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1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1996
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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 0-23694
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HEARTLAND WIRELESS COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
Delaware 73-1435149
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(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
200 Chisholm Place, Suite 200, Plano, Texas 75075
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(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (972) 423-9494
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Securities registered pursuant to Section 12(b) of the Act: None.
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Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.001 per share
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(Title of Class)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy statements incorporated
by reference in Part III of this Form 10-K or any amendment to this Form 10-K.
[ ]
The aggregate market value of voting stock held by non-affiliates of the
registrant is $32,098,816, based on the closing price of the registrant's
common stock, $.001 par value per share (the "Common Stock"), on March 25,
1997, as reported on the Nasdaq Stock Market's National Market.
The number of outstanding shares of Common Stock as of March 25, 1997, was
19,587,715.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement to be delivered to
stockholders in connection with the Annual Meeting of Stockholders expected to
be held on or before June 16, 1997, and to be filed with the Securities and
Exchange Commission pursuant to Regulation 14A, are incorporated by reference
into Part III of this Form 10-K.
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HEARTLAND WIRELESS COMMUNICATIONS, INC.
FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
TABLE OF CONTENTS
PART I
PAGE
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Item 1. Business...................................................................................... 3
Item 2. Properties.................................................................................... 18
Item 3. Legal Proceedings............................................................................. 18
Item 4. Submission of Matters to a Vote of Security Holders........................................... 18
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters......................... 19
Item 6. Selected Financial Data....................................................................... 19
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations......... 20
Item 8. Financial Statements and Supplementary Data................................................... 28
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.......... 29
PART III
Item 10. Directors and Executive Officers of the Registrant............................................ 29
Item 11. Executive Compensation........................................................................ 29
Item 12. Security Ownership of Certain Beneficial Owners and Management................................ 30
Item 13. Certain Relationships and Related Transactions................................................ 30
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.............................. 30
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PART I
ITEM 1. BUSINESS
OVERVIEW
Heartland Wireless Communications, Inc. (the "Company") develops, owns and
operates wireless cable television systems, primarily in small to mid-size
markets located in the central United States. At December 31, 1996, the
Company had wireless cable channel rights in 95 markets representing
approximately 10.3 million households, approximately 9.3 million of which the
Company believes can be served by line-of-sight ("LOS") transmissions (which
generally require a direct, unobstructed transmission path from the central
transmitting antenna to the antenna located on the subscriber's premises).
At December 31, 1996, pro forma for the acquisition of two operating
systems consummated in January 1997 and including one operating system managed
by the Company, the Company's 95 markets included 56 markets in which the
Company has systems in operation (the "Existing Systems") and 39 future launch
markets in which the Company has aggregated sufficient wireless cable channel
rights to commence construction of a system or the Company has leases with or
options from applicants for channel licenses that the Company expects to be
granted by the Federal Communications Commission (the "FCC"). At December 31,
1996, the Existing Systems were providing wireless cable service to
approximately 181,400 subscribers using the Company's new method for reporting
subscribers. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Changes in Method for Reporting Subscribers;
Write-Offs."
The Company generally targets small to mid-size markets with significant
numbers of LOS households that are unpassed by traditional hard-wire cable.
Many of these households, particularly in rural areas, have limited access to
local off-air VHF/UHF channels (such as ABC, NBC, CBS and Fox), and typically
do not have access to pay television service except via satellite receivers.
As a result, the Company believes that its wireless cable television service is
an attractive alternative to existing choices for such households. The Company
estimates that, within its 95 wireless cable markets, approximately 20%-40% of
the line of sight households are unpassed by traditional hard-wire cable
systems.
Wireless cable programming is transmitted through the air via microwave
frequencies from a transmission facility to a small receiving antenna at each
subscriber's location, which generally requires a direct, unobstructed
line-of-sight from the transmission facility to the subscriber's receiving
antenna, by utilizing up to 195 megahertz ("MHz") of radio spectrum allocated
by the FCC for ITFS and MDS service (each as defined herein), both of which
comprise the spectrum used for providing commercial wireless cable service.
See "Business--Regulatory Environment." Traditional hard-wire cable systems
also transmit signals from a transmission facility, but deliver the signal to a
subscriber's location through an extensive network of coaxial cable and
amplifiers. Because wireless cable systems do not require such an extensive
cable network, wireless cable operators such as the Company can provide
subscribers with a high quality picture and a reliable signal resulting in
fewer transmission disruptions at a lower system capital cost per installed
subscriber than traditional hard-wire cable systems.
Like traditional hard-wire cable system operators, the Company can offer
its subscribers local off-air VHF/UHF channels from ABC, NBC, CBS and Fox
affiliates, as well as HBO, Showtime, Disney, ESPN, CNN, USA, WGN, WTBS,
Discovery, the Nashville Network, A&E and other programming services. The
channels that the Company offers in each market will vary depending upon the
channel rights secured in such market at the time of system launch. In
addition, the available channels in a market will typically change as the
Company continues to acquire channel rights.
The executive offices of the Company are located at 200 Chisholm Place,
Suite 200, Plano, Texas 75075, and the telephone number of the executive
offices is (972) 423-9494. The Company's operations and marketing headquarters
are based in Durant, Oklahoma. Unless the context otherwise requires, all
references in this Form 10-K to the Company refer collectively to Heartland
Wireless Communications, Inc., its predecessors and its majority-owned
subsidiaries.
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CABLE INDUSTRY OVERVIEW
Cable Television Industry. The cable television industry began in the
late 1940s and 1950s to serve the needs of residents in predominantly rural
areas with limited access to local off-air VHF/UHF broadcasts. The cable
television industry expanded to metropolitan areas due to, among other things,
better reception and more programming. Today, cable television systems offer
various types of programming, which generally include basic service, premium
service and, in some instances, pay-per-view service.
A traditional cable television customer generally pays an initial
connection charge and a fixed monthly fee for basic service. The amount of the
monthly basic service fee varies from one area to another and is a function, in
part, of the number of channels and services included in the basic service
package and the cost of such services to the television system operator. In
most instances, a separate monthly fee for each premium service and certain
other specific programming is charged to customers, with discounts generally
available to customers receiving multiple premium services. Monthly service
fees for basic, enhanced basic and premium services constitute the major source
of revenue for cable television systems. Converter rentals, remote control
rentals, installation charges and reconnect charges for customers who were
previously disconnected are also included in a cable television system's
revenues, but generally are not a major component of such revenues.
Wireless Cable Industry Background. Initially, most cable systems were
hard-wire systems, using coaxial cable and amplifiers to transmit television
signals. In 1983, the FCC allocated a portion of the radio spectrum from 2500
to 2700 MHz, which previously had been allocated entirely for educational use,
to commercial wireless cable operation. Simultaneously, the FCC also modified
its rules on the usage of the remaining portion of such spectrum allocated for
educational use to permit ITFS licensees to lease excess capacity to commercial
operators.
Like a traditional hard-wire cable system, wireless cable operates from a
transmission facility ("head-end"), consisting of satellite reception and other
equipment necessary to receive the desired programming. Programming is then
transmitted by microwave transmitters from an antenna located on a tower to a
small receiving antenna located on a subscriber's rooftop. At the subscriber's
location, the microwave signals are converted to frequencies that can pass
through conventional coaxial cable into an addressable descrambling converter
located on top of a television set. Wireless cable requires a clear
line-of-sight, because the microwave frequencies used will not pass through
large trees, hills, tall buildings or other obstructions. However, many signal
blockages can be overcome with the use of signal boosters which retransmit an
otherwise blocked signal over a limited area.
The Company believes that its coverage ultimately will be further enhanced
upon the implementation of digital technology. Currently, wireless cable
companies can offer up to 33 analog channels of programming. The ability to
offer substantially more programming utilizing existing wireless channel
capacity is dependent on effectively applying digital technology, which is a
technology whereby one analog channel is compressed such that the same 6 MHz of
spectrum can transmit six or more channels. FCC approval is required before
the Company's wireless cable systems can be converted to digital technology.
The FCC issued a Declaratory Ruling in July 1996 which effectively established
interim rules to govern the transition from analog to digital technology and
authorized wireless cable operators to file minor modifications to existing
systems to specify digital operation. The FCC has yet to commence a rulemaking
proceeding to adopt permanent rules. There can be no assurance as to what
permanent rules and policies the FCC will adopt to govern the use of digital
technology, when such rules and policies will be adopted, or the Company's
ability to comply with those rules and policies. It is expected that digital
technology will be commercially available sometime in 1997. It is also
expected that the cost of digital equipment will materially exceed the cost of
analog equipment. There can be no assurance, however, that digital converter
boxes and other equipment necessary to implement digital technology, including
satellite delivery of digital signals, will be available on this timetable or
that digital technology can be successfully deployed.
The Company believes that conversion to a fully digital system would
require a significant investment in capital and time. As a result, conversion
from current analog technology to a digital technology will not take place in
all markets simultaneously, if at all. Whether the Company elects to implement
digital technology, if and when available, will depend upon a number of factors
including equipment costs, required staffing levels, possibility of subscriber
growth and numerous competitive factors. Nonetheless, the Company does not
believe
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that it will be required to convert from analog to digital technology in most of
its markets in the near future because of the size of these markets and nature
of competitive pressures in such markets.
REGULATORY ENVIRONMENT
General. The wireless cable industry is subject to regulation by the FCC
pursuant to the Communications Act of 1934, as amended (the "Communications
Act"). The Communications Act empowers the FCC, among other things, to issue,
revoke, modify and renew licenses within the spectrum available to wireless
cable; to approve the assignment and/or transfer of control of such licenses;
to approve the location of wireless cable systems; to regulate the kind,
configuration and operation of equipment used by wireless cable systems; and to
impose certain equal employment opportunity and other reporting requirements on
wireless cable operators.
The FCC has determined that wireless cable systems are not "cable systems"
for purposes of the Communications Act. Accordingly, a wireless cable system
does not require a local franchise and is subject to fewer local regulations
than a hard-wire cable system. Moreover, all transmission and reception
equipment for a wireless cable system can be located on private property;
accordingly, there is no need to make use of utility poles or dedicated
easements or other public rights-of-way. Although wireless cable operators
typically have to lease the right to use wireless cable channels from the
holders of channel licenses, unlike hard-wire cable operators, they do not have
to pay local franchise fees. Recently, legislation has been introduced in some
states, including Illinois, Maryland, Pennsylvania and Virginia, to authorize
state and local authorities to impose on all video program distributors
(including wireless cable operators) a tax on the distributors' gross receipts
comparable to the franchise fees cable operators pay. Similar legislation
might be introduced in several other states. While the proposals vary among
states, the bills all would require, if passed, as much as 5.0% of gross
receipts to be paid by wireless distributors to local authorities. Efforts are
underway by the industry trade association to preempt such state taxes through
federal legislation. In addition, the industry is opposing the state bills as
they are introduced, and, in Virginia, it has succeeded in being exempted from
the video tax that was eventually enacted into law. However, it is not
possible to predict whether new state laws will be enacted which impose new
taxes on wireless cable operators. The imposition of a gross receipts tax on
the Company could have a material adverse effect on the Company's business.
In the nation's 50 largest metropolitan markets, 33 channels are available
for wireless cable (in addition to local off-air VHF/UHF broadcast channels
that are not retransmitted over the microwave channels). In the Company's
markets, 32 channels are available for wireless cable (in addition to local
off-air VHF/UHF broadcast channels that are not retransmitted over the
microwave channels), 12 of which can be licensed to for-profit entities such as
the Company for full-time usage without programming restrictions ("MDS"
channels). Except in limited circumstances, the other 20 wireless cable
channels can generally only be licensed to qualified non-profit educational
organizations, and, in general, each must be used a minimum of 20 hours per
week per channel for educational programming ("ITFS" channels). The remaining
excess air time on an ITFS channel may be leased to wireless cable operators
for commercial use, without further programming restrictions (other than the
right of the ITFS license holder, at its option, to recapture up to an
additional 20 hours of air time per week for educational programming). Certain
programs (e.g., The Discovery Channel and A&E) qualify as educational and
thereby facilitate full-time usage of an ITFS channel by commercial wireless
cable operators. Additionally, a technique known as "channel mapping" permits
ITFS licensees to meet their minimum educational programming requirements by
transmitting educational programming over several ITFS channels at different
times, but the viewer sees the transmission as one channel. In addition,
lessees of ITFS excess air time, including the Company, generally have the
right to transmit to their subscribers the educational programming provided by
the lessor at no incremental cost. In 1994, the FCC amended its rules to
permit "channel loading." Channel loading permits ITFS license holders to
consolidate their educational programming on one or more of their ITFS channels
thereby providing wireless cable operators leasing such channels, including the
Company, with greater flexibility in their use of ITFS channels. The remaining
12 wireless cable channels (commonly referred to as MDS or commercial channels)
available in most of the Company's markets are made available by the FCC for
full-time commercial usage without programming restrictions. The FCC's
allocation of frequencies to wireless cable is subject to change and in the
future the FCC might propose to alter the present wireless cable allocation to
provide a portion of the spectrum for other emerging technologies. The Company
believes that if any such action were taken to reallocate any of the current
wireless cable spectrum, the FCC would allocate substitute frequency rights to
the wireless cable industry or provide other concessions.
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In 1985, the FCC established a lottery procedure for awarding MDS licenses.
In 1990, the FCC established a filing "window" system for new multichannel MDS
("MMDS") applications. The FCC's selection among more than one acceptable MMDS
application filed during the same filing window was determined by a lottery.
Generally, once an MMDS application was selected by the FCC and the applicant
resolved any deficiencies identified by the FCC, a conditional license was
issued, allowing construction of the station to commence. Construction
generally must be completed within one year of the date of grant of the
conditional license, in the case of MMDS channels, or 18 months, in the case of
ITFS channels. ITFS and MMDS licenses generally have terms of 10 years.
Licenses must be renewed and may be revoked for cause in a manner similar to
other FCC licenses. FCC rules prohibit the sale for profit of an MMDS
conditional license or of a controlling interest in the conditional license
holder prior to construction of the station or, in certain instances, prior to
the completion of one year of operation. The FCC, however, does permit the
leasing of 100% of an MMDS license holder's spectrum capacity to a third party
and the granting of options to purchase a controlling interest in a license once
the required license holding period has lapsed and certain other conditions are
met. During the lifetime of any such lease or option agreement, the licensee
must remain in control of its FCC license to avoid violating FCC transfer of
control rules. Where two or more ITFS applicants file applications for the same
channels and the proposed facilities could not be operated without impermissible
interference, the FCC employs a set of comparative criteria to select from among
the competing applicants.
The FCC has concluded its auction ("BTA Auction") of available commercial
wireless cable spectrum in 487 "Basic Trading Areas" ("BTAs") and six
additional BTA-like geographic areas around the country. The winner of a BTA
has the right to develop the available MDS frequencies throughout the BTA,
consistent with certain specified interference criteria that protect existing
ITFS and MDS channels. Existing ITFS and MDS channel rights holders also must
protect the BTA winner's spectrum from interference caused by power increases
or tower relocations. The Company was the winning bidder in 93 BTAs at a total
cost of approximately $19.8 million. Under the terms of the BTA Auction, the
Company remitted a $1.0 million deposit at the commencement of the BTA Auction
and subsequently has remitted 20% of the total committed amount (less the $1.0
million deposit), or approximately $3.0 million, as down payments. The
remaining 80% of the committed amount, or approximately $15.8 million, bears
interest at 9.5% and will be paid over a 10-year period that began in the
fourth quarter of 1996 (the "BTA Obligation"). The Company will be required to
make quarterly interest-only payments for the first two years and quarterly
payments of principal and interest over the remaining eight years. CS Wireless
Systems, Inc. ("CS Wireless"), of which the Company owns approximately 34% of
the outstanding common stock, will reimburse the Company for all amounts paid
in the BTA Auction relating to 12 BTAs at a total cost of approximately $5.3
million, of which $1.1 million had been reimbursed as of December 31, 1996. The
Company had certain post-auction filing obligations including, but not limited
to, applications that propose new transmission facilities, exhibits concerning
its involvement in bidding consortia, and its plans to build-out two-thirds of
the market over a five-year period. The Company has made its initial filing in
each of the 93 BTAs for which the Company was the winning bidder. As of March
27, 1997, the FCC had not denied any of the Company's post-auction filings.
Due to the unique nature of the BTA Auction, there is no prior regulatory
history regarding the scope and nature of the information the FCC will require,
or how the FCC will treat the information.
Application for renewal of MDS and ITFS licenses must be filed within a
certain period prior to expiration of the license term, and petitions to deny
applications for renewal may be filed during certain periods following the
filing of such applications. Licenses are subject to revocation or
cancellation for violations of the Communications Act or the FCC's rules and
policies. Conviction of certain criminal offenses may also render a licensee
or applicant unqualified to hold a license. The Company's lease agreements
with license holders typically require the license holders, at the Company's
expense, to use their best efforts, in cooperation with the Company, to make
various required filings with the FCC in connection with the maintenance and
renewal of licenses. The Company believes this reduces the likelihood that a
license will be revoked, canceled or not renewed by the FCC.
The FCC also regulates transmitter locations and signal strength. The
operation of a wireless cable television system requires the co-location of a
commercially viable number of channels operating with common technical
characteristics. In order to commence operations in many of the Company's
future launch markets, the Company has filed or will be required to file
applications with the FCC to modify licenses for unbuilt stations. In applying
for these modifications, the Company must demonstrate that its proposed signal
does not violate interference standards in the FCC-protected area of another
wireless cable channel license holder. A wireless cable license holder
generally is protected from interference from another wireless cable operator
within a 35-mile
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radius of the transmission site. An ITFS license holder is entitled to
protection to all of its receive sites, but is only entitled to be awarded a
35-mile protected service area during excess capacity use by a wireless cable
operator. In addition, modifications submitted after the BTA Auction are
required to protect auction winners from interference. If such changes would
cause the Company's signal to cause interference in the FCC-protected service
area of another wireless cable channel license holder, the Company would be
required to obtain the consent of such other license holder; however, there can
be no assurance that such consent would be received and the failure to receive
such consent could adversely affect the Company's ability to serve the affected
market.
On February 19, 1997 the FCC issued a Report and Order ("WCS Order") in
which the FCC reallocated the frequency ranges of 2310-2320 MHz and 2345-2360
MHz (2.3 GHz band) on a primary basis for "wireless communications service," or
"WCS," including wireless Internet services and local loop connections. These
frequency ranges fall between the MDS and ITFS frequencies used by wireless
cable operators. The FCC intends to auction the WCS spectrum in April 1997.
The Company believes that, because of the location of the reallocated WCS
spectrum and the unregulated signal power level currently authorized for WCS,
the use of WCS spectrum could cause interference with the Company's wireless
cable channels without appropriate modifications to or replacement of its
downconverters to eliminate such interference. The Wireless Cable Association
("WCA") filed a Petition for Expedited Reconsideration of the WCS Order on
March 10, 1997 requesting the FCC to reconsider its decision not to impose a
power limitation on WCS licensees. The Wireless Cable Association also filed an
Emergency Motion for Stay on March 10, 1997 requesting the FCC to temporarily
stay the WCS spectrum auction until the FCC considers fully the WCA's Petition
for Reconsideration of the WCS Order. In addition, the Company believes that
the majority of its rural markets will not be affected in the near future by WCS
interference; however, there can be no assurance that either the WCA's or other
challenges to the WCS Order will be successful or that certain of the Company's
markets will not experience significant interference from WCS operators.
