UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934 FOR
THE QUARTERLY PERIOD ENDED JUNE 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _____ TO _____
Commission file number: 0-32617
HORIZON TELCOM, INC.
(Exact name of Registrant as specified in its charter)
OHIO 31-1449037
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
68 EAST MAIN STREET
CHILLICOTHE, OHIO 45601-0480
(Address of principal executive offices) (Zip Code)
(740) 772-8200
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
As of August 9, 2002, there were 90,552 shares of class A common stock
outstanding and 271,926 shares of class B common stock outstanding.
HORIZON TELCOM, INC.
FORM 10-Q
SECOND QUARTER REPORT
TABLE OF CONTENTS
PAGE NO.
--------
PART I FINANCIAL INFORMATION
Item 1. Financial Statements..........................................................................3
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations....................................................................20
Item 3. Quantitative and Qualitative Disclosures About Market Risk...................................38
PART II OTHER INFORMATION
Item 1. Legal Proceedings............................................................................39
Item 2. Changes in Securities and Use of Proceeds....................................................39
Item 3. Defaults Upon Senior Securities..............................................................39
Item 4. Submission of Matters to a Vote of Security Holders..........................................40
Item 5. Other Information............................................................................40
Item 6. Exhibits and Reports on Form 8-K.............................................................54
As used herein and except as the context may otherwise require, "the
Company," "we," "us," "our" or "Horizon Telcom" means, collectively, Horizon
Telcom, Inc., and its subsidiaries: Horizon PCS, Inc., The Chillicothe Telephone
Company, Horizon Technology, Inc., and Horizon Services, Inc. References to
"Horizon PCS" refer to Horizon PCS, Inc., and its subsidiaries: Horizon Personal
Communications, Inc. ("HPC"), and Bright Personal Communications Services, LLC
("Bright PCS").
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HORIZON TELCOM, INC., AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
As Of June 30, 2002, and December 31, 2001
- --------------------------------------------------------------------------------
June 30, December 31,
2002 2001
------------- -------------
(unaudited)
ASSETS
- ------
CURRENT ASSETS:
Cash and cash equivalents (includes $105,000,000 on deposit in
accordance with covenant. See Note 7)............................ $ 133,385,460 $ 127,154,227
Restricted cash...................................................... 24,062,500 24,597,222
Investments, available-for-sale, at fair value....................... 668,670 3,537,720
Investments, held-to-maturity at cost................................ 6,525,263 --
Accounts receivable - subscriber, less allowance for doubtful
accounts of approximately $2,661,000 in 2002 and $2,662,000 in
2001............................................................. 21,804,341 15,275,708
Accounts receivable - interexchange carriers, access charge pools and
other, less allowance for doubtful accounts of approximately
$222,000 in 2002 and $477,000 in 2001............................ 5,077,648 5,691,105
Inventories.......................................................... 4,503,693 6,512,026
Taxes applicable to future years, prepaid expenses and other......... 4,598,673 2,550,498
--------------- --------------
Total current assets........................................ 200,626,248 185,318,506
--------------- --------------
OTHER ASSETS:
Intangibles, net..................................................... 41,610,868 42,840,534
Goodwill............................................................. 7,191,180 7,191,180
Restricted cash...................................................... 12,032,009 24,062,500
Debt issuance costs, nets of amortization............................ 21,790,672 20,584,960
Prepaid pension costs and other...................................... 9,821,208 8,638,966
--------------- -------------
Total other assets.......................................... 92,445,937 103,318,140
--------------- -------------
PROPERTY, PLANT AND EQUIPMENT, NET........................................ 319,144,326 289,277,220
--------------- -------------
Total assets.......................................... $ 612,216,511 $ 577,913,866
================ ==============
(Continued on next page)
3
HORIZON TELCOM, INC., AND SUBSIDIARIES
Condensed Consolidated Balance Sheets (Continued)
As of June 30, 2002, and December 31, 2001
- --------------------------------------------------------------------------------
June 30, December 31,
2002 2001
-------------- --------------
(unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
- ----------------------------------------------
CURRENT LIABILITIES:
Lines of credit.................................................... $ 18,400,000 $ 19,167,338
Current maturities of long-term debt............................... 2,000,000 2,000,000
Accounts payable................................................... 6,470,349 9,933,862
Accounts payable - interexchange carriers and access charge pools.. 107,103 1,895,452
Payable to Sprint.................................................. 14,841,718 10,244,529
Deferred personal communications service ("PCS") revenue........... 4,675,289 3,712,734
Accrued taxes...................................................... 4,539,916 4,842,912
Accrued vacation, payroll and other accrued liabilities............ 24,777,615 28,984,309
---------------- ---------------
Total current liabilities................................. 75,811,990 80,781,136
---------------- ---------------
LONG-TERM DEBT AND OTHER LIABILITIES:
Long-term debt, net of discount.................................... 520,209,607 402,055,643
Deferred Federal income taxes, net................................. 3,656,680 4,632,157
Postretirement benefit obligation.................................. 6,180,434 5,756,305
Deferred activation revenue........................................ 5,130,237 3,808,618
Other long-term liabilities........................................ 11,837,067 12,007,327
---------------- ---------------
Total long-term debt and other liabilities................ 547,014,025 428,260,050
---------------- ---------------
Total liabilities..................................... 622,826,015 509,041,186
---------------- ---------------
CONVERTIBLE PREFERRED STOCK OF SUBSIDIARY............................... 151,061,781 145,349,043
COMMITMENTS AND CONTINGENCIES (Note 8)
STOCKHOLDERS' EQUITY (DEFICIT):
Common stock - class A, no par value, 200,000 shares authorized,
99,726 shares issued, stated at $4.25 per share................. 423,836 423,836
Common stock - class B, no par value, 500,000 shares authorized,
299,450 shares issued, stated at $4.25 per share................ 1,272,662 1,272,029
Treasury stock - 36,698 shares at cost............................. (5,504,700) (5,504,700)
Accumulated other comprehensive income (loss), net................. (441,487) 1,332,044
Additional paid-in capital......................................... 72,197,212 72,188,904
Deferred stock option compensation................................. (889,975) (1,079,610)
Retained deficit................................................... (228,728,833) (145,108,866)
---------------- ---------------
Total stockholders' equity (deficit)...................... (161,671,285) (76,476,363)
---------------- ---------------
Total liabilities and stockholders' equity (deficit).. $ 612,216,511 $ 577,913,866
================= ===============
The accompanying notes are an integral part of these condensed
consolidated financial statements.
4
HORIZON TELCOM, INC., AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
For the Three and Six Months Ended June 30, 2002 and 2001 (unaudited)
- --------------------------------------------------------------------------------
For the Three Months Ended For the Six Months Ended
June 30, June 30,
--------------------------------- ---------------------------------
2002 2001 2002 2001
---------------- --------------- ---------------- ---------------
OPERATING REVENUES:
PCS subscriber and roaming..................... $ 50,124,293 $ 23,229,724 $ 95,857,681 $ 41,365,738
PCS equipment.................................. 1,597,640 1,498,774 3,972,928 2,574,737
Basic local and long-distance service.......... 4,753,442 5,109,750 9,351,273 9,927,812
Network access................................. 6,735,297 4,011,701 11,330,767 9,040,454
Equipment systems sales, information services,
Internet access and other.................. 2,061,334 1,905,028 4,167,083 3,479,655
---------------- --------------- ---------------- ---------------
Total operating revenues................. 65,272,006 35,754,977 124,679,732 66,388,396
---------------- --------------- ---------------- ---------------
OPERATING EXPENSES:
Cost of goods sold ............................ 3,836,701 2,521,578 8,928,711 4,861,435
Cost of services (exclusive of items shown
separately below).......................... 44,994,073 24,476,346 84,486,215 46,208,706
Selling and marketing.......................... 11,676,942 10,709,254 26,762,400 18,119,670
General and administrative (exclusive of items
shown separately below).................... 13,901,747 11,023,541 26,699,836 18,589,770
Non-cash compensation.......................... 87,768 835,172 189,635 945,444
Depreciation and amortization.................. 15,230,985 6,239,747 25,350,995 11,374,123
---------------- --------------- ---------------- ---------------
Total operating expenses................. 89,728,216 55,805,638 172,417,792 100,099,148
---------------- --------------- ---------------- ---------------
OPERATING LOSS...................................... (24,456,210) (20,050,661) (47,738,060) (33,710,752)
---------------- --------------- ---------------- ---------------
NONOPERATING INCOME (EXPENSE):
Interest expense, net.......................... (15,925,172) (7,037,469) (29,128,751) (13,800,872)
Subsidiary preferred stock dividends........... (2,856,397) (2,717,954) (5,712,766) (5,353,577)
Interest income and other, net................. 589,253 1,427,999 1,045,689 4,430,539
---------------- --------------- ---------------- ---------------
Total nonoperating expense............ (18,192,316) (8,327,424) (33,795,828) (14,723,910)
---------------- --------------- ---------------- ---------------
LOSS BEFORE INCOME TAX EXPENSE AND MINORITY INTEREST
(42,648,526) (28,378,085) (81,533,888) (48,434,662)
INCOME TAX EXPENSE.................................. (972,437) (346,063) (1,180,071) (1,023,968)
MINORITY INTEREST IN LOSS........................... -- -- -- 983,883
---------------- --------------- ---------------- ---------------
NET LOSS............................................ $ (43,620,963) $ (28,724,148) $ (82,713,959) $ (48,474,747)
================ =============== ================ ===============
Basic and diluted net loss per share................ $ (120.36) $ (79.28) $ (228.25) $ (135.14)
================ =============== ================ ===============
Weighted-average common shares outstanding ......... 362,429 362,320 362,379 358,696
================ =============== ================ ===============
The accompanying notes are an integral part of these condensed
consolidated financial statements.
5
HORIZON TELCOM, INC., AND SUBSIDIARIES
Condensed Consolidated Statements of Other Comprehensive Income (Loss)
For the Three and Six Months Ended June 30, 2002 and 2001 (unaudited)
- --------------------------------------------------------------------------------
For the Three Months Ended For the Six Months Ended
June 30, June 30,
2002 2001 2002 2001
-------------- -------------- -------------- --------------
NET LOSS......................................... $ (43,620,963) $ (28,724,148) $ (82,713,959) $ (48,474,747)
============== ============== ============== ==============
OTHER COMPREHENSIVE INCOME (LOSS)................
Net unrealized gain (loss) on hedging activities. (269,901) (54,168) 120,042 (353,073)
Net unrealized loss on securities
available-for-sale net of taxes of $626,932
and $975,477 for the three and six months
ended June 30, 2002, respectively........... (1,215,938) -- (1,893,573) --
-------------- -------------- -------------- --------------
COMPREHENSIVE INCOME (LOSS)...................... $ (45,106,802) $ (28,778,316) $ (84,487,490) $ (48,827,820)
============== ============== ============== ==============
The accompanying notes are an integral part of these condensed
consolidated financial statements.
6
HORIZON TELCOM, INC., AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
For the Six Months Ended June 30, 2002 and 2001 (unaudited)
- --------------------------------------------------------------------------------
For the Six Months Ended
June 30,
2002 2001
------------------ ------------------
NET CASH FLOWS USED IN OPERATING ACTIVITIES................................... $ (35,018,135) $ (38,061,427)
------------------ ------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures..................................................... (54,634,274) (73,151,559)
Purchase of short-term investments....................................... (6,525,263) (24,880,965)
Proceeds from sale of fixed assets....................................... 1,543,482 --
Proceeds from redemption of RTFC certificates............................ -- 2,895,646
------------------ ------------------
Net cash used in investing activities................................. (59,616,055) (95,136,878)
------------------ ------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowing on long-term debt.............................................. 105,000,000 2,500,000
Lines of credit - repayments, net of borrowings.......................... (767,338) --
Deferred financing fees.................................................. (2,461,230) (1,177,673)
Treasury stock received as dividend...................................... -- (4,311)
Dividends paid........................................................... (906,009) (861,260)
------------------ ------------------
Net cash provided by financing activities............................. 100,865,423 456,756
------------------ ------------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS.......................... 6,231,233 (132,741,549)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD................................ 127,154,227 192,011,997
------------------ ------------------
CASH AND CASH EQUIVALENTS, END OF PERIOD...................................... $ 133,385,460 $ 59,270,448
================== ==================
The accompanying notes are an integral part of these condensed
consolidated financial statements.
7
HORIZON TELCOM, INC., AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
As of June 30, 2002, and December 31, 2001,
And for the Three and Six Months Ended June 30, 2002 and 2001 (unaudited)
- --------------------------------------------------------------------------------
NOTE 1 - GENERAL
The results of operations for the interim periods shown are not necessarily
indicative of the results to be expected for the fiscal year. In the opinion of
management, the information contained herein reflects all adjustments necessary
to make a fair statement of the results for the periods presented. All such
adjustments are of a normal recurring nature. The financial information
presented herein should be read in conjunction with the Company's Form 10-K for
the year ended December 31, 2001, which includes information and disclosures not
presented herein.
NOTE 2 - ORGANIZATION AND BUSINESS OPERATIONS
The Company is a facilities-based telecommunications carrier that provides a
variety of voice and data services to commercial, residential/small business and
local market segments. The Company provides wireless personal communications
service to a twelve-state region in the Midwest, including Ohio, Indiana,
Pennsylvania, Virginia and West Virginia, as an affiliate of Sprint PCS through
its majority-owned subsidiary, Horizon PCS, Inc. The Company also provides
landline telephone service, very-high-data-rate digital subscriber line ("VDSL")
television service and sells equipment to business and residential customers to
the southern Ohio region, principally in and surrounding Chillicothe, Ohio
through its wholly-owned subsidiary, the Chillicothe Telephone Company
("Chillicothe Telephone"). Through its wholly-owned subsidiary, Horizon
Technology, Inc, formerly known as United Communications, Inc. ("Horizon
Technology"), the Company offers dial-up and broadband Internet access services,
network services and resell long distance services. The Company also owns 100%
of Horizon Services, Inc. ("Horizon Services"), which provides administrative
services to other subsidiaries. Administrative services provided by Horizon
Services generally include such functions as insurance, billing services,
accounting services, computer access and other information technology services
and human resources services.
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Note 1 in the Notes to Consolidated Financial Statements in the Company's
Annual Report on Form 10-K for the year ended December 31, 2001, describes the
Company's significant accounting policies in greater detail than presented
herein.
BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
reflect the operations of Horizon Telcom, and its subsidiaries have been
prepared in accordance with the rules and regulations of the Securities and
Exchange Commission ("SEC"). Certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles in the United States have been condensed or
omitted pursuant to such rules and regulations. All material intercompany
transactions and balances have been eliminated in consolidation.
ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ materially from those
estimates. See "Critical Accounting Policies" under "Item 2. Management's
Discussion and Analysis of Financial Results and Operations" of this Form 10-Q.
8
HORIZON TELCOM, INC., AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
As of June 30, 2002, and December 31, 2001,
And for the Three and Six Months Ended June 30, 2002 and 2001 (unaudited)
- --------------------------------------------------------------------------------
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ACCOUNTING FOR RATE REGULATION
Chillicothe Telephone is subject to rate-regulation. Statement of Financial
Accounting Standards ("SFAS") No. 71, "Accounting for the Effects of Certain
Types of Rate Regulation" provides that rate-regulated public utilities account
for revenues and expenses and report assets and liabilities consistent with the
economic effect of the way in which the regulators establish rates. Chillicothe
Telephone follows the accounting and reporting requirements of SFAS No. 71. As
of June 30, 2002, the Company has recorded regulatory assets and liabilities of
approximately $197,000 and $1,380,000, respectively. As of December 31, 2001,
regulatory assets and liabilities were approximately $331,000 and $481,000,
respectively.
As part of the acquisition of Bright PCS, the former members of Bright PCS
have approximately an 8% ownership in Horizon PCS. The Company accounts for this
ownership by recording the portion of net income (loss) attributable to the
minority shareholders (a loss of $983,883 for the six months ended June 30,
2001) as minority interest in earnings (loss) in the accompanying condensed
consolidated statements of operations. The minority interest's share in the
Company's losses during 2001 reduced the minority interest's accounting basis to
zero. There will be no further allocations to minority interest until such time
as Horizon PCS becomes profitable and any unallocated losses to minority
interest are offset with income in future periods.
RESTRICTED CASH
In connection with Horizon PCS' December 2001 offering of $175,000,000 of
senior notes, the first four semi-annual interest payments due under the terms
of the notes were placed in escrow. The first payment was made in June 2002.
Amounts to be paid toward interest payments due in the next twelve months have
been classified as short-term.
INVESTMENTS
The classification of investments in debt and equity securities is
determined by management at the date individual investments are acquired. The
classification of those securities and the related accounting policies are as
follows:
Held-to-maturity securities are debt securities for which the Company has
both the intent and ability to hold to maturity, regardless of changes in market
conditions, liquidity needs or changes in general economic conditions. They are
carried at historical cost.
Available-for-sale securities are debt and equity securities which the
Company intends to hold for an indefinite period of time, but not necessarily to
maturity. Any decision to sell a security classified as available-for-sale would
be based on various factors, including changes in market conditions, liquidity
needs and similar criteria. Available-for-sale securities are carried at fair
value as determined by quoted market prices.
Trading securities are debt and equity securities which the Company intends
to purchase and sell frequently and has the intent to sell in the near future at
the time the security is purchased. Trading securities are carried at fair value
with unrealized holding gains and losses reported in the statement of
operations.
Other investments in which the Company does not have a significant
ownership and for which there is no ready market are carried at cost.
Information regarding these and all other investments is reviewed periodically
for evidence of impairment in value.
9
HORIZON TELCOM, INC., AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
As of June 30, 2002, and December 31, 2001,
And for the Three and Six Months Ended June 30, 2002 and 2001 (unaudited)
- --------------------------------------------------------------------------------
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment, including improvements that extend useful
lives, are stated at original or acquisition cost while maintenance and repairs
are charged to operations as incurred. Construction work in progress includes
expenditures for the purchase of capital equipment, construction and items such
as direct payroll-related benefits and interest capitalized during construction.
The Company accounts for long-lived assets in accordance with the
provisions of SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets." SFAS No. 144 requires that long-lived assets and certain
identifiable intangibles be reviewed for impairment whenever events or changes
in circumstances indicate the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future undiscounted net cash
flows expected to be generated by the asset. If such assets are considered to be
impaired, the impairment to be recognized is measured by the amount by which the
carrying amount of the assets exceeds the fair value of the assets. Assets to be
disposed of are reported at the lower of the carrying amount or fair value, less
costs to sell.
DERIVATIVE FINANCIAL INSTRUMENTS
The Company's policies do not permit the use of derivative financial
instruments for speculative purposes. The Company uses interest rate swaps to
manage interest rate risk. The net amount paid or received on interest rate
swaps is recognized as an adjustment to interest expense. The Company has
adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," as amended by SFAS No. 138, "Accounting for Derivative Instruments
and Certain Hedging Activities." These statements established accounting and
reporting standards for derivative instruments and hedging activities that
require an entity to recognize all derivatives as an asset or liability measured
at fair value. Depending on the intended use of the derivative, changes in its
fair value will be reported in the period of change as either a component of
earnings or a component of other comprehensive income. Pursuant to the
derivative criteria established by SFAS No. 133, an item with exposure to
variability in expected future cash flows that is attributable to a particular
risk is considered a cash flow hedge. The exposure may be associated with an
existing recognized asset or liability such as future interest payments on
variable-rate debt.
REVENUE RECOGNITION
Horizon PCS sells handsets and accessories, which are recorded at the time
of the sale as equipment revenue. After the handset has been purchased, the
subscriber purchases a service package, which is recognized monthly as service
is provided and is included as subscriber revenue. The Company defers monthly
service revenue billed in advance. Roaming revenue is recorded when Sprint PCS
subscribers, other Sprint PCS affiliate subscribers and non-Sprint PCS
subscribers roam onto Horizon PCS' network.
Horizon PCS' accounting policy for the recognition of activation fee
revenue is to record the revenue over the periods such revenue is earned in
accordance with the current interpretations of SEC Staff Accounting Bulletin
("SAB") No. 101, "Revenue Recognition in Financial Statements." Accordingly,
activation fee revenue and direct customer activation expense is deferred and
will be recorded over the average life for those customers that are assessed an
activation fee, currently 30 months, as subscriber revenue and selling and
marketing, respectively.
Horizon PCS records 100% of PCS subscriber revenues from its customers,
Sprint PCS roaming revenues from Sprint PCS subscribers based outside its
markets and non-Sprint PCS roaming revenues. Sprint PCS retains 8% of all
collected service revenue as a management fee. Collected service revenues
include PCS subscriber revenues and non-Sprint PCS roaming revenues, but exclude
Sprint PCS roaming revenues, roaming charges billed to Horizon PCS customers for
roaming onto a non-Sprint PCS network and revenues from sales of equipment.
