to Lynch Telephone Corporation VIII. JOHNSON, MACKOWIAK, MOORE & MYOTT, LLP 6 INDEPENDENT AUDITOR'S REPORT To the Board of Managers CLR Video, L.L.C. Wetmore, Kansas We have audited the accompanying balance sheet of CLR Video, L.L.C. (a limited liability company) as of December 31, 1996, and the related statements of operations, members' equity and cash flows for the year then ended. These financial statements are the responsibility of CLR Video, L.L.C.'s management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of CLR Video, L.L.C. as of December 31, 1996, and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles. The financial statements for the period from inception (November 30, 1995) to December 31, 1995 were reviewed by us, and our report thereon, dated March 14, 1996, stated we were not aware of any material modifications that should be made to those statements for them to be in conformity with generally accepted accounting principles. However, a review is substantially less in scope than an audit and does not provide a basis for the expression of an opinion on the financial statements taken as a whole. FREDERICK & WARINNER, L.L.C. Lenexa, Kansas January 29, 1997 7 March 30, 1998 To the Board of Directors Dunkirk & Fredonia Telephone Company Fredonia, New York 14063 We hereby consent to the incorporation by reference in the previously filed Registration Statement on Form S-8 (Registration No. 33-46953) of our report, dated January 31, 1997 on the financial statements of Dunkirk & Fredonia Telephone Company which appears in this annual report on Form 10-K of Lynch Corporation and subsidiaries, for the year ended December 31, 1997. JOHNSON, MACKOWIAK, MOORE & MYOTT, LLP -----END PRIVACY-ENHANCED MESSAGE-----