In addition, wireless cable operators have experienced interference from
operators of personal communications systems, or PCS, because of proximity to
PCS substations and the orientation of individual receive sites. To date, the
Company has not experienced significant interference from PCS operators and
currently does not expect significant interference in the majority of its
markets. However, there can be no assurance that the Company will not
experience significant PCS interference in the future in certain markets.
The Cable Act. On October 5, 1992, Congress passed the Cable Television
Consumer Protection and Competition Act of 1992 (the "Cable Act"), which
imposes greater regulation on traditional hard-wire cable operators and permits
regulation of prices in areas in which there is no "effective competition."
Pursuant to the Cable Act, the FCC, among other things, adopted comprehensive
new federal standards for local regulation of certain rates charged by
traditional hard-wire cable operators. The Cable Act also provides for
deregulation of traditional hard-wire cable in a given market when other
multi-channel video providers serve, in the aggregate, at least 15% of the
cable franchise area. Rates charged by wireless cable operators, typically
already lower than traditional hard-wire cable rates, are not subject to
regulation under the Cable Act.
Under the retransmission consent provisions of the Cable Act and the FCC's
implementing regulations, all multi-channel video providers (including both
hard-wire and wireless cable) seeking to retransmit certain commercial
broadcast signals must first obtain the permission of the broadcast station.
Hard-wire cable systems, but not wireless cable systems, are required under the
Cable Act and the FCC's "must carry" rules to retransmit a specified number of
local commercial television or qualified low power television signals. Oral
argument was recently heard in the Supreme Court in a case challenging the
"must carry" provisions of the Cable Act. If the challenge is successful and
"must carry" is overturned, the retransmission consent requirement would remain
in effect and will be negotiated by all broadcasters.
The 1996 Telecommunications Act. In February 1996, the Telecommunications
Act of 1996 (the "1996 Telecommunications Act") was enacted. Pursuant to the
1996 Telecommunications Act, all cable programming service tier rate regulation
will be eliminated after three years. In addition, for "small systems" (as
defined in the 1996 Telecommunications Act) and under certain other
circumstances, including cases where a cable system faces "effective
competition," such rate regulation will be eliminated immediately. Until these
sunset provisions go into effect, hard-wire cable operators will continue to be
subject to rate regulations. The 1996 Telecommunications Act removes certain
barriers to investment by telephone companies in hard-wire cable companies.
The legislation lifts the current statutory cross-ownership ban contained in
the Communications Act, which prevents a telephone
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company from using hard-wire facilities to provide cable television service to
the same community where it provides telephone service. The statutory ban was
never applied to a telephone company's investment in wireless cable. Telephone
companies operating in the markets serviced by the Company were legally
permitted to build, lease or purchase hard-wire cable systems and become
competitors of the Company. Although the 1996 Telecommunications Act offered
specific benefits and relief to the wireless cable industry including: (1)
clarifying that wireless cable operators are not "common carriers" and therefore
not subject to a number of regulations governing such licensees, and (2)
directing the FCC to implement rules preempting municipalities' or local
governments' regulations restricting wireless cable reception antennae,
including restrictions of homeowners associations, the Company is currently
unable to predict what effect these regulations may have on the Company. Direct
broadcast satellite operators were afforded relief under the legislation in the
form of an exemption from local taxes on their service. Wireless cable
operators did not receive such an exemption; however, the wireless cable
industry has continued to lobby Congress for a similar exemption.
While current FCC regulations are intended to promote the development of a
competitive multichannel video programming industry, the rules and regulations
affecting the wireless cable industry may change, and any future changes in FCC
rules, regulations, policies and procedures could have a material adverse
effect on the industry as a whole and on the Company in particular. In
addition, a number of legal challenges to the Cable Act and the regulations
promulgated thereunder have been filed, both in the courts and before the FCC.
These challenges, if successful, could substantially increase the Company's
operating costs, make some programming unavailable to the Company and otherwise
have a material adverse effect on the wireless cable industry as a whole or the
Company in particular. Other aspects of the Cable Act that have been
challenged, the outcome of which could adversely affect the Company and the
wireless cable industry in general, include the Cable Act's provisions
governing rate regulation. The Cable Act empowered the FCC to regulate the
subscription rates charged by traditional hard-wire cable operators. As
described above, the FCC issued rules requiring such cable operators, under
certain circumstances, to reduce the rates charged for basic services by 17%.
The Cable Act also empowered the FCC to establish certain minimum customer
service standards to be maintained by traditional hard-wire cable operators.
These standards include prompt responses to customer telephone inquiries,
reliable and timely installations and repairs and readily understandable
billing practices. Should these provisions withstand court and regulatory
challenges, the extent to which wireless cable operators may continue to
maintain an advantage over traditional hard-wire cable operators in price and
customer service practices could be diminished.
Other Regulations. Because the vast complex of coaxial cable utilized by
traditional hard-wire cable operators requires a "right of way" to cross
municipal streets, such operators must acquire a municipal franchise and pay
municipal franchise fees. Because wireless cable uses FCC approved
frequencies, it does not require a municipal right of way. Accordingly,
wireless cable operators are not subject to those franchise fees. Traditional
hard-wire cable operators are also required to set aside public access channels
for municipal and local resident use. Wireless cable operators are not subject
to these or other franchise requirements.
Wireless cable license holders are subject to regulation by the FAA with
respect to the construction, maintenance and lighting of transmission towers
and to certain local zoning regulations affecting construction of towers and
other facilities. There may also be restrictions imposed by local authorities.
There can be no assurance that the Company will not be required to incur
additional costs in complying with such regulations and restrictions.
AVAILABILITY OF PROGRAMMING
General. Once a wireless cable operator has obtained the right to
transmit programming over specified frequencies, the operator must then obtain
the right to use the programming to be transmitted. Currently, with the
exception of the retransmission of off-air VHF/UHF broadcast signals,
programming is made available in accordance with contracts with program
suppliers under which the system operator pays a royalty based on the number of
subscribers receiving service each month. Individual program pricing varies
from supplier to supplier; however, more favorable pricing for programming is
generally afforded to operators with larger subscriber bases. The Company,
Wireless One, Inc. ("Wireless One"), CAI Wireless Systems, Inc. ("CAI") and CS
Wireless recently formed a cooperative organization to obtain volume-based
programming contracts at a discount from rates currently paid by each of the
parties. There can be no assurances that the cooperative will achieve such
discounts. The likelihood that program material will be unavailable to the
Company has been significantly mitigated by the Cable Act and various FCC
regulations issued thereunder which, among other things, impose limits on
exclusive
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programming contracts and prohibit cable programmers in which a cable operator
has an attributable interest from discriminating against cable competitors with
respect to the price, terms and conditions of programming. Only a few of the
major cable television programming services carried by the Company are not
currently directly owned by vertically integrated multiple cable system
operators and the Company historically has not had difficulty in arranging
satisfactory contracts for these services. The basic programming package
offered in each of the Existing Systems is comparable to that offered by the
local traditional hard-wire cable operators. However, several of such local
traditional hard-wire cable operators currently offer more premium, pay-per-view
and public access channels than the Company.
Copyright. Under the Federal copyright laws, permission from the
copyright holder generally must be secured before a video program may be
retransmitted. Under Section 111 of the Copyright Act of 1976 (the "Copyright
Act"), certain "cable systems" are entitled to engage in the secondary
transmission of programming without the prior permission of the holders of
copyrights in the programming. In order to do so, a cable system must secure a
compulsory copyright license. Such a license may be obtained upon the filing
of certain reports and the payment of certain fees set by copyright arbitration
royalty panels.
Wireless cable operators may rely on Section 111. In 1994, Congress
enacted legislation that clarified the ability of wireless cable operators to
obtain the benefit of the compulsory copyright license. Periodically, Congress
has considered proposals to phase out the compulsory license. Congress has
requested the U.S. Copyright Office to hold a public hearing on the issue of
compulsory license. That hearing currently is scheduled for May 1997. Because
the Existing Systems retransmit only a limited number of broadcast channels,
the Company does not believe that the termination of the compulsory copyright
license would have a material adverse effect on the Company.
Effective October 6, 1993, broadcasters (other than superstations) could
require that cable operators obtain their consent before retransmitting off-air
VHF/UHF broadcasts. The FCC has exempted wireless cable operators from the
retransmission consent rules if the receive-site antenna is either owned by the
subscriber or within the subscriber's control and available for purchase by the
subscriber upon the termination of service. In all other cases, wireless cable
operators must obtain consent to retransmit broadcast signals. The Company has
obtained such consents in each of its Existing Systems where the Company is
retransmitting broadcast signals on a wireless cable channel. Such consents
will be required in the Company's other markets. There can be no assurance
that the Company will be able to obtain such consents on terms satisfactory to
the Company, if at all.
PAY TELEVISION INDUSTRY TRENDS
The Company's business will be affected by pay television industry trends
and, in order to maintain and increase its subscriber base in the years ahead,
the Company will need to adapt rapidly to industry trends and modify its
practices to remain competitive. Due to the limited number of physical
components of the wireless transmission system, the Company believes it will be
less expensive for it to adapt to coming industry trends than for traditional
hard-wire cable operators. The cost of such adaptation by the Company could
nonetheless be substantial.
Compression. Several decoder manufacturing companies are developing
digital compression technology, which would allow several programs to be
carried in the amount of bandwidth where only one program is carried now.
Manufacturers have projected varying compression ratios for future equipment,
with estimates ranging from 6-to-1 to 10-to-1. The Company believes
compression technology, allowing six to 10 channels within one 6-MHz bandwidth,
will be commercially available sometime in 1997. It is generally expected that
the intended use for this expanded channel capacity would be for pay-per-view
video services. Wireless cable companies will be able to use digital
compression technology through upgraded set-top converters. The Company
believes traditional hard-wire cable companies will be required to expend
significant funds on upgrading current systems in order to utilize
digitally-compressed signals.
Advertising. Until recently, most advertising on cable has been sold by
program suppliers, who sell national advertising time as part of the signal
they deliver to cable operators. Recently, however, advertisers have begun
placing advertisements on channels dedicated exclusively to advertising, as
well as in local available time (typically, two minutes each hour) set aside by
program suppliers for local insertions in their programming of
- 9 -
10
advertisements sold by cable operators. Use of local available time requires
automatic spot insertion equipment, which is readily available today at a
minimal capital cost.
Internet and the World Wide Web. Certain hard-wire cable operators have
announced their intentions to introduce cable modems that would connect to the
Internet and the World Wide Web at significantly higher bandwidths than
currently offered over conventional telephone lines. In addition, several
multimedia and Internet software and access providers plan to develop rich
multimedia content to be distributed over the Internet, such as digital audio
and video, interactive home shopping and video games, as high-bandwidth Internet
connections become widely available. Certain wireless cable operators have
successfully tested wireless cable modems that connect to the Internet at speeds
equal to or greater than hard-wire cable modems and T-1 telephone lines. The
Company has no immediate plans to introduce wireless Internet access products
and services in its markets; however, the Company believes that it will be able
to offer high-speed Internet access service as products and services and market
demand require high-bandwidth Internet access service.
COMPETITION
In addition to competition from established traditional hard-wire cable
systems, wireless cable operators face competition from a number of other
sources, including potential competition from emerging trends and technologies
in the pay television industry, some of which are described below.
Direct Broadcast Satellite ("DBS"). DBS involves the transmission of an
encoded signal direct from a satellite to the customer's home. Because the
signal is at a higher power level and frequency than most satellite-transmitted
signals, its reception can be accomplished with a relatively small (18-inch)
dish mounted on a rooftop or in the yard. DBS cannot, for technical and legal
reasons, provide local VHF/UHF broadcast channels as part of its service,
although many DBS subscribers receive such channels via standard over-air
receive antennae. Moreover, DBS may provide subscribers with access to
broadcast network distant signals only when such subscribers reside in areas
unserved by any broadcast station. The cost to a DBS subscriber for equipment
and service is generally substantially higher than the cost to wireless cable
subscribers. Several DBS services currently are available throughout the
Company's markets, and more are expected to be launched in 1997. DBS currently
has approximately 4.5 million subscribers. The Company does not currently
experience, and does not anticipate in the near future that it will experience,
significant competition from DBS in the markets in which the Company operates
due primarily to DBS' higher cost and failure to provide local VHF/UHF
broadcast channels. However, in August 1996, the U.S. Copyright Office issued
an advisory letter indicating that it "would not question" DBS companies that
file copyright statements that include the retransmission of local broadcast
signals. There is no assurance that the Company will continue to maintain a
competitive advantage over DBS services as a result of DBS' traditional
inability to provide local VHF/UHF broadcast channels.
Local Multi-Point Distribution Service ("LMDS"). In 1993, the FCC
proposed to redesignate the 28 gigahertz band to create a new video programming
delivery service referred to as local multipoint distribution service. In July
1996, the FCC proposed to award LMDS licenses in each of 493 BTAs pursuant to
auctions. Sufficient spectrum for up to 49 analog channels has been designated
for the LMDS service. On March 12, 1997, the FCC adopted rules to govern these
licenses. The FCC will award two licenses in each BTA (one for 1150 MHz and
one for 150 MHz). The FCC determined that telephone companies and traditional
hard-wire cable operators will not be permitted to bid on LMDS licenses in
their territory. Auctions are expected to be held sometime in 1997.
Satellite Receivers. Satellite receivers are generally six to 12 foot
dishes mounted in the yards of homes to receive television signals from
orbiting satellites. Until the implementation of encryption, these dishes
enabled reception of any and all signals without payment of fees. Having to
purchase decoders and pay for programming has reduced their popularity,
although the Company will to some degree compete with these systems in
marketing its services.
Satellite Master Antenna Television ("SMATV"). SMATV is a multi-channel
television service offered through a wired plant very similar to a traditional
hard-wire cable system, except that it operates without a franchise from a
local authority. SMATV operates under an agreement with a private landowner to
service one or more specific multiple-dwelling units, so long as no public
right of way is crossed between such units. The FCC has recently amended its
rules to provide point-to-point delivery of video programming by SMATV
operators and other video delivery systems in the 18 gigahertz band.
- 10 -
11
Telephone Companies. Before 1996, local exchange carriers ("LECs") were
prohibited from providing video programming directly to subscribers in their
respective telephone service areas. The FCC has ruled, however, that LECs may
acquire wireless cable channel operations. Moreover, certain U.S. District
Courts and Courts of Appeal have held that the "telco-cable cross-ownership
ban" abridges the First Amendment rights of LECs to free expression under the
U.S. Constitution. The 1996 Telecommunications Act lifts barriers to the
provision of cable television services by telephone companies including allowing
telephone companies to provide video service as "open video systems," which are
similar to traditional cable systems but are subject to different regulatory
requirements. While the competitive effect of the entry of telephone companies
into the video programming business is still uncertain, the Company believes
that wireless cable systems will continue to maintain a cost advantage over
fiber optic distribution technologies.
Off-Air VHF/UHF Broadcasts. Off-air VHF/UHF broadcasts (such as those
providing programming from ABC, NBC, CBS and Fox) provide a free programming
alternative to the public. Previously, wireless cable systems could retransmit
these broadcast signals without permission. However, effective October 6,
1993, pursuant to the Cable Act, broadcasters may require that cable operators
obtain their consent before retransmitting off-air VHF/UHF broadcasts. The
Company has obtained such consents in the Existing Systems where the Company is
retransmitting on a wireless cable channel. The FCC also has recently
permitted broadcasters to acquire, subject to certain restrictions, ownership
interests in traditional hard-wire cable systems.
Low Power Television ("LPTV"). LPTV utilizes a limited portion of the
spectrum allocated by the FCC for local off-air VHF/UHF broadcasts, but LPTV
utilizes lower power transmission equipment than local off-air VHF/UHF
broadcasts and its signal may be encrypted. LPTV typically has only a 15 to 20
mile signal range. LPTV requires a separate transmitter for each channel and a
standard antenna at the receiving site. Moreover, current proposals for
Advanced Television or High Definition Television may have an adverse effect on
certain LPTV stations.
BUSINESS STRATEGY
The Company's primary business objective is to develop, own and operate
wireless cable television systems in markets in which the Company believes it
can achieve positive system cash flow after system launch and then expand such
system while ultimately increasing such system's cash flow.
Rural Market Focus. The Company aggregates wireless cable channel rights
and locates operations in geographic clusters of small to mid-size markets that
have a substantial number of households not currently passed by traditional
hard-wire cable. The Company believes that this size market typically has a
stable economic base, less competition from alternative forms of entertainment
and other conditions conducive to wireless cable transmissions. Within the
rural areas of these small to mid-size markets, the Company's subscribers
consist primarily of single family households, as compared to the non-rural
areas of these markets that are typically passed by hard-wire cable and in
which multiple dwelling units ("MDUs") comprise a much larger percentage of the
Company's subscribers. The Company generally focuses its marketing primarily
on rural, unpassed single family households because they generate a higher
revenue per subscriber than MDU subscribers. However, in 1996, the Company's
MDU subscribers increased as a result of the substantial existing MDU
penetration of several of the markets acquired by the Company in 1996. As of
December 31, 1996, the Company's subscriber base consisted of approximately
94.3% single family units and 5.7% MDUs, using the Company's revised method for
calculating MDU subscribers. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Changes in Method for
Reporting Subscribers; Write-Offs." The Company currently expects that the
percentage of MDU subscribers should decline as the Company maintains its focus
on adding subscribers in rural, unpassed areas.
Managed Subscriber Penetration. The Company attempts to manage system
launch and subscriber growth in order to contain system launch costs and to
achieve positive cash flow. Within a system, the Company initially directs its
marketing at unpassed households, which typically have limited access to local
off-air VHF/UHF broadcast channels. Once a system achieves positive System
EBITDA (defined in "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Overview"), the Company may expand the channel
offering and add subscribers.
- 11 -
12
Low Cost Structure. Wireless cable systems typically cost less to build
and operate than traditional hard-wire cable systems. While both traditional
hard-wire cable operators and wireless cable operators must construct a
transmission facility ("head-end"), traditional hard-wire cable operators must
also install an extensive network of coaxial cable and amplifiers in order to
transmit signals from the head-end to subscribers. Once the head-end is
constructed, the Company estimates that each additional single family household
subscriber currently requires an incremental capital expenditure by the Company
of approximately $465, consisting of, on average, $280 of material (depending
upon the type and sophistication of the equipment), $145 of installation labor
and overhead charges and $40 of direct commission. The Company has recently
launched systems utilizing a more sophisticated type of equipment that costs
approximately $65 less per installation and therefore it believes that the
average cost of materials will decline as more subscribers are added in systems
that utilize such equipment. Typically, an MDU subscriber requires an
incremental capital expenditure by the Company lower than that of a single
family household subscriber. Also, without an extensive cable network, wireless
cable operators typically incur lower system maintenance costs and depreciation
expense. Finally, by locating its operations in geographic clusters, the
Company can further contain costs by taking advantage of economies of scale in
management, sales and customer service.