Horizon PCS reports the amounts retained by Sprint PCS as general and
administrative expense.
10
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The landline telephone services operating segment consists of basic local
and long-distance toll, network access services and other telephone service
revenue.
Intra-LATA, (Local Access and Transport Area) (i.e., the area of southern
Ohio, including Columbus originally covered by area code 614), basic local
exchange and long-distance service revenue consists of flat rate services and
measured services billed to customers utilizing Chillicothe Telephone's
telephone network. Long distance intraLATA/interstate revenue consists of
message services that terminate beyond the basic service area of the originating
wire center.
Network access revenue consists of revenue derived from the provision of
exchange access services to an interexchange carrier or to an end user beyond
the exchange carrier's network. Other revenue includes directory advertising
related to a telephone directory published annually.
The wireless personal communications services operating segment consists of
PCS subscriber revenues and roaming revenues. PCS subscriber revenues consist
primarily of monthly service fees and other charges billed to customers for
Sprint PCS service in our territory under a variety of service plans. Roaming
revenues consist of Sprint PCS roaming and non-Sprint PCS roaming. We receive
Sprint PCS roaming revenues at a per minute rate from Sprint PCS or another
Sprint PCS affiliate when Sprint PCS subscribers based outside of our territory
use our portion of the Sprint PCS network. Non-Sprint PCS roaming revenues
include payments from wireless service providers, other than Sprint PCS, when
those providers' subscribers roam on our network.
We record 100% of PCS subscriber revenues from our customers, Sprint PCS
roaming revenues from Sprint PCS subscribers based outside our markets and
non-Sprint PCS roaming revenues. Sprint PCS retains 8% of all collected service
revenue as a management fee. Collected service revenues include PCS subscriber
revenues and non-Sprint PCS roaming revenues, but exclude Sprint PCS roaming
revenues, roaming charges billed to our customers for roaming onto a Sprint PCS
network and revenues from sales of equipment. We report the amounts retained by
Sprint PCS as general and administrative expenses.
PCS equipment revenues consist of digital handsets and accessories sold to
customers in our territory through our directly-owned channels.
Other revenues include Internet access services, equipment systems sales
and information services. Internet access revenues for our bright.net services
are monthly service fees and other charges billed to our bright.net customers.
Service fees primarily consist of monthly recurring charges billed to customers.
Equipment systems sales and other revenues consist of sales made by Chillicothe
Telephone to various businesses or other residential customers for equipment
used on the telephone system.
NET LOSS PER SHARE
The Company computes net loss per common share in accordance with SFAS No.
128, "Earnings per Share" and SAB No. 98. Basic and diluted net loss per share
is computed by dividing net loss for each period by the weighted-average
outstanding common shares. No conversion of common stock equivalents has been
assumed in the calculations since the effect would be antidilutive. As a result,
the number of weighted-average outstanding common shares as well as the amount
of net loss per share is the same for basic and diluted net loss per share
calculations for all periods presented. There are three items that could
potentially dilute basic earnings per share in the future. These items include
common stock options, stock purchase warrants and convertible preferred stock.
These items will be included in the diluted earnings per share calculation when
dilutive.
11
HORIZON TELCOM, INC., AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
As of June 30, 2002, and December 31, 2001,
And for the Three and Six Months Ended June 30, 2002 and 2001 (unaudited)
- --------------------------------------------------------------------------------
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other
Intangible Assets." SFAS No. 141 addresses financial accounting and reporting
for all business combinations and requires that all business combinations
entered into subsequent to June 2001 be recorded under the purchase method. This
statement also addresses financial accounting and reporting for goodwill and
other intangible assets acquired in a business combination at acquisition. SFAS
No. 142 addresses financial accounting and reporting for intangible assets
acquired individually or with a group of other assets at acquisition. This
statement also addresses financial accounting and reporting for goodwill and
other intangible assets subsequent to their acquisition.
These statements were adopted by the Company on January 1, 2002. Goodwill
amortization ceased as of December 31, 2001, and the Company is required to
complete an impairment test of the remaining goodwill balance annually (or more
frequently if impairment indicators arise). As of June 30, 2002, Horizon PCS has
goodwill of approximately $7,191,000, net of accumulated amortization, related
to the acquisition of Bright PCS. See Note 9 herein for additional information.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations." This statement addresses financial accounting and reporting for
obligations associated with the retirements of tangible long-lived assets and
the associated asset retirement costs. It applies to legal obligations
associated with the retirement of long-lived assets that result from the
acquisition, construction, development and (or) the normal operation of a
long-lived asset. The Company will adopt this statement effective January 1,
2003. The adoption is not expected to have a material effect on the Company's
financial position, results of operations or cash flows.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 addresses financial
accounting and reporting for the impairment of long-lived assets. The statement
supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed Of," and the accounting and reporting
provisions of APB Opinion No. 30. SFAS No. 144 removes goodwill from its scope,
as goodwill is addressed in the impairment test described above under SFAS No.
142. The Company adopted SFAS No. 144 on January 1, 2002. See Note 6 for
discussion on the impact of the adoption of this statement.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." SFAS No. 145 addresses the accounting for gains and losses from
the extinguishments of debt, economic effects and accounting practices of
sale-leaseback transactions and makes technical corrections to existing
pronouncements. The Company will adopt SFAS No. 145 on July 1, 2002, and the
adoption is not expected to have a material effect on the Company's financial
position, results of operations or cash flows.
In June 2002 the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." This Statement addresses financial accounting
and reporting for costs associated with exit or disposal activities and
nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." Charges
relating to the exit of an activity or disposal of long-lived assets will be
recorded when they are incurred and measurable. Prior to SFAS No. 146, these
charges were accrued at the time of commitment to exit or dispose of an
activity. The Company has not yet determined the financial impact the adoption
of this pronouncement will have on its financial position or results of
operations.
12
HORIZON TELCOM, INC., AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
As of June 30, 2002, and December 31, 2001,
And for the Three and Six Months Ended June 30, 2002 and 2001 (unaudited)
- --------------------------------------------------------------------------------
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform with the 2002
presentation.
NOTE 4 - SEGMENT INFORMATION
The Company is organized around the differences in products and services it
offers. Under this organizational structure, the Company operates in two
reportable business segments as defined by SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information." These segments are wireless
personal communications services and landline telephone services. The wireless
personal communications services segment includes three major revenue streams:
PCS subscriber revenues, PCS roaming revenues and PCS equipment sales. The
landline telephone services segment includes four major revenue streams: basic
local service, long-distance toll, network access services and other related
telephone services.
Other business activities of the Company include Internet access services,
equipment systems sales, and other miscellaneous revenues, which do not meet the
definition of a reportable segment under SFAS No. 131. Amounts related to these
business activities are included below under the heading "All other."
Unallocated administrative expenses represent general and administrative
expenses, which are incurred at a corporate level. All other assets represent
common assets not identified to an operating segment.
The Company evaluates the performance of the segments based on operating
earnings before the allocation of administrative expenses. Information about
interest income and expense and income taxes is not provided on a segment level.
The accounting policies of the segments are the same as described in the summary
of significant accounting policies.
The following table includes revenue, intercompany revenues, operating
earnings (loss), depreciation and amortization expense and capital expenditures
for the three and six months ended June 30, 2002 and 2001, and assets as of June
30, 2002, and December 31, 2001, for each segment and reconciling items
necessary to total to amounts reported in the condensed consolidated financial
statements:
Net Revenue
Three Months Ended June 30, Six Months Ended June 30,
------------------------------- -------------------------------
2002 2001 2002 2001
------------- ------------- -------------- -------------
Wireless personal communications services.. $ 51,721,933 $ 24,728,498 $ 99,830,609 $ 43,940,475
Landline telephone services................. 11,488,739 9,121,451 20,682,040 18,968,266
All other................................... 2,061,334 1,905,028 4,167,083 3,479,655
------------- ------------- -------------- -------------
Total net revenues...................... $ 65,272,006 $ 35,754,977 $ 124,679,732 $ 66,388,396
============= ============= ============== =============
Intercompany Revenue
Three Months Ended June 30, Six Months Ended June 30,
------------------------------- -------------------------------
2002 2001 2002 2001
------------- ------------- -------------- -------------
Wireless personal communications services.. $ 91,986 $ 42,914 $ 193,092 $ 84,592
Landline telephone services................. 403,341 206,153 805,255 446,911
All other................................... 111,422 50,416 218,739 52,492
-------------- ------------- -------------- --------------
Total intercompany revenues............. $ 606,749 $ 299,483 $ 1,217,086 $ 583,995
============== ============= ============== ==============
13
HORIZON TELCOM, INC., AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
As of June 30, 2002, and December 31, 2001,
And for the Three and Six Months Ended June 30, 2002 and 2001 (unaudited)
- --------------------------------------------------------------------------------
NOTE 4 - SEGMENT INFORMATION (CONTINUED)
Operating Earnings (Loss)
Three Months Ended June 30, Six Months Ended June 30,
------------------------------- --------------------------------
2002 2001 2002 2001
-------------- ------------- -------------- --------------
Wireless personal communications services.. $ (26,312,512) $(19,960,670) $ (49,102,318) $ (34,271,147)
Landline telephone services................. 5,416,299 3,427,170 8,964,841 7,760,461
All other................................... (810,890) (354,792) (1,783,945) (1,061,650)
Unallocated administrative expenses......... (2,749,107) (3,162,369) (5,816,638) (6,138,416)
-------------- ------------- -------------- --------------
Total operating loss.................... $ (24,456,210) $(20,050,661) $ (47,738,060) $ (33,710,752)
============== ============= ============== ==============
Depreciation and Amortization
Three Months Ended June 30, Six Months Ended June 30,
------------------------------ ------------------------------
2002 2001 2002 2001
------------- ------------ ------------ ------------
Wireless personal communications services... $ 12,979,776 $ 4,407,543 $ 20,929,407 $ 7,821,586
Landline telephone services................. 1,723,654 1,540,381 3,403,328 3,039,409
All other................................... 527,555 291,823 1,018,260 513,128
------------- ------------ ------------ ------------
Total depreciation and amortization..... $ 15,230,985 $ 6,239,747 $ 25,350,995 $ 11,374,123
============= ============ ============ ============
Capital Expenditures
Three Months Ended June 30, Six Months Ended June 30,
------------------------------ -------------------------------
2002 2001 2002 2001
------------- ------------ ------------ ------------
Wireless personal communications services.. $ 25,675,000 $ 33,965,565 $ 49,113,012 $ 66,019,254
Landline telephone services................ 1,851,251 1,366,190 3,853,782 3,503,637
All other.................................. 774,777 1,796,320 1,667,480 3,628,668
------------- ------------ ------------ -------------
Total capital expenditures............. $ 28,301,028 $ 37,128,075 $ 54,634,274 $ 73,151,559
============= ============ ============ =============
Assets
------------------------------------
June 30, December 31,
2002 2001
---------------- --------------
Wireless personal communications services................ $ 519,368,840 $ 480,754,022
Landline telephone services.............................. 86,815,525 90,951,437
All other................................................ 6,032,146 6,208,407
---------------- --------------
Total assets......................................... $ 612,216,511 $ 577,913,866
================ ==============
14
HORIZON TELCOM, INC., AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
As of June 30, 2002, and December 31, 2001,
And for the Three and Six Months Ended June 30, 2002 and 2001 (unaudited)
- --------------------------------------------------------------------------------
NOTE 4 - SEGMENT INFORMATION (CONTINUED)
Net operating revenues by product and service for each segment were as
follows:
Three Months Ended June 30, Six Months Ended June 30,
------------------------------ -------------------------------
2002 2001 2002 2001
------------- ------------ ------------ -------------
Wireless personal communications services:
PCS subscriber revenue..................... $ 37,008,341 $ 15,491,834 $ 71,922,441 $ 27,513,389
PCS roaming revenue........................ 13,115,952 7,737,890 23,935,240 13,852,349
PCS equipment sales........................ 1,597,640 1,498,774 3,972,928 2,574,737
------------- ------------ ------------ -------------
Total personal communication services.... 51,721,933 24,728,498 99,830,609 43,940,475
------------- ------------ ------------ -------------
Landline telephone services:
Basic local service........................ 3,658,433 3,661,483 7,263,689 7,239,286
Long-distance service...................... 269,022 407,690 578,414 849,729
Network access............................. 6,735,297 4,011,701 11,330,767 9,040,454
Other related telephone service............ 825,987 1,040,577 1,509,170 1,838,797
------------- ------------ ------------ -------------
Total landline telephone services........ 11,488,739 9,121,451 20,682,040 18,968,266
------------- ------------ ------------ -------------
Other:
Internet access services................... 818,577 826,627 1,625,405 1,589,731
Equipment system sales..................... 240,617 445,326 620,953 708,746
Other miscellaneous revenues............... 1,002,140 633,075 1,920,725 1,181,178
------------- ------------ ------------ -------------
Total other.............................. 2,061,334 1,905,028 4,167,083 3,479,655
------------- ------------ ------------ -------------
Total operating revenues............... $ 65,272,006 $ 35,754,977 $124,679,732 $ 66,388,396
============= ============ ============ =============
NOTE 5 - INVESTMENTS
At June 30, 2002, the Company held short-term investments in marketable
securities with maturities greater than three months. All held-to-maturity
securities mature within one year of June 30, 2002. The following summarizes
unrealized gains and losses on investments at June 30, 2002:
Unrealized Unrealized Fair
Cost Gain Loss Value
----------- ------------ ---------- -----------
Equity securities available-for-sale.. $ 250,000 $ 418,670 $ -- $ 668,670
Debt securities held-to-maturity...... 6,525,263 20,269 -- 6,545,532
15
HORIZON TELCOM, INC., AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
As of June 30, 2002, and December 31, 2001,
And for the Three and Six Months Ended June 30, 2002 and 2001 (unaudited)
- --------------------------------------------------------------------------------
NOTE 6 - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following:
June 30, December 31,
2002 2001
--------------- ---------------
Network assets.......................................... $ 267,803,742 $ 220,849,771
Switching equipment..................................... 62,254,424 35,253,986
Land and buildings...................................... 15,602,647 15,223,363
Computer and telecommunications equipment............... 14,966,196 14,292,341
Furniture, vehicles and office equipment................ 11,594,782 12,477,119
--------------- ---------------
Property, plant and equipment in service, at cost..... 372,221,791 298,096,580
Accumulated depreciation................................ (83,867,001) (68,604,457)
--------------- ---------------
Property, plant and equipment in service, net...... 288,354,790 229,492,123
Construction work in progress........................... 30,789,536 59,785,097
--------------- ---------------
Total property, plant and equipment, net......... $ 319,144,326 $ 289,277,220
=============== ===============
Applicable interest charges incurred during the construction of new
facilities and network assets are capitalized as one of the elements of cost and
are amortized over the assets' estimated useful lives, in accordance with SFAS
No. 34. The Company capitalized interest of approximately $3,185,000 and
$3,233,000 for the six months ended June 30, 2002 and 2001, respectively.
During 2002, Horizon PCS launched switches in Tennessee and Pennsylvania
and decommissioned some switching equipment in Chillicothe, Ohio. As a result,
approximately $6.2 million of switching equipment is considered an impaired
asset as defined by SFAS No. 144. Accordingly, depreciation expense for the
three and six months ended June 30, 2002, included approximately $3.5 million of
expense related to accelerated depreciation on the impaired assets. The total
amount of depreciation recorded to date on this equipment approximates $5.8
million. The residual book value of $400,000 approximates fair market value at
June 30, 2002, based on quoted market prices. This switch is in use and is
reported under switching equipment for our wireless personal communications
services segment.
NOTE 7 - LONG-TERM DEBT
The components of long-term debt outstanding are as follows:
Interest Rate at June 30, December, 31,
June 30, 2002 2002 2001
----------------- ---------------- ----------------
Discount notes.......................... 14.00% 295,000,000 295,000,000
Senior notes............................ 13.75% $ 175,000,000 $ 175,000,000
Secured credit facility-term loan A..... 5.87% 105,000,000 --
Secured credit facility-term loan B..... 6.09% 50,000,000 50,000,000
1998 Senior Notes....................... 6.62% 12,000,000 12,000,000
1993 Senior Notes....................... 6.72% 6,000,000 6,000,000
--------------- ---------------
Long-term debt, face value.............. 643,000,000 538,000,000
Less: unaccreted interest portion of
discount notes........................ (122,790,393) (135,944,357)
--------------- ----------------
Total long-term debt, net........... $ 520,209,607 $ 402,055,643
=============== ================
As of June 30, 2002, Horizon PCS had $95.0 million committed under its
secured credit facility in the form of a line of credit at a variable interest
rate equal to the London Interbank Offered Rate ("LIBOR") plus 400-basis points.
16
HORIZON TELCOM, INC., AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
As of June 30, 2002, and December 31, 2001,
And for the Three and Six Months Ended June 30, 2002 and 2001 (unaudited)
- --------------------------------------------------------------------------------
NOTE 7 - LONG-TERM DEBT (CONTINUED)
Horizon PCS' secured credit facility includes financial covenants that must
be met each quarter. Horizon PCS did not meet the covenant for earnings before
interest, taxes, depreciation and amortization ("EBITDA") for the first quarter
of 2002. As a result of higher than expected gross and net additions to Horizon
PCS subscribers for that quarter, it incurred additional expenses to add those
customers. Although Horizon PCS ultimately benefits from the revenues generated
by new subscribers, it incurs one-time expenses associated with new subscribers,
including commissions, handset subsidies, set up costs for the network and
marketing expenses. As a result, these new subscriber costs negatively affect
EBITDA in the short-term during the period of the addition of new subscribers,
which led to non-compliance with the EBITDA covenant for the first quarter of
2002.
On June 27, 2002, Horizon PCS obtained a waiver of the non-compliance with
the EBITDA covenant for the first quarter of 2002 and entered into an amendment
of the secured credit facility. The amended facility primarily adjusts certain
financial covenants and increases the margin on the base interest by 25-basis
points, while also providing for the payment of fees to the banking group, an
increase in post-default interest rates, a new financial covenant regarding
minimum available cash, additional prepayment requirements, restrictions on
Horizon PCS' borrowings under the remaining $95.0 million revolving credit
facility and deposit requirements on its use of the $105.0 million borrowed
under the secured credit facility in March 2002. These requirements are
described in detail in the Form 8-K filed by Horizon PCS on June 27, 2002 (See
also "Liquidity and Capital Resources" under "Item 2. Management's Discussion
and Analysis of Financial Condition and Results of Operations").
The Note Purchase Agreement for the 1993 Senior Notes of Chillicothe
Telephone Company contains a covenant that restricts the amount of investments
that Chillicothe Telephone may make in loans, stock or other securities of
another company. For the quarter ended June 30, 2002, Chillicothe Telephone
failed to comply with the covenant related to these restricted investments,
which constitutes an event of default under the note purchase agreement. The
Company has entered into a waiver agreement with the noteholders to remedy the
non-compliance. The waiver was signed by both parties on August 8, 2002.
In August 2002, Chillicothe Telephone will issue $30,000,000 of 6.64%, 10
year Senior notes due in full July 1, 2012. The proceeds of the offering will be
used to retire both the short term line of credit with Huntington National Bank
($18,400,000 at June 30, 2002) and the 1993 Senior Notes ($8,000,000 at June 30,
2002). The remaining funds will be used for general corporate purposes.
NOTE 8 - COMMITMENTS AND CONTINGENCIES
OPERATING LEASES
The Company leases office space and various equipment under several
operating leases. In addition, Horizon PCS has tower lease agreements with third
parties whereby it leases towers for substantially all its cell sites. The tower
leases are operating leases with a term of five to ten years with three
consecutive five-year renewal option periods.
Horizon PCS also leases space for its retail stores. At June 30, 2002,
Horizon PCS leased 39 of its 40 retail stores.
CONSTRUCTION EXPENDITURES
Construction expenditures for the year ended December 31, 2002, are
estimated to be between approximately $70,000,000 and $85,000,000. The majority
of the estimated expenditures are for the build-out and upgrade of the PCS
network.
17
HORIZON TELCOM, INC., AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
As of June 30, 2002, and December 31, 2001,
And for the Three and Six Months Ended June 30, 2002 and 2001 (unaudited)
- --------------------------------------------------------------------------------
NOTE 8 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
LEGAL MATTERS
The Company is party to legal claims arising in the normal course of
business. Although the ultimate outcome of the claims cannot be ascertained at
this time, it is the opinion of management that none of these matters, when
resolved, will have a material adverse impact on the Company's results of
operations, cash flows or financial condition.