Churn Rate. Because of recent subscriber write-offs and changes in
the Company's methodology for calculating certain MDU subscribers, the churn
rate for the quarter and year ended December 31, 1996 was 9.6% and 4.1%,
respectively. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Changes in Method for Reporting Subscribers;
Write-Offs." Excluding the subscriber write-offs and methodology change for
reporting MDU subscribers, and on a comparable basis with prior periods, the
Company's average monthly churn rate was 3% and 2.2% for the fourth quarter and
year ended December 31, 1996, respectively. For the two months ended February
28, 1997, the Company experienced a rate of subscriber turnover of an average
of approximately 2% per month. The Company expects its churn rate in the
foreseeable future to be lower than the industry standard because a majority
of its markets are characterized by (i) limited or no access to affordable pay
television alternatives, (ii) less competition from alternative forms of
entertainment and (iii) a stable population base. In addition, the Company
has implemented improved subscriber qualification and retention policies that
include a combination of credit checks, service deposits, advance payments and
installation fees for certain subscribers.
EXISTING SYSTEMS AND FUTURE LAUNCH MARKETS
The following tables provide information regarding the 95 markets in which
the Company has, or expects to acquire, wireless cable channel rights that it
intends to retain and develop as of December 31, 1996. In these markets, the
Company has acquired or is in the process of acquiring sufficient channel
rights to commence the launch of a system in the market. The Existing Systems
are listed in order of date of launch or, for acquired markets, date of
acquisition. The subscriber numbers set forth below have been calculated based
upon the Company's revised methodology for reporting subscribers in MDUs,
effective December 31, 1996, and reflect subscribers written off as of December
31, 1996. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Changes in Method for Reporting Subscribers;
Write-Offs."
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13
ESTIMATED ESTIMATED NUMBER OF
TOTAL LINE-OF-SIGHT SUBSCRIBERS
EXISTING SYSTEMS HOUSEHOLDS(1) HOUSEHOLDS(2) AT 12/31/96
- ------------------ ------------- ------------- -----------
Ada, OK 23,348 21,013 4,483
Wichita Falls, TX 102,928 97,783 4,744
Midland, TX 166,893 158,548 4,086
Abilene, TX 130,313 123,800 3,201
Lawton, OK 102,777 97,638 7,252
Laredo, TX 344,135 326,929 4,346
Enid, OK 85,059 80,807 4,788
Lindsay, OK 57,628 51,865 3,469
Ardmore, OK 68,069 61,263 3,704
Mt. Pleasant, TX 35,268 31,742 2,879
Chanute, KS 56,109 50,810 4,856
Stillwater, OK 76,917 69,225 5,760
Texarkana, TX 147,371 132,634 1,850
Lubbock, TX 139,626 125,663 4,980
McLeansboro, IL 91,458 82,312 1,965
Vandalia, IL 127,329 114,596 2,217
Olney, IL 71,203 64,082 2,309
Taylorville, IL 177,350 159,615 2,460
Peoria, IL 317,703 285,933 2,079
Bucyrus, OH 254,160 228,744 1,459
Paragould, AR 109,927 98,934 2,870
Sikeston, MO 107,662 96,896 3,051
Manhattan, KS 59,541 53,587 1,938
Olton, TX 36,669 34,836 1,399
O'Donnell, TX 77,669 73,785 1,408
Monroe City/Lakenan, MO 76,686 69,017 2,199
Sherman/Denison, TX 105,576 95,019 8,663
Freeport, IL 200,291 150,218 1,884
Paris, TX 58,378 52,540 3,666
Strawn/Ranger, TX 36,212 32,591 1,326
Corsicana/Athens, TX 72,619 65,357 2,485
Champaign, IL 211,583 190,425 3,695
Austin, TX 389,958 350,962 15,470
Waco, TX 113,234 101,911 6,071
Temple/Killeen, TX 120,216 108,194 9,872
Corpus Christi, TX 144,805 130,324 14,735
Hamilton, TX 44,291 39,862 3,283
Marion, KS 74,337 66,903 1,805
Sterling, Kansas 81,484 73,336 1,539
Macomb/Walnut Grove, IL 142,457 128,211 2,356
Tulsa, OK 353,392 318,053 7,789
George West, TX 28,135 25,322 1,943
Kingsville/Falfurrias, TX 39,396 35,457 1,251
Uvalde/Sabinal, TX 16,585 14,926 955
Medicine Lodge/Anthony, KS 16,588 14,929 1,062
Gainesville, TX 87,788 79,010 951
Jourdanton/Charlotte, TX 34,410 30,969 941
Kerrville, TX 27,547 24,792 339
Greenville, PA 352,903 317,613 361
Jacksonville, IL 49,180 44,262 416
Radcilffe, IA(3) 77,356 73,101 1,819
Weatherford, OK 33,017 31,367 87
Montgomery City, MO 67,656 67,656 264
Beloit, KS 40,599 36,539 142
Woodward, OK 24,771 22,294 270
Watonga, OK 26,122 23,510 181
--------- --------- ---
Total Existing Markets.... 6,114,684 5,537,710 181,373
========= ========= =======
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14
ESTIMATED ESTIMATED
TOTAL LINE-OF-SIGHT
FUTURE LAUNCH MARKETS(4) HOUSEHOLDS(1) HOUSEHOLDS(2)
- ------------------------- ------------- -------------
Altus, OK...................... 32,186 30,576
Amarillo, TX................... 190,779 181,241
Borger, TX..................... 22,713 21,576
Bumet, TX...................... 26,991 24,291
Casper, WY..................... 50,882 45,794
Cheyenne, WY................... 42,053 37,847
Columbia, MO................... 175,834 158,251
Crow, TX....................... 74,996 67,497
Des Moines, IA................. 347,158 312,442
El Dorado, AR.................. 63,860 57,474
El Paso, TX.................... 237,811 214,030
Elk City, OK................... 27,698 24,928
Fischer, TX.................... 332,891 299,602
Flagstaff, AZ.................. 31,819 28,638
Forrest City, AR............... 58,424 43,819
Great Bend, KS................. 29,126 26,213
Hays, KS....................... 67,328 60,595
Henryetta, OK.................. 35,093 31,584
Holdenville, OK................ 53,169 47,852
Kalispell, MT (3).............. 33,263 29,937
Kossuth, TX.................... 55,118 49,606
Lenapah, OK.................... 55,284 49,755
Lufkin, TX..................... 127,770 114,993
Mayfield, KY................... 189,337 170,403
McAlester, OK(5)............... 39,058 35,152
Miami, OK...................... 95,937 86,344
Muskogee, OK(6)................ 89,906 80,916
Ottawa/LaSalle, IL............. 259,678 233,710
Peaksville, MO................. 50,565 45,508
Ponca City, OK................. 45,257 40,731
Purdin, MO..................... 29,173 26,256
Scottsbluff, NE (3)............ 24,995 22,496
Searcy, AR..................... 75,909 68,318
Seminole, OK................... 44,314 39,833
Shreveport, LA................. 225,031 191,276
Springfield, MO................ 241,182 217,064
Stromsberg, NE................. 36,554 31,071
Topeka, KS..................... 257,509 231,759
Tyler, TX...................... 259,470 233,523
------------- -------------
Total-Future Markets........... 4,136,121 3,712,901
- -------------------- ------------- -------------
Total-All Company Markets...... 10,250,805 9,250,611
- ------------------------- ============= =============
(1) Estimated Total Households represent the Company's estimate of the total
number of households that are within the Company's service area. The
Company's service area includes (i) areas that are presently served, (ii)
areas where systems are not presently in operation but where the Company
intends to commence operations and (iii) areas where service may be
provided by signal repeaters or, in some cases, pursuant to FCC
applications.
(2) Estimated Line-of-Sight Households represents the Company's estimate of
the number of households that can receive an adequate signal from the
Company in its service area (determined by applying a discount to the
Estimated Total Households in order to account for those homes that
the Company estimates will be unable to receive service due to certain
characteristics of the particular market). The calculation of Estimated
LOS Households assumes (i) the grant of pending applications for new
licenses or for modification of existing licenses and (ii) the grant of
applications for new licenses and license modification applications which
have not yet been filed with the FCC.
(3) The Company is operating or maintaining these markets, as applicable,
under a Management Agreement.
(4) Such markets include markets with respect to which the Company has
systems under construction or aggregated or is aggregating additional
wireless cable channel rights. The Company expects a substantial number
of such licenses to be granted by the FCC.
(5) System launched in February 1997.
(6) System launched in January 1997.
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15
Existing Systems. As of December 31, 1996, pro forma for the acquisition
of two operating systems consummated in January 1997 and including one operating
system managed by the Company, the Company had 56 Existing Systems. The Company
generally offers 16 to 24 basic wireless cable channels (including three to six
local off-air VHF/UHF broadcast channels that are retransmitted), one to three
premium channels (HBO, Showtime or Cinemax) and one pay-per-view channel.
Generally, the Company's Existing Systems lease all of their wireless cable
channels. The terms of such leases typically expire five to 10 years from the
license grant date, ranging from years 1998 to 2005, and such leases provide for
either a right of first refusal or two automatic five-year renewal periods or
one 10-year renewal period if such automatic renewals are then permitted by the
FCC. The Existing Systems transmit at 10 to 100 watts of power from a
transmission tower that generally has a signal pattern covering a radius of 35
to 50 miles.
Future Launch Markets. In these markets, the Company has aggregated or is
aggregating additional wireless cable channel rights. Certain of the Company's
channel rights in the future launch markets are in the form of lease agreements
with educational entities that have pending applications for ITFS channels or
that have had applications returned without prejudice by the FCC which will be
refiled. These ITFS applications undergo review by the FCC's engineering and
legal staff. Because the FCC's application review process does not lend itself
to complete certainty, and given the considerable number of applications
involved, no assurance can be given as to the precise number of applications
that will be granted.
The Company currently does not expect to launch any new markets during the
next three to six months, during which period the Company's time and resources
will be focused on increasing cash flow and profitability in the Existing
Systems. Following such period, the Company will determine an appropriate
construction schedule for its future launch markets, based upon multiple
factors, including, but not limited to, the availability of capital resources,
the number of wireless cable channels for which FCC licenses have been
obtained, the expiration dates of leases and FCC construction permits, the
number of potential subscribers in each market and the proximity of a market to
the Existing Systems of other markets ready for construction. Construction
will involve the construction of a transmission building near a transmission
tower and the installation of transmission equipment and, in certain cases, the
construction of the transmission tower. The construction of the transmission
facility will enable the Company to launch wireless cable service in such
markets.
CUSTOMER SERVICE, VALUE AND QUALITY
The Company believes that the key factors that determine the
attractiveness of its service offerings are the following: (i) customer
service; (ii) programming, (iii) price, and (iv) picture quality and
reliability.
Customer Service. The Company has established a goal of maintaining high
levels of customer satisfaction. In furtherance of that goal, the Company
emphasizes employee training, responsiveness and convenient installation
scheduling. The Company has established customer retention programs in an
effort to obtain and retain new subscribers. In an effort to further improve
customer service, the Company is currently re-evaluating its customer retention
programs.
Programming. In the Existing Systems, the Company believes that it has
assembled sufficient channel rights and programming agreements to provide a
programming package competitive with those offered by traditional hard-wire
cable and DBS operators. Additionally, the Company has the capacity to offer
pay-per-view programming and impulse addressability not currently widely
offered by traditional hard-wire cable operators. The Company's typical
channel offering includes between 16 and 24 basic cable channels (including
three to six local off-air VHF/UHF broadcast channels that are retransmitted),
one to three premium channels (HBO, Showtime or Cinemax) and one pay-per-view
channel on an event-by-event basis. Specific programming packages vary
according to particular market demand.
Price. The Company offers its subscribers a programming package
consisting of basic service and premium programs. The Company can offer a
price to its subscribers for basic service that is competitive with traditional
hard-wire cable and DBS operators. The Company believes it will continue to be
price competitive with traditional hard-wire cable and DBS operators with
respect to comparable programming. The Company's typical single family unit
pricing structure is $22.95 to $24.95 for basic service and $5.95 to $9.95 for
one premium service channel or $15.95 for a combination premium service.
Depending on market demand and competition,
- 15 -
16
the Company offers a combination package consisting of basic service, rental of
the receive-site equipment and two premium channels for $29.95 to $34.95 per
month for existing subscribers.
Picture Quality and Reliability. The Company believes that it is
positioning itself as a reliable alternative to traditional hard-wire cable by
delivering a high quality signal throughout the entire signal area of the
Existing Systems. Wireless cable subscribers enjoy substantially outage-free,
highly reliable picture quality because there is no coaxial cable, amplifiers
or processing and filtering equipment between the head-end and the subscriber's
household, as in the case of traditional hard-wire cable. Within the signal
range of the Existing Systems, the picture quality of the Company's service is
at least as good as that typically received by traditional hard-wire cable
subscribers because, absent any line-of-sight obstruction, there is less
opportunity for signal degradation between the Company's head-end and the
subscriber.
EMPLOYEES
As of March 21, 1997, the Company had approximately 1,390 employees. None
of the Company's employees are subject to a collective bargaining agreement.
The Company has experienced no work stoppages and believes that it generally
has good relations with its employees. The Company also presently utilizes the
services of independent contractors to install certain of its wireless cable
systems and market its services.
ACQUISITIONS, DIVESTITURES AND RECENT TRANSACTIONS
February 1996 Transactions. Effective February 23, 1996, the Company,
directly or through one or more subsidiaries, acquired all the assets and
liabilities and succeeded to the businesses of American Wireless Systems, Inc.
and CableMaxx, Inc., and acquired substantially all of the assets and certain
liabilities and succeeded to all the businesses of Fort Worth Wireless Cable
T.V. Associates, Wireless Cable TV Associates #38 and Three Sixty Corp.,
successor to Technivision, Inc. (collectively referred to herein as the
"Transactions"). The Company issued approximately 6.76 million shares of
Common Stock representing approximately 34.9% of its then outstanding Common
Stock in connection with the Transactions. Following the CS Transaction
(described below) and the subsequent distribution of other wireless cable
assets acquired in the Transactions, the Company retained wireless cable
channel rights in the following markets acquired in the Transactions:
Amarillo, Corsicana/Athens, Austin, Corpus Christi, El Paso, Lubbock,
Sherman/Denison, Temple/Killeen, and Waco, Texas. In addition to the
consideration received upon the transfer of markets acquired in the
Transactions to CS Wireless, the Company has received approximately $13.6
million in cash from other sales of markets acquired in the Transactions.
The CS Wireless Transaction. Effective February 23, 1996, immediately
following the closing of the Transactions, the Company, CAI and CS Wireless
consummated a Participation Agreement pursuant to which the Company (or certain
of its subsidiaries) contributed or sold a substantial portion of the assets
received in the Transactions and certain other assets to CS Wireless (the "CS
Wireless Transaction"). Simultaneously with the contribution and sale of such
assets by the Company to CS Wireless, CAI (or certain of its subsidiaries) also
contributed to CS Wireless (directly or by contribution of stock of
subsidiaries) certain wireless cable television assets which, collectively with
the Company's contributed assets, created a company with approximately 5.7
million line-of-sight households and approximately 58,500 subscribers as of
February 23, 1996.
In connection with the CS Wireless Transaction, the Company (or its
subsidiaries) received (i) shares of CS Wireless common stock constituting
approximately 35% of the outstanding shares of CS Wireless common stock, (ii)
approximately $28.3 million in cash paid at the closing, (iii) a promissory
note in the principal sum of $25 million (which note has been prepaid by its
terms) and (iv) a promissory note in the sum of $15 million payable 10 years
from closing and prepayable from asset sales and certain other events. CS
Wireless, CAI and the Company are in the process of completing certain
post-closing adjustments. Components of such adjustments include the relative
accounts payable, accounts receivable and related working capital assets of the
contributed systems, the number of granted channels represented and actually
contributed to CS Wireless for each market, the amount of any increase or
decrease in the number of subscribers in each contributed system from the
number of subscribers previously disclosed and related factors. The Company
has received $5.0 million in cash in partial payment of such adjustments.
Following the completion of these adjustments, additional payments of cash
and/or shares of CS Wireless common stock are expected to be made to the
Company by CS Wireless and/or CAI.
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17
Also, in connection with the closing of the CS Wireless Transaction, CAI,
the Company and CS Wireless entered into a stockholders agreement (the "CS
Wireless Stockholders Agreement"). The CS Wireless Stockholders Agreement
provides, among other things, that the Company and CAI will agree to vote their
shares of CS Wireless Common Stock in favor of a Board of Directors of CS
Wireless having nine members consisting of (i) up to four members designated by
CAI (provided that at least one of whom may not be an affiliate of either CAI
or the Company); (ii) up to three members designated by the Company (provided
that at least one of whom may not be an affiliate of either CAI or the
Company); (iii) the Chief Executive Officer of CS Wireless; and (iv) the Chief
Operating Officer of CS Wireless. The Stockholders' Agreement and CS Wireless'
bylaws further provide that certain major transactions will require the
affirmative approval of at least 70% (seven of nine) of the Directors of CS
Wireless.
Telinor Investment. In July 1996, the Company acquired 49% of the
outstanding capital stock of Television Interactiva del Norte, SA de C.V., a
Mexican corporation ("Telinor"), for approximately $0.5 million. The Company
anticipates that Telinor will seek to aggregate wireless cable channel rights
throughout Mexico.
$15 Million Note Offering. On March 25, 1996, the Company consummated a
private placement of $15 million principal amount of 13% Senior Notes (the
"Series C Notes"). On January 22, 1997, the Company consummated an exchange
offer pursuant to which $15 million principal amount of 13% Senior Series D
Notes ("Series D Notes") were issued in exchange for an equal principal amount
of Series C Notes, all of which were cancelled. The terms of the Series C
Notes and the Series D Notes are identical in all material respects except that
the Series D Notes have been registered under the Securities Act and therefore
do not have legends restricting their transfer.
$25 Million Revolving Credit Facility. On November 27, 1996, a wholly
owned subsidiary of the Company entered into a senior secured revolving credit
facility, permitting borrowings in an aggregate principal amount outstanding at
any time of up to $25.0 million (the "Bank Facility"). Approximately $6.7
million in borrowings under the Bank Facility were repaid from the proceeds of
the private placement of the 14% Notes (defined below) and the Bank Facility
has been terminated.
$125 Million Note Offering. On December 20, 1996, the Company consummated
a private placement of $125 million principal amount of 14% Senior Notes (the
"Old Notes"). On February 10, 1997, the Company filed a Registration Statement
on Form S-4 (No. 333-12577) with the SEC to register the offering of $125
million principal amount of 14% Series B Senior Notes (the "Exchange Notes" and
collectively with the Old Notes the "14% Notes") in exchange for the Old Notes
(the "Exchange Offer"). The terms of the Exchange Notes and the 14% Notes are
identical in all material respects. The Exchange Offer will expire April 10,
1997, unless extended by the Company. Upon the consummation of the Exchange
Offer, the Exchange Notes will be registered under the Securities Act and
therefore will not have legends restricting their transfer.
Programming Cooperative. In February 1997, the Company, CS Wireless,
Wireless One and CAI formed a cooperative organization to negotiate and obtain
volume-based programming contracts at a discount from rates currently paid by
each of the parties. The organization may expand its purposes upon approval of
each party to include mutually advantageous endeavors such as volume-based
purchases of equipment and other services. There can be no assurance that any
such benefits will be realized.
Other Divestitures. On May 6, 1996, the Company consummated the sale of
wireless cable markets in Memphis and Flippin, Tennessee to TruVision Wireless,
Inc. ("TruVision") for approximately $5.4 million in cash. On June 21, 1996,
the Company sold wireless cable channel rights in Los Angeles, California for
$8.2 million in cash plus a reimbursement of $1.5 million of expenses. On July
17, 1996, a subsidiary of the Company consummated the sale of wireless cable
channel rights in Adairsville, Powers Crossroads and Rutledge, Georgia to CS
Wireless for $7.2 million in cash.
Pending Acquisitions and Divestitures. The Company has entered into a
nonbinding letter of intent to acquire one wireless cable operating system in
Iowa and wireless cable assets in one market in each of Nebraska and Montana
from CS Wireless. In addition, a subsidiary of the Company has agreed to sell
to CAI certain wireless cable assets in Portsmouth, New Hampshire. The Company
will receive approximately 267,000 shares
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of common stock of CS Wireless as its portion of the consideration for such
assets. Also, the Company has entered into an agreement with American
Telecasting, Inc. in which the parties agreed to exchange certain wireless cable
channel rights and related assets in South Dakota, Florida, Michigan and
Illinois. Each of the above agreements is subject to customary closing
conditions. The Company anticipates that these agreements will be consummated
on or before June 30, 1997, although there can be no assurance that any of
these transactions will be consummated.
RECENT EVENTS
On March 29, 1997, John A. Fanning, Interim President and Chief Executive
Officer, resigned as a Director of the Company. Mr. Fanning remains Interim
President and Chief Executive Officer of the Company. Further, on March 29,
1997, the remaining Directors ratified and authorized a Search Committee
comprised of Alvin H. Lane, Jr., Dennis M. O'Rourke and John A. Sprague to
conduct a search for and hire a permanent Chief Executive Officer without
further action from the Board of Directors. In connection therewith, Jupiter
Partners, L.P., the holder of $40,150,000 gross proceeds of 9% convertible
subordinated discount notes issued by the Company ("Convertible Notes"), and
Hunt Capital Group, L.L.C. and L. Allen Wheeler, principal stockholders of the
Company, stated their intention as security holders of the Company to nominate
(or to request their respective designees to the Board of Directors of the
Company to nominate), upon the selection of a permanent Chief Executive
Officer, a slate of directors comprised of a representative of each of them,
together with the permanent Chief Executive Officer and three (3) independent
directors.
ITEM 2. PROPERTIES
The Company leases approximately 24,000 square feet of office space, of
which approximately 10,000 square feet is subleased to CS Wireless, for its
executive offices in Plano, Texas under a lease that expires April 10, 2003. The
Company pays approximately $385,000 per annum rent for such space, of which
$192,500 (50%) is reimbursed to the Company by CS Wireless. The Company leases
from affiliates of L. Allen Wheeler, a director of the Company, and David E.
Webb, a former executive officer and director of the Company, approximately
16,350 square feet in several locations for its operating, executive,
telemarketing and collections offices in Durant, Oklahoma under leases that
expire between March 1, 2000 and May 31, 2000. The Company pays a total of
$108,000 per annum rent for such space. The Company leases approximately an
additional 30,000 square feet of tower and warehouse space in Durant, Oklahoma
from an affiliate of Messrs. Webb and Wheeler under two leases that expire on
March 1, 2000 and August 1, 2000. The Company pays $35,000 per annum rent for
such space. The Company leases from an affiliate of Messrs. Webb, Wheeler and
Robert R. Story, a former executive officer of the Company, an additional 12,430
square feet of office space in Durant, Oklahoma under a lease that expires March
1, 2000. The Company pays $62,000 per annum rent for such space. The Company
believes that these facilities are adequate for the foreseeable future.
The principal physical assets of a wireless cable system consist of
satellite signal reception equipment, radio transmitters and transmission
antennae, as well as office space and transmission tower space. The Company
leases office space for the Existing Systems and will, in the future, purchase
or lease additional office space in other locations where it launches other
wireless cable systems. The Company also owns transmission towers or leases
space on transmission towers located in its markets. The current capacity
range of the Company's transmission facilities is from 10 to 100 watts, capable
of generating a signal over a 35 to 50 mile range. The Company believes that
office space and space on transmission towers currently is readily available on
acceptable terms in the markets where the Company intends to operate wireless
cable systems.
ITEM 3. LEGAL PROCEEDINGS
The Company is a party, from time to time, to routine litigation incident
to its business. It is the opinion of management that no pending litigation
matter will have a material adverse effect on the Company's consolidated
financial position or operating results.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Between October 29, 1996 and December 9, 1996, the Company engaged in the
solicitation of consents ("Consent Solicitation") of the holders of its 13%
Series B Senior Notes due 2003 ("Series B Notes") and holders of its Series C
Notes (together with the Series B Notes, the "Notes", and collectively all of
the Company's 13% Senior Notes are referred to as the 13% Notes") to amend
certain (i) provisions of the indentures (the "13% Note Indentures") of the
Notes to permit the Company to, among other things, issue the 14% Notes and
(ii) definitions and covenants in the 13% Note Indentures, which impose
restrictions on the Company's ability to pursue certain additional financing
and investment opportunities that the Company believes were necessary to
enhance the value of the Company (collectively, the "Amendments").
Pursuant to the terms of the 13% Note Indentures, the Amendments required
the approval of at least a majority in aggregate principal amount of the Notes
that were outstanding on or before December 5, 1996, the expiration date of the
Consent Solicitation. The Amendments received approval of 100% in aggregate
principal amount of the Notes and, accordingly, became effective as of December
9, 1996, upon the execution of supplemental indentures embodying such
Amendments. Promptly upon the effectiveness of the supplemental indentures
including the Amendments, the Company paid to each holder of the Notes who
delivered a properly
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completed and executed consent form $60 in cash for each $1,000 principal amount
of Notes for which such consent form was delivered by such holder. The Company
paid an aggregate of $6.9 million to the holders of the Notes in this regard.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Common Stock began trading on the Nasdaq National Market on April 22,
1994. The following table sets forth, on a per share basis for the periods
shown, the high and low closing sale prices of the Common Stock as reported on
the Nasdaq National Market. Such quotations reflect inter-dealer prices,
without retail mark-up, mark-down or commission and may not necessarily
represent actual transactions.
Closing Sale Price
--------------------
High Low
--------- ---------
Fiscal Year Ended December 31, 1995:
First Quarter............................. $17.25 $11.75
Second Quarter............................ $24.25 $15.50
Third Quarter............................. $25.75 $19.50
Fourth Quarter............................ $31.50 $27.00
Fiscal Year Ended December 31, 1996:
First Quarter............................. $29.75 $23.00
Second Quarter............................ $28.63 $22.88
Third Quarter............................. $25.25 $19.56
Fourth Quarter............................ $25.25 $11.75
Fiscal Year Ending December 31, 1997:
First Quarter (through March 25, 1997).... $12.38 $ 2.13
On March 25, 1997, the last reported sale price for the Common Stock as
reported on the Nasdaq National Market was $2.38 per share. As of March 25,
1997, there were approximately 707 holders of record of the Common Stock.
The Company has never declared or paid any cash dividends on the Common
Stock and does not presently intend to pay cash dividends on the Common Stock
in the foreseeable future. The Company intends to retain future earnings for
reinvestment in its business. The Company's ability to declare or pay cash
dividends is affected by the ability of the Company's present and future
subsidiaries to declare and pay dividends or otherwise transfer funds to the
Company since the Company conducts its operations through majority-owned
subsidiaries. The terms governing the preferred stock issued by one of the
Company's majority-owned subsidiaries include a preference as to dividend
payments over the Company, as a holder of common stock of such subsidiary.
Certain covenants in a Note Purchase Agreement among the Company, Jupiter
Partners L.P. and Thomas R. Haack prohibit the Company from declaring or paying
cash dividends. Future loan facilities, if any, obtained by the Company or any
of its subsidiaries also may prohibit or restrict the payment of dividends or
other distributions. Subject to the waiver of such prohibitions and compliance
with such limitations, the payment of cash dividends on shares of Common Stock
will be within the discretion of the Company's Board of Directors and will
depend upon the earnings of the Company, the Company's capital requirements,
applicable requirements of the Delaware General Corporation Law and other
factors that are considered relevant by the Company's Board of Directors.
ITEM 6. SELECTED FINANCIAL DATA
The selected historical financial data presented below as of December 31,
1996 and 1995 and for the years ended December 31, 1996, 1995 and 1994 were
derived from the consolidated financial statements of the Company, which were
audited by KPMG Peat Marwick LLP, independent certified public accountants, and
which are included elsewhere in this Form 10-K. The selected historical
financial data presented below as of December
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31, 1994, 1993 and 1992 and for the years ended December 31, 1993 and 1992 were
derived from consolidated financial statements of the Company, which were
audited by KPMG Peat Marwick LLP, but which are not included in this Form 10-K.
This selected consolidated financial data should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Company's consolidated financial statements (including the
notes thereto) included elsewhere in this Form 10-K.
(IN THOUSANDS, EXCEPT PER SHARE DATA) Year Ended December 31,
------------------------------------------------------------------
1996 1995 1994 1993 1992
-------- -------- ------- ----- ----
STATEMENT OF OPERATIONS DATA:
Revenues................................................. $56,017 $15,300 $2,229 $869 $205
Operating expenses:
Systems operations..................................... 21,255 4,893 762 321 36
Selling, general and administrative.................... 42,435 11,887 4,183 647 148
Depreciation and amortization.......................... 39,323 6,234 1,098 138 35
-------- -------- ------- ----- ----
Total operating expenses............................ 103,013 23,014 6,043 1,106 219
-------- -------- ------- ----- ----
Operating loss........................................... (46,996) (7,714) (3,814) (237) (14)
Interest expense, net.................................... (18,166) (10,857) (210) (73) --
Equity in losses of affiliates........................... (18,612) (1,369) (387) -- --
Other income (expense)................................... 4,981 (247) (227) (96) (37)
Income tax benefit....................................... 28,156 4,285 1,595 -- --
-------- -------- ------- ----- ----
Loss before extraordinary item........................... $(50,637) $(15,902) $(3,043) $(406) $(51)
Extraordinary item, net of tax benefit................... (10,424) -- -- -- --
======== ======== ======= ===== ====
Net loss $(61,061) $(15,902) $(3,043) $(406) $(51)
======== ======== ======= ===== ====
Loss before extraordinary item per common share.......... $(2.74) $(1.34) $(0.30) $(0.05) $(0.01)
Extraordinary item per common share...................... (0.57) -- -- -- --
Net loss per common share................................ $(3.31) $(1.34) $(0.30) $(0.05) $(0.01)
Weighted average number of common
shares outstanding....................................... 18,473 11,866 10,011 8,000 8,000
(IN THOUSANDS, EXCEPT PER SHARE DATA) December 31,
------------------------------------------------------------------
1996 1995 1994 1993 1992
-------- -------- ------- ----- ----
BALANCE SHEET DATA:
Cash and cash equivalents.................................. $79,596 $23,143 $11,986 $815 $ 165
Total assets............................................... 515,364 205,405 77,921 8,665 2,268
Long-term debt, including current portion.................. 303,538 141,652 40,506 1,593 --
Total stockholders' equity................................. 180,847 51,688 30,081 4,493 1,004
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
The Company develops, owns and operates wireless cable television systems.
The Company has wireless cable channel rights in small to mid-size markets in
the central United States. The Company targets small to mid-size markets with
significant numbers of households that are unpassed by traditional hard-wire
cable. The Company offers its subscribers local off-air VHF/UHF channels, as
well as HBO, Showtime, Disney, ESPN, CNN, USA, WGN, WTBS, Discovery, the
Nashville Network, A&E and other popular cable television networks. At December
31, 1996 the Company had wireless cable channel rights in 95 markets,
representing approximately 10.3 million households, approximately 9.3 million
of which can be served by line-of-sight transmissions. Furthermore, the Company
estimates that within these markets, approximately 20%-40% of line-of-sight
households are currently unpassed by traditional hard-wire cable systems. At
December 31, 1996, pro forma for the acquisition of two operating systems
consummated in January 1997 and including one operating system managed by the
Company, the Company had 56 markets with systems in operation, providing
wireless cable service to an aggregate of 181,373 subscribers. In addition, the
Company owns an approximate 20% equity interest in Wireless One and an
approximate 34% equity interest in CS Wireless.
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The Company has experienced significant subscriber growth since its
inception, both internally and through acquisitions. Although the Company has
recorded net losses of $80.6 million since inception, 31 systems achieved
positive System EBITDA for the year ended December 31, 1996. The Company's 25
remaining systems did not achieve positive System EBITDA for the year ended
December 31, 1996, primarily as a result of their early stages of development
and number of subscribers, and the write-off of subscribers and related account
balances at December 31, 1996. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Changes in Method for
Reporting Subscribers; Write-Offs."
"System EBITDA" means net income (loss) plus interest expense, income tax
expense, depreciation and amortization expense and all other non-cash charges,
less any non-cash items which have the effect of increasing net income or
decreasing net loss, for a system and includes all selling, general and
administrative expenses attributable to employees employed in that system. For
the periods presented, there are no such non-cash items. EBITDA is presented
because it is a widely accepted financial indicator of a company's ability to
service and/or incur indebtedness. However, EBITDA is not a financial measure
determined under generally accepted accounting principles and should not be
considered as an alternative to net income as a measure of operating results or
to cash flows as a measure of funds available for discretionary or other
liquidity purposes.
Effective December 31, 1996, the Company (i) revised its methodology for
reporting MDU subscribers and (ii) wrote off approximately 33,000 subscribers
with delinquent balances. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Changes in Method for Reporting
Subscribers; Write-Offs." As a result of the methodology changes and write
offs, the Company's reported subscriber base decreased, while the average
monthly revenue per subscriber and the average monthly churn rate increased.
The changes resulted in (a) a total reduction of the Company's reported
subscriber base at December 31, 1996 of approximately 59,300 subscribers, of
which approximately 26,300 relates to the change in methodology for reporting
MDU subscribers and 33,000 relating to the write-off of subscribers with
delinquent balances, (b) an increase in reported average monthly revenue per
subscriber during the fourth quarter of 1996 from $27.14 (excluding the
methodology changes and subscriber write-offs) to $28.70 (including the
methodology changes and subscriber write-offs), and (c) an increase in the
reported average monthly churn rate during the fourth quarter from 3.0%
(excluding the methodology changes and subscriber write-offs) to 9.6%
(including the methodology changes and subscriber write-offs). For the year
ended December 31, 1996 and in future periods, the Company will report its
subscriber base, average revenue per subscriber and churn rate based upon the
new methodology (the "new method"). However, the Company is unable to
retroactively apply the new methodology to the prior periods. Therefore, the
information set forth below will contain information with subscriber data
calculated using the old methodology (the "old method") solely for the purposes
of comparison with prior periods.
In addition to the matters noted above, certain other statements made in
this report are forward looking. Such statements are based on an assessment of
a variety of factors, contingencies and uncertainties deemed relevant by
management, including (i) business conditions and subscriber growth in the
Company's existing markets, (ii) the successful launch of systems in new and
existing markets, (iii) the Company's existing indebtedness and the need for
additional financing to fund subscriber growth and system development, (iv) the
successful integration of new systems processes (including subscriber
qualification and retention efforts) and management personnel, (v) regulatory
and interference issues, including the grant of pending applications for new
licenses or for modification of existing licenses and the grant of applications
for new licenses and license modification applications that have not yet been
filed with the FCC, and (vi) competitive products and services, as well as
those matters discussed specifically elsewhere herein. As a result, the actual
results realized by the Company could differ materially from the statements
made herein. Investors are cautioned not to place undue reliance on the forward
looking statements made in this report.
RESULTS OF OPERATIONS FOR THE THREE YEARS ENDED DECEMBER 31, 1996
Revenues. The Company's revenues consist of monthly fees paid by
subscribers for basic programming, premium programming, program guides,
equipment rental and other miscellaneous fees. The Company's revenues were
$56.0 million in 1996, $15.3 million in 1995 and $2.2 million in 1994,
representing increases of 266% from 1995 to 1996 and 595% from 1994 to 1995. As
discussed more fully in Note 1 of the notes to the
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consolidated financial statements, the Company changed, effective January 1,
1995, its method of accounting for the direct cost and installation fees related
to subscriber installations. The revenue increases from 1994 to 1996 were
primarily due to average subscribers, calculated under the old method,
increasing to 168,566 in 1996 from 43,360 in 1995 and 5,966 in 1994. Under the
old method, average monthly revenue per subscriber was $27.93 during 1996,
$29.41 for 1995 and $27.35 for 1994. The decrease in average monthly revenue per
subscriber in 1996 as compared to 1995 was primarily due to an increase in MDU
subscribers, which typically generate lower per subscriber revenue than
single-family units, and an increase in the number of "soft disconnect"
subscribers. Soft disconnect subscribers are subscribers who are past due on
their bills and not receiving service; however, their equipment has not been
recovered. The increase in average monthly revenue per subscriber in 1995 as
compared to 1994 was primarily due to increased premium channel penetration. At
December 31, 1996, proforma for the acquisition of two operating systems
consummated in January 1997 and including one operating system managed by the
Company, the Company had 240,700 subscribers under the old method (181,373
subscribers under the new method) versus 85,160 subscribers at December 31, 1995
and 19,840 subscribers at December 31, 1994. Under the old method, approximately
55% of the subscriber increase from 1995 to 1996 was attributable to same-system
growth (net subscriber additions in the Company's systems in operation at
December 31, 1995), 19% was attributable to 16 new systems launched during 1996
and 26% was attributable to seven operating systems acquired, net of three
operating systems divested, during 1996. During 1996, the Company reclassified
the Lufkin, Texas market from an operating system to a future market.
Approximately 43% of the subscriber increase from 1994 to 1995 was attributable
to same-system growth, 41% was attributable to 17 new systems launched during
1995 and 16% was attributable to six operating systems acquired, net of two
operating systems divested, during 1995. Proforma for the acquisition of two
operating systems consummated during January 1997 and including one operating
system managed by the Company, the Company had 56 systems in operation at
December 31, 1996, compared to 34 systems in operation at December 31, 1995 and
13 systems at December 31, 1994.