ALLIANCES NETWORK AGREEMENTS
The Alliances are two independent PCS providers offering service under the
NTELOS brand name. In August 1999, Horizon PCS entered into a network services
agreement with the Alliances for 13 of its markets in Virginia and West
Virginia. The initial term is through June 8, 2008, with four automatic ten-year
renewals. This agreement was amended in the third quarter of 2001. Under the
amended agreement, Horizon PCS is obligated to pay fixed minimum monthly fees
until December 2003, at a lower rate per minute than the prior agreement. Usage
in excess of the monthly minute allowance is charged at a set rate per minute.
NOTE 9 - GOODWILL AND INTANGIBLE ASSETS
During 1999 Horizon PCS entered into a joint venture agreement through the
purchase of 25.6% of Bright PCS. On June 27, 2000, the Company acquired the
remaining 74.4% of Bright PCS. The total purchase price was approximately
$49,300,000 and was treated as a purchase method acquisition for accounting
purposes. In conjunction with this transaction, Horizon PCS also acquired the
Bright PCS management agreement with Sprint PCS and, with it, the right to use
the Sprint PCS licenses in Bright PCS' markets. Horizon PCS has recognized an
intangible asset totaling approximately $33,000,000 related to this licensing
agreement which will be amortized over 20 years, the initial term of the
underlying management agreement, resulting in annual amortization expense of
$1,707,000 through October 2019. Accumulated amortization at June 30, 2002, was
approximately $3,428,000.
The purchase price exceeded the fair market value of the net assets acquired
by approximately $7,778,000. The resulting goodwill was amortized on a
straight-line basis over 20 years until December 31, 2001. At June 30, 2002, the
remaining unamortized balance of goodwill was approximately $7,191,000.
The Company adopted SFAS No. 142 on January 1, 2002 (Note 3). As a result of
the adoption, goodwill amortization ceased as of December 31, 2001, and the
Company was required to complete an impairment test on its remaining goodwill
balance as of the date of adoption. The Company completed the first step
required by SFAS No. 142 and determined the goodwill remaining at January 1,
2002, was not impaired. The Company will complete an impairment test of the
remaining goodwill balance annually, or more frequently if impairment indicators
arise.
18
HORIZON TELCOM, INC., AND SUBSIDIARIES
Notes to Interim Condensed Consolidated Financial Statements
As of June 30, 2002, and December 31, 2001,
And for the Three and Six Months Ended June 30, 2002 and 2001 (unaudited)
- --------------------------------------------------------------------------------
The following pro forma disclosure reconciles net loss available to common
stockholders, as presented on the accompanying condensed consolidated statements
of operations, excluding the effect of goodwill amortization:
Three Months Ended June 30, Six Months Ended June 30,
2002 2001 2002 2001
-------------- ---------------- ---------------- ----------------
Reported net loss.................. $ 43,620,963) $ (28,724,148) $ (82,713,959) $ (48,474,747)
Goodwill amortization.............. -- 97,222 -- 194,444
-------------- ---------------- ---------------- ----------------
Adjusted net loss............... (43,620,963) (28,626,926) (82,713,959) (48,280,303)
============== ================ ================ ================
Basic and diluted net loss per
share........................... $ (120.36) $ (79.28) $ (228.25) $ (135.14)
Goodwill amortization.............. -- 0.27 -- 0.54
-------------- ---------------- ---------------- ----------------
Adjusted basic and diluted
net loss per share............ $ (120.36) $ (79.01) $ (228.25) $ (134.60)
============== ================ ================ ================
During 2000, Horizon PCS agreed to grant to Sprint PCS warrants to acquire
2,510,460 shares of Horizon PCS class A common stock in exchange for the right
to service PCS markets in additional areas. By September 30, 2000, Sprint PCS
had substantially completed its obligations under the agreement and Horizon PCS
completed the required purchase of certain Sprint PCS assets. The warrants will
be granted on the earlier of July 31, 2003, or an initial public offering of
Horizon PCS' common stock. Horizon PCS valued the warrants and recorded an
intangible asset of approximately $13,356,000. The intangible asset is being
amortized over the remaining term of the Sprint PCS management agreement
resulting in approximately $752,000 of amortization expense per year through
June 2018. Accumulated amortization at June 30, 2002, was approximately
$1,317,000.
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This discussion reflects the operations of Horizon Telcom, Inc., and its
subsidiaries, The Chillicothe Telephone Company, Horizon PCS, Inc., Horizon
Services, Inc., and Horizon Technology, Inc. The following discussion and
analysis should be read in conjunction with the consolidated financial
statements and the related notes.
FORWARD-LOOKING STATEMENTS
This quarterly report on Form 10-Q includes forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended (the
Securities Act), and Section 21E of the Securities Exchange Act of 1934, as
amended (the Exchange Act), which can be identified by the use of
forward-looking terminology such as: "may," "might," "could," "would,"
"believe," "expect," "intend," "plan," "seek," "anticipate," "estimate,"
"project" or "continue" or the negative thereof or other variations thereon or
comparable terminology. All statements other than statements of historical fact
included in this quarterly report on Form 10-Q, including without limitation,
the statements under "Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations" and under "Item 5. Other Information" and
elsewhere herein regarding our financial position and liquidity are
forward-looking statements. These forward-looking statements also include, but
are not limited to:
o changes in industry conditions created by the Federal
Telecommunications Act of 1996 and related state and federal
legislation and regulations;
o recovery of the substantial costs, which will result from the
implementation and expansion of our new businesses;
o retention of our existing customer base and our ability to attract new
customers;
o rapid changes in technology;
o our future compliance with debt covenants;
o actions of our competitors;
o estimates of current and future population for our markets;
o forecasts of growth in the number of consumers and businesses using
personal communication services;
o estimates for churn and ARPU (defined below);
o statements regarding our plans for and costs of the build-out of our
PCS network;
o statements regarding our anticipated revenues, expense levels,
liquidity and capital resources and projections of when we will launch
commercial PCS and achieve break-even or positive EBITDA and operating
cash flow; and
o the anticipated impact of recent accounting pronouncements.
Although we believe the expectations reflected in such forward-looking
statements are reasonable, we can give no assurance such expectations will prove
to have been correct. Important factors with respect to any such forward-looking
statements, including certain risks and uncertainties that could cause actual
results to differ materially from our expectations (Cautionary Statements), are
disclosed in this quarterly report on Form 10-Q, including, without limitation,
in conjunction with the forward-looking statements included in this quarterly
report on Form 10-Q. Important factors that could cause actual results to differ
materially from those in the forward-looking statements included herein include,
but are not limited to:
o our potential need for additional capital or the need for refinancing
existing indebtedness;
20
o our dependence on our affiliation with Sprint PCS and our dependence
on Sprint PCS' back office services;
o our future compliance with debt covenants;
o the need to successfully complete the build-out of our portion of the
Sprint PCS network on our anticipated schedule;
o changes or advances in technology;
o competition in the industry and markets in which we operate and the
creditworthiness of new customers;
o changes in government regulation; and
o general economic and business conditions.
These forward-looking statements involve known and unknown risks,
uncertainties and other factors which may cause our actual results, performance
or achievements to be materially different from any future results, performance
or achievements expressed or implied by such forward-looking statements. All
subsequent written and oral forward-looking statements attributable to us or
persons acting on our behalf are expressly qualified in their entirety by the
Cautionary Statements. See "Item 5. Other Information" for further information
regarding several of these risks and uncertainties.
OVERVIEW
Horizon Telcom operates primarily within two operating segments: landline
telephone services and wireless personal communications services. See Note 4 of
"Notes to Interim Condensed Consolidated Financial Statements" for additional
financial information regarding Horizon Telcom's operating segments. At June 30,
2002, Chillicothe Telephone serviced 39,000 access lines in Chillicothe, Ohio
and the surrounding area. Horizon Technology provided Internet service to 13,900
customers through its bright.net Internet service. At June 30, 2002, Horizon PCS
had launched service covering approximately 7.4 million residents, or
approximately 73% of the total population in its territory, and serving
approximately 235,100 customers.
HISTORY AND BACKGROUND
Horizon Telcom is a holding company, which, in addition to its common stock
ownership of Horizon PCS, owns 100% of Chillicothe Telephone, a local telephone
company. Horizon Telcom also owns 100% of Horizon Services, which provides
administrative services to Horizon PCS and other Horizon Telcom affiliates, and
100% of Horizon Technology, a separate long-distance and Internet services
business. Prior to providing PCS service, one of Horizon PCS' subsidiaries
operated a DirecTV affiliate. We sold that business in 1996. We also launched
our Internet services business in 1995.
Horizon Telcom provides a variety of voice and data services to commercial,
residential/small business and local market segments. Horizon Telcom provides
landline telephone service, VDSL television service and Internet access services
to the southern Ohio region, principally in and surrounding Chillicothe, Ohio.
Horizon Telcom also provides PCS operations to a twelve-state region in the
Midwest, including Ohio, Indiana, Virginia and West Virginia, as an affiliate of
Sprint PCS.
CRITICAL ACCOUNTING POLICIES
Allowance for Doubtful Accounts. Estimates are used in determining our
allowance for doubtful accounts, which are based on a percentage of our accounts
receivables by aging category. The percentage is derived by considering our
historical collections and write-off experience, current aging and credit
quality trends and Sprint PCS' credit policy. However, our historical write-off
and receivables trends for our wireless customers are limited due to our strong
subscriber growth and the recent launch of new markets.
21
Under Sprint's service plans, wireless customers who do not meet certain
credit criteria can select any plan offered subject to an account spending
limit, referred to as ASL, to control credit risk exposure. Account spending
limits range from $125 to $200 depending on the credit quality of the customer.
Prior to May 2001, all of these customers were required to make a deposit
ranging from $125 to $200 that could be credited against future billings. In May
2001, the deposit requirement was eliminated on certain, but not all, credit
classes ("No Deposit ASL" or "NDASL"). As a result, a significant amount of our
new wireless customer additions (approximately 59% between May 1, 2001, and
March 31, 2002) have been under the NDASL program. This increase in sub-prime
credit customers under the NDASL program has led to higher churn rates (defined
below) and an increase in account write-offs. While the average balance
written-off for an NDASL customer is lower than the write-off balances of
non-account spending limit customers, the number of NDASL write-offs has caused
an increase in the total amount written-off each quarter, resulting in a higher
allowance and provision for doubtful accounts. Beginning in April 2002, the
NDASL program was replaced by the "Clear Pay Program," which re-instated the
deposit requirement for most credit classes with account spending limits and
featured increased back-office controls with respect to credit qualification and
account collections. We anticipate the implementation of the deposit under the
Clear Pay Program will reduce our future bad debt exposure. If the deposit
requirement is later removed or if these allowance for doubtful accounts
estimates are insufficient for any reason, our operating income, EBITDA and
available cash would be reduced. At June 30, 2002, the allowance for doubtful
wireless customer accounts was $2,301,000, which represents 10% of wireless
accounts receivables. At June 30, 2002, 38% of the wireless subscribers in our
markets were account spending limit customers with no deposit paid.
Our landline segment accounts receivable consist primarily of amounts billed
to interexchange carriers (like AT&T) for allowing their customers to access our
network when their customers place a call. Accounts receivable also include
charges for advertising in Chillicothe Telephone's yellow pages directory and
amounts billed to customers for monthly services. Our collection history with
interexchange carriers has been good. However, we do have some exposure to
WorldCom and WorldCom's MCI division, which declared bankruptcy on July 21,
2002. We estimate amounts billed to WorldCom to be approximately $460,000 at
June 30, 2002, of which approximately $110,000 had been collected as of the date
of this filing. The allowance for doubtful landline segment accounts receivable
is approximately 9% of amounts billed at June 30, 2002.
Revenue Recognition. Horizon PCS sells wireless handsets and accessories
which are recorded at the time of the sale as equipment revenue. After the
handset has been purchased, the subscriber purchases a service package which is
recognized monthly as service is provided and is included as subscriber revenue.
Horizon PCS defers monthly service revenue billed in advance. Roaming revenue is
recorded when Sprint PCS subscribers, other Sprint PCS affiliate subscribers and
non-Sprint PCS subscribers roam onto Horizon PCS' network.
Service revenues consist of PCS subscriber revenues and roaming revenues.
PCS subscriber revenues consist primarily of monthly service fees and other
charges billed to customers for Sprint PCS service in our territory under a
variety of service plans. Roaming revenues consist of Sprint PCS and non-Sprint
PCS roaming. We receive Sprint PCS roaming revenues at a per minute rate from
Sprint PCS or another Sprint PCS affiliate when Sprint PCS subscribers based
outside of our territory use our portion of the Sprint PCS network. Non-Sprint
PCS roaming revenues include payments from wireless service providers, other
than Sprint PCS, when those providers' subscribers roam on our network.
We record 100% of PCS subscriber revenues from our customers, Sprint PCS
roaming revenues from Sprint PCS subscribers based outside our markets and
non-Sprint PCS roaming revenues. Sprint PCS retains 8% of all collected service
revenue as a management fee. Collected service revenues include PCS subscriber
revenues and non-Sprint PCS roaming revenues, but exclude Sprint PCS roaming
revenues, roaming charges billed to our customers for roaming onto a Sprint PCS
network and revenues from sales of equipment. We report the amounts retained by
Sprint PCS as general and administrative expense.
Horizon PCS' accounting policy for the recognition of activation fee
revenue is to record the revenue over the periods such revenue is earned in
accordance with the current interpretations of SAB No. 101, "Revenue Recognition
in Financial Statements." Accordingly, activation fee revenue and direct
customer activation expense is deferred and will be recorded over the average
life for those customers, currently estimated to be 30 months, that are assessed
an activation fee. Prior to January 1, 2002, we estimated the average life of a
customer to be 36 months. We reduced this estimate to 30 months in consideration
of an increase in churn (defined below) resulting from the NDASL program
discussed earlier.
22
The landline telephone services operating segment consists of basic local
and long-distance toll, network access services and other related telephone
service revenue. Intra-LATA, (Local Access and Transport Area) (i.e., the area
of southern Ohio, including Columbus originally covered by area code 614), basic
local exchange and long-distance service revenue consists of flat rate services
and measured services billed to customers utilizing Chillicothe Telephone's
telephone network. Long distance intraLATA/interstate revenue consists of
message services that terminate beyond the basic service area of the originating
wire center. Network access revenue consists of revenue derived by our landline
telephone services segment from the provision of exchange access services to an
interexchange carrier or to an end user beyond the exchange carrier's network.
Other related telephone service revenue includes directory advertising related
to a telephone directory published annually.
Other revenues include Internet access services, equipment systems sales and
information services. Internet access revenues for our bright.net services are
monthly service fees and other charges billed to our bright.net customers.
Service fees primarily consist of monthly recurring charges billed to customers.
Equipment systems sales and other revenues consist of sales made by Chillicothe
Telephone to various businesses or other residential customers for equipment
used on the telephone system.
23
THREE MONTHS ENDED JUNE 30, 2002 COMPARED TO THREE MONTHS ENDED JUNE 30, 2001
OPERATING REVENUES
WIRELESS PERSONAL COMMUNICATIONS SERVICES
The following table sets forth the revenue components of the wireless
personal communications services segment for the three months ended June 30:
2002 2001 $ change % change
----------- ---------------------- --------
(Dollars in thousands)
PCS Subscriber revenues....... $ 37,008 $ 15,492 $ 21,516 139%
PCS Roaming revenues.......... 13,116 7,738 5,378 70%
PCS equipment revenues........ 1,598 1,499 99 7%
A key metric in the wireless communications industry is Average Revenue Per
Unit ("ARPU"). ARPU summarizes the average monthly service revenue per customer.
ARPU is computed by dividing service revenue and roaming for the period by the
average subscribers for the period.
The following summarizes APPU for the three months ended June 30:
2002 2001
------------------ -------------------
Service revenues*................ $ 56 $ 55
Roaming revenues................. 19 27
------------------ -------------------
ARPU.......................... $ 75 $ 82
================== ===================
- -------
* Excludes impact of a non-recurring adjustment to Horizon PCS' access revenue.
Another key metric is churn. Churn is the monthly rate of customer turnover
that both voluntarily and involuntarily discontinued service during the month.
Churn is computed by dividing the number of customers that discontinued service
during the month, net of 30-day returns, by the beginning customer base for the
period. Churn for the three months ended June 30, 2002, was 3.2% compared to
2.1% for the three months ended June 30, 2001. This increase in churn is a
result of an increase in the amount of sub-prime credit quality customers the
Company added whose service was involuntarily discontinued during the period.
For the three months ended June 30, 2002 and 2001, Horizon PCS subscribers
increased by approximately 12,400 and 21,600 customers, respectively. Gross
activations increased 31% and were offset by an increase in the churn of NDASL
subscribers for an overall lower net customer additions for the three months
ended June 30, 2002, over the three months ended June 30, 2001.
The growth in PCS service revenues is the result of the growth in our
customer base as well as an increase in travel and roaming revenue. Subscriber
revenues increased approximately $21.5 million to approximately $37.0 million
for the three months ended June 30, 2002. We managed approximately 235,100
customers at June 30, 2002, compared to approximately 106,300 at June 30, 2001.
We believe our customer base has grown because we have launched additional
markets and increased our sales force.
Sprint PCS assesses access charges to long distance carriers on Horizon
PCS' behalf for the termination of landline originated calls in our markets.
Though regulations generally entitle a carrier that terminates a call on the
behalf of another to be compensated for providing that service, these
regulations were developed in a period where services of this nature were
provided exclusively by local exchange carriers. Certain long distance carriers,
including AT&T, have disputed Sprint PCS's assessment of these charges as well
as the corresponding rate at which the charges were determined. In July 2002,
the FCC ruled that AT&T was not required to pay these charges unless AT&T had
agreed to do so in its contract with Sprint PCS and remanded the case to a U.S.
District Court for further proceedings. Because the case is still pending we
cannot predict, with certainty, the final outcome of this action. As a result,
we recorded a reduction in revenue in the second quarter of 2002 of
approximately $1.3 million representing previously billed and recognized access
revenue. The Company plans to cease recognition of this type of revenue in
future quarters, unless there is ultimately a favorable ruling by the courts or
the FCC on this issue. Sprint PCS has asserted the right to recover these
revenues from us. We will continue to assess the ability of Sprint PCS or other
carriers to recover these charges. We are also continuing to review the
availability of defenses we may have against Sprint PCS' claim to recover these
revenues from us.
Roaming revenues increased from approximately $7.7 million during the three
months ended June 30, 2001, to approximately $13.1 million for the three months
ended June 30, 2002, an increase of approximately $5.4 million. This increase
resulted from launching additional markets over the past year, including markets
covering major interstate highways.
24
On April 27, 2001, Sprint PCS and its affiliates announced an agreement on a
new Sprint PCS roaming rate; the receivable and payable roaming rate decreased
from $0.20 per minute to $0.15 per minute effective June 1, 2001, and decreased
further to $0.12 per minute effective October 1, 2001. The Sprint PCS roaming
rate changed to $0.10 per minute on January 1, 2002. After 2002, the rate will
be changed to "a fair and reasonable return" which has not yet been determined.
This decrease in the rate will reduce our revenue and expense per minute, but we
anticipate this rate reduction will be offset by volume increases from the
continued build-out of our network and subscriber growth, resulting in greater
overall roaming revenue and expense in the future.
PCS equipment revenues consist of handsets and accessories sold to
customers. Equipment revenues for the three months ended June 30, 2002 were
approximately $1.6 million, compared to approximately $1.5 million for the three
months ended June 30, 2001, an increase of approximately $100,000. The increase
in equipment revenues is the result of our increase in the number of handsets
sold, somewhat offset by a lower sales price per unit.
LANDLINE TELEPHONE SERVICES
The following table sets forth the revenue components of the landline
telephone services segment for the three months ended June 30:
2002 2001 $ change % change
------------- ------------ ----------- ----------
(Dollars in thousands)
Basic local, long-distance and other landline $ 4,753 $ 5,110 $ (357) (7%)
Network access............................... 6,735 4,012 2,723 68%
Long-distance service revenue decreased for the three months ended June 30,
2002, as the Company continues to see lower usage for long-distance service. We
expect this trend to continue for the foreseeable future, as more customers use
wireless devices where long distance is included for one monthly fee. The
increase in network access is due to a recent ruling by the United States Court
of Appeals that deals with a similar landline telecommunications company and its
related carrier access rates. As a result of this ruling, the Company recognized
an additional $2.1 million of revenue during the second quarter that had
previously been set aside to settle future over earnings claims by other
carriers.
OTHER REVENUES
The following table sets forth the revenue components of the other revenues
segment for the three months ended June 30:
2002 2001 $ change % change
------------- ------------ ----------- ----------
(Dollars in thousands)
Internet access services..................... $ 819 $ 827 $ (8) (1%)
Equipment systems, information services, and
other revenues.......................... 1,243 1,078 165 15%
Other revenues were impacted by increased VDSL revenue as we continue to
build our customer base.