Systems Operations. Systems operations expenses include programming costs,
channel lease payments, costs of service calls and churn, transmitter site and
tower rentals, cost of program guides and certain repairs and maintenance
expenditures. Programming costs (with the exception of minimum payments), cost
of program guides and channel lease payments (with the exception of certain
fixed payments) are variable expenses which increase as the number of
subscribers increases. Systems operations expenses were $21.3 million in 1996,
$4.9 million in 1995 and $0.76 million in 1994. As a percentage of revenues,
systems operations expenses were 38% in 1996, 32% in 1995 and 34% in 1994. As a
percentage of revenue, systems operations expense increased from 1995 to 1996,
primarily due to increased programming costs as a percentage of revenue. The
Company experienced higher programming costs during 1996 due to the acquisition
of markets with a larger number of channels and the promotion of a special
programming package which carried lower margins than the Company's basic
programming package. The Company expects programming expense as a percentage of
revenue to slightly increase over the short-term; however, the Company is
currently evaluating all of its programming packages as to their impact on cash
flow and profitability, which may result in an increase or a decrease in the
Company's future programming expenses as a percentage of revenue. In addition,
the Company experienced increased service call expense, due to installation
corrections at certain subscriber households. The Company expects to continue
to experience increased service call expense as its subscriber base increases.
The decrease in systems operations expense as a percentage of revenue from 1994
to 1995 was due to revenue increases (as previously discussed) and the
semi-fixed nature of the Company's systems operations expense.
Selling, General and Administrative ("SG&A"). The Company has experienced
increasing SG&A since its inception as a result of its increasing wireless
cable activities and associated administrative costs, including costs related
to opening and maintaining additional offices, additional accounting and
support costs and additional compensation expense. SG&A was $42.4 million in
1996, $11.9 million in 1995 and $4.2 million in 1994. As a percentage of
revenues, SG&A was 76% in 1996, 78% in 1995 and 191% in 1994. As discussed
more fully in Note 1 of the notes to the consolidated financial statements, the
Company changed, effective January 1, 1995, its method of accounting for the
direct costs and installation fees related to subscriber installations. In
addition to the aforementioned reasons, the increase in SG&A from 1995 to 1996
was due to increased bad debt and advertising expense. Bad debt expense as a
percentage of revenue increased from 5% in 1995 to 13% in 1996. The
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significant increase in bad debt expense was due to the Company's prior
subscriber qualification and retention efforts and resulted in the write-off of
approximately 33,000 subscribers and associated accounts receivable as of
December 31, 1996. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Changes in Method for Reporting
Subscribers; Write-Offs." The Company believes that it has implemented improved
subscriber qualification and retention policies which include a combination of
credit checks, service deposits, advance payments and installation fees for
certain subscribers. Advertising expense as a percentage of revenue increased
from 7% in 1995 to 10% in 1996. During the fourth quarter of 1996, the Company
changed its advertising mix from direct sales to telemarketing. Direct sales
commissions are capitalized by the Company, while advertising expenses such as
telemarketing activities are expensed as incurred. In addition, the Company
conducted a number of special advertising campaigns during the year. The
Company is currently reviewing its sales and marketing strategies in order to
improve their cost effectiveness. The outcome of such review may significantly
affect the Company's future advertising expenses. Other increase in SG&A from
1994 to 1995 is principally due to an increase in the Company's corporate and
executive staff to support the Company's overall growth, increased advertising
costs to support the Company's subscriber growth, and, to a lesser extent,
increased costs associated with property and casualty insurance, group health
insurance and property taxes.
Depreciation and Amortization. Depreciation and amortization expense
includes depreciation of systems and equipment and amortization of license and
leased license investment and the excess of cost over fair value of net assets
acquired. Depreciation and amortization expense was $39.3 million in 1996, $6.2
million in 1995 and $1.1 million in 1994. As discussed more fully in Note 1 of
the notes to the consolidated financial statements, the Company changed,
effective January 1, 1995, its method of accounting for the direct costs and
installation fees related to subscriber installations. The increases in
depreciation expenses from 1994 to 1996 were due to additional systems and
equipment in connection with the launch of 16 systems during 1996, 17 systems
during 1995 and six systems during 1994 and increased amortization expense on
license and leased license investment of systems in operation and excess of cost
over fair value of net assets acquired related to the acquisition of wireless
cable channel rights, operating wireless cable systems and the acquisition of
minority interests in certain subsidiaries of the Company. In addition, during
1996, the Company incurred increased depreciation expense related to (i) the
increased write off of the unamortized balance of capitalized labor and
overhead, sales commissions and non-recoverable equipment associated with
subsidiaries which have disconnected (including the write-off of approximately
33,000 subscribers) (see "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Changes in Method for Reporting
Subscribers; Write-Offs"), (ii) the write-off of license and leased license
investment in certain markets where the Company was unsuccessful in obtaining
wireless cable channel rights, and (iii) changes in estimates of useful lives.
In the fourth quarter of 1996, the Company reduced its estimates of the useful
lives of the non-recoverable portion of subscriber installation costs and
license and leased license investment and excess of cost over fair value of
assets acquired. Its amortization period related to the nonrecoverable portion
of subscriber installation costs was reduced from six years (approximately 1.5%
churn per month) to four years (approximately 2.0% churn per month) to
correspond to the Company's estimate of its average subscription term. The
estimated useful life of license and leased license investment and excess of
cost over fair market value of net assets acquired was reduced from 20 years to
15 years.
Operating Loss. The Company generated operating losses of $47.0 million
during 1996, $7.7 million during 1995 and $3.8 million during 1994. EBITDA was
negative $7.7 million for 1996, negative $1.5 million for 1995 and negative
$2.7 million for 1994. As previously discussed, the increases in the Company's
operating loss and negative EBITDA from 1994 to 1996 was primarily due to
increased systems operations and SG&A expense, partially offset by increases in
revenue. Increased depreciation and amortization expenses from 1994 to 1996
also contributed to the increases in the Company's operating losses during
these periods.
Interest Income. Interest income was $3.8 million in 1996, $2.9 million in
1995 and $0.4 million in 1994. The increase in interest income from 1995 to
1996 was due to higher average cash equivalents subsequent to the receipt of
approximately $53.3 million in cash related to the formation of CS Wireless and
cash received from asset sales. The increased interest income from 1994 to
1995 was due to higher average cash equivalents subsequent to the Company's
placement of $100 million of 13% Notes.
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24
Interest Expense. The Company incurred interest expense of $22.0 million in
1996, $13.7 million in 1995 and $.6 million in 1994. The increase in interest
expense over the periods presented is due to increases in borrowed funds.
Interest expense during 1996 primarily consisted of (i) non-cash interest of
$4.2 million related to interest on the Convertible Notes, (ii) interest on the
Company's 13% Notes, (iii) interest related to the Company's Bank Facility, (iv)
interest on debt incurred in conjunction with the BTA auction, and (v) interest
on the Company's 14% Notes from December 20, 1996. Interest expense during 1995
included (i) non-cash interest of $3.8 million related to interest on the
Convertible Notes and (ii) interest on the Company's 13% Notes since April 26,
1995. Interest expense during 1994 included (i) non-cash interest of $0.3
million related to one month's interest on the Convertible Notes, (ii) interest
on bridge financing provided by Internationale Nederlanden (U.S.) Capital
Corporation and (iii) interest expense on short-term borrowings that were repaid
in connection with the Company's initial public offering in April 1994.
Equity in Losses of Affiliates. The Company had equity in losses of
affiliates of $18.6 million in 1996, $1.4 million in 1995 and $.4 million in
1994. Equity in losses of affiliates during 1996 represents losses from CS
Wireless in which the Company has an approximate 34% interest and losses in
Wireless One in which the Company has an approximate 20% interest. The Company
acquired its interest in CS Wireless on February 23, 1996. Equity in losses of
affiliates during 1995 primarily represents losses from Wireless One. The
Company acquired its interest in Wireless One in October 1995. Equity in losses
of affiliates during 1994 represents losses from RuralVision Joint Venture in
which the Company had a 50% interest. The Company ceased to be a joint venturer
in RuralVision Joint Venture during May 1995.
Other Income (Expenses). Other income (expenses) is comprised of gain on
the sale of assets and other non-operating income, offset by minority interests
in the net earnings of subsidiaries, dividends on preferred stock of certain
subsidiaries and other non-operating expenses. In 1996, the Company had other
income of $5.3 million related to a gain on the sale of the Flippin, Tennessee
market and the sale of channel rights in three Georgia markets. Offsetting
this income, the Company incurred $.4 million of other expenses, of which $.2
million related to non-operational settlement charges. In 1995, the Company
incurred $.3 million of other expenses, of which $.2 million relates to
non-operational settlement charges between the Company and an unaffiliated
third party and $21,000 relates to dividends on preferred stock of certain
subsidiaries. During 1994, the Company incurred $.2 million of other expenses,
primarily consisting of a recapitalization charge relating to costs incurred in
connection with a rescinded offering of securities and $21,000 relates to
minority interest owners' share of net earnings in subsidiaries and dividends
on preferred stock of certain subsidiaries.
Income Tax Benefit. As discussed more fully in Note 6 of the notes to the
consolidated financial statements, the Company recognized income tax benefits
related to the Company's losses before income taxes and extraordinary items of
$28.2 million for 1996, $4.3 million for 1995 and $1.6 million for 1994. The
Company recognized income tax benefits to the extent of future reversals of
existing taxable temporary differences.
Extraordinary Item. In December 1996, the Company recognized an
extraordinary loss of $11.5 million, net of tax of $1.1 million. This
extraordinary loss resulted from a substantive modification of the terms of the
13% Notes due to the amount of consent fees paid ($6.9 million). For financial
reporting purposes, the 13% Notes have been treated as having been extinguished
and reissued upon the consummation of the 14% Notes, and recorded at their
estimated fair value as of such date. The extraordinary loss consists of the
associated write-off of debt issuance costs related to the 13% Notes of $5.3
million, the consent payments of $6.9 million, the decrease in the 13% Notes
of $1.1 million to reflect their estimated fair value and other costs of $.4
million.
Net Loss. The Company has recorded net losses since inception. The Company
incurred net losses of $61.1 million or $3.31 per share during 1996, $15.9
million or $1.34 per share during 1995 and $3.0 million or $0.30 per share
during 1994. As previously discussed, although the Company's total revenue
increased 266% from 1995 to 1996 and 586% from 1994 to 1995, due to initial
operating losses associated with the launch of 16 markets during 1996, 17
markets during 1995 and six markets during 1994, increased systems operations,
SG&A, depreciation and amortization and interest expense, and the extraordinary
item in 1996, the Company's net losses
- 24 -
25
have increased from 1994 to 1996. The Company expects to continue to incur net
losses throughout 1997 and beyond.
LIQUIDITY AND CAPITAL RESOURCES
The wireless cable television business is a capital intensive business.
Since inception, the Company has expended funds to lease or otherwise acquire
channel rights in various markets and systems in operation, to construct
operating systems and to finance initial system operating losses. To date, the
primary sources of capital of the Company have been from the sale of the
Company's common stock, debt financing and the sale of wireless cable channel
rights that are not part of the Company's strategic plan.
The Company estimates that a launch of a wireless cable system in a
typical market will involve the initial expenditure of approximately $0.5
million to $0.9 million for wireless cable system transmission equipment and
tower construction, depending upon the type and sophistication of the equipment
and whether the Company is required to construct a transmission tower, and
incremental installation costs of approximately $465 per single family
household subscriber for equipment, labor, overhead charges and direct
commission. The Company has recently launched systems utilizing a more
sophisticated type of equipment that will cost approximately $65 less per
installation and therefore it believes that the average cost of materials will
continue to decrease as subscribers are added in systems that utilize such
equipment. The Company is currently reviewing its installation cost structure
in an effort to improve operational efficiency. As a result, the Company's
incremental installation costs may vary from those presented above. Other
launch costs include the cost of securing adequate space for marketing and
warehouse facilities, as well as costs related to employees. As a result of
these costs, operating losses are likely to be incurred by a system during the
start-up period.
Cash used in operations was $22.8 million in 1996 and $6.5 million in 1995,
versus cash provided by operations of $0.7 million in 1994. The increase in
cash consumed by operations during 1996 was primarily due to increased systems
operations, SG&A and interest expense, partially offset by a 266% increase in
revenues from 1995 to 1996 and a decrease in working capital. The increase in
cash used in operations during 1995 as compared to 1994 was primarily due to
increases in systems operations, SG&A and interest expense, as well as initial
operating losses associated with the launch of 17 systems during 1995, versus
six systems in 1994.
Cash used in investing activities was $34.2 million in 1996, $96.7 million
in 1995 and $46.5 million in 1994. Cash used in investing activities
principally relates to the construction of additional operating systems, the
acquisition and installation of subscriber receive-site equipment, the upgrade
of transmission equipment in certain markets and the acquisition of wireless
cable channel rights and operating systems, partially offset by the sale of
wireless cable channel rights that are not a part of the Company's strategic
plan. In addition, as discussed more fully in Note 3 of the notes to the
consolidated financial statements, cash provided by/used in investing
activities includes purchases and sales of debt securities, representing
proceeds from the sale of the Company's 13% Notes and 14% Notes placed in
escrow for the semi-annual payment of interest. The Company's purchases of
systems and equipment have increased over the periods presented due to (i) the
launch of 16 systems during 1996, 17 systems during 1995 and six systems during
1994 and (ii) the purchase of subscriber receive-site equipment due to the
Company's subscriber base, as calculated under the old method, increasing from
2,735 subscribers at December 31, 1993 to 240,700 subscribers at December 31,
1996.
As discussed more fully in Notes 3 and 8 of the notes to the consolidated
financial statements, cash used in investing activities during 1996 also
included the Company's acquisition of the Champaign, Illinois and Gainesville,
Texas operating systems, payments related to the BTA Auction and out-of-pocket
expenses related to the acquisition of the businesses of CableMaxx, Inc. and
American Wireless Systems, Inc., assets of Fort Worth Wireless Cable T.V.
Associates, Wireless Cable T.V. Associates #38 and certain of the wireless cable
television assets of Three Sixty Corp., formerly Technivision, Inc.
(Collectively the "CableMaxx, AWS and Technivision Acquisitions"). These uses
of cash were partially offset by the receipt of approximately $58.3 million in
cash from CS Wireless in connection with the Company's contribution of wireless
cable assets to CS Wireless, and sale of wireless cable channel rights in
Memphis and Flippin, Tennessee; Los Angeles, California; Anahauc, Texas; Tilden,
Illinois; and Adairsville,
- 25 -
26
Powers Crossroads and Rutledge, Georgia for total proceeds of approximately
$23.8 million. As discussed more fully in Note 8 of the notes to the
consolidated financial statements, cash used in investing activities during 1995
included the Company's investment in RuralVision Joint Venture, the acquisition
of certain wireless cable assets from RuralVision Joint Venture and Cross
Country Wireless, Inc., the acquisition of the Lubbock, Texas and Tulsa,
Oklahoma markets and payments made in connection with the CableMaxx, AWS and
Technivision Acquisitions. These uses of cash were partially offset by the sale
of wireless cable channel rights in five markets and the repayment of a $10.0
million note from Wireless One. Cash used in investing activities during 1994
included the Company's investment in RuralVision Joint Venture and the
acquisition of certain wireless cable assets from RuralVision Joint Venture.
Net cash provided by financing activities was $113.4 million in 1996,
$114.3 million in 1995 and $57.0 million in 1994. As discussed more fully in
Notes 3 and 8 of the notes to the consolidated financial statements, cash
provided by financing activities during 1996 includes the net proceeds from the
sale of $125 million of 14% Notes and $15 million of 13% Notes, partially
offset by payments on long-term debt assumed in the CableMaxx, AWS and
Technivision Acquisitions and the repayment of the Bank Facility. As discussed
more fully in Note 3 of the notes to the consolidated financial statements,
cash provided by financing activities during 1995 primarily represents the sale
of $100 million of 13% Notes. Cash provided by financing activities during 1994
includes the net proceeds from the Company's initial public offering and the
sale of the Convertible Notes.
At March 20, 1997, the Company had approximately $55.0 million of
cash-on-hand and subscriber equipment in inventory and to be retrieved from
disconnected subscribers to add approximately 70,000 new subscribers. In
addition, the Company holds a $15.0 million note from CS Wireless, of which the
Company expects to receive approximately $7.3 million during 1997, upon the
consummation of certain asset sales by CS Wireless.
In an effort to conserve capital resources, the Company has suspended new
system launches for the next three to six months. Following such period, the
Company will determine an appropriate launch schedule based upon multiple
factors, including, but not limited to, the availability of capital resources
and the number of wireless cable channels for which the Company has obtained FCC
licenses in such markets. In addition, the Company is currently in the process
of evaluating its Existing Systems in order to identify 15 to 20 Existing
Systems for aggressive subscriber growth. The remaining Existing Systems will
be operated to maximize cash flow, and the Company expects that subscriber
additions in these systems will be sufficient to replace churn. Offsetting
these cash savings are increased service calls anticipated by the Company during
the first half of 1997 in order to continue to improve picture quality, correct
installation deficiencies and add decoders at certain subscriber households. In
addition, during the first half of 1997, the Company anticipates increased
expenses related to the retrieval of subscriber equipment due to subscriber
write-offs as of December 31, 1996. See "Management's Discussion and Analysis
of Financial Condition and Result of Operations -- Changes in Method for
Reporting Subscribers; Write-Offs." Furthermore, the Company may be required to
modify or replace its downconverters in certain markets due to potential
interference from "wireless communications services" or "WCS" anticipated to be
auctioned by the FCC in April 1997. The Company believes that the location of
WCS spectrum and the unregulated signal power level currently authorized for WCS
could cause interference to certain of the Company's wireless cable channels.
The Company is unable to quantify the cost of such modifications, if any. As a
result of the aforementioned factors, the Company estimates that its
cash-on-hand will be sufficient to fund its operations and debt service
requirements through the first quarter of 1998.
As a result of the offering of 13% Notes and 14% Notes and the possible
incurrence of additional indebtedness, the Company will be required to satisfy
certain debt service requirements. Following the disbursements in April 1997
and April 1998 of all of the funds in the escrow accounts established in
connection with the 13% Note Indentures and the Indenture governing the 14%
Notes (the "14% Note Indenture"), respectively, a substantial portion of the
Company's cash flow will be devoted to debt service on the 13% Notes and 14%
Notes, respectively. The ability of the Company to make payments of principal
and interest will be largely dependent upon its future performance. Many
factors, some of which will be beyond the Company's control (such as prevailing
economic conditions), may affect its performance. There can be no assurance
that the
- 26 -
27
Company will be able to generate sufficient cash flow to cover required interest
and principal payments when due on the 13% Notes, the 14% Notes or any other
indebtedness of the Company, including indebtedness incurred to the FCC in
connection with the BTA Auction. If the Company is unable to make interest and
principal payments in the future, it may, depending upon the circumstances which
then exist, seek additional equity or debt financing, attempt to refinance its
existing indebtedness or sell all or part of its business or assets to raise
funds to repay its indebtedness.
Despite the Company's efforts to conserve capital resources and to
maximize cash flow, the Company does not expect that sufficient cash flow will
be generated to fund subscriber growth and new system development after the
first quarter of 1998 and beyond. As a result, in order to continue growing
the Company's subscriber base and to launch future operating systems, the
Company will be required to seek external sources of funding to satisfy its
capital needs. Such sources of funding may be financed in whole or in part
directly by the Company and/or by its existing or future subsidiaries, through
debt or equity financings, joint ventures or other arrangements. As in the
past, the Company may also seek capital through the sale of its existing
portfolio wireless cable channel rights. There can be no assurance that the
sale of the Company's existing portfolio of wireless cable channel rights or
sufficient debt or equity financing will be available on satisfactory terms and
conditions, if at all. Failure to obtain such additional funds could adversely
affect the growth and cash flow of the Company and would require the Company to
suspend its subscriber growth and new system development plans.
CHANGES IN METHOD FOR REPORTING SUBSCRIBERS; WRITE-OFFS.
Effective December 31, 1996, the Company changed its methodology for
reporting subscribers in multiple dwelling units ("MDUs"). MDU subscribers who
receive bills directly from the Company, who previously had been reported using
an equivalent basic unit ("EBU") rate of $9.05, have been reclassified as
individually-billed units, similar to single family units ("SFU") subscribers.
In addition, under the new methodology, MDU subscribers who are billed in bulk
to the MDU owner have been converted to SFU subscribers using an EBU rate of
$17.95, as opposed to $9.05 under the old methodology. These methodology
changes resulted in a reduction to the Company's reported subscriber base at
December 31, 1996 of approximately 26,300 subscribers. As adjusted, during the
fourth quarter of 1996, the Company's direct-billed MDU subscriber base
generated average monthly revenue per subscriber of $27.31 and the Company's
bulk-billed MDU subscribers generated average monthly revenue per subscriber of
$17.95, versus $9.05 during the third quarter of 1996 for both direct and
bulk-billed MDU subscribers. MDU and EBU subscriber reporting conventions are
subjective, and any changes in methodology that decrease subscriber count
result in a corresponding increase in average revenue per subscriber. The
Company believes that using the revised EBU rate of $17.95 and reclassifying
individually billed units more accurately reflects the revenue derived from
these subscribers, and will minimize the impact on monthly revenue per
subscriber resulting from future changes in the number of MDU subscribers
relative to SFU subscribers.
Separately, the Company has identified approximately 33,000 subscribers
with delinquent balances to whom it does not expect to provide service in the
future. Of these subscribers, approximately 20,700 were "soft disconnect"
subscribers who, as of December 31, 1996, had past due account balances. Soft
disconnect subscribers are subscribers who are past due on their bills and are
not receiving service whose equipment has not been recovered. The remaining
approximate 12,300 subscribers were active subscribers at December 31, 1996
that the Company has disconnected or intends to disconnect during the first
quarter of 1997. The Company has written off all 33,000 subscribers and the
accounts receivable related to such subscribers as of December 31, 1996. In
addition, the Company has written off as a charge to depreciation expense, the
unamortized balance of capitalized labor, sales commissions and non-recoverable
equipment related to such subscribers.
Generally, the Company defines an "active subscriber" as a subscriber
receiving programming service with an outstanding receivable balance of less
than 60 days past due or a subscriber that has a pay-out plan with the Company.
In no event will a subscriber with an outstanding balance greater than 90 days
past due be counted in the Company's subscriber base.
Including the year-end subscriber write-off and the change in methodology
for reporting MDU subscribers, the Company's monthly churn rate was 9.6% and
4.1% for the fourth quarter and year ended December 31, 1996, versus 2.0% for
the third quarter ended September 30, 1996. Excluding the subscriber
write-offs and methodology changes for reporting MDU subscribers, and on a
comparable basis with prior periods, the Company's average monthly churn rate
was 3.0% and 2.2% for the fourth quarter and year ended December 31, 1996,
versus 1.7% for the third quarter ended September 30, 1996.
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28
INCOME TAX MATTERS
The Company and certain of its subsidiaries will file a consolidated
Federal income tax return. Subsidiaries in which the Company owns less than 80%
of the voting stock will file separate Federal income tax returns. The Company
has had no material state or Federal income tax expense since inception. As of
December 31, 1996, the Company had approximately $68.1 million in net operating
losses for U.S. Federal for tax purposes, expiring in years 2008 through 2011.
The Company estimates that approximately $38 million of the above losses relate
to various acquisitions and as such are subject to certain limitations. In
addition, the Internal Revenue Code of 1986, as amended (the "Code"), limits the
amount of loss carryforwards that a company can use to offset future income upon
the occurrence of certain changes in ownership. As a result of the investment in
the Company by Hunt Capital Group, L.L.C., the Company's initial public offering
of its common stock in April 1994 and other transactions discussed more fully in
Note 6 of the notes to the consolidated financial statements, the Company has
undergone more than a 50% change in ownership. Management does not anticipate
any significant limitation on the use of the Company's net operating losses as a
result of such change in ownership.
INFLATION
Management does not believe that inflation has had or is likely to have
any significant impact on the Company's operations. Management believes that
the Company will be able to increase subscriber rates, if necessary, to keep
pace with inflationary increases in costs.
FUTURE OPERATING RESULTS
The Company's future revenues and profitability are difficult to predict
due to a variety of risks and uncertainties, including (i) business conditions
and growth in the Company's existing markets, (ii) the successful launch of
systems in new markets, (iii) the Company's existing indebtedness and the need
for additional financing to fund subscriber growth and system development, (iv)
government regulation, including FCC regulations, (v) the Company's dependence
on channel leases, (vi) the successful integration of future acquisitions and
(vii) numerous competitive factors, including alternative methods of
distributing and receiving television transmissions.
The Company is currently in the process of reviewing and evaluating all of
its business operations, processes and systems and the Company has engaged
Arthur Andersen L.L.P. and others to assist the Company in this effort. In
addition, the Company is currently in the process of identifying 15 to 20
Existing Systems to target for aggressive marketing and subscriber growth.
While the Company plans to increase its subscriber base during 1997, the rate of
increase cannot be estimated with precision or certainty. In addition, the
Company cannot quantify the potential impact on its 1997 financial performance
resulting from the implementation of expense reductions, new business processes
and management information systems. Furthermore, successful selection,
marketing and operating of the 15 to 20 Existing Systems targeted for aggressive
growth will have a significant impact on the Company's 1997 operating and
financial performance.
Because of the foregoing uncertainties affecting the Company's future
operating results, past performance should not be considered to be a reliable
indicator of future performance, and investors should not use historical trends
to anticipate results or trends in future periods. In addition, the Company's
participation in a highly dynamic industry often results in significant
volatility in the price of the Company's Common Stock.
- 28 -
29
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Consolidated Financial Statements
Heartland Wireless Communications, Inc. and Subsidiaries
PAGE
Independent Auditors' Report F-1
Consolidated Balance Sheets as of December 31, 1996 and 1995 F-2
Consolidated Statements of Operations for the
Three Years Ended December 31, 1996 F-3
Consolidated Statements of Stockholders' Equity for the
Three Years Ended December 31, 1996 F-4
Consolidated Statements of Cash Flow for the
Three Years Ended December 31, 1996 F-5
Notes to Consolidated Financial Statements F-7
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information called for by this item is incorporated herein by
reference to the sections of the definitive Proxy Statement to be filed with
the Commission not later than 120 days after the fiscal year ended December 31,
1996, and delivered to stockholders in connection with the Annual Meeting of
Stockholders expected to be held on or before June 16, 1997, captioned
"Election of Directors," "Executive Officers" and "Disclosure Pursuant to
Section 16 of the Exchange Act."
ITEM 11. EXECUTIVE COMPENSATION
The information called for by this item is incorporated herein by
reference to the sections of the definitive Proxy Statement to be filed with
the Commission not later than 120 days after the fiscal year ended December 31,
1996, and delivered to stockholders in connection with the Annual Meeting of
Stockholders to be held on or before June 16, 1997, captioned "Meetings of the
Board of Directors and Committees of the Board of Directors; Compensation of
Directors" and "Executive Compensation Related Information."
- 29 -
30
ITEM 12. SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT
The information called for by this item is incorporated herein by
reference to the sections of the definitive Proxy Statement to be filed with
the Commission not later than 120 days after the fiscal year ended December 31,
1996, and delivered to stockholders in connection with the Annual Meeting of
Stockholders expected to be held on or before June 16, 1997, captioned
"Security Ownership of Certain Beneficial Owners, Directors and Management."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information called for by this item is incorporated herein by
reference to the sections of the definitive Proxy Statement to be filed with
the Commission not later than 120 days after the fiscal year ended December 31,
1996, and delivered to stockholders in connection with the Annual Meeting of
Stockholders expected to be held on or before June 16, 1997, captioned "Certain
Transactions and Relationships."
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents Filed as Part of the Report
1. Financial Statements
The following financial statements are filed as part of this Form 10-K:
Page
Independent Auditors' Report..................................................................... F-1
Consolidated Balance Sheets as of December 31, 1996 and 1995..................................... F-2
Consolidated Statements of Operations for the three years ended December 31, 1996................ F-3
Consolidated Statements of Stockholders' Equity for the three years ended December 31, 1996...... F-4
Consolidated Statements of Cash Flows for the three years ended December 31, 1996................ F-5
Notes to Consolidated Financial Statements....................................................... F-7
2. Financial Statement Schedules
The following financial statement schedules are filed as part of this Form
10-K:
Page
Independent Auditors' Report..................................................................... S-1
Schedule II -- Valuation and Qualifying Accounts -- Three years ended December 31, 1996.......... S-2
Schedules other than the above have been omitted because they are either not
applicable or the required information has been disclosed in the financial
statements or notes thereto.
- 30 -
31
3. Exhibits
2.1 Letter Agreement regarding formation of the Registrant (filed as Exhibit
2.1 as the Registrant's Registration Statement on Form S-1, File No.
33-74244 (the "Form S-1"), and incorporated herein by reference)
2.2 Supplement to Letter Agreement regarding formation of the Registrant
(filed as Exhibit 2.2 to the Form S-1 and incorporated herein by
reference)
3.1 Restated Certificate of Incorporation of the Registrant (filed as
Exhibit 3.1 to the Form S-1 and incorporated herein by reference)
3.2 Restated By-laws of the Registrant (filed as Exhibit 3.2 to the Form S-1
and incorporated herein by reference)
4.1 1994 Employee Stock Option Plan of the Registrant (filed as Exhibit 4.1
to the Registrant's Registration Statement on Form S-8 (File No.
333-04263) and incorporated herein by reference
4.2 Revised Form of Nontransferable Incentive Stock Option Agreement under
the 1994 Employee Stock Option Plan of the Registrant (filed as Exhibit
4.2 to the Registrant's Registration Statement on Form S-4, File No.
33-91930 (the "February 1996 Form S-4")and incorporated herein by
reference)
4.3 Revised Form of Nontransferable Non-Qualified Stock Option Agreement
under the 1994 Employee Stock Option Plan of the Registrant (filed as
Exhibit 4.3 to the February 1996 Form S-4 and incorporated herein by
reference)
4.4 1994 Stock Option Plan for Non-Employee Directors of the Registrant
(filed as Exhibit 4.4 to the Form S-1 and incorporated herein by
reference)
4.5 Form of Stock Option Agreement under the 1994 Stock Option Plan for
Non-Employee Directors of the Registrant (filed as Exhibit 4.5 to the
Form S-1 and incorporated herein by reference)
4.6 Indenture between the Registrant and First Trust of New York, National
Association , as Trustee (the "Trustee") (filed as Exhibit 4.20 to the
Registrant's Registration Statement on Form S-4, File No. 333-12577 (the
"December 1996 Form S-4") and incorporated herein by reference)
4.7 Supplemental Indenture dated as of December 9, 1996, between the
Registrant and the Trustee (filed as Exhibit 4.21 to the December 1996
Form S-4 and incorporated herein by reference)
4.8 Heartland Wireless Communications, Inc. 401(k) Plan (filed as Exhibit
4.3 to the Registrant's Registration Statement on Form S-8 (File No.
333-05943) and incorporated herein by reference)
*10.1 Standard Form of MMDS License Agreement
*10.2 Standard Form of ITFS License Agreement
10.3 Form of Indemnity Agreement between the Registrant and each of its
directors (filed as Exhibit 10.3 to the Form S-1 and incorporated herein
by reference)
10.4 Noncompetition Agreement between the Registrant and J.R. Holland, Jr.
(filed as Exhibit 10.4 to the Form S-1 and incorporated herein by
reference)
- 31 -
32
10.5 Noncompetition Agreement between the Registrant and David E. Webb
(filed as Exhibit 10.5 to the Form S-1 and incorporated herein by
reference)
10.6 Noncompetition Agreement between the Registrant and John R. Bailey
(filed as Exhibit 10.6 to the Form S-1 and incorporated herein by
reference)
10.7 Noncompetition Agreement between the Registrant and Randy R. Hendrix
(filed as Exhibit 10.7 to the Form S-1 and incorporated herein by
reference)
10.8 Noncompetition Agreement between the Registrant and L. Allen Wheeler
(filed as Exhibit 10.9 to the Form S-1 and incorporated herein by
reference)
10.9 Building Lease Agreement dated June 1, 1990, between Wireless
Communications, Inc. and The Federal Building, Inc. (filed as Exhibit
10.13 to the 1994 Form 10-K and incorporated herein by reference)
10.10 Building Lease Agreement dated January 2, 1995, between the Registrant
and W&W Commercial Group, L.L.C. (filed as Exhibit 10.14 to the 1994
Form 10-K and incorporated herein by reference)
10.11 Building Lease Agreement dated May 1, 1994, between Wireless
Communications, Inc. and The Federal Building, Inc.
10.12 Purchase Agreement among the Registrant, BT Securities and Lazard (filed
as Exhibit 10.17 to the February 1995 Form S-4 and incorporated herein
by reference)
10.13 Building Lease Agreement dated November 20, 1995, between the registrant
and the Federal Building, Inc. (filed as Exhibit 10.18 to the February
1996 Form S-4 and incorporated herein by reference)
10.14 Office Lease dated April 10, 1996 between Merit Office Portfolio Limited
Partnership and the Registrant for the Registrant's Plano, Texas office
(filed as Exhibit 10.1 to the Form 10-Q Quarterly Report for the quarter
ended June 30, 1996 ("June 1996 Form 10-Q") and incorporated herein by
reference)
10.15 Sublease Agreement dated June 14, 1996 between the Registrant and CS
Wireless (filed as Exhibit 10.2 to the June 1996 Form 10-Q and
incorporated herein by reference)
*10.16 Building Lease Agreement dated February 1, 1996, as amended June 1,
1996, between Registrant and National Horizon Development, L.C.
*21 List of Subsidiaries
*23 Consent of KPMG Peat Marwick LLP
*27 Financial Data Schedule
* Filed herewith.
(b) Reports on Form 8-K
During the fourth quarter of the year ended December 31, 1996, the Company
filed the following reports on Form 8-K:
(i) Current Report on Form 8-K dated December 20, 1996 with respect
to the sale of $125 million of its 14% Senior Notes.
- 32 -
33
(ii) Current Report on Form 8-K dated November 22, 1996 regarding
third quarter financial results.
- 33 -
34
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Heartland Wireless Communications, Inc.:
We have audited the accompanying consolidated balance sheets of Heartland
Wireless Communications, Inc. and subsidiaries as of December 31, 1996 and
1995, and the related consolidated statements of operations, stockholders'
equity and cash flows for each of the years in the three-year period ended
December 31, 1996. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Heartland Wireless
Communications, Inc. and subsidiaries as of December 31, 1996 and 1995, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1996, in conformity with generally
accepted accounting principles.
As discussed in note 1(d) to the consolidated financial statements, the Company
changed its method of accounting for the direct costs and installation fees
related to subscriber installations in 1995.
KPMG Peat Marwick LLP
Dallas, Texas
March 24, 1997
F - 1
35
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 1996 and 1995
(in thousands, except share data)
Assets 1996 1995
------ ---------- ----------
Current assets:
Cash and cash equivalents $ 79,596 $ 23,143
Restricted assets - investment in debt securities (note 3) 21,215 12,324
Subscriber receivables, net of allowance for doubtful accounts of
$5,468 in 1996 and $961 in 1995 5,382 2,544
Prepaid expenses and other 1,586 1,583
Assets held for sale (note 8) - 2,200
--------- ---------
Total current assets 107,779 41,794
--------- ---------
Investments in affiliates, at equity (notes 8 and 9) 68,095 14,077
Systems and equipment, net (notes 2, 3 and 8) 145,797 60,649
License and leased license investment, net of accumulated
amortization of $7,127 in 1996 and $1,095 in 1995 (note 8) 129,725 60,421
Excess of cost over fair value of net assets acquired, net of accumulated
amortization of $1,691 in 1996 and $283 in 1995 (notes 4 and 8) 28,220 4,411
Restricted assets - investment in debt securities (note 3) 8,792 6,415
Note receivable from affiliate (note 8) 16,275 -
Other assets, net 10,681 17,638
--------- ---------
$515,364 $205,405
========= =========
Liabilities and Stockholders' Equity
------------------------------------
Current liabilities:
Accounts payable $ 9,804 $ 6,863
Accrued expenses and other liabilities 20,936 3,345
Current portion of long-term debt (note 3) 1,188 765
--------- ---------
Total current liabilities 31,928 10,973
--------- ---------
Long-term debt, less current portion (note 3) 302,350 140,887
Deferred income taxes (note 6) - 1,628
Minority interests in subsidiaries (note 4) 239 229
Stockholders' equity (note 5):
Common stock, $.001 par value; authorized 50,000,000 shares,
issued 19,584,229 shares in 1996 and 12,611,131 shares in 1995 20 13
Additional paid-in capital 261,652 71,165
Accumulated deficit (80,551) (19,490)
Treasury stock at cost, 10,252 shares in 1996 (274) -
--------- ---------
Total stockholders' equity 180,847 51,688
Commitments and contingencies (notes 7 and 11)
---------- ---------
$515,364 $205,405
========= =========
See accompanying notes to consolidated financial statements.
F - 2
36
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
Three years ended December 31, 1996
(in thousands, except share data)
1996 1995 1994
----------- --------- --------
Revenues $ 56,017 $ 15,300 $ 2,229
---------- -------- -------
Operating expenses:
Systems operations 21,255 4,893 762
Selling, general and administrative 42,435 11,887 4,183
Depreciation and amortization 39,323 6,234 1,098
---------- -------- -------
Total operating expenses 103,013 23,014 6,043
---------- -------- -------
Operating loss (46,996) (7,714) (3,814)
Other income (expense):
Interest income 3,811 2,860 380
Interest expense (21,977) (13,717) (590)
Equity in losses of affiliates (notes 8 and 9) (18,612) (1,369) (387)
Other income (expense), net (note 8) 4,981 (247) (227)
---------- -------- -------
Total other income (expense) (31,797) (12,473) (824)
---------- -------- -------
Loss before income taxes and extraordinary
item (78,793) (20,187) (4,638)
Income tax benefit (note 6) 28,156 4,285 1,595
---------- -------- -------
Loss before extraordinary item (50,637) (15,902) (3,043)
Extraordinary item - loss on extinguishment
of debt, net of tax (note 3) (10,424) -- --
---------- --------- --------
Net loss $(61,061) $(15,902) $(3,043)
========== ======== =======
Loss per common share:
Loss before extraordinary item $ (2.74) $ (1.34) $ (.30)
Extraordinary item (.57) -- --
---------- --------- --------
Net loss $ (3.31) $ (1.34) $ (.30)
========== ======== =======
See accompanying notes to consolidated financial statements.