OPERATING EXPENSES
Cost of goods sold. Cost of goods sold primarily includes the costs of
handsets and accessories sold to customers. Cost of goods sold also includes, to
a lesser extent, the cost of business system sales incurred by Chillicothe
Telephone. Cost of goods sold for the three months ended June 30, 2002, was
25
approximately $3.8 million, compared to $2.5 million for the three months ended
June 30, 2001, an increase of approximately $1.3 million. For competitive and
marketing reasons, we have sold handsets to our customers below our cost and
expect to continue to sell handsets at a price below our cost for the
foreseeable future. Additionally, we expect to incur additional expense as
existing customers upgrade their handsets to newer models and to take advantage
of new services that may be available with 3G including high-speed data
applications.
Cost of services. Cost of services for Chillicothe Telephone and Horizon
Technology includes the support, switching, access and circuitry expenses
utilized for maintaining telephone service. Cost of services also includes
expenses related to the startup and installation of Chillicothe Telephone's VDSL
service. Cost of services for Horizon PCS includes costs associated with
operating its network including site rent, utilities, maintenance, engineering
personnel and other expenses related to operations. Cost of services also
includes interconnection expenses, customer care, Sprint charges and roaming
fees. Horizon PCS pays Sprint PCS roaming fees when Horizon PCS' customers use
Sprint PCS' network outside of our territory. Horizon PCS pays non-Sprint PCS
roaming fees to other wireless service providers when our customers use their
networks.
Also included in cost of services are costs incurred under Horizon PCS'
network services agreement with the Alliances. In the third quarter of 2001,
Horizon PCS negotiated an amendment to its agreement with the Alliances and a
related amendment to its Sprint PCS agreements. Under the Alliances amendment,
Horizon PCS is obligated to pay a fixed minimum monthly fee for a stated minimum
period. Horizon PCS expects to incur lower overall fees under this agreement at
expected usage levels as compared to the previous agreement that was based on a
per minute fee. The Alliances are also obligated to upgrade their networks to
provide 3G technology.
Sprint provides back-office and other services to Horizon PCS. Recently,
Sprint PCS has sought to increase service fees during the remainder of 2002 and
beyond in connection with its development of 3G-related back-office systems and
platforms. If Sprint PCS were to increase its fees significantly, these
increased operating expenses would have an adverse effect on Horizon PCS' EBITDA
and cash flow.
Cost of services for the three months ended June 30, 2002, was approximately
$45.0 million, compared to approximately $24.5 million for the three months
ended June 30, 2001, an increase of approximately $20.5 million. Of the
increase, approximately $20.2 million was related to Horizon PCS, while
Chillicothe Telephone and Horizon Technology increased by approximately
$300,000, which was related to the continued installation and programming
expenses associated with our VDSL service.
Horizon PCS' increase in cost of services reflects the increase in Sprint
PCS roaming expense and long distance charges of approximately $6.2 million and
the increase in costs incurred under our network services agreement with the
Alliances of approximately $3.2 million, both as a result of our subscriber
growth during 2001 and the first half of 2002. Additionally, at June 30, 2002,
Horizon PCS' network covered approximately 7.4 million people versus 5.7 million
residents at June 30, 2001. As a result, cost of service in 2002 was higher than
2001 due to the increase in network operations expense, including tower lease
expense, circuit costs and payroll expense, of approximately $6.6 million.
Growth in our customer base resulted in increased customer care, activations and
billing expense of approximately $3.6 million and other variable expenses,
including interconnection and national platform expenses, of approximately
$600,000.
Selling and marketing expenses. Selling and marketing expenses consist of
costs associated with operating Horizon PCS' 40 retail stores, including
marketing, advertising, payroll and sales commissions. Selling and marketing
expense also includes salaries and commissions paid to our sales representatives
and sales support personnel, commissions paid to national and local third party
distribution channels and subsidies on handsets sold by third parties for which
we do not record revenue, and expenses related to Chillicothe Telephone and
Horizon Technology marketing and advertising programs.
Selling and marketing expenses rose to approximately $11.7 million for the
three months ended June 30, 2002 compared to $10.7 million for the same period
in 2001, an increase of approximately $1.0 million. Horizon PCS' increase was
approximately $900,000, while Chillicothe Telephone and Horizon Technology were
essentially flat, increasing by approximately $100,000.
Horizon PCS' increase reflects the increase in the costs of operating 40
retail stores in 2002 compared to 21 at the end of the second quarter of 2001.
The costs include an increase in commissions paid to third parties of
approximately $500,000, and increase in subsidies on handsets sold by third
parties of approximately $300,000 and an increase in marketing and advertising
26
in our sales territory of approximately $100,000. We expect selling and
marketing expense to increase in the aggregate as we expand our coverage, launch
additional stores and add customers.
General and administrative expenses. General and administrative costs
include the costs related to corporate support functions. These include finance
functions, billing and collections, accounting services, computer access and
administration, executive, supervisory, consulting, customer relations, human
resources and other administrative services. The Sprint PCS management fee is
also included in general and administrative expenses.
General and administrative expenses rose by approximately $2.9 million to
approximately $13.9 million for the three months ended June 30, 2002, compared
to the same period last year. Horizon PCS' increase was approximately $2.8
million which reflects an increase in the provision of doubtful accounts of
approximately $2.5 million, an increase in the Sprint PCS management fee of
approximately $1.6 million, as a result of higher subscriber revenues in 2002,
offset by a decrease in other general expenses of approximately $1.3 million.
During the second quarter of 2001, Horizon PCS recognized approximately $1.3
million of legal and consulting expenses related to the exploration of strategic
business alternatives. Chillicothe Telephone and Horizon Technology's general
and administrative expenses increased by approximately $100,000 primarily due to
an increase in the provision for doubtful accounts.
Non-cash compensation expense. For the three months ended June 30, 2002 and
2001, we recorded stock-based compensation expense of approximately $100,000 and
$800,000, respectively. This compensation expense is the amortization of the
value of stock options granted in November 1999. Stock-based compensation
expense will continue to be recognized through the conclusion of the vesting
period for these options in 2005. The annual non-cash compensation expense
expected to be recognized for these options is approximately $413,000 for the
full year 2002, $389,000 in 2003, $193,000 in 2004 and $71,000 in 2005.
Depreciation and amortization expense. Depreciation and amortization
expenses increased by approximately $9.0 million to a total of approximately
$15.2 million during the three months ended June 30, 2002. The increase reflects
the continuing construction of our PCS network as well as capital additions for
VDSL and other telephone services. During 2002, Horizon PCS launched switches in
Tennessee and Pennsylvania and decommissioned some switching equipment in
Chillicothe, Ohio. As a result, approximately $6.2 million of switching
equipment is considered an impaired asset as defined by SFAS No. 144.
Accordingly, depreciation expense for the three and six months ended June 30,
2002, included approximately $3.5 million of expense related to accelerated
depreciation on the impaired assets.
In addition, since our acquisition of Bright PCS was accounted for as a
purchase transaction, amortization has increased as a result of amortizing the
related intangible assets. Amortization expense of the intangible asset was
approximately $400,000 during the three months ended June 30, 2002 and 2001.
Related goodwill amortization was approximately $100,000 during the three months
ended June 30, 2001. Goodwill amortization ceased as of December 31, 2001, with
the adoption of SFAS No. 142. See "Recent Accounting Pronouncements" below.
Amortization expense also includes amortization of an intangible asset
recorded in September 2000, related to the new markets granted to us by Sprint
PCS in September 2000. We agreed to grant warrants to purchase shares of Horizon
PCS' common stock to Sprint PCS in exchange for the right to provide service in
additional markets. The warrants will be issued to Sprint PCS at the earlier of
an initial public offering of Horizon PCS' common stock or July 31, 2003. The
intangible asset is being amortized over the remaining term of the Sprint PCS
management agreement, resulting in approximately $800,000 of amortization
expense per year. Amortization expense related to this intangible asset was
approximately $200,000 for each of the three months ended June 30, 2002 and
2001.
Interest expense, net. Interest expense for the three months ended June 30,
2002, was approximately $15.9 million, compared to approximately $7.0 million
for the three months ended June 30, 2001. The increase in interest expense was a
result of our additional debt outstanding during the three months ended June 30,
2002, compared to the same period in 2001.
27
Interest expense on Chillicothe Telephone's line of credit and term loans
was approximately $500,000 during the three months ended June 30 2002. As a
result of a lower interest rate environment in 2002 compared to the second
quarter of 2001, interest expense on Chillicothe Telephone's line of credit
decreased approximately $37,000 for the three months ended June 30, 2002.
Chillicothe Telephone's line of credit accrues interest on the outstanding
balance at a variable rate tied to LIBOR (3.39% as of June 30, 2002 based on
LIBOR plus 155-basis points) and is due and payable every thirty days. The
outstanding balance on the line of credit at June 30, 2002, was $18.4 million
compared to $15.3 million at June 30, 2001. At June 30, 2002, the balance on
Chillicothe Telephone's term loans was $20.0 million including current
maturities and the weighted average rate was 6.66%.
Interest on Horizon PCS' outstanding balance of the secured credit facility
accrues at LIBOR plus a specified margin. On June 29, 2001, Horizon PCS agreed
to several changes in the secured credit facility including a 25-basis point
increase in the margin on the base interest rate. At June 30, 2002, the interest
rate on the $105.0 million term loan A borrowed under Horizon PCS' secured
credit facility was 5.87%, while the interest rate on the $50.0 million term
loan B was 6.09%. Interest expense on the secured credit facility was
approximately $2.7 million and approximately $1.2 million during the three
months ended June 30, 2002 and 2001, respectively.
Horizon PCS accrues interest at a rate of 14.00% annually on the discount
notes issued in September 2000 and will pay interest semi-annually in cash
beginning in October 2005. Unaccreted interest expense on the discount notes was
approximately $122.8 million at June 30, 2002. Interest expense on the discount
notes was approximately $6.8 million and $5.9 million during the three months
ended June 30, 2002 and 2001, respectively.
On June 15, 2002, Horizon PCS began making semi-annual interest payments on
its senior notes issued in December 2001, at an annual rate of 13.75%. Interest
expense accrued on the senior notes was approximately $6.0 million during the
three months ended June 30, 2002. Under the terms of the senior notes, cash to
cover the first four semi-annual interest payments was placed in an escrow
account.
Interest expense also includes approximately $600,000 and $200,000 during
the three months ended June 30, 2002 and 2001, respectively, of amortization
from the deferred financing fees related to Horizon PCS' secured credit
facility, its discount notes and its senior notes. Also contributing to the
increase in interest expense during the three months ended June 30, 2002, was
approximately $400,000 in commitment fees, Horizon PCS paid on the unused
portion of its secured credit facility.
Capitalized interest during the three months ended June 30, 2002 and 2001,
was approximately $1.1 million and $1.6 million, respectively. We expect our
interest expense to increase in the future as we borrow under Horizon PCS'
secured credit facility to fund the PCS network build-out and operating losses.
Subsidiary preferred stock dividends. Horizon PCS' convertible preferred
stock pays a stock dividend at the rate of 7.5% per annum, payable
semi-annually, commencing May 1, 2001. The dividends are paid with additional
shares of convertible preferred stock. Through June 30, 2002, Horizon PCS has
issued an additional 3,245,134 shares of convertible preferred stock in payment
of stock dividends, including 1,060,201 shares that were issued on May 1, 2002.
Interest income and other, net. Interest income and other for the three
months ended June 30, 2002, was approximately $600,000 compared to approximately
$1.4 million in 2001 and consisted primarily of interest income. This decrease
was due primarily to a lower average balance of cash investments during the
second quarter of 2002 as compared to the same period in 2001 and due to a lower
short-term interest rate environment in 2002.
Income tax expense. Income tax expense for the three months ended June 30,
2002, was approximately $1.0 million compared to approximately $300,000 in 2001.
Before September 26, 2000, Horizon PCS was included in the consolidated Federal
income tax return of Horizon Telcom. Horizon PCS provided for Federal income
taxes on a pro-rata basis, consistent with a consolidated tax-sharing agreement.
As a result of the sale of Horizon PCS convertible preferred stock in September
2000, Horizon PCS is not able to participate in the tax sharing agreement with
its parent nor is Horizon Telcom able to recognize any net operating loss
benefits from Horizon PCS. We expect to continue to record income tax expense as
28
a result of this tax deconsolidation. Horizon PCS is unable to recognize any tax
benefits from its net operating losses until it generates taxable income. Thus,
Horizon PCS filed a separate Federal income tax return for the short period
after the deconsolidation through December 31, 2000 and will file a separate
return for all subsequent periods.
Minority interest in loss. As part of the acquisition of Bright PCS, the
former members of Bright PCS have approximately an 8% ownership in Horizon PCS,
excluding the impact of the possible conversion of convertible preferred stock
and exercise of options and warrants. Horizon Telcom accounts for this ownership
by recording the portion of net loss attributable to the minority shareholders
as minority interest in loss in the accompanying condensed consolidated
statements of operations. There will not be any further allocations to minority
interests until such time as Horizon PCS becomes profitable and any unallocated
losses to minority interests are offset with income in future periods.
Other comprehensive income (loss). During the second quarter of 2002, the
Company recorded an unrealized loss, net of associated tax, of $1,215,938 on its
investment in marketable securities classified as available-for-sale. The equity
security held is VeriSign, Inc., whose market value has declined significantly
during the past year, and is reflective of the volatility in the general market
for technology stocks over the past six to twelve months.
During 2001, Horizon PCS entered into two two-year interest rate swaps,
effectively fixing the $50.0 million of its term loan B borrowed under the
secured credit facility. We do not expect the effect of these swaps to have a
material impact to interest expense for the remainder of their lives. Horizon
PCS recorded an unrealized loss of approximately $270,000 in other comprehensive
income during the second quarter of 2002.
29
SIX MONTHS ENDED JUNE 30, 2002 COMPARED TO SIX MONTHS ENDED JUNE 30, 2001
OPERATING REVENUES
WIRELESS PERSONAL COMMUNICATIONS SERVICES
As of June 30, 2002, we provided personal communication service directly to
approximately 235,100 customers. For the six months ended June 30, 2002 and
2001, Horizon PCS subscribers increased by approximately 41,000 and 39,900
customers, respectively. Gross activations increased 64% because we have
launched additional markets and increased our sales force, but activations were
partially offset by an increase in the churn of NDASL subscribers, for a
slightly higher net number of customer additions for the six months ended June
30, 2002, over the six months ended June 30, 2001. Churn for the six months
ended June 30, 2002, was 3.2% compared to 2.2% for the six months ended June 30,
2001.
The following table sets forth the revenue components of the wireless
personal communications services segment for the six months ended June 30:
2002 2001 $ change % change
------------- ------------ ----------- ------------
(Dollars in thousands)
PCS Subscriber revenues...................... $ 71,922 $ 27,513 $ 44,409 161%
PCS Roaming revenues......................... 23,935 13,852 10,083 73%
PCS equipment revenues....................... 3,973 2,575 1,398 54%
The following summarizes ARPU for the six months ended June 30:
2002 2001
-------------- ------------
Service revenues*........................... $ 56 $ 54
Roaming revenues............................ 19 27
-------------- ------------
ARPU..................................... $ 75 $ 81
============== ============
* Excludes impact of a non-recurring adjustment to Horizon PCS' access revenue.
The growth in PCS service revenues is the result of the growth in our
customer base as well as an increase in travel and roaming revenue. Subscriber
revenues increased approximately $44.4 million for the six months ended June 30,
2002. We managed approximately 235,100 customers at June 30, 2002, compared to
approximately 106,300 at June 30, 2001.
Roaming revenues increased approximately $10.1 million to $23.9 million for
the six months ended June 30, 2002 compared to the same period in 2001. This
increase resulted from launching additional markets over the past year,
including markets covering major interstate highways.
On April 27, 2001, Sprint PCS and its affiliates announced an agreement on a
new Sprint PCS roaming rate; the receivable and payable roaming rate decreased
from $0.20 per minute to $0.15 per minute effective June 1, 2001, and decreased
further to $0.12 per minute effective October 1, 2001. The Sprint PCS roaming
rate changed to $0.10 per minute on January 1, 2002. After 2002, the rate will
be changed to "a fair and reasonable return" which has not yet been determined.
This decrease in the rate will reduce our revenue and expense per minute, but we
anticipate this rate reduction will be offset by volume increases from the
continued build-out of our PCS network and subscriber growth, resulting in
greater overall roaming revenue and expense in the future.
Equipment revenues for the six months ended June 30, 2002, were
approximately $4.0 million, compared to approximately $2.6 million for the six
months ended June 30, 2001, an increase of $1.4 million. The increase in
equipment revenues is the result of an increase in the number of handsets sold,
somewhat offset by a lower price per unit.
30
LANDLINE TELEPHONE SERVICES
The following table sets forth the revenue components of the landline
telephone services segment for the six months ended June 30:
2002 2001 $ change % change
------------- ------------ ----------- ----------
(Dollars in thousands)
Basic local, long-distance and other landline. $ 9,351 $ 9,928 $ (577) (6%)
Network access................................ 11,331 9,040 2,291 25%
Long-distance service revenue decreased for the six months ended June 30,
2002, as the Company continues to see lower usage for long-distance service. We
expect this trend to continue for the foreseeable future, as more customers use
wireless devices where long distance is included for one monthly fee. The
increase in network access is due to a recent ruling by the United States Court
of Appeals that deals with a similar landline telecommunications company and its
related carrier access rates. As a result of this ruling, the Company recognized
an additional $2.1 million of revenue during the second quarter that had
previously been set aside to settle future over earnings claims by other
carriers.
OTHER REVENUES
The following table sets forth the revenue components of the other revenues
segment for the six months ended June 30:
2002 2001 $ change % change
------------- ------------ ----------- ------------
(Dollars in thousands)
Internet access services..................... $ 1,625 $ 1,590 $ 35 2%
Equipment systems, information services, and
other revenues.......................... 2,542 1,890 652 34%
Other revenues were impacted by increased VDSL revenue as we continue to
build our customer base.
OPERATING EXPENSES
Cost of goods sold. Cost of goods sold for the six months ended June 30,
2002, was approximately $8.9 million, compared to approximately $4.9 million for
the six months ended June 30, 2001, an increase of approximately $4.0 million.
For competitive and marketing reasons, we have sold handsets to our customers
below our cost and expect to continue to sell handsets at a price below our cost
for the foreseeable future.
Cost of services. Cost of services for the six months ended June 30, 2002,
was approximately $84.5 million, compared to approximately $46.2 million for the
six months ended June 30, 2001, an increase of approximately $38.3 million. Of
the increase, approximately $37.9 million was related to Horizon PCS, while
Chillicothe Telephone and Horizon Technology increased by approximately
$400,000, which was related to the continued installation and programming
expenses associated with our VDSL service.
Horizon PCS' increase in cost of services reflects the increase in Sprint
PCS roaming expense and long distance charges of approximately $11.7 million,
the increase in network operations, including tower lease expense, circuit costs
and payroll expense of approximately $11.5 million, increased customer care,
activations and billing expense, of approximately $7.1 million, an increase in
costs incurred under our network services agreement with the Alliances of
approximately $6.0 million and other variable expenses, including
interconnection and national platform expenses, of approximately $1.6 million.
Selling and marketing expenses. Selling and marketing expenses rose to
approximately $26.8 million for the six months ended June 30, 2002 compared to
approximately $18.1 million for the same period in 2001, an increase of
approximately $8.7 million. Horizon PCS' increase was approximately $8.5
million, while Chillicothe Telephone and Horizon Technology were essentially
flat, increasing by approximately $200,000.
31
Horizon PCS' increase reflects the increase in the costs of operating 40
retail stores in 2002 compared to 21 at the end of the second quarter of 2001.
The costs include marketing and advertising in our sales territory of
approximately $4.8 million, the increase in subsidies on handsets sold by third
parties of approximately $2.0 million and the increase in commissions paid to
third parties of approximately $1.7 million. We expect selling and marketing
expense to increase in the aggregate as we expand our coverage, launch
additional stores and add customers.
General and administrative expenses. General and administrative expenses
rose by approximately $8.1 million to approximately $26.7 million for the six
months ended June 30, 2002, compared to the same period last year. Horizon PCS'
increase was approximately $7.3 million which reflects an increase in the
provision of uncollectible accounts of approximately $5.3 million, primarily due
to NDASL customers and an increase in the Sprint PCS management fee of
approximately $3.3 million, as a result of higher subscriber revenues in 2002,
offset by a decrease in other general expenses of approximately $1.3 million.