F - 3
37
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
Three years ended December 31, 1996
(in thousands, except share data)
Common stock Additional
------------------- paid-in Accumulated Treasury
Shares Amount capital deficit stock Total
---------- ------ ----------- ----------- -------- -----------
Balance, December 31, 1993 8,000,000 $ 8 $ 5,030 $ (545) $ - $ 4,493
Issuance of common stock
pursuant to initial public
offering (note 5) 2,415,000 2 22,350 - - 22,352
Issuance of common stock for
acquisitions (note 4) 694,280 1 6,278 - - 6,279
Net loss - - - (3,043) - (3,043)
---------- ------ ----------- ---------- ------- ----------
Balance, December 31, 1994 11,109,280 11 33,658 (3,588) - 30,081
Issuance of common stock for
minority interest acquisitions
(note 4) 338,121 1 5,263 - - 5,264
Issuance of common stock for
acquisitions (note 8) 1,122,730 1 21,999 - - 22,000
Issuance of warrants (note 3) - - 4,200 - - 4,200
Exercise of stock options 41,000 - 396 - - 396
Gain on equity investment, net
of taxes of $3,318 (note 8) - - 5,649 - - 5,649
Net loss - - - (15,902) - (15,902)
---------- ------ ----------- ---------- ------- ----------
Balance, December 31, 1995 12,611,131 13 71,165 (19,490) - 51,688
Issuance of common stock for
acquisitions (note 8) 6,923,788 7 184,840 - (274) 184,573
Exercise of stock options
warrants and other, including
tax benefit 49,310 - 658 - - 658
Gain on equity investment, net
of taxes of $2,931 (note 8) - - 4,989 - - 4,989
Net loss - - - (61,061) - (61,061)
---------- ------ ----------- ---------- ------- ----------
Balance, December 31, 1996 19,584,229 $20 $261,652 $(80,551) $(274) $180,847
========== ====== =========== ========== ======= ==========
See accompanying notes to consolidated financial statements.
F - 4
38
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Three years ended December 31, 1996
(in thousands)
1996 1995 1994
----------- ----------- ---------
Cash flows from operating activities:
Net loss $(61,061) $(15,902) $ (3,043)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization 39,323 6,234 1,098
Deferred income tax benefit (29,240) (4,285) (1,595)
Debt accretion and debt issuance cost amortization 4,331 4,467 301
Equity in losses of affiliates 18,612 1,369 387
Gain on sale of assets (5,279) (43) (16)
Extraordinary item - debt extinguishment 4,253 - -
Changes in assets and liabilities, net of acquisitions:
Subscriber receivables (2,568) (2,109) (57)
Prepaid expenses and other (414) (955) (656)
Accounts payable, accrued expenses and other liabilities 9,289 4,750 4,292
---------- ---------- --------
Net cash provided by (used in) operating activities (22,754) (6,474) 711
---------- ---------- --------
Cash flows from investing activities:
Investment in affiliate (3,050) (5,426) (12,431)
Distribution from affiliate 58,340 10,000 -
Proceeds from assets held for sale 24,139 3,423 -
Purchases of systems and equipment (93,298) (43,151) (12,415)
Expenditures for licenses and leased licenses (2,382) (2,883) (3,354)
Purchases of debt securities (24,550) (24,120) -
Proceeds from maturities of debt securities 14,250 5,380 -
Acquisitions, net of cash acquired (7,618) (38,723) (16,300)
Other - (953) -
---------- ---------- --------
Net cash used in investing activities (34,169) (96,703) (46,500)
---------- ---------- --------
(Continued)
F - 5
39
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows, Continued
(in thousands)
1996 1995 1994
------------- ----------- ----------
Cash flows from financing activities:
Proceeds from issuance of common stock and warrants $ - 24,596 22,352
Proceeds from long-term debt 141,350 95,800 40,150
Payment of debt issuance costs and consent fees (12,973) (5,948) (2,395)
Payments on long-term debt (13,017) - -
Proceeds from short-term borrowings and notes payable 6,700 3,070 10,409
Payments on short-term borrowings and notes payable (9,233) (3,243) (11,947)
Other 549 59 (1,609)
------------ ---------- ---------
Net cash provided by financing activities 113,376 114,334 56,960
------------ ---------- ---------
Net increase in cash and cash equivalents 56,453 11,157 11,171
Cash and cash equivalents at beginning of year 23,143 11,986 815
------------ ---------- ---------
Cash and cash equivalents at end of year $ 79,596 $ 23,143 $ 11,986
============ ========== =========
Cash paid for interest $ 14,434 $ 6,362 $ 297
============ ========== =========
See accompanying notes to consolidated financial statements.
F - 6
40
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Three years ended December 31, 1996
(tables in thousands, except per share data)
(1) General and Summary of Significant Accounting Policies
(a) Description of Business
Heartland Wireless Communications, Inc. (the "Company") develops, owns
and operates wireless cable television systems, primarily in small to
mid-size markets located in the central United States. The Company
currently has systems in operation in 56 markets.
Wireless cable television is a new industry within the highly
competitive pay television industry. The Company's cable television
systems face or may face competition from several sources, such as
traditional hard-wire cable companies, satellite master antenna
television systems, direct broadcast satellite and other alternate
methods of distributing and receiving television transmissions. As
the telecommunications industry continues to evolve, the Company may
face additional competition from new providers of entertainment and
data services. There can be no assurance that the Company will
compete successfully with existing or potential competitors in the pay
television industry.
The growth of the Company's business requires substantial investment
on a continuing basis to finance capital expenditures related to
subscriber growth and system development. The Company believes that
its cash and cash equivalents and cash generated from operations will
be sufficient to fund the Company's operations and expansion at least
through the first quarter of 1998. Additional funds will be necessary
to complete the launch, build-out and expansion of all of the
Company's wireless cable systems and to bring such systems to a mature
state. Such sources of funding may be financed in whole or in part
directly by the Company through debt or equity financings, joint
ventures, the sale and/or exchange of existing wireless cable channel
rights, or other arrangements. There can be no assurance that the
Company will achieve positive cash flow from operations, that the
Company will consummate the sale of any wireless cable channel rights
or that sufficient debt or equity financing will be available to the
Company. In addition, subject to restrictions under its outstanding
debt, the Company may pursue other opportunities to acquire additional
wireless cable channel rights and businesses that may utilize the
capital currently expected to be available for its current markets.
The amount and timing of the Company's future capital requirements
will depend upon a number of factors, including programming costs,
equipment costs, marketing costs, staffing levels, subscriber growth
and competitive conditions, many of which are beyond the control of
the Company. Failure to obtain any required additional financing
could materially affect the growth, cash flow or earnings/loss of the
Company.
(Continued)
F - 7
41
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(tables in thousands, except per share data)
(b) Principles of Consolidation
The consolidated financial statements include the accounts of the
Company and its majority-owned subsidiaries. Significant intercompany
balances and transactions between the entities have been eliminated in
consolidation.
(c) Investments in Debt Securities
Investments in debt securities at December 31, 1996 consist of U.S.
Treasury Notes which mature periodically through April 15, 1998. The
Company has the ability and intent to hold these investments until
maturity and, accordingly, has classified these investments as
held-to-maturity investments. Held-to-maturity investments are
recorded at amortized cost, adjusted for amortization of premiums or
discounts. Premiums and discounts are amortized over the life of the
related held-to-maturity investment as an adjustment to yield using
the effective interest method. A decline in market value of the
Company's investments below cost that is deemed other than temporary
results in a reduction in carrying amount to fair value. The
impairment is charged to earnings and a new cost basis for the
investment is established. As of December 31, 1996 and 1995, gross
unrealized gains and losses related to the Company's investments in
debt securities were not material.
(d) Systems and Equipment
Systems and equipment are stated at cost and include the cost of
transmission equipment as well as subscriber installations. In the
third quarter of 1995, the Company changed, effective January 1, 1995,
its method of accounting for the direct costs and installation fees
related to subscriber installations to achieve a better matching of
its revenues and expenses. Pursuant to the change, the Company's
policy is to capitalize the excess of direct costs of subscriber
installations over installation fees. These direct costs include
reception materials and equipment on subscriber premises, installation
labor and overhead charges, and direct commissions. Such capitalized
costs are amortized on a subscriber-by-subscriber basis over the
useful life of the asset for the recoverable portion of such costs and
the estimated average subscription term (presently four years) for the
nonrecoverable portion of such costs. Any unamortized balance of the
non-recoverable portion of the cost of a subscriber installation is
fully depreciated upon subscriber disconnect and the related cost and
accumulated depreciation are removed from the balance sheet.
Prior to the accounting change, the Company's policy was to expense
all direct commissions associated with subscriber installations and to
recognize as revenue all installation fees to the extent of selling
costs (including direct commissions) incurred to obtain subscribers.
Historically, such selling costs have exceeded installation fees. In
addition, upon subscriber disconnect, the Company continued to
depreciate the full capitalized installation cost subsequent to the
disconnection. The Company has not presented the cumulative effect of
the
(Continued)
F - 8
42
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(tables in thousands, except per share data)
change in accounting because the effect of this change on periods
prior to January 1, 1995 was not material. In addition, the results
of operations for any prior annual period would not differ materially
from results under the new method of accounting. The effect of this
change on the results of operations for the year ended December 31,
1995 was to decrease net loss by approximately $1.1 million ($.09 per
common share).
Depreciation and amortization of systems and equipment are recorded on
a straight-line basis for financial reporting purposes over useful
lives ranging from 4 to 10 years. Repair and maintenance costs are
charged to expense when incurred; renewals and betterments are
capitalized.
Equipment awaiting installation consists primarily of accessories,
parts and supplies for subscriber installations and is stated at the
lower of average cost or market.
(e) License and Leased License Investment
License and leased license investment includes costs incurred to
acquire and/or develop wireless cable channel rights. Costs incurred
to acquire channel rights issued by the Federal Communications
Commission ("FCC") are deferred and amortized ratably over an
estimated useful life of 15 years beginning with inception of service
in each respective market. As of December 31, 1996, approximately
$39.5 million of the license and leased license investment was not yet
subject to amortization.
(f) Excess of Cost over Fair Value of Net Assets Acquired
The excess of cost over fair value of net assets acquired is amortized
on a straight-line basis over the expected periods to be benefited,
generally 15 years. The Company assesses the recoverability of this
intangible asset by determining whether the amortization of the
balance over its remaining life can be recovered through undiscounted
future operating cash flows of the acquired operation. The amount of
impairment, if any, is measured based on projected discounted future
operating cash flows using a discount rate reflecting the Company's
average cost of funds. The assessment of the recoverability of excess
of cost over fair value of net assets acquired will be impacted if
estimated future operating cash flows are not achieved.
(g) Long-Lived Assets
The Company adopted the provisions of SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be
Disposed Of, on January 1, 1996. This Statement requires that
long-lived assets and certain identifiable intangibles be reviewed for
impairment whenever events or changes in circumstances indicate that
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 net cash flows expected to be
(Continued)
F - 9
43
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(tables in thousands, except per share data)
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. The adoption of this Statement
did not have a material impact on the Company's financial position,
results of operations, or liquidity.
The Company's estimates of future gross revenues and operating cash
flows, the remaining estimated lives of long-lived assets, or both
could be reduced in the future due to changes in, among other things,
technology, government regulation, available financing or competition.
As a result, the carrying amounts of long-lived assets, including
excess of cost over fair value of net assets acquired, could be
reduced by amounts which would be material to the financial
statements.
In the fourth quarter of 1996, the Company reduced its estimates of
the useful lives of the nonrecoverable portion of subscriber
installation costs, license and leased license investment, and excess
of cost over fair value of net assets acquired. The amortization
period related to the nonrecoverable portion of subscriber
installation costs was reduced from six years to four years to
correspond to the Company's current estimate of its average
subscription term. The estimated useful life of license and leased
license investment and excess of cost over fair value of net assets
acquired was reduced from 20 years to 15 years. The effect of this
change in estimate was to increase 1996 depreciation and amortization
expense by $3.4 million and increase 1996 net loss by $2.2 million and
$.12 per share.
(h) Investments in Affiliates
The Company uses the equity method of accounting for investments in
affiliates where the ability to exercise significant influence over
such entities exists.
(i) Revenue Recognition
Revenues from subscribers are recognized in the period of service.
(j) Systems Operations
Systems operations expenses consist principally of programming fees,
channel lease costs, tower rental and other costs of providing
services.
(Continued)
F - 10
44
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(tables in thousands, except per share data)
(k) Income Taxes
Deferred income taxes are recognized for the tax consequences in
future years of differences between the financial statement carrying
amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using the
enacted tax rates applicable to the periods in which the differences
are expected to affect taxable income. Valuation allowances are
established when necessary to reduce deferred tax assets to the amount
expected to be realized.
(l) Sales of Subsidiary and Affiliate Stock
Gains and losses from the sales of capital stock by the Company's
majority-owned subsidiaries and affiliates accounted for using the
equity method are recognized as equity transactions in consolidation.
(m) Net Loss Per Common Share
Net loss per common share is based on the net loss applicable to
common stock divided by the weighted average number of common shares
outstanding of 18,473,000 for the year ended December 31, 1996,
11,866,000 for the year ended December 31, 1995 and 10,041,000 for the
year ended December 31, 1994.
Shares issuable upon exercise of stock options, warrants and
convertible debt are antidilutive and have been excluded from the
calculation. Fully-diluted loss per common share is not presented as
it would not materially differ from primary loss per common share.
(n) Statements of Cash Flows
The Company considers all highly liquid investments purchased with
original maturities of three months or less to be cash equivalents.
During the year ended December 31, 1995, the Company entered into
capital leases and noncompetition agreements of $872,000 and $315,000,
respectively. During the year ended December 31, 1996, the Company
entered into capital leases and a noncompetition agreement of $676,000
and $750,000, respectively.
(o) Stock Option Plans
Prior to January 1, 1996, the Company accounted for its stock option
plans in accordance with the provisions of Accounting Principles Board
("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and
related interpretations. As such, compensation expense would be
recorded on the date of grant only if the current market price of the
underlying stock exceeded
(Continued)
F - 11
45
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(tables in thousands, except per share data)
the exercise price. On January 1, 1996, the Company adopted SFAS No.
123, Accounting for Stock-Based Compensation, which permits entities to
recognize as expense over the vesting period the fair value of all
stock-based awards on the date of grant. Alternatively, SFAS No. 123
also allows entities to continue to apply the provisions of APB Opinion
No. 25 and provide pro forma net income and pro forma earnings per
share disclosures for employee stock option grants made in 1995 and
future years as if the fair-value based method defined in SFAS No. 123
had been applied. The Company has elected to continue to apply the
provisions of APB Opinion No. 25 and provide the pro forma disclosures
of SFAS No. 123.
(p) Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the 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
from those estimates.
(2) Systems and Equipment
Systems and equipment consists of the following at December 31, 1996 and
1995:
1996 1995
---------- --------
Equipment awaiting installation $ 14,114 $10,052
Subscriber premises equipment and installation costs 98,289 30,437
Transmission equipment and system construction costs 43,309 22,180
Office furniture and equipment 6,858 2,054
Buildings and leasehold improvements 1,604 423
---------- --------
164,174 65,146
Accumulated depreciation and amortization 18,377 4,497
---------- --------
$145,797 $60,649
========== ========
As of December 31, 1996, equipment awaiting installation and approximately
$225,000 of transmission equipment and system construction costs were not
yet subject to depreciation.
(Continued)
F - 12
46
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(tables in thousands, except per share data)
(3) Long-term Debt
Long-term debt at December 31, 1996 and 1995 consists of the following:
1996 1995
---------- ----------
Convertible Notes $ 48,239 $ 44,174
13% Senior Notes 111,565 96,010
14% Senior Notes 125,000
Other notes payable 18,734 1,468
---------- ----------
303,538 141,652
Less current portion 1,188 765
---------- ----------
$302,350 $140,887
========== ==========
On November 30, 1994, the Company consummated the private placement of
$40,150,000 in gross proceeds of 9% Convertible Subordinated Discount Notes
(the "Convertible Notes") pursuant to the terms of a Note Purchase
Agreement. The Convertible Notes accrete at a rate of 9% compounded
semiannually, to an aggregate principal amount of $62.4 million at November
30, 1999. Thereafter, interest accrues at the rate of 9% per annum and is
payable semiannually from November 30, 1999 or earlier upon the occurrence
of a Material Default (as defined in the Note Purchase Agreement). The
Convertible Notes mature on November 1, 2004 and are subordinated as to all
existing and future indebtedness of the Company other than indebtedness
that is expressly subordinated to the Convertible Notes.
At the option of a holder, the Convertible Notes are convertible into
common stock of the Company at $15.34 per share (the "Conversion Price").
The Convertible Notes are redeemable at the option of the Company at any
time on or after November 30, 1999 at 100% of the principal amount at
maturity plus accrued and unpaid interest. However, such redemption right
is only available if the market price of the Company's common stock exceeds
150% of the Conversion Price for a specified trading period.
In April 1995, the Company consummated a private placement of 100,000 units
consisting of $100 million aggregate principal amount of 13% Senior Notes
due 2003 (the "13% Senior Notes") and 600,000 warrants to purchase an equal
number of shares of common stock at an exercise price of $19.525 per share.
The warrants are exercisable beginning April 1996 and terminate in April
2000. For financial reporting purposes, the warrants were valued at $4.2
million. In March 1996, the Company consummated a private placement of an
additional $15 million aggregate principal amount of the 13% Senior Notes.
The 13% Senior Notes are redeemable, in whole or in part, at the option of
the Company at any time on or after April 15, 1999 at redemption prices
ranging from 105.6% to 100% of par. Interest on the 13% Senior
(Continued)
F - 13
47
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(tables in thousands, except per share data)
Notes is payable semiannually on April 15 and October 15 of each year. The
Company placed a portion of the net proceeds realized from the sales of the
13% Senior Notes into an escrow account for the payment of two years of
interest on the 13% Senior Notes. The amounts placed in the escrow account
have been invested in U.S. Treasury Notes. As of December 31, 1996, the
escrow account amounted to $7.3 million and will be utilized to fund the
April 15, 1997 interest payment on the 13% Senior Notes.
In March 1996, the FCC concluded an auction for the award of initial
commercial wireless cable licenses for 487 basic trading areas ("BTAs") and
six additional BTA-like geographic areas around the country (the "BTA
Auction"). The Company was the winning bidder in 93 BTAs at a total cost
of approximately $19.8 million. Under the terms of the BTA Auction, the
Company remitted a $1.0 million deposit at the commencement of the BTA
Auction and, because the Company qualified as a "small business" for
purposes of the BTA Auction, subsequently has been required to remit only
20% of the total committed amount (less the $1.0 million deposit), or
approximately $3.0 million. The remaining 80% of the committed amount, or
approximately $15.8 million, bears interest at 9.5% and will be paid over a
10-year period commencing in the fourth quarter of 1996. The Company will
be required to make quarterly interest payments for the first two years and
quarterly payments of principal and interest over the remaining eight
years.
Pursuant to the CS Wireless Transaction (as hereinafter defined), CS
Wireless Systems, Inc. ("CS Wireless") will reimburse the Company for all
amounts paid in the BTA Auction relating to 12 BTAs awarded to the Company
at a total cost of approximately $5.3 million. As of December 31, 1996, CS
Wireless had reimbursed the Company approximately $1.1 million. The
remaining amount owed to the Company of $4.4 million has been included in
the investment in affiliates at December 31, 1996.
In December 1996, the Company consummated a private placement of
$125,000,000 aggregate principal amount of 14% Senior Notes due 2004 (the
"14% Senior Notes"). The 14% Senior Notes are redeemable, in whole or in
part, at the option of the Company at any time on or after October 15, 2002
at redemption prices ranging from 102.333% to 100% of par. Interest on the
14% Senior Notes is payable semiannually on April 15 and October 15 of each
year. The Company placed $22 million of the net proceeds realized from the
sale of the 14% Senior Notes into an escrow account for the payment of the
first three interest payments on the 14% Senior Notes. The amounts placed
in the escrow account have been invested in U.S. Treasury Notes. As of
December 31, 1996, the escrow account amounted to $22.3 million and will be
utilized to fund the April 1997, October 1997 and April 1998 interest
payments on the 14% Senior Notes.
The 13% Senior Notes, 14% Senior Notes and Convertible Notes contain
covenants that, among other things, prohibit or limit the ability of the
Company and its subsidiaries to pay dividends, to sell or lease channel
rights, to make certain acquisitions and incur certain indebtedness.
In September 1995, the Company engaged in the solicitation of consents from
the holders of the 13% Senior Notes to amend certain provisions of the
indenture to permit the Company to consummate the Wireless One Transaction,
the CableMaxx, AWS and Technivision Acquisitions and the CS Wireless
Transaction (as hereinafter defined) and additionally amend certain
definitions and
(Continued)
F - 14
48
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(tables in thousands, except per share data)
covenants. The proposed amendments to the indenture became effective as of
October 2, 1995 upon the execution of a supplemental indenture. The
Company paid an aggregate of $955,000 to consenting holders in October
1995.
In October 1996, the Company engaged in the solicitation of consents from
the holders of its 13% Senior Notes to permit the Company to (1) issue the
14% Senior Notes and (2) amend certain definitions and covenants in the 13%
Senior Note indentures related to, among other things, additional financing
and investment opportunities. As consideration for the consents, the
Company paid each holder who consented to the amendments $60 for each
$1,000 principal amount of 13% Senior Notes held by such holder. The
Company paid $5 of the consent payment upon the execution of a supplemental
indenture and $55 of the consent payment upon consummation of the offering
related to the 14% Senior Notes.
During December 1996, the Company consummated its private placement of the
14% Senior Notes and amended certain definitions and covenants in the 13%
Senior Note indentures. As a result of a substantive modification of the
terms of the debt due to the amount of consent fees paid, the transaction
has been treated as an extinguishment of the 13% Senior Notes.
Accordingly, for financial reporting purposes, the 13% Senior Notes have
been treated as having been extinguished and reissued upon the consummation
of the offering of the 14% Senior Notes, and recorded at their estimated
fair value as of such date. The write-off of debt issuance costs of $5.3
million related to the 13% Senior Notes, the consent payments and certain
other costs of $7.3 million, and the decrease in the 13% Senior Notes of
$1.1 million to reflect their estimated fair value have been recorded as an
extraordinary loss of $11.5 million, net of tax of $1.1 million.
The Company is currently highly leveraged, and it is expected to continue
to have a high level of debt for the foreseeable future. As a result of
its leverage and in order to repay existing indebtedness, the Company will
be required to generate substantial operating cash flow. The ability of
the Company to meet these requirements will depend on, among other things,
prevailing economic conditions and financial, business and other factors,
some of which are beyond the control of the Company.
Aggregate maturities of long-term debt as of December 31, 1996 for the five
years ending December 31, 2001 are as follows: 1997 - $1.2 million; 1998 -
$1.4 million; 1999 - $2.2 million; 2000 - $1.6 million; and 2001 - $1.7
million.
(4) Minority Interests
In connection with the development of certain wireless cable television
markets, the Company sold stock in certain of its subsidiary companies
principally for cash. In addition to providing a portion of the cash
necessary for market development, the sales of subsidiary stock were
intended to provide for local community involvement and ownership in the
related wireless cable systems.
(Continued)
F - 15
49
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(tables in thousands, except per share data)
In April 1994, the Company acquired all of the outstanding minority
ownership interests held by the minority interest owner in six of the
Company's majority-owned subsidiaries in exchange for the issuance by the
Company of 650,000 restricted shares of common stock. As a result of the
acquisition, the six subsidiaries became wholly-owned subsidiaries of the
Company. Additionally, at various dates during 1994, the Company acquired
minority interests in certain other subsidiaries for an aggregate of
approximately $1.6 million in cash and 44,280 restricted shares of common
stock. The acquisitions of the minority ownership interests in 1994 were
accounted for using the purchase method of accounting. For financial
reporting purposes, the total purchase price was approximately $7,882,000
and assumed a value per share of $8.93 to $10.75 for the restricted shares.
A deferred tax liability of approximately $2.6 million was recorded for
differences between the assigned values and the tax bases of assets and
liabilities recognized in the acquisition of the minority interests. A
corresponding amount has been recorded as excess of cost over fair value of
net assets acquired.
In March 1995, the Company issued an aggregate of 304,038 registered shares
of common stock in exchange for minority interests in 21 subsidiaries (17
of which are now wholly-owned). The acquisitions of the minority interests
in 1995 were accounted for using the purchase method of accounting. For
financial reporting purposes, the total purchase price was approximately
$5.1 million, including out-of-pocket expenses of approximately $500,000.
A deferred tax liability of approximately $1.4 million was recorded for
differences between the assigned values and the tax bases of assets and
liabilities recognized in the acquisitions of the minority interests. A
corresponding amount has been recorded as excess of cost over fair value of
net assets acquired.
(5) Stockholders' Equity
(a) Public Offering
In April 1994, the Company completed an initial public offering of
2,100,000 shares of its common stock. In June 1994, the Company sold
an additional 315,000 shares of common stock upon exercise by the
underwriters of their over-allotment option. The aggregate net
proceeds to the Company were approximately $22.4 million.
(b) Stock Options
In April 1994, the Company adopted the 1994 Employee Stock Option Plan
which, as amended in May 1996, provides for the granting of options to
purchase a maximum of 1,950,000 shares of common stock. Options may
be granted to key employees at exercise prices of not less than 100%
of the fair market value of the common stock on the date of grant.
Options typically vest over a five-year period (although options
granted to certain employees were 40% vested upon grant and vest an
additional 20% per year over a three-year period) and expire at the
end of option periods of not more than seven years.
(Continued)
F - 16
50
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(tables in thousands, except per share data)
During 1994, the Company also adopted the 1994 Stock Option Plan for
Non-Employee Directors which provides for the granting of options to
purchase a maximum of 50,000 shares of common stock. Generally, each
non-employee director will be granted on an annual basis an option to
acquire 2,000 shares of common stock at exercise prices equal to the
fair market value of the common stock on the date of grant. Options
granted generally become exercisable in 25% cumulative annual
installments beginning one year from the date of grant and expire at
the end of option periods of not more than seven years.
At December 31, 1996, there were 717,500 additional shares available
for grant under the plans. The per-share weighted-average fair value
of stock options granted during 1996 and 1995 was $10.82 and $7.56 on
the date of grant using the Black-Scholes option-pricing model with
the following weighted-average assumptions used: expected dividend
yield 0%, risk-free interest rate of 6.5% in 1996 and 6.75% in 1995,
volatility of 36% and expected lives of five years.
The Company applies APB Opinion No. 25 in accounting for its plans
and, accordingly, no compensation cost has been recognized for its
stock options in the financial statements. Had the Company determined
compensation cost based on the fair value at the grant date for its
stock options under SFAS No. 123, the Company's net loss would have
been increased to the pro forma amounts indicated below:
1996 1995
--------- ---------
Net loss as reported $(61,061) $(15,902)
Net loss per share as reported (3.31) (1.34)
Net loss pro forma $(66,622) $(18,707)
Net loss per share pro forma (3.61) (1.58)
Pro forma net loss reflects only options granted in 1996 and 1995.
Therefore, the full impact of calculating compensation cost for stock
options under SFAS No. 123 is not reflected in the pro forma net loss
amounts presented above because compensation cost is reflected over
the options' vesting period of three to five years and compensation
cost for options granted prior to January 1, 1995 is not considered.
(Continued)
F - 17
51
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(tables in thousands, except per share data)
The following table summarizes the activity in stock options under
these plans:
Number Weighted average
---------- ------------------
of options exercise price
---------- ------------------
Granted 543 $10.54
Cancelled (130) 10.50
-----
Outstanding at December 31, 1994 413 10.55
Granted 371 16.73
Exercised (41) 10.50
-----
Outstanding at December 31, 1995 743 13.64
Granted 514 25.09
Exercised (40) 10.50
Cancelled (16) 24.41
-----
Outstanding at December 31, 1996 1,201 18.50
=====
The following table summarizes information about stock options
outstanding at December 31, 1996:
Options Outstanding Options Exercisable
------------------------------------------------------- --------------------------------------
Weighted-Average Weighted-
Range of Number Outstanding Remaining Average Exercise Number Exercisable Weighted-Average
Exercise Prices at 12/31/96 Contractual Life Price at 12/31/96 Exercise Price
- ---------------- ------------------ ----------------- ---------------- ------------------ ----------------
$10.50 to 15.75 604,000 4.7 years $12.21 373,800 $11.93
15.76 to 23.64 139,500 5.8 22.20 22,400 22.12
23.65 to 29.25 458,000 6.2 33.19 - -
--------- -------
$10.50 to 29.25 1,201,500 5.4 $18.50 396,200 $12.51
========= =======
At December 31, 1995, the number of options exercisable was 279,800
and the weighted-average exercise price of those options was $11.71.
(6) Income Taxes
Income tax benefit related to continuing operations of $28.2 million, $4.3
million and $1.6 million for the years ended December 31, 1996, 1995 and
1994, respectively, consists of a deferred tax benefit. In addition,
deferred income tax benefit of $1.1 million and $110,000 was allocated to
the extraordinary item and stockholders' equity, respectively, for the year
ended December 31, 1996.
(Continued)
F - 18
52
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(tables in thousands, except per share data)
Income tax benefit for the years ended December 31, 1996, 1995 and 1994
differed from the amount computed by applying the U.S. federal income tax
rate of 35% to loss before income taxes as a result of the following:
1996 1995 1994
--------- -------- --------
Computed "expected" tax benefit $(27,578) $(7,065) $(1,623)
Amortization of goodwill 521 104 27
Loss for which no tax benefit
was recognized - 3,190 104
Other (1,099) (514) (103)
-------- ------- -------
$(28,156) $(4,285) $(1,595)
======== ======= =======
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at
December 31, 1996 and 1995 are presented below:
1996 1995
------------ --------
Deferred tax assets:
Net operating loss carryforwards $ 25,200 $ 6,988
Investments in affiliates 263 841
Subscriber receivables 1,970 -
Debt restructuring 1,574 -
Other 124 18
----------- -------
Total gross deferred tax assets 29,131 7,847
Less valuation allowance (20,011) (3,981)
----------- -------
Net deferred tax assets 9,120 3,866
----------- -------
Deferred tax liabilities:
License and leased license investment (8,308) (3,990)
Systems and equipment (812) (1,504)
----------- -------
Total gross deferred tax liabilities (9,120) (5,494)
----------- -------
Net deferred tax liability $ - $(1,628)
=========== =======
The net changes in the total valuation allowance for the years ended
December 31, 1996 and 1995 were increases of $16.0 million and $3.2
million, respectively. In assessing the realizability of deferred tax
assets, the Company considers whether it is more likely than not that some
portion or all of the deferred tax assets will not be realized. The
ultimate realization of deferred tax assets is dependent upon the
generation of future taxable income during the periods in which those
temporary differences become deductible. The Company considers the
scheduled reversal of deferred tax liabilities, projected future taxable
income, and tax planning strategies in making this assessment. Based upon
these considerations, the Company has recognized deferred tax assets to
the extent such assets can be realized through future reversals of existing
taxable temporary differences.
(Continued)
F - 19
53
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(tables in thousands, except per share data)
As of December 31, 1996, the Company has approximately $68 million of
federal income tax loss carryforwards which expire in years 2008 through
2011. The Company estimates that approximately $38 million of the above
losses relate to various acquisitions and are subject to certain
limitations.
(7) Leases and FCC Licenses
The Company is dependent on leases with third parties for most of its
wireless cable channel rights. Under FCC rules, the base term of each
lease cannot exceed the term of the underlying FCC license. FCC licenses
for wireless cable channels generally must be renewed every ten years, and
there is no automatic renewal of such licenses. The use of such channels
by the lessors is subject to regulation by the FCC and, therefore, the
Company's ability to continue to enjoy the benefits of these leases is
dependent upon the lessors' continuing compliance with applicable
regulations. The remaining initial terms of most of the Company's channel
leases range from 5 to 10 years, although certain of the Company's channel
leases have initial terms expiring in the next several years. Most of the
Company's leases grant the Company a right of first refusal to purchase the
channels after the expiration of the lease if FCC rules and regulations so
permit, provide for automatic renewal of the lease term upon FCC renewal of
the license and/or require the parties to negotiate lease renewals in good
faith. Although the Company does not believe that the termination of or
failure to renew a single channel lease would adversely affect the Company,
several of such terminations or failures in one or more markets that the
Company actively serves could have a material adverse effect on the
Company. Channel rights lease agreements generally require payments based
on the greater of specified minimums or amounts based upon various
subscriber levels. Additionally, FCC licenses also specify construction
deadlines, which, if not met, could result in the loss of the license.
Requests for additional time to construct may be filed and are subject to
review pursuant to FCC rules.
Payments under the channel rights lease agreements generally begin upon the
completion of construction of the transmission equipment and facilities and
approval for operation pursuant to the rules and regulations of the FCC.
However, for certain leases, the Company is obligated to begin payments
upon grant of the channel rights. Channel rights lease expense was $3.3
million, $2.1 million and $167,000 for the years ended December 31, 1996,
1995 and 1994, respectively.
The Company also has certain operating leases for office space, equipment
and transmission tower space. Rent expense incurred in connection with
other operating leases was $3.5 million, $436,000 and $205,000 for the
years ended December 31, 1996, 1995 and 1994, respectively.
(Continued)
F - 20
54
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(tables in thousands, except per share data)
Future minimum lease payments due under channel rights leases and other
noncancellable operating leases at December 31, 1996 are as follows (in
thousands):
Channel Other
Year ending rights operating
December 31, leases leases
- ------------ --------- ---------
1997 $ 3,028 $ 4,558
1998 3,043 4,099
1999 3,046 3,593
2000 3,046 1,173
2001 2,855 478
--------- ---------
$15,018 $13,901
========= =========
(8) Acquisitions/Dispositions
(a) RuralVision Joint Venture
In August 1994, RuralVision Joint Venture ("RuralVision Joint
Venture"), a newly-formed general partnership in which each of the
Company and Cross Country Wireless, Inc. ("Cross Country") had a 50%
interest, purchased certain assets (the "Rural Vision Assets"),
including five operating wireless cable systems and channel rights in
approximately 100 markets, from RuralVision Central, Inc. and
RuralVision South, Inc. (collectively, "RuralVision"). The aggregate
purchase price of approximately $50 million for the RuralVision Assets
was comprised of a $46 million note bearing interest at the rate of 8%
per annum (the "RuralVision Note") and approximately $4 million of
acquisition-related costs paid primarily by the Company and Cross
Country.
In December 1994, the Company acquired an operating wireless cable
system and wireless cable channel rights in 37 other markets from
RuralVision Joint Venture for an aggregate purchase price of $14
million in cash. The Company allocated the purchase price to the
assets acquired and liabilities assumed based on the estimated fair
values of such assets and liabilities.
In January 1995, the Company, Cross Country and RuralVision Joint
Venture entered into the Venture Distribution Agreement, as a result
of which the Company (i) paid an additional $4.32 million in
satisfaction of 50% of the remaining balance of the RuralVision Note,
(ii) paid $513,000 in satisfaction of 50% of the remaining balance of
certain liabilities which RuralVision Joint Venture had assumed, (iii)
paid transaction costs of $592,000, and (iv) received a distribution
from RuralVision Joint Venture of an operating wireless cable system
and wireless cable channel rights in 36 other markets with a carrying
amount of approximately $17.4 million. As part of this transaction,
the Company granted to Cross Country the right to
(Continued)
F - 21
55
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(tables in thousands, except per share data)
sell certain remaining RuralVision Joint Venture assets to the Company
for $3.25 million in May 1995. Cross Country subsequently exercised
its right to sell these assets to the Company and, as a consequence,
the Company acquired such markets. In addition, in May 1995, the
Company ceased to be a joint venturer in RuralVision Joint Venture.
In connection with the Company's allocation of the purchase price of
the acquisition in December 1994, the Company identified wireless
cable channel rights in certain markets which management expected to
sell and classified $12.5 million of such assets as assets held for
sale. Based on management's analysis of additional assets to be sold
that were included in the assets distributed to the Company as part of
the January 27, 1995 Venture Distribution Agreement, the assets held
for sale increased to $21.5 million. During 1995, losses of $265,000
related to the assets held for sale (consisting primarily of rental
expense under channel rights lease agreements) were excluded from the
statement of operations and accounted for as an adjustment to the
carrying amount of assets held for sale. The Company received cash
and notes of approximately $11 million and $2.2 million during 1995
and 1996, respectively, related to the assets held for sale. The
remaining portion of assets originally classified as held for sale has
been allocated to the net assets of the respective markets based on
management's decision to retain such markets.
(b) Wireless One Transaction
In October 1995, the Company contributed certain assets and related
liabilities with respect to two operating wireless cable systems and
certain other wireless cable markets in Texas, Louisiana, Alabama,
Georgia and Florida to Wireless One, Inc. ("Wireless One") for
consideration consisting of approximately 35% of the outstanding
common stock of Wireless One and approximately $10 million of notes
(the "Wireless One Transaction"). In October 1995, Wireless One
completed an initial public offering of 3,000,000 shares of its common
stock and, concurrently therewith