During the second quarter of 2001, Horizon PCS recognized approximately $1.3
million of legal and consulting expenses related to the exploration of strategic
business alternatives. Chillicothe Telephone and Horizon Technology's general
and administrative expenses increased by approximately $800,000 primarily due to
additional payroll and other general corporate expenses.
Non-cash compensation expense. For the six months ended June 30, 2002 and
2001, we recorded stock-based compensation expense of approximately $200,000 and
$900,000, respectively. This compensation expense is the amortization of the
value of stock options granted in November 1999.
Depreciation and amortization expense. Depreciation and amortization
expenses increased by approximately $14.0 million to a total of $25.4 million in
2002. The increase reflects the continuing construction of our PCS network as
well as capital additions for VDSL and other telephone services. During 2002,
Horizon PCS launched switches in Tennessee and Pennsylvania and decommissioned
some switching equipment in Chillicothe, Ohio. As a result, approximately $6.2
million of switching equipment is considered an impaired asset as defined by
SFAS No. 144. Accordingly, depreciation expense for the three and six months
ended June 30, 2002, included approximately $3.5 million of expense related to
accelerated depreciation on the impaired assets.
During 2002, Horizon PCS launched wireless switches in Tennessee and
Pennsylvania and disconnected some switching equipment in Chillicothe, Ohio. As
a result, approximately $6.2 million of switching equipment is considered an
impaired asset as defined by SFAS No. 144. Accordingly, depreciation expense for
the three and six months ended June 30, 2002, includes approximately $3.5
million of expense related to accelerated depreciation on the impaired assets.
In addition, since our acquisition of Bright PCS was accounted for as a
purchase transaction, amortization has increased as a result of amortizing the
related intangible assets. Amortization expense of the intangible asset was
approximately $900,000 during the six months ended June 30, 2002 and 2001.
Related goodwill amortization was approximately $200,000 during the six months
ended June 30, 2001. Goodwill amortization ceased as of December 31, 2001, with
the adoption of SFAS No. 142. See "Recent Accounting Pronouncements" below.
Amortization expense also includes amortization of an intangible asset
recorded in September 2000, related to the new markets granted to us by Sprint
PCS. We agreed to grant warrants to purchase shares of Horizon PCS' common stock
to Sprint PCS in exchange for the right to provide service in additional
markets. The warrants will be issued to Sprint PCS at the earlier of an initial
public offering of Horizon PCS' common stock or July 31, 2003. The intangible
asset is being amortized over the remaining term of the Sprint PCS management
agreement, resulting in approximately $800,000 of amortization expense per year.
Amortization expense related to this intangible asset was approximately $400,000
for each of the six months ended June 30, 2002 and 2001.
Interest expense, net. Interest expense for the six months ended June 30,
2002, was approximately $29.1 million, compared to approximately $13.8 million
for the six months ended June 30, 2001. The increase in interest expense was a
result of our additional debt outstanding during the six months ended June 30,
2002, compared to the same period in 2001.
Interest expense on Chillicothe Telephone's line of credit and term loans
was approximately $1.0 million for the six months ended June 30 2002. As a
result of a lower interest rate environment in 2002 compared to the first half
of 2001, interest expense on Chillicothe Telephone's line of credit decreased
approximately $200,000 for the six months ended June 30, 2002. Chillicothe
32
Telephone's line of credit accrues interest on the outstanding balance at a
variable rate tied to LIBOR (3.39% as of June 30, 2002 based on LIBOR plus
155-basis points) and is due and payable every ninety days. The outstanding
balance on the line of credit at June 30, 2002, was $18.4 million compared to
$15.3 million at June 30, 2001. At June 30, 2002, the balance on Chillicothe
Telephone's term loans was $20.0 million including current maturities and the
weighted average rate was 6.66%.
Interest on Horizon PCS' outstanding balance of the secured credit facility
accrues at LIBOR plus a specified margin. On June 29, 2001, Horizon PCS agreed
to several changes in the secured credit facility including a 25-basis point
increase in the margin on the base interest rate. At June 30, 2002, the interest
rate on the $105.0 million term loan A borrowed under the secured credit
facility was 5.87%, while the interest rate on the $50.0 million term loan B was
6.09%. Interest expense on the secured credit facility was approximately $3.9
million and approximately $2.5 million for the six months ended June 30, 2002
and 2001, respectively.
Horizon PCS accrues interest at a rate of 14.00% annually on the discount
notes issued in September 2000 and will pay interest semi-annually in cash
beginning in October 2005. Unaccreted interest expense on the discount notes was
approximately $122.8 million at June 30, 2002. Interest expense on the discount
notes was approximately $13.2 million and $11.5 million during the six months
ended June 30, 2002 and 2001, respectively.
On June 15, 2002, Horizon PCS began making semi-annual interest payments on
its senior notes issued in December 2001, at an annual rate of 13.75%. Interest
expense accrued on the senior notes was approximately $12.0 million during the
six months ended June 30, 2002. Under the terms of the senior notes, cash to
cover the first four semi-annual interest payments was placed in an escrow
account.
Interest expense also includes approximately $1.2 million and $400,000
during the six months ended June 30, 2002 and 2001, respectively, of
amortization from the deferred financing fees related to Horizon PCS' secured
credit facility, its discount notes and its senior notes. Also contributing to
the increase in interest expense during the six months ended June 30, 2002, was
approximately $1.0 million in commitment fees Horizon PCS paid on the unused
portion of its secured credit facility.
Capitalized interest during the six months ended June 30, 2002 and 2001, was
approximately $3.2 million in each period. We expect our interest expense to
increase in the future as we borrow under our secured credit facility to fund
the PCS network build-out and operating losses.
Subsidiary preferred stock dividends. Horizon PCS' convertible preferred
stock pays a stock dividend at the rate of 7.5% per annum, payable
semi-annually, commencing May 1, 2001. The dividends are paid with additional
shares of convertible preferred stock. Through June 30, 2002, Horizon PCS had
issued an additional 3,245,134 shares of convertible preferred stock in payment
of stock dividends, including 1,060,201 shares that were issued on May 1, 2002.
Interest income and other, net. Interest income and other for the six months
ended June 30, 2002, was approximately $1.0 million compared to approximately
$4.4 million in 2001 and consisted primarily of interest income. This decrease
of $3.4 million was due primarily to a lower average balance of cash investments
during the second quarter of 2002, as compared to the same period in 2001 and
due to a lower short-term interest rate environment in 2002.
Income tax expense. Income tax expense for the six months ended June 30,
2002, was approximately $1.2 million compared to approximately $1.0 million in
2001. Before September 26, 2000, Horizon PCS was included in the consolidated
Federal income tax return of Horizon Telcom. Horizon PCS provided for Federal
income taxes on a pro-rata basis, consistent with a consolidated tax-sharing
agreement. As a result of the sale of Horizon PCS convertible preferred stock in
September 2000, Horizon PCS is not able to participate in the tax sharing
agreement with its parent nor is Horizon Telcom able to recognize any net
operating loss benefits from Horizon PCS. We expect to continue to record income
tax expense as a result of this tax deconsolidation. Horizon PCS is unable to
recognize any tax benefits from its net operating losses until it generates
taxable income. Thus, Horizon PCS filed a separate Federal income tax return for
33
the short period after the deconsolidation through December 31, 2000 and will
file a separate return for all subsequent periods.
Minority interest in loss. As part of the acquisition of Bright PCS, the
former members of Bright PCS have approximately an 8% ownership in Horizon PCS,
excluding the impact of the possible conversion of convertible preferred stock
and exercise of options and warrants. Horizon Telcom accounts for this ownership
by recording the portion of net loss attributable to the minority shareholders
as minority interest in loss in the accompanying condensed consolidated
statements of operations. There will not be any further allocations to minority
interests until such time as Horizon PCS becomes profitable and any unallocated
losses to minority interests are offset with income in future periods.
Other comprehensive income (loss). During the first six months of 2002, the
Company recorded an unrealized loss, net of associated tax, of $1.9 million on
its investment in marketable securities classified as available-for-sale. The
equity security held is VeriSign, Inc., whose market value has declined
significantly during the past year, and is reflective of the volatility in the
general market for technology stocks over the past six to twelve months.
During 2001, Horizon PCS entered into two two-year interest rate swaps,
effectively fixing the $50.0 million of its term loan B borrowed under the
secured credit facility. We do not expect the effect of these swaps to have a
material impact to interest expense for the remainder of their lives. Horizon
PCS recovered approximately $100,000 of previously unrealized losses in other
comprehensive income during the first half of 2002.
LIQUIDITY AND CAPITAL RESOURCES
In 1996, Horizon Telcom was formed as part of a reorganization of
Chillicothe Telephone and several of its affiliates. Since that time, Horizon
Telcom has met its needs for capital primarily by borrowing, by selling selected
businesses and assets, and by funds generated from operations. In 2000, Horizon
Telcom also formed Horizon PCS, to which it transferred its subsidiary Horizon
Personal Communications. In June 2000, Horizon PCS acquired the remaining 74% of
Bright PCS it did not own at that time. Horizon PCS also entered into several
major financing transactions in September 2000 and December 2001.
For our debt outstanding at June 30,2002, the following table presents the
estimated future outstanding long-term debt at the end of each year and future
required annual principal payments for each year then ended associated with our
financing based on our projected level of long-term indebtedness:
(Dollars in millions) Years Ending December 31,
-------------------------------------------------------------------
2002 2003 2004 2005 2006 Thereafter
------------ ------------ ------------ ----------- ------------ -----------
Horizon PCS:
Secured credit facility,
due 2008....................... $ 155.0 $ 155.0 $ 155.0 $ 155.0 $ 155.0 $ 155.0
Variable interest rate (1) . 5.94% 5.94% 5.94% 5.94% 5.94% 5.94%
Principal payments.......... $ - $ - $ 8.3 $ 20.2 $ 26.8 $ 99.7
Discount notes, due 2010 (2)..... $ 186.3 $ 217.5 $ 253.1 $ 283.7 $ 286.1 $ 295.0
Fixed interest rate......... 14.00% 14.00% 14.00% 14.00% 14.00% 14.00%
Principal payments.......... $ - $ - $ - $ - $ - $ 295.0
Senior notes, due 2011........... $ 175.0 $ 175.0 $ 175.0 $ 175.0 $ 175.0 $ 175.0
Fixed interest rate......... 13.75% 13.75% 13.75% 13.75% 13.75% 13.75%
Principal payments.......... $ - $ - $ - $ - $ - $ 175.0
Chillicothe Telephone:
1998 Senior notes, due 2018...... $ 12.0 $ 12.0 $ 12.0 $ 12.0 $ 12.0 $ 12.0
Fixed interest rate......... 6.62% 6.62% 6.62% 6.62% 6.62% 6.62%
Principal payments.......... $ - $ - $ - $ - $ - $ 12.0
1993 Senior notes, due 2005 (3).. $ 6.0 $ 4.0 $ 2.0 $ - $ - $ -
Fixed interest rate......... 6.72% 6.72% 6.72% - - -
Principal payments.......... $ 2.0 $ 2.0 $ 2.0 $ 2.0 $ - $ -
34
(1) Interest rate on the secured credit facility equals the LIBOR plus a
margin that varies from 400 to 450-basis points. At June 30, 2002,
$50.0 million was effectively fixed at 8.53% through an interest rate
swap discussed in "Item 3. Quantitative and Qualitative Disclosures
About Market Risk." The interest rate is assumed to equal 5.94% for all
periods ($50.0 million at 6.09% and $105.0 million at 5.87%).
(2) Face value of the discount notes is $295.0 million. End of year
balances presented here are net of the discount and assume accretion of
the discount as interest expense at an annual rate of 14.00%.
(3) In August 2002, Chillicothe Telephone will issue $30,000,000 of 6.64%,
10 year Senior notes due in full July 1, 2012. The proceeds of the
offering will be used to retire both the short term line of credit
with Huntington National Bank ($18,400,000 at June 30, 2002) and the
1993 Senior Notes ($8,000,000 at June 30, 2002). The remaining funds
will be used for general corporate purposes.
At June 30, 2002, we had cash and cash equivalents of approximately $133.4
million including Horizon PCS deposit requirements discussed above and working
capital of approximately $124.8 million. At December 31, 2001, we had cash and
cash equivalents of approximately $127.2 million and working capital of
approximately $104.5 million. The increase in cash and cash equivalents of
approximately $6.2 million is attributable to the $105.0 million draw on Horizon
PCS' secured credit facility offset by the funding of our net loss of
approximately $44.2 million (this loss also includes certain non-cash charges)
and funding our capital expenditures of approximately $54.6 million for the six
months ended June 30, 2002.
Net cash used in operating activities was approximately $35.0 million for
the six months ended June 30, 2002. This reflects the continuing use of cash for
our operations to build Horizon PCS' customer base, including but not limited to
providing service in our markets and the costs of acquiring new customers.
Net cash used in investing activities was approximately $59.6 million for
the six months ended June 30, 2002, reflecting the continuing build-out of the
Horizon PCS network as well as the deployment of capital necessary to offer VDSL
service. At June 30, 2002, we operated approximately 757 cell sites in our PCS
network (an additional 494 cell sites were operated by the Alliances in our
territories). This represents an addition of approximately 153 sites during the
six months ended June 30, 2002, and approximately 310 since June 30, 2001. In
addition to the sites, we have increased the number of switching stations in our
territory and have increased our number of retail stores from 38 at the end of
2001, to 40 at June 30, 2002. We will incur additional capital expenditures as
we complete the build-out of our network, including the launch of additional PCS
retail stores, completing additional cell sites and expanding capacity at our
switches as needed. We are also upgrading our network to provide 3G (third
generation) wireless service, which will increase voice capacity and allow for
high-speed data transmission.
During the second quarter of 2002, approximately $6.5 million of cash
equivalents matured and were reinvested in short-term debt securities. All of
the investments mature within one year of June 30, 2002.
Net cash provided by financing activities for the six months ended June 30,
2002, was approximately $100.9 million consisting primarily of the March 2002
draw on Horizon PCS' term loan A required under the secured credit facility. We
incurred $2.5 million of deferred financing fees related to the amendment of
Horizon PCS' covenants under its secured credit facility.
Horizon PCS' secured credit facility includes financial covenants that must
be met each quarter. Horizon PCS did not meet the covenant for EBITDA for the
first quarter of 2002. As a result of higher than expected gross and net
additions to Horizon PCS subscribers for the quarter, Horizon PCS incurred
additional expenses to add those customers. Although Horizon PCS ultimately
benefit from the revenues generated by new subscribers, Horizon PCS incurs
one-time expenses associated with new subscribers, including commissions,
handset subsidies, set up costs for the network and marketing expenses. As a
result, these new subscriber costs negatively affect EBITDA in the short-term
during the period of the addition of new subscribers, which led to
non-compliance with the EBITDA covenant for the first quarter of 2002.
On June 27, 2002, Horizon PCS entered into a fourth amendment to its secured
credit facility with its bank group. The amendment adjusts certain financial
covenants and increases the margin on the base interest rate by 25-basis points
to LIBOR plus 400 to 450-basis points, while also providing for the payment of
fees to the banking group, an increase in post-default interest rates, a new
financial covenant regarding minimum available cash, additional prepayment
requirements, restrictions on Horizon PCS' borrowings under the remaining $95.0
million line of credit and deposit requirements on the $105.0 million borrowed
under the secured credit facility in March 2002.
35
The amendment and details on the requirements and restrictions were filed
with the Company's Form 8-K on June 27, 2002. The following table details the
minimum balance requirements placed on Horizon PCS' $105.0 million term loan A
borrowed in March 2002 and classified as cash and cash equivalents on the
accompanying condensed consolidated balance sheets:
Deposit balance
requirement
------------------
At June 30, 2002....................................... $ 105,000,000
July 1, 2002, through August 15, 2002.................. 88,000,000
August 16, 2002, through September 30, 2002............ 71,000,000
October 1, 2002, through November 15, 2002............. 63,000,000
November 16, 2002, through December 31, 2002........... 55,000,000
January 1, 2003, through February 15, 2003............. 33,000,000
February 16, 2003, through March 31, 2003.............. 11,000,000
April 1, 2003, through May 15, 2003.................... 5,500,000
On December 7, 2001, Horizon PCS received $175.0 million from the issuance
of unsecured senior notes. Interest payments on the senior notes are made
semi-annually at 13.75%. A portion of the offering proceeds was placed in an
escrow account to fund the first four semi-annual interest payments and is
classified as restricted cash. The first interest payment was made on June 15,
2002.
At June 30, 2002, Horizon PCS had a $95.0 million line of credit committed
under its secured credit facility. We believe the available borrowings under the
secured credit facility will be adequate to fund the network build-out,
anticipated operating losses and working capital requirements until Horizon PCS
achieves positive EBITDA, which we now expect to occur in first quarter of 2004.
We believe the increase in churn and subsequent write-offs of involuntary NDASL
deactivations combined with a slow down in activation growth during the second
quarter of 2002 has extended the time it will take to reach positive EBITDA. We
do not believe the restrictions on our future borrowings and required cash
deposits will result in material restrictions in our liquidity or our ability to
meet future anticipated working capital requirements.
Income from ongoing Horizon PCS operations and EBITDA are not measures of
financial performance under generally accepted accounting principles and should
not be considered alternatives to net income (loss) as measures of performance
or to cash flows as a measure of liquidity.
At June 30, 2002, Chillicothe Telephone had $11.6 million available to be
borrowed under its $30.0 million line of credit.
The Note Purchase Agreement for the 1993 Senior Notes of Chillicothe
Telephone contains a covenant that restricts the amount of investments that
Chillicothe Telephone may make in loans, stock or other securities of another
company. For the quarter ended June 30, 2002, Chillicothe Telephone failed to
comply with the covenant related to these restricted investments, which
constitutes an event of default under the note purchase agreement. The Company
has entered into a waiver agreement with the noteholders to remedy the
non-compliance. The waiver was signed by both parties on August 8, 2002.
In August 2002, Chillicothe Telephone will issue $30,000,000 of 6.64%, 10
year Senior notes due in full July 1, 2012. The proceeds of the offering will be
used to retire both the short term line of credit with Huntington National Bank
($18,400,000 at June 30, 2002) and the 1993 Senior Notes ($8,000,000 at June 30,
2002). The remaining funds will be used for general corporate purposes.
For the year ended December 31, 2002, we anticipate our annual funding
needs will be approximately $165.0 million, of which approximately $70.0 million
to $85.0 million will be used for capital expenditures; the remainder will be
used to fund working capital and operating losses. The terms of their respective
credit agreements prohibit or severely restrict the ability of Chillicothe
Telephone and Horizon PCS to provide funds to their affiliates in the event the
affiliate experiences a shortfall. The funds required to build out the network
and to fund operating losses, working capital needs and other capital
requirements may vary materially from our estimates and additional funds may be
36
needed as a result of unforeseen delays, cost overruns, unanticipated expenses,
regulatory changes, engineering design changes and required technological
upgrades and other technological risks.
Other future cash expenditures that may require additional borrowings
include:
O expanding the coverage within our existing operating markets or
improving call quality with fill-in coverage;
O opening additional retail stores, beyond our current plan of 50
stores;
O mergers or acquisitions of other Sprint PCS affiliates or other
compatible PCS carriers;
O the grant to us by Sprint PCS of additional markets under our Sprint
PCS agreements; and/or
O expanding our network, if economically justifiable, by exercising our
right to build our own network in our markets which are covered by our
network services agreement with the Alliances under the terms of that
amended agreement.
If we are unable to obtain any necessary additional funding or if we incur
further restrictions on the availability of our current funding and Horizon PCS
is unable to complete its network build-out and upgrade, the result may be a
termination of our Sprint PCS agreement; we will no longer be able to offer
Sprint PCS products and services. In this event, Sprint PCS may purchase our
operating assets or capital stock under terms defined in our agreements with
Sprint PCS. Also, any delays in our build-out may result in penalties under our
Sprint PCS agreement, as amended.
Other factors that may impact liquidity are:
O we may not be able to sustain our growth or obtain sufficient revenue
to achieve and sustain positive cash flow from operations or
profitability;
O we may experience a higher churn rate, which could result in lower
revenue;
O new customers may be of lower credit quality, which may require a
higher provision for doubtful accounts;
O increased competition causing declines in ARPU;
O our failure to comply with restrictive financial and operational
covenants under the secured credit facility; and
O our upgrade to 3G services, due to which we have incurred significant
capital expenditures, may not be successful in the marketplace and may
not result in incremental revenue.
SEASONALITY
Our local and long-distance telephone, Internet and data services businesses
are not subject to seasonal influences. Our wireless telephone business is
subject to seasonality because the wireless industry is heavily dependent on
calendar fourth quarter results. Among other things, that industry relies on
significantly higher customer additions and handset sales in the calendar fourth
quarter as compared to the other three calendar quarters. A number of factors
contribute to this trend, including:
O the increasing use of retail distribution, which is more dependent
upon the year-end holiday shopping season;
O the timing of new product and service announcements and introductions;
O competitive pricing pressures; and
O aggressive marketing and promotions.
INFLATION
We believe that inflation has not had an adverse effect on our results of
operations.
37
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2001, the FASB issued SFAS No. 141, "Business Combinations" and
SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 addresses
financial accounting and reporting for all business combinations and requires
that all business combinations entered into subsequent to June 2001 be recorded
under the purchase method. This statement also addresses financial accounting
and reporting for goodwill and other intangible assets acquired in a business
combination at acquisition. SFAS No. 142 addresses financial accounting and
reporting for intangible assets acquired individually or with a group of other
assets at acquisition. This statement also addresses financial accounting and
reporting for goodwill and other intangible assets subsequent to their
acquisition.
These statements were adopted by the Company on January 1, 2002. Goodwill
amortization ceased as of December 31, 2001, and the Company is required to
complete an impairment test of the remaining goodwill balance annually (more
frequently if impairment indicators arise). As of June 30, 2002, Horizon PCS has
goodwill of approximately $7,191,000, net of accumulated amortization, related
to the acquisition of Bright PCS. See Note 9 of "Notes to Interim Condensed
Consolidated Financial Statements" for additional financial information.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." This statement addresses financial accounting and
reporting for obligations associated with the retirements of tangible long-lived
assets and the associated asset retirement costs. It applies to legal
obligations associated with the retirement of long-lived assets that result from
the acquisition, construction, development and (or) the normal operation of a
long-lived asset. The Company will adopt this statement effective January 1,
2003. The adoption is not expected to have a material effect on the Company's
financial position, results of operations or cash flows.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 addresses financial
accounting and reporting for the impairment of long-lived assets. The statement
supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed Of," and the accounting and reporting
provisions of APB Opinion No. 30. SFAS No. 144 removes goodwill from its scope,
as goodwill is addressed in the impairment test described above under SFAS No.
142. The Company adopted SFAS No. 144 on January 1, 2002. See Note 3 of the
accompanying "Notes to Interim Condensed Consolidated Financial Statements" for
disclosure on the impact of adoption of this statement.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." SFAS No. 145 addresses the accounting for gains and losses from
the extinguishments of debt, economic effects and accounting practices of
sale-leaseback transactions and makes technical corrections to existing
pronouncements. The Company will adopt SFAS No. 145 on July 1, 2002, and the
adoption is not expected to have a material effect on the Company's financial
position, results of operations or cash flows.
In June 2002 the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." This Statement addresses financial accounting
and reporting for costs associated with exit or disposal activities and
nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." Charges
relating to the exit of an activity or disposal of long-lived assets will be
recorded when they are incurred and measurable. Prior to SFAS No. 146, these
charges were accrued at the time of commitment to exit or dispose of an
activity. The Company has not yet determined the financial impact the adoption
of this pronouncement will have on its financial position or results of
operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not engage in commodity futures trading activities and do not enter
into derivative financial instruments for trading or other speculative purposes.
We also do not engage in transactions in foreign currencies that would expose us
to market risk. We manage the interest rate risk on our outstanding long-term
debt through the use of fixed and variable-rate debt and interest rate swaps.
38
In the normal course of business, our operations are exposed to interest
rate risk. Our primary interest rate risk exposure relates to (i) Horizon PCS'
variable-rate secured credit facility and Chillicothe Telephone's variable rate
line of credit, (ii) our ability to refinance our fixed-rate discount and senior
notes at maturity at market rates, and (iii) the impact of interest rate
movements on our ability to meet interest expense requirements and meet
financial covenants under our debt instruments.
In the first quarter of 2001, we entered into a two-year interest rate
swap, effectively fixing $25.0 million of the term loan borrowed under the
secured credit facility. In the third quarter of 2001, we entered into another
two-year interest rate swap effectively fixing another $25.0 million of the term
loan borrowed under the secured credit facility. The following table compares
the current market rates on the balances subject to the swap agreement:
(Dollars in millions) At June 30, 2002
--------------------------------------
Balance Market rate Swap rate
------- ----------- ---------
Swap 1................... $25.0 6.09% 9.40%
Swap 2................... $25.0 6.09% 7.65%
Since our swap interest rates are currently greater than the market interest
rates on our underlying debt, our results from operations currently reflect a
higher interest expense than had we not hedged our position. Since inception and
through June 30, 2002, we have recognized approximately $200,000 in losses due
to the ineffectiveness of these swaps in the consolidated statements of
operations. At June 30, 2002, the Company recognized approximately $700,000 in
other comprehensive losses on the balance sheet.
While we cannot predict our ability to refinance existing debt, we continue
to evaluate our interest rate risk on an ongoing basis. If we do not renew our
swaps, or, if we do not hedge variable-rate incremental borrowings under our
secured credit facility, we will increase our interest rate risk, which could
have a material impact on our future earnings. As of June 30, 2002,
approximately 84% of our long-term debt is fixed-rate or is variable-rate that
has been swapped under fixed-rate hedges, thus reducing our exposure to interest
rate risk. A 100-basis point increase in interest rates would increase our
interest expense approximately $1.2 million.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Horizon PCS' secured credit facility includes financial covenants that must
be met each quarter. Horizon PCS did not meet the covenant for EBITDA for the
first quarter of 2002. As a result of higher than expected gross and net
additions to Horizon PCS subscribers for the quarter, Horizon PCS incurred
additional expenses to add those customers. Although Horizon PCS ultimately
benefits from the revenues generated by new subscribers, they incur one-time
expenses associated with new subscribers, including commissions, handset
subsidies, set up costs for the network and marketing expenses. As a result,
these new subscriber costs negatively affect EBITDA in the short-term during the
period of the addition of new subscribers, which led to non-compliance with the
EBITDA covenant for the first quarter of 2002.
On June 27, 2002, Horizon PCS obtained a waiver of the non-compliance with
the EBITDA covenant for the first quarter of 2002 and entered into an amendment
of the secured credit facility. The amended facility primarily adjusts certain
financial covenants and increases the margin on the base interest by 25-basis
points, while also providing for the payment of fees to the banking group, an
increase in post-default interest rates, a new financial covenant regarding
minimum available cash, additional prepayment requirements, restrictions on
Horizon PCS' borrowings under the remaining $95.0 million revolving credit
39
facility and deposit requirements on the $105.0 million borrowed under the
secured credit facility in March 2002.
The Note Purchase Agreement for the 1993 Senior Notes of Chillicothe
Telephone contains a covenant that restricts the amount of investments that
Chillicothe Telephone may make in loans, stock or other securities of another
company. For the quarter ended June 30, 2002, Chillicothe Telephone failed to
comply with the covenant related to these restricted investments, which
constitutes an event of default under the note purchase agreement. The Company
has entered into a waiver agreement with the noteholders to remedy the
non-compliance. The waiver was signed by both parties on August 8, 2002.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
On May 15, 2002, the Company held its Annual Meeting of Shareholders. The
following matter was voted upon:
1. The election of nine (9) directors to serve until the next Annual
Meeting of Stockholders and until their successors are elected and
have qualified.
The following table provides the number of votes cast for and withheld
as to the election of directors.
Name of Nominee Votes For Votes Withheld
- ---------------------------------- ------------------ ---------------------
Robert McKell..................... 89,372 1,180
Thomas McKell..................... 89,132 1,420
Jack E. Thompson.................. 89,367 1,185
Joseph S. McKell.................. 89,372 1,180
David McKell...................... 89,372 1,180
Helen M. Sproat................... 89,372 1,180
John E. Herrnstein................ 89,372 1,180
Joseph G. Kear.................... 89,372 1,180
Jerry B. Whited................... 89,372 1,180
ITEM 5. OTHER INFORMATION
RISK FACTORS
RISKS RELATED TO CHILLICOTHE TELEPHONE, LONG DISTANCE AND INTERNET BUSINESS
The information set forth under this heading describes risk factors relating
to the business of our wholly-owned subsidiaries the Chillicothe Telephone
Company, Horizon Technology and Horizon Services. References under this heading
to "we," "us" and "our" are to those subsidiaries.
SIGNIFICANT COMPETITION IN TELECOMMUNICATIONS SERVICES IN OUR MARKETS MAY CAUSE
US TO LOSE CUSTOMERS.
We face, or will face, significant competition in the markets in which we
currently provide local telephone, long distance, data and Internet services.
Many of our competitors are substantially larger and have greater financial,
technical and marketing resources than we do. In particular, larger competitors
have certain advantages over us, which could cause us to lose customers and
impede our ability to attract new customers, including:
O long-standing relationships and greater name recognition with
customers;
O financial, technical, marketing, personnel and other resources
substantially greater than ours;
O more capital to deploy services; and
O potential to lower prices of competitive services.
40
These factors place us at a disadvantage when we respond to our competitors'
pricing strategies, technological advances and other initiatives. Additionally,
our competitors may develop services that are superior to ours or that achieve
greater market acceptance.
We face competition from other current and potential market entrants,
including:
O domestic and international long distance providers seeking to enter,
re-enter or expand entry into our local communications marketplace;
O other domestic and international competitive communications providers,
resellers, cable television companies and electric utilities; and
O providers of broadband and Internet services.
A continuing trend toward combinations and strategic alliances in the
communications industry could give rise to significant new competitors. This
could cause us to lose customers and impede our ability to attract new
customers.
WE MAY NOT BE ABLE TO SUCCESSFULLY INTEGRATE NEW TECHNOLOGIES OR RESPOND
EFFECTIVELY TO CUSTOMER REQUIREMENTS.
The communications industry is subject to rapid and significant changes in
technology, frequent new service introductions and evolving industry standards.
We cannot predict the effect of these changes on us or our industry.
Technological developments may reduce the competitiveness of our networks and
require unbudgeted upgrades or the procurement of additional products that could
be expensive and time consuming. If we fail to adapt successfully to
technological changes or obsolescence or fail to obtain access to important new
technologies, we could lose customers and be limited in our ability to attract
new customers.
If our back office and customer care systems are unable to meet the needs of
our customers, we may lose customers.
Sophisticated back office processes and information management systems are
vital to our anticipated growth and our ability to achieve operating
efficiencies. We are dependent on third-party vendors for billing, service and
customer support systems. We cannot assure you that these systems will perform
as expected as we increase our number of customers. If they fail to perform as
expected, we could lose customers. The following could prevent our back office
and customer care systems from meeting the needs of our customers:
O failure of third-party vendors to deliver products and services in a
timely manner at acceptable costs;
O our failure to identify key information and processing needs;
O our failure to integrate products or services effectively;
O our failure to upgrade systems as necessary; or
O our failure to attract and retain qualified systems support personnel.
Furthermore, as our suppliers revise and upgrade their hardware, software
and equipment technology, we could encounter difficulties in integrating this
new technology into our business or find that such new hardware, software and
technology is not appropriate for our business. In addition, our right to use
such hardware, software and technology depends upon license agreements with
third party vendors. Vendors may cancel or elect not to renew some of these
agreements, which may adversely affect our business.
BECAUSE WE OPERATE IN A HEAVILY REGULATED INDUSTRY, CHANGES IN REGULATION COULD
HAVE A SIGNIFICANT EFFECT ON OUR REVENUES AND COMPLIANCE COSTS.
We are subject to significant regulation that could change in a manner
adverse to us. We operate in a heavily regulated industry, and the majority of
our revenues generally have been supported by regulations, including in the form
of support for the provision of telephone services in rural areas. Laws and
regulations applicable to us and our competitors may be, and have been,
41
challenged in the courts, and could be changed by Congress or regulators at any
time. In addition, any of the following have the potential to have a significant
impact on us:
RISK OF LOSS OR REDUCTION OF NETWORK ACCESS CHARGE REVENUES. Approximately
12% of the Company's total revenues for the year ended December 31, 2001,
came from network access charges, which are paid to us by intrastate
carriers and interstate long distance carriers for originating and
terminating calls in the regions we serve. The amount of access charge
revenues that we receive is calculated based on guidelines set by federal
and state regulatory bodies, and such guidelines could change at any time.
The FCC continues to reform the federal access charge system. States often
mirror these federal rules in establishing intrastate access charges. It is
unknown at this time how changes to the FCC's access charge regime will
affect us. Federal policies being implemented by the FCC strongly favor
access charge reform, and our revenues from this source could be at risk.
Regulatory developments of this type could adversely affect our business.
RISK OF LOSS OR REDUCTION OF UNIVERSAL SERVICE SUPPORT. We receive Universal
Service Support Fund, or USSF, revenues to support the high cost of our
operations in rural markets. If Chillicothe Telephone were unable to receive
support from the Universal Service Support Fund, or if such support was
reduced, Chillicothe Telephone would be unable to operate as profitably as
before such reduction.
In addition, potential competitors generally cannot, under current laws,
receive the same universal service support enjoyed by Chillicothe Telephone.
Chillicothe Telephone therefore enjoys a significant competitive advantage,
which could, however, be removed by regulators at any time. The Telecom Act
provides that competitors could obtain the same support as we do if the
Public Utilities Commission of Ohio determines that granting such support to
competitors would be in the public interest. If such universal service
support were to become available to potential competitors, we might not be
able to compete as effectively or otherwise continue to operate as
profitably in our Chillicothe Telephone markets. Any shift in universal
service regulation could, therefore, have an adverse effect on our business.
The method for calculating the amount of such support could change in 2002.
It is unclear whether the chosen methodology will accurately reflect the
costs incurred by Chillicothe Telephone, and whether it will provide for the
same amount of universal service support that Chillicothe Telephone enjoyed
in the past. The outcome of any of these proceedings or other legislative or
regulatory changes could affect the amount of universal service support that
we receive, and could have an adverse effect on our business.
RISK OF LOSS OF PROTECTED STATUS UNDER INTERCONNECTION RULES. Chillicothe
Telephone takes the position that it does not have to comply with more
burdensome requirements in the Telecommunications Act of 1996 (the "Telecom
Act") governing the rights of competitors to interconnect to our traditional
telephone companies' networks due to our status as a rural telephone
company. If state regulators decide that it is in the public's interest to
impose these interconnection requirements on us, more competitors could
enter our traditional telephone markets than are currently expected and we
could incur additional administrative and regulatory expenses as a result of
such newly imposed interconnection requirements.
RISKS POSED BY COSTS OF REGULATORY COMPLIANCE. Regulations create
significant compliance costs for us. Our subsidiary that provides intrastate
services is also generally subject to certification, tariff filing and other
ongoing regulatory requirements by state regulators. Challenges to these
tariffs by regulators or third parties could cause us to incur substantial
legal and administrative expenses.
Regulatory changes in the telecommunications industry involve uncertainties,
and the resolution of these uncertainties could adversely affect our business by
facilitating greater competition against us, reducing potential revenues or
raising our costs.
The Telecom Act provides for significant changes in the telecommunications
industry, including the local telecommunications and long distance industries.
This federal statute and the related regulations remain subject to judicial
review and additional rulemakings of the FCC, thus making it difficult to
predict what effect the legislation will have on us, our operations and our
competitors. Several regulatory and judicial proceedings have recently
concluded, are underway or may soon be commenced, that address issues affecting
our operations and those of our competitors, which may cause significant changes
42
to our industry. We cannot predict the outcome of these developments, nor can we
assure that these changes will not have a material adverse effect on us.
RISKS RELATED TO HORIZON PCS, OUR WIRELESS PERSONAL COMMUNICATIONS SERVICES
BUSINESS
WE HAVE NOT HAD ANY PROFITABLE YEARS IN THE PAST FIVE YEARS, AND WE MAY NOT
ACHIEVE OR SUSTAIN OPERATING PROFITABILITY OR POSITIVE CASH FLOW FROM OPERATING
ACTIVITIES.
At Horizon PCS, we expect to incur significant operating losses and to
generate significant negative cash flow from operating activities until 2004
while we continue to construct our network and grow our customer base. Our
operating profitability will depend upon many factors, including our ability to
market our services, achieve our projected market penetration and manage
customer turnover rates. If we do not achieve and maintain operating
profitability and positive cash flow from operating activities on a timely
basis, we may not be able to meet our debt service requirements, and Horizon
Telcom could lose all or part of its investment in Horizon PCS.
IF WE FAIL TO COMPLETE THE BUILD-OUT OF OUR NETWORK, SPRINT PCS MAY TERMINATE
THE SPRINT PCS AGREEMENTS AND WE WOULD NO LONGER BE ABLE TO OFFER SPRINT PCS
PRODUCTS AND SERVICES FROM WHICH WE GENERATE SUBSTANTIALLY ALL OUR REVENUES.
Our long-term affiliation agreements with Sprint PCS, which we refer to as
the Sprint PCS agreements, require us to build and operate the portion of the
Sprint PCS network located in our territory in accordance with Sprint PCS'
technical specifications and coverage requirements. The agreements also require
us to provide minimum network coverage to the population within each of the
markets which make up our territory by specified dates.
Under our original Sprint PCS agreements, we were required to complete the
build-out in several of our markets in Pennsylvania and New York by December 31,
2000. Sprint PCS and HPC agreed to an amendment of the build-out requirements,
which extended the dates by which we were to launch coverage in several markets.
The amended Sprint PCS agreement provides for monetary penalties to be paid by
us if coverage is not launched by these extended contract dates. The amounts of
the penalties depends on the market and length of delay in launch, and in some
cases, whether the short fall relates to an initial launch in the market of
completion of the remaining build out. The penalties must be paid in cash or, if
both Horizon PCS and Sprint PCS agree, in shares of Horizon PCS stock.
Under the amended Sprint PCS agreement, portions of the New York, Sunbury,
Williamsport, Oil City, Dubois, Erie, Meadville, Sharon, Olean, Jamestown,
Scranton, State College, Stroudsburg, Allentown and Pottsville markets were
required to be completed and launched by October 31, 2001. Although we have
launched service in portions of each of these markets, we have not completed all
of the build-out requirements. We notified Sprint PCS in November 2001 that it
is our position that the reasons for the delay constitute events of "force
majeure" as described in the Sprint PCS agreements and that, consequently, no
monetary penalties or other remedies would be applicable. The delay has been
primarily caused due to delays in obtaining the required backhaul services from
local exchange carriers and zoning and other approvals from governmental
authorities. On January 30, 2002, Sprint PCS notified us that, as a result of
these force majeure events, it does not consider our build-out delay to be a
breach of the Sprint PCS agreement. Horizon PCS has agreed to use commercially
reasonable efforts to complete the build-out by June 30, 2002 for most of these
markets. Horizon PCS has not been able to complete some of the sites in some
markets due to continuing force majeure issues.
We will require additional expenditures of significant funds for the
continued development, construction, testing, deployment and operation of our
network. These activities are expected to place significant demands on our
managerial, operational and financial resources. A failure to meet our build-out
requirements for any of our markets, or to meet Sprint PCS' technical
requirements, would constitute a breach of the Sprint PCS agreements that could
lead to their termination if not cured within the applicable cure period. If
Sprint PCS terminates these agreements, we will no longer be able to offer
Sprint PCS products and services.
43
OUR SUBSTANTIAL INDEBTEDNESS COULD ADVERSELY AFFECT OUR FINANCIAL HEALTH AND
PREVENT US FROM FULFILLING OUR LONG-TERM DEBT OBLIGATIONS.
As of June 30, 2002, Horizon PCS' total debt outstanding was $625.0 million,
comprised of $155.0 million borrowed under its secured credit facility, $175.0
million due under its senior notes issued in December 2001 and $295.0 million
represented by its discount notes (which are reported on the balance sheet at
June 30, 2002, net of a discount of approximately $122.8 million).
Our substantial debt will have a number of important consequences, including
the following:
O we may not have sufficient funds to pay interest on, and principal of,
our debt;
O we have to dedicate a substantial portion of any positive cash flow
from operations to the payment of interest on, and principal of, our
debt, which will reduce funds available for other purposes;
O we may not be able to obtain additional financing for currently
unanticipated capital requirements, capital expenditures, working
capital requirements and other corporate purposes;
O some borrowings likely will be at variable rates of interest, which
will result in higher interest expense in the event of increases in
market interest rates;
O due to the liens on substantially all of our assets and the pledges of
equity ownership of our subsidiaries that secure our secured credit
facility, our lenders may control our assets upon a default;
O our debt increases our vulnerability to general adverse economic and
industry conditions;
O our debt limits our flexibility in planning for, or reacting to,
changes in our business and the industry in which we operate; and
O our debt places us at a competitive disadvantage compared to our
competitors that have less debt.
TO SERVICE OUR INDEBTEDNESS, WE WILL REQUIRE A SIGNIFICANT AMOUNT OF CASH. OUR
ABILITY TO GENERATE CASH DEPENDS ON MANY FACTORS BEYOND OUR CONTROL.
Our ability to make payments on and to refinance our indebtedness, and to
fund our network build-out, anticipated operating losses and working capital
requirements will depend on our ability to generate cash in the future. This, to
a certain extent, is subject to general economic, financial, competitive,
legislative, regulatory and other factors that are beyond our control.
We cannot be certain that our business will generate sufficient cash flow
from operations or that future borrowings will be available to us under our
secured credit facility in an amount sufficient to enable us to pay our
indebtedness or to fund our other liquidity needs. We may need to refinance all
or a portion of our indebtedness, including the notes, on or before maturity. We
may not be able to refinance any of our indebtedness on commercially reasonable
terms, or at all.
IF WE FAIL TO PAY OUR DEBT, OUR LENDERS MAY SELL OUR LOANS TO SPRINT PCS GIVING
SPRINT PCS THE RIGHTS OF A CREDITOR TO FORECLOSE ON OUR ASSETS.
If the lenders accelerate the amounts due under our secured credit facility,
Sprint PCS has the right to purchase our obligations under that facility and
become a senior lender. To the extent Sprint PCS purchases these obligations,
Sprint PCS' interests as a creditor could conflict with ours. Sprint PCS' rights
as a senior lender would enable it to exercise rights with respect to our assets
and Sprint PCS' continuing relationship in a manner not otherwise permitted
under the Sprint PCS agreements.
IF SPRINT PCS TERMINATES THE SPRINT PCS AGREEMENTS, THE BUY-OUT PROVISIONS OF
THOSE AGREEMENTS MAY DIMINISH THE VALUATION OF OUR COMPANY.
Provisions of the Sprint PCS agreements could affect the valuation of
Horizon PCS, and decrease our ability to raise additional capital. If Sprint PCS
terminates these agreements, Sprint PCS may purchase our operating assets or
capital stock for 80% of the "Entire Business Value", as defined by the
44
agreement. If the termination is due to our breach of the Sprint PCS agreements,
the percent is reduced to 72% instead of 80%. Under our Sprint PCS agreements,
the Entire Business Value is generally the fair market value of our wireless
business valued on a going concern basis as determined by an independent
appraiser and assumes that we own the FCC licenses in our territory. In
addition, Sprint PCS must approve any change of control of our ownership and
consent to any assignment of the Sprint PCS agreements. Sprint PCS also has a
right of first refusal if we decide to sell our operating assets in our Bright
PCS markets. We are also subject to a number of restrictions on the transfer of
our business including a prohibition on selling Horizon PCS or its operating
assets to a number of identified and yet to be identified competitors of Sprint
PCS or Sprint. These and other restrictions in the Sprint PCS agreements may
limit the marketability of and reduce the price a buyer may be willing to pay
for Horizon PCS or its business and may operate to reduce the Entire Business
Value of Horizon PCS.
THE TERMINATION OF OUR STRATEGIC AFFILIATION WITH SPRINT PCS OR SPRINT PCS'
FAILURE TO PERFORM ITS OBLIGATIONS UNDER THE SPRINT PCS AGREEMENTS WOULD
SEVERELY RESTRICT OUR ABILITY TO CONDUCT OUR BUSINESS.
Because Sprint PCS owns the FCC licenses which we use in our territory, our
ability to offer Sprint PCS products and services on our network is dependent on
the Sprint PCS agreements remaining in effect and not being terminated. Sprint
PCS may terminate the Sprint PCS agreements for breach by us of any material
terms. We also depend on Sprint PCS' ability to perform its obligations under
the Sprint PCS agreements. The termination of the Sprint PCS agreements or the
failure of Sprint PCS to perform its obligations under the Sprint PCS agreements
would severely restrict our ability to conduct our wireless digital
communications business.
IF SPRINT PCS DOES NOT COMPLETE THE CONSTRUCTION OF ITS NATIONWIDE PCS NETWORK,
WE MAY NOT BE ABLE TO ATTRACT AND RETAIN CUSTOMERS, WHICH WOULD ADVERSELY AFFECT
OUR REVENUES.
Sprint PCS' network may not provide nationwide coverage to the same extent
as its competitors' networks, which could adversely affect our ability to
attract and retain customers. Sprint PCS is creating a nationwide PCS network
through its own construction efforts and those of its affiliates. Today, neither
Sprint PCS nor any other PCS provider offers service in every area of the United
States. Sprint PCS has entered into affiliation agreements similar to ours with
companies in other territories pursuant to its nationwide PCS build-out
strategy. Our business and results of operations depend on Sprint PCS' national
network and, to a lesser extent, on the networks of its other affiliates. Sprint
PCS and its affiliate program are subject, in varying degrees, to the economic,
administrative, logistical, regulatory and other risks described in this
document. Sprint PCS' and its other affiliates' PCS operations may not be
successful, which in turn could adversely affect our ability to generate
revenues.
WE ARE DEPENDENT UPON SPRINT PCS' BACK OFFICE SERVICES AND ITS THIRD-PARTY
VENDORS' BACK OFFICE SYSTEMS. PROBLEMS WITH THESE SYSTEMS, OR TERMINATION OF
THESE ARRANGEMENTS, COULD DISRUPT OUR BUSINESS AND POSSIBLY INCREASE OUR COSTS.
Because Sprint PCS provides our back office systems such as billing,
customer care and collections, our operations could be disrupted if Sprint PCS
is unable to maintain and expand its back office services, or to efficiently
outsource those services and systems through third-party vendors. The rapid
expansion of Sprint PCS' business will continue to pose a significant challenge
to its internal support systems. Additionally, Sprint PCS has relied on
third-party vendors for a significant number of important functions and
components of its internal support systems and may continue to rely on these
vendors in the future. We depend on Sprint PCS' willingness to continue to offer
these services to us and to provide these services at competitive costs. The
Sprint PCS agreements provide that, upon nine months' prior written notice,
Sprint PCS may elect to terminate any of these services. If Sprint PCS
terminates a service for which we have not developed a cost-effective
alternative, our operating costs may increase beyond our expectations and
restrict our ability to operate successfully.
WE DEPEND ON OTHER TELECOMMUNICATIONS COMPANIES FOR SOME SERVICES WHICH, IF
DELAYED, COULD DELAY OUR PLANNED NETWORK BUILD-OUT AND DELAY OUR EXPECTED
INCREASES IN CUSTOMERS AND REVENUES.
We depend on other telecommunications companies to provide facilities and
transport to interconnect portions of our network and to connect our network
with the landline telephone system. American Electric Power, Ameritech, AT&T,
Verizon, Sprint (long distance) and Qwest are our primary suppliers of
facilities and transport. Without these services, we could not offer Sprint PCS
services to our customers in some areas. From time to time, we have experienced
45
delays in obtaining facilities and transport from these companies, and in
obtaining local telephone numbers for use by our customers, which are sometimes
in short supply, and we may continue to experience delays and interruptions in
the future. Delays in obtaining facilities and transport could delay our
build-out plans and our business may suffer. Delays could also result in a
breach of our Sprint PCS agreements, subjecting these agreements to potential
termination by Sprint PCS.
IF WE DO NOT MEET ALL OF THE CONDITIONS UNDER HORIZON PCS' SECURED CREDIT
FACILITY, WE MAY NOT BE ABLE TO DRAW DOWN ALL OF THE FUNDS UNDER THE FACILITY
AND, AS A RESULT, WE MAY NOT BE ABLE TO COMPLETE THE BUILD-OUT OF OUR NETWORK,
WHICH MAY RESULT IN THE TERMINATION OF THE SPRINT PCS AGREEMENTS.
Our secured credit facility provides for aggregate borrowings of $250.0
million of which $155.0 million was borrowed as of June 30, 2002. Availability
of future borrowings will be subject to customary credit conditions at each
funding date, including the following:
O the absence of any default or event of default;
O the continuing accuracy of all representations and warranties; and
O no material adverse change.
If we do not meet these conditions at each funding date, our secured lenders
may choose not to lend any or all of the remaining amounts, and if other sources
of funds are not available, we may not be in a position to complete the
build-out of our network. If we do not have sufficient funds to complete our
network build-out, we may be in breach of the Sprint PCS agreements and in
default under our secured credit facility.
Horizon PCS' secured credit facility includes financial covenants that must
be met each quarter. Horizon PCS did not meet the covenant for EBITDA for the
first quarter of 2002. As a result of higher than expected gross and net
additions to Horizon PCS subscribers for the quarter, Horizon PCS incurred
additional expenses to add those customers. Although Horizon PCS ultimately
benefits from the revenues generated by new subscribers, Horizon PCS incur
one-time expenses associated with new subscribers, including commissions,
handset subsidies, set up costs for the network and marketing expenses. As a
result, these new subscriber costs negatively affect Horizon PCS' EBITDA in the
short-term during the period of the addition of new subscribers which led to
non-compliance with the EBITDA covenant for the first quarter of 2002.
On June 27, 2002, Horizon PCS obtained a waiver of the non-compliance with
the EBITDA covenant for the first quarter of 2002 and entered into an amendment
of the secured credit facility. The amended facility primarily adjusts certain
financial covenants and increases the margin on the base interest by 25-basis
points, while also providing for the payment of fees to the banking group, an
increase in post-default interest rates, a new financial covenant regarding
minimum available cash, additional prepayment requirements, restrictions on
Horizon PCS' borrowings under the remaining $95.0 million revolving credit
facility and deposit requirements on the $105.0 million borrowed under the
secured credit facility in March 2002.
Although under its most recent forecast, Horizon PCS currently expects to
remain in compliance with the covenants as amended, there can be no assurance
that its financial results will not be lower than expected in future quarters,
causing another non-compliance to occur, which could have a material adverse
effect on Horizon PCS' financial condition and results of operations.
MATERIAL RESTRICTIONS IN OUR DEBT INSTRUMENTS MAY MAKE IT DIFFICULT TO OBTAIN
ADDITIONAL FINANCING OR TAKE OTHER NECESSARY ACTIONS TO REACT TO CHANGES IN OUR
BUSINESS.
The indenture governing Horizon PCS' senior notes contains various covenants
that limit our ability to engage in a variety of transactions. In addition, the
indenture governing our discount notes and the secured credit agreement both
impose additional material operating and financial restrictions on us. These
restrictions, subject to ordinary course of business exceptions, limit our
ability to engage in some transactions, including the following:
O designated types of mergers or consolidations;
46
O paying dividends or other distributions to our stockholders;
O making investments;
O selling assets;
O repurchasing our common stock;
O changing lines of business;
O borrowing additional money; and
O transactions with affiliates.
In addition, Horizon PCS' secured credit facility requires us to maintain
certain ratios, including:
O leverage ratios;
O an interest coverage ratio; and
O a fixed charges ratio,
and to satisfy certain tests, including tests relating to:
O minimum covered population;
O minimum number of PCS subscribers in our territory;
O minimum total revenues; and
O minimum EBITDA.
These restrictions could limit our ability to obtain debt financing,
repurchase stock, refinance or pay principal or interest on our outstanding
debt, consummate acquisitions for cash or debt or react to changes in our
operating environment. An event of default under the secured credit facility may
prevent the Company and the guarantors of the senior notes and the discount
notes from paying those notes or the guarantees of those notes.
THE TERMS OF THE CONVERTIBLE PREFERRED STOCK MAY AFFECT OUR FINANCIAL RESULTS.
The terms of the convertible preferred stock give the holders of the
preferred stock the following principal rights:
O to initially designate two members of our board of directors, subject
to reduction based on future percentage ownership;
O to approve or disapprove fundamental corporate actions and
transactions;
O to receive dividends in the form of additional shares of our
convertible preferred stock, which may increase and accelerate upon a
change in control; and
O to require us to redeem the convertible preferred stock in 2005.
If we become subject to the repurchase right or change of control redemption
requirements under the convertible preferred stock while our secured credit
facility, our discount notes or the senior notes are outstanding, we will be
required to seek the consent of the lenders under our secured credit facility,
the holders of the discount notes and the holders of the senior notes to
repurchase or redeem the convertible preferred stock, or attempt to refinance
the secured credit facility, the discount notes and the senior notes. If we fail
47
to obtain these consents, there will be an event of default under the terms
governing our secured credit facility. In addition, if we do not repurchase or
redeem the convertible preferred stock and the holders of the convertible
preferred stock obtain a judgment against us, any judgment in excess of $5.0
million would constitute an event of default under the indentures governing the
discount notes and the senior notes.
IF WE BREACH OUR AGREEMENT WITH SBA COMMUNICATIONS CORP. ("SBA"), OR IT
OTHERWISE TERMINATES ITS AGREEMENT WITH US, OUR RIGHT TO PROVIDE WIRELESS
SERVICE FROM MOST OF OUR CELL SITES WILL BE LOST.
We lease cell sites from SBA. We rely on our contract with SBA to provide us
with access to most of our cell sites and to the towers located on these sites.
If SBA were to lose its underlying rights to these sites, our ability to provide
wireless service from these sites would end, subject to our right to cure
defaults by SBA. If SBA terminates our agreement as a result of our breach, we
will lose our right to provide wireless services from most of our cell sites.
WE MAY HAVE DIFFICULTY IN OBTAINING INFRASTRUCTURE EQUIPMENT AND HANDSETS, WHICH
COULD RESULT IN DELAYS IN OUR NETWORK BUILD-OUT, DISRUPTION OF SERVICE OR LOSS
OF CUSTOMERS.
If we cannot acquire the equipment required to build or upgrade our network
in a timely manner, we may be unable to provide wireless communications services
comparable to those of our competitors or to meet the requirements of the Sprint
PCS agreements. Manufacturers of this equipment could have substantial order
backlogs. Accordingly, the lead time for the delivery of this equipment may be
longer than anticipated. In addition, the manufacturers of specific types
handsets may have to distribute their limited supply of products among their
numerous customers. Some of our competitors purchase large quantities of
communications equipment and may have established relationships with the
manufacturers of this equipment. Consequently, they may receive priority in the
delivery of this equipment. If we do not obtain equipment or handsets in a
timely manner, we could suffer delays in the build-out of our network,
disruptions in service and a reduction in customers.
IF THE WEST VIRGINIA PCS ALLIANCE AND VIRGINIA PCS ALLIANCE FAIL TO PROVIDE
THEIR NETWORK TO US IN THEIR MARKETS, OR IF OUR NETWORK SERVICES AGREEMENT WITH
THE ALLIANCES IS OTHERWISE TERMINATED, WE WILL LOSE THE ABILITY TO USE THE
ALLIANCES' NETWORKS.
West Virginia PCS Alliance and Virginia PCS Alliance, which we refer to as
the Alliances, are two related, independent PCS providers whose network is
managed by NTELOS. Under our network services agreement, the Alliances provide
us with the use of and access to key components of their network in most of our
markets in Virginia and West Virginia. We directly compete with the Alliances in
the markets where we use their network. If the Alliances fail to maintain the
standards for their network as set forth in our network services agreement with
them or otherwise fail to provide their network for our use, our ability to
provide wireless services in these markets may be adversely affected, and we may
not be able to provide seamless service for our customers. If we breach our
obligations to the Alliances, or if the Alliances otherwise terminate the
network services agreement, we will lose our right to use the Alliances' network
to provide service in these markets. In that event, it is likely that we will be
required to build our own network in those markets and incur the substantial
costs associated with doing so.
SPRINT PCS' VENDOR DISCOUNTS MAY BE DISCONTINUED, WHICH COULD INCREASE OUR
EQUIPMENT COSTS AND REQUIRE MORE CAPITAL THAN WE HAD PROJECTED TO BUILD-OUT OR
UPGRADE OUR NETWORK.
We intend to continue to purchase our infrastructure equipment under Sprint
PCS' vendor agreements that include significant volume discounts. If Sprint PCS
were unable to continue to obtain vendor discounts for its affiliates, the loss
of vendor discounts could increase our equipment costs for our network
build-out.
CONFLICTS WITH SPRINT PCS MAY NOT BE RESOLVED IN OUR FAVOR, WHICH COULD RESTRICT
OUR ABILITY TO MANAGE OUR BUSINESS AND PROVIDE SPRINT PCS PRODUCTS AND SERVICES,
ADVERSELY AFFECTING OUR RELATIONSHIPS WITH OUR CUSTOMERS, INCREASE OUR EXPENSES
OR DECREASE OUR REVENUES.
Under the Sprint PCS agreements, Sprint PCS has a substantial amount of
control over the conduct of our business. Conflicts between us may arise, and as
Sprint PCS owes us no duties except as set forth in the Sprint PCS agreements,
48
these conflicts may not be resolved in our favor. The conflicts and their
resolution may harm our business. For example:
O Sprint PCS may price its national plans based on its own objectives
and may set price levels and customer credit policies that may not be
economically sufficient for our business;
O Sprint PCS may increase the prices we pay for our back office
services; and
O Sprint or Sprint PCS may make decisions that adversely affect our use
of the Sprint and Sprint PCS brand names, products or services.
WE MAY NOT BE ABLE TO COMPETE WITH LARGER, MORE ESTABLISHED WIRELESS PROVIDERS
WHO HAVE RESOURCES TO COMPETITIVELY PRICE THEIR PRODUCTS AND SERVICES, WHICH
COULD IMPAIR OUR ABILITY TO ATTRACT AND RETAIN CUSTOMERS.
Our ability to compete will depend in part on our ability to anticipate and
respond to various competitive factors affecting the telecommunications
industry, including new services that may be introduced, changes in consumer
preferences, demographic trends, economic conditions and discount pricing
strategies by competitors. In each market, we compete with at least two cellular
providers that have had their infrastructure in place and have been operational
for a number of years. They may have significantly greater financial and
technical resources than we do, they could offer attractive pricing options and
they may have a wider variety of handset options. We expect existing cellular
providers will continue to upgrade their systems and provide expanded digital
services to compete with the Sprint PCS products and services we offer. Many of
these wireless providers generally require their customers to enter into
long-term contracts, which may make it more difficult for us to attract
customers away from them.
We will also compete with several PCS providers and other existing
communications companies in our markets and expect to compete with new entrants
as the FCC licenses additional spectrum to mobile services providers. A number
of our cellular, PCS and other wireless competitors have access to more licensed
spectrum than the amount licensed to Sprint PCS in most of our territory and
therefore will be able to provide greater network call volume capacity than our
network to the extent that network usage begins to reach or exceed the capacity
of our licensed spectrum. Our inability to accommodate increases in call volume
could result in more dropped or disconnected calls. In addition, any competitive
difficulties that Sprint PCS may experience could also harm our competitive
position and success.
We anticipate that market prices for two-way wireless voice services and
products generally will continue to decline as a result of increased in
competition. Consequently we may be forced to increase spending for advertising
and promotions. Increased competition also may lead to continued increases in
customer churn. These trends could cause further delays in our expected dates to
achieve positive EBITDA.
WE MAY NOT BE ABLE TO OFFER COMPETITIVE ROAMING CAPABILITY, WHICH COULD IMPAIR
OUR ABILITY TO ATTRACT AND RETAIN CUSTOMERS.
We rely on agreements with competitors to provide automatic roaming
capability to our PCS customers in many of the areas of the United States not
covered by the Sprint PCS network, which primarily serves metropolitan areas.
Some competitors may be able to offer coverage in areas not served by the Sprint
PCS network or may be able to offer roaming rates that are lower than those
offered by Sprint PCS and its affiliates. Some of our competitors are seeking to
reduce access to their networks through actions pending with the FCC. Moreover,
the engineering standard for the dominant air interface upon which PCS customers
roam is currently being considered for elimination by the FCC as part of a
streamlining proceeding. If the FCC eliminates this standard, our Sprint PCS
customers may have difficulty roaming in some markets.
THERE IS NO UNIFORM SIGNAL TRANSMISSION TECHNOLOGY AND IF WE DECIDE TO USE OTHER
TECHNOLOGIES IN THE FUTURE, THIS DECISION COULD SUBSTANTIALLY INCREASE OUR
EQUIPMENT EXPENDITURES TO REPLACE THE TECHNOLOGY USED ON OUR NETWORK.
The wireless telecommunications industry is experiencing evolving industry
standards. We have employed CDMA technology, which is the digital wireless
communications technology selected by Sprint PCS for its network. CDMA may not
provide the advantages expected by us and by Sprint PCS. In addition to CDMA,
there are two other principal signal transmission technologies, time division
multiple access, or TDMA, and global systems for mobile communications, or GSM.
49
These three signal transmission technologies are not compatible with each other.
If one of these technologies or another technology becomes the preferred
industry standard, we may be at a competitive disadvantage and competitive
pressures may require Sprint PCS to change its digital technology which, in
turn, may require us to make changes at substantially increased costs.
WE MAY NOT RECEIVE AS MUCH SPRINT PCS ROAMING REVENUE AS WE ANTICIPATE AND OUR
NON-SPRINT PCS ROAMING REVENUE IS LIKELY TO BE LOW.
We are paid a fee from Sprint PCS or a Sprint PCS affiliate for every minute
that a Sprint PCS subscriber based outside of our territory uses our network.
Similarly, we pay a fee to Sprint PCS or a Sprint PCS affiliate for every minute
that our customers use the Sprint PCS network outside our territory. Our
customers may use the Sprint PCS network outside our territory more frequently
than we anticipate, and Sprint PCS subscribers based outside our territory may
use our network less frequently than we anticipate. The fee for each Sprint PCS
roaming minute used was decreased from $0.20 per minute before June 1, 2001, to
$0.15 per minute effective June 1, 2001, and further decreased to $0.12 per
minute effective October 1, 2001. The Sprint PCS roaming rate was changed to
$0.10 per minute in 2002. After 2002, the rate will be changed to "a fair and
reasonable return," which has not yet been determined. As a result, we may
receive less Sprint PCS roaming revenue in the aggregate, than we previously
anticipated or we may have to pay more Sprint PCS roaming fees in the aggregate
than we anticipate. Furthermore, we do not expect to receive substantial
non-Sprint PCS roaming revenue.
IF SPRINT PCS CUSTOMERS ARE NOT ABLE TO ROAM INSTANTANEOUSLY OR EFFICIENTLY ONTO
OTHER WIRELESS NETWORKS, WE MAY SUFFER A REDUCTION IN OUR REVENUES AND NUMBER OF
CUSTOMERS.
The Sprint PCS network operates at a different frequency and uses or may use
a different signal transmission technology than many analog cellular and other
digital systems. To access another provider's analog cellular, TDMA or GSM
digital system when outside the territory served by the Sprint PCS network, a
Sprint PCS customer is required to utilize a dual-band/dual-mode handset
compatible with that provider's system. Generally, because dual-band/dual-mode
handsets incorporate two radios rather than one, they are more expensive, larger
and heavier than single-band/single-mode handsets. The Sprint PCS network does
not allow for call hand-off between the Sprint PCS network and another wireless
network, so a customer must end a call in progress on the Sprint PCS network and
initiate a new call when outside the territory served by the Sprint PCS network.
In addition, the quality of the service provided by a network provider during a
roaming call may not approximate the quality of the service provided by Sprint
PCS. The price of a roaming call may not be competitive with prices of other
wireless companies for roaming calls, and Sprint PCS customers may not be able
to use Sprint PCS advanced features, such as voicemail notification, while
roaming. These roaming issues may cause us to suffer a reduction in our revenues
and number of customers.
PARTS OF OUR TERRITORIES HAVE LIMITED LICENSED SPECTRUM, WHICH MAY ADVERSELY
AFFECT THE QUALITY OF OUR SERVICE.
In the majority of our markets, Sprint PCS has licenses covering 20 MHz or
30 MHz of spectrum. However, Sprint PCS has licenses covering only 10 MHz in
parts of our territory covering approximately 3.8 million residents out of a
total population of over 10.2 million residents. In the future, as our customers
in those areas increase in number, this limited licensed spectrum may not be
able to accommodate increases in call volume and may lead to increased dropped
calls and may limit our ability to offer enhanced services.
NON-RENEWAL OR REVOCATION BY THE FCC OF THE SPRINT PCS LICENSES WOULD
SIGNIFICANTLY HARM OUR BUSINESS BECAUSE WE WOULD NO LONGER HAVE THE RIGHT TO
OFFER WIRELESS SERVICE THROUGH OUR NETWORK.
We are dependent on Sprint PCS' licenses, which are subject to renewal and
revocation by the FCC. Sprint PCS' licenses in many of our territories will
expire as early as 2005 but may be renewed for additional ten-year terms. There
may be opposition to renewal of Sprint PCS' licenses upon their expiration and
the Sprint PCS licenses may not be renewed. The FCC has adopted specific
standards to apply to PCS license renewals. For example, if Sprint PCS does not
demonstrate to the FCC that Sprint PCS has met the five-year construction
requirements for each of its PCS licenses, it can lose those licenses. Failure
to comply with these standards in our territory could cause the imposition of
fines on Sprint PCS by the FCC or the revocation or forfeiture of the Sprint PCS
licenses for our territory, which would prohibit us from providing service in
our markets.
50
IF THE SPRINT PCS AGREEMENTS DO NOT COMPLY WITH FCC REQUIREMENTS, SPRINT PCS MAY
TERMINATE THE SPRINT PCS AGREEMENTS, WHICH COULD RESULT IN OUR INABILITY TO
PROVIDE SERVICE.
The FCC requires that licensees like Sprint PCS maintain control of their
licensed spectrum and not delegate control to third-party operators or managers
like us. Although the Sprint PCS agreements reflect an arrangement that the
parties believe meets the FCC requirements for licensee control of licensed
spectrum, we cannot be certain the FCC will agree with us. If the FCC were to
determine that the Sprint PCS agreements need to be modified to increase the
level of licensee control, we have agreed with Sprint PCS to use our best
efforts to modify the Sprint PCS agreements to comply with applicable law. If we
cannot agree with Sprint PCS to modify the Sprint PCS agreements, they may be
terminated. If the Sprint PCS agreements are terminated, we would no longer be a
part of the Sprint PCS network and we would have extreme difficulty in
conducting our business.
WE MAY NEED MORE CAPITAL THAN WE CURRENTLY ANTICIPATE TO COMPLETE THE BUILD-OUT
AND UPGRADE OF OUR NETWORK, AND A DELAY OR FAILURE TO OBTAIN ADDITIONAL CAPITAL
COULD DECREASE OUR REVENUES.
The completion of our network build-out will require substantial capital.
Additional funds would be required in the event of:
O significant departures from our current business plan;
O unforeseen delays, cost overruns, unanticipated expenses; or
O regulatory, engineering design and other technological changes.
For example, it is possible that we will need substantial funds if we find
it necessary or desirable to overbuild the territory currently served through
our arrangements with the Alliances. Due to our highly leveraged capital
structure, additional financing may not be available or, if available, may not
be obtained on a timely basis or on terms acceptable to us or within limitations
permitted under our existing debt covenants. Failure to obtain additional
financing, should the need for it develop, could result in the delay or
abandonment of our development and expansion plans, and we may be unable to fund
our ongoing operations.
BECAUSE SPRINT PCS HAS RECENTLY REQUIRED US TO UPGRADE OUR NETWORK TO PROVIDE
"THIRD GENERATION" TECHNOLOGY, WE WILL FACE ADDITIONAL CAPITAL EXPENSES.
The wireless industry is seeking to implement new "third generations," or
"3G", technology. Sprint PCS has selected a version of 3G technology (1XRTT) for
its own networks and required us to upgrade our network to provide those
services. We currently estimate the network upgrade to 1XRTT will cost
approximately $35 million, but actual costs could exceed this estimate. Sprint
PCS launched the new 3G technology in August 2002. We participated in that
launch along with other Sprint PCS affiliates. We still have additional
expenditures pending to complete the full implementation of 3G in all of our
markets. If other wireless carriers implement their 3G upgrades on a more rapid
timetable, or on a more cost efficient basis, or on a more advanced technology
basis, we will likely suffer competitive disadvantages in our markets. While
there are potential advantages with 3G technology, such as increased network
capacity and additional capabilities for wireless data applications, the
technology has not been proven in the marketplace and has the risks inherent in
other technological innovations.
Sprint provides back-office and other services to Horizon PCS. Recently,
Sprint PCS has sought to increase service fees during the remainder of 2002 and
beyond in connection with its development of 3G-related back-office systems and
platforms. If Sprint PCS were to increase its fees significantly, these
increased operating expenses would have an adverse effect on Horizon PCS' EBITDA
and cash flow.
UNAUTHORIZED USE OF OUR NETWORK AND OTHER TYPES OF FRAUD COULD DISRUPT OUR
BUSINESS AND INCREASE OUR COSTS.
We will likely incur costs associated with the unauthorized use of our
network, including administrative and capital costs associated with detecting,
monitoring and reducing the incidence of fraud. Fraud impacts interconnection
costs, capacity costs, administrative costs, fraud prevention costs and payments
to other carriers for unbillable fraudulent roaming. Although we believe we have
a plan in place to implement appropriate controls to minimize the effect to us
of fraudulent usage, their efforts may not be successful.
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EXPANDING OUR TERRITORY MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS.
As part of our business strategy, we may expand our territory through the
grant of additional markets from Sprint PCS or through acquisitions of other
Sprint PCS affiliates. We will evaluate strategic acquisitions and alliances
principally relating to our current operations. These transactions may require
the approval of Sprint PCS and commonly involve a number of risks, including:
O difficulty assimilating acquired operations and personnel;
O diversion of management attention;
O disruption of ongoing business;
O inability to retain key personnel;
O inability to successfully incorporate acquired assets and rights into
our service offerings;
O inability to maintain uniform standards, controls, procedures and
policies; and
O impairment of relationships with employees, customers or vendors.
Failure to overcome these risks or any other problems encountered in these
transactions could have a material adverse effect on our business. In connection
with these transactions, we may also issue additional equity securities, incur
additional debt.
THE SPRINT PCS AGREEMENTS AND OUR HORIZON PCS RESTATED CERTIFICATE OF
INCORPORATION INCLUDE PROVISIONS THAT MAY DISCOURAGE, DELAY OR RESTRICT ANY SALE
OF OUR OPERATING ASSETS OR COMMON STOCK TO THE POSSIBLE DETRIMENT OF OUR
NOTEHOLDERS.
The Sprint PCS agreements restrict our ability to sell our operating assets
and common stock. Generally, Sprint PCS must approve a change of control of our
ownership and consent to any assignment of the Sprint PCS agreements. The Sprint
PCS agreements also give Sprint PCS a right of first refusal if we decide to
sell the operating assets of our Bright PCS markets to a third party. In
addition, provisions of our restated certificate of incorporation could also
operate to discourage, delay or make more difficult a change in control of
Horizon PCS. For example, our Horizon PCS restated certificate of incorporation
provides for:
O two classes of common stock, with our class B common stock having ten
votes per share;
O the issuance of preferred stock without stockholder approval; and
O a classified board, with each board member serving a three-year term.
The restrictions in the Sprint PCS agreements and the provisions of our
Horizon PCS restated certificate of incorporation could discourage any sale of
Horizon PCS' operating assets or common stock.
HORIZON TELCOM WILL BE ABLE TO CONTROL THE OUTCOME OF SIGNIFICANT MATTERS
PRESENTED TO STOCKHOLDERS AS A RESULT OF ITS OWNERSHIP POSITION, WHICH COULD
POTENTIALLY IMPAIR OUR ATTRACTIVENESS AS A TAKEOVER TARGET.
Horizon Telcom beneficially owns approximately 54.7% of Horizon PCS'
outstanding common stock on fully diluted basis as of June 30, 2002. In
addition, the shares held by Horizon Telcom are class B shares, which have ten
votes per share. The class A shares have only one vote per share. As a result,
Horizon Telcom holds approximately 81.2% of the voting power on a fully diluted
basis at June 30, 2002. Horizon Telcom will have the voting power to control the
election of Horizon PCS' board of directors and it will be able to cause
amendments to Horizon PCS' restated certificate of incorporation or Horizon PCS
restated bylaws. Horizon Telcom also may be able to cause changes in Horizon
PCS' business without seeking the approval of any other party. These changes may
not be to the advantage of Horizon PCS or in the best interest of its other
stockholders or the holders of its notes. For example, Horizon Telcom will have
the power to prevent, delay or cause a change in control of Horizon PCS and
could take other actions that might be favorable to Horizon Telcom, but not
necessarily to other Horizon PCS stockholders. This may have the effect of
52
delaying or preventing a change in control. In addition, Horizon Telcom is
controlled by members of the McKell family, who collectively own approximately
60.6% of the voting interests of Horizon Telcom. Therefore, the McKell family,
acting as a group, may be able to exercise indirect control over Horizon PCS.
HORIZON PCS MAY EXPERIENCE A HIGH RATE OF CUSTOMER TURNOVER, WHICH WOULD
INCREASE ITS COSTS OF OPERATIONS AND REDUCE OUR REVENUE AND PROSPECTS FOR
GROWTH.
Horizon PCS' strategy to minimize customer turnover, commonly known as
churn, may not be successful. As a result of customer turnover, we lose the
revenue attributable to these customers and increase the costs of establishing
and growing our customer base. The PCS industry has experienced a higher rate of
customer turnover as compared to cellular industry averages. We have experienced
an increase in churn during the first half of 2002, primarily caused by NDASL
customers' inability to pay for services billed. Current and future strategies
to reduce customer churn may not be successful. The rate of customer turnover is
affected by the following factors, several of which are not within our ability
to address:
O extent of network coverage;
O reliability issues such as blocked calls, dropped calls and handset
problems;
O non-use of phones;
O change of employment;
O a lack of affordability;
O price competition;
O Sprint PCS' customer credit policies;
O customer care concerns; and
O other competitive factors.
A high rate of customer turnover could adversely affect our competitive
position, results of operations and our costs of, or losses incurred in,
obtaining new customers, especially because we subsidize some of the cost of the
handsets purchased by our customers.
Our allowance for doubtful accounts may not be sufficient to cover
uncollectible accounts. On an ongoing basis, we estimate the amount of customer
receivables that we may not collect to reflect the expected loss on such
accounts in the current period. However, our allowance for doubtful accounts may
underestimate actual unpaid receivables for various reasons, including:
O adverse changes in our churn rate exceeding our estimates;
O adverse changes in the economy generally exceeding our expectations;
or
O unanticipated changes in Sprint PCS" products and services and credit
policies.
If our allowance for doubtful accounts is insufficient to cover losses on
our receivables, our business, financial position or results of operations could
be materially adversely affected.
53
BECAUSE THE WIRELESS INDUSTRY HAS EXPERIENCED HIGHER CUSTOMER ADDITIONS AND
HANDSET SALES IN THE FOURTH CALENDAR QUARTER AS COMPARED TO THE OTHER THREE
CALENDAR QUARTERS, A FAILURE BY US TO ACQUIRE SIGNIFICANTLY MORE CUSTOMERS IN
THE FOURTH QUARTER COULD HAVE A DISPROPORTIONATE NEGATIVE EFFECT ON OUR RESULTS
OF OPERATIONS.
The wireless industry is historically dependent on fourth calendar quarter
results. Our overall results of operations could be significantly reduced if we
have a worse than expected fourth calendar quarter for any reason, including the
following:
O our inability to match or beat pricing plans offered by competitors;
O our failure to adequately promote Sprint PCS' products, services and
pricing plans;
O our inability to obtain an adequate supply or selection of handsets;
O a downturn in the economy of some or all of the markets in our
territory; or
O a generally poor holiday shopping season.
REGULATION BY GOVERNMENT AGENCIES MAY INCREASE OUR COSTS OF PROVIDING SERVICE OR
REQUIRE US TO CHANGE OUR SERVICES, WHICH COULD IMPAIR OUR FINANCIAL PERFORMANCE.
The licensing, construction, use, operation, sale and interconnection
arrangements of wireless telecommunications systems are regulated to varying
degrees by the FCC, the Federal Aviation Administration and, depending on the
jurisdiction, state and local regulatory agencies and legislative bodies.
Adverse decisions regarding these regulatory requirements could negatively
impact our operations and our cost of doing business.
USE OF HAND-HELD PHONES MAY POSE HEALTH RISKS, REAL OR PERCEIVED, WHICH COULD
RESULT IN THE REDUCED USE OF OUR SERVICES OR LIABILITY FOR PERSONAL INJURY
CLAIMS.
Media reports have suggested that radio frequency emissions from wireless
handsets may be linked to various health problems, including cancer, and may
interfere with various electronic medical devices, including hearing aids and
pacemakers. Concerns over radio frequency emissions may discourage use of
wireless handsets or expose us to potential litigation. Any resulting decrease
in demand for our services, or costs of litigation and damage awards, could
impair our ability to profitably operate our business.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) Exhibits
3.1* Articles of Incorporation of Horizon Telcom, Inc.
3.2* Bylaws of Incorporation of Horizon Telcom, Inc.
4.1* Form of Stock Certificate
10.3.3**+ Addendum V to Sprint PCS Management Agreement between Horizon PCS
and Sprint PCS, Inc. as of June 1, 2001.
10.21.1** Amendment No. 1 to PCS CDMA Product Supply Contract between
Motorola, Inc. and Horizon Personal Communications, inc. dated as
of September 22, 2000.
10.27.1** Letter Agreement dated April 11, 2002 between SBA Towers, Inc.
and Horizon Personal Communications, Inc.
10.40.4 Waiver Agreement dated May 9, 2002, by and among Horizon Personal
Communications, Inc. (the "Company"), Bright Personal
Communications Services, LLC, an Ohio limited liability company
("Bright") (each of the Company and Bright, individually a
"Borrower" and collectively, the "Borrowers"), Horizon PCS, Inc.,
a Delaware corporation (the "Parent"), those Subsidiaries of the
Parent listed on the signature pages hereto (together with the
Parent, individually a "Guarantor" and collectively the
"Guarantors"; the Guarantors, together with the Borrowers,
individually a "Credit Party" and collectively the "Credit
Parties"), the lenders party hereto (the "Lenders"), First Union
National Bank, as Administrative Agent (the "Administrative
Agent"), Westdeutsche Landesbank Girozentrale, as Syndication
54
Agent and Arranger (the "Syndication Agent"), and Fortis Capital
Corp., as Documentation Agent (the "Documentation Agent")
(incorporated by reference to Exhibit 10.40.3 of Form 10-Q of
Horizon PCS, Inc. for quarter ending March 31, 2002, filed on May
15, 2002).
10.40.5 Second Waiver Agreement dated as of June 7, 2002, by and among
Horizon Personal Communications, Inc., and Bright Personal
Communications Services, LLC, Horizon PCS, Inc. (the "Parent")
and certain Subsidiaries of the Parent, the several banks and
other financial institutions as may from time to time become
parties to the Agreement, First Union National Bank, as
Administrative Agent, Westdeutsche Landesbank Girozentrale, as
Syndication Agent and Arranger and Fortis Capital Corp., as
Documentation Agent. (incorporated by reference to the
Registrant's Current Report on Form 8-K filed on June 10, 2002).
10.40.6 Fourth Amendment to Credit Agreement and Waiver dated as of June
27, 2002, by and among Horizon Personal Communications, Inc., and
Bright Personal Communications Services, LLC, Horizon PCS, Inc.
(the "Parent") and certain Subsidiaries of the Parent, the
several banks and other financial institutions as may from time
to time become parties to the Agreement, Wachovia Bank, National
Association (successor to First Union National Bank), as
Administrative Agent, Westdeutsche Landesbank Girozentrale, as
Syndication Agent and Arranger and Fortis Capital Corp., as
Documentation Agent (incorporated by reference to the
Registrant's Current Report on Form 8-K filed on June 27, 2002).
10.47** Employment Agreement between Horizon PCS, Inc., and Alan G.
Morse.
10.48*** Waiver Agreement between The Chillicothe Telephone Company,
American United Life Insurance Company and The State Life
Insurance Company dated as of August 8, 2002.
99.1*** Certification of Periodic Financial Reports.
___________________________
* Incorporated by reference to the exhibit with the same number previously
filed by the Registrant on Form 10 (Reg. No. 0-32617)
** Incorporated by reference to the Quarterly Report on Form 10-Q for the
quarter ended June 30, 2002 of Horizon PCS Inc. (File No. 333-51280)
*** Filed herewith.
+ Horizon PCS, Inc. requested confidential treatment for certain portions of
this exhibit pursuant to Rule 24b-2 of the Securities Exchange Act of 1934.
(B) Reports on Form 8-K
1. On June 27, 2002, we filed a Current Report on Form 8-K with the SEC
that provided information under "ITEM 5 - Other Event" disclosing that
Horizon PCS reached an amendment agreement with its lending group to
waive its non-compliance with covenant while the amended facility was
being negotiated.
2. On June 28, 2002, we filed a Current Report on Form 8-K with the SEC
that provided information under "ITEM 4 - Change in Registrant's
Certifying Accountant" disclosing that we had dismissed Arthur
Andersen LLP, and engaged KPMG LLP, as our independent accountants.
55
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HORIZON TELCOM, INC.
(Registrant)
Date: August 11, 2002 By: /s/ Thomas McKell
------------------------------------
Thomas McKell
Chief Executive Officer
Date: August 11, 2002 By: /s/ Peter M. Holland
-----------------------------------
Peter M. Holland
Chief Financial Officer
(Principal Financial and
Chief Accounting Officer)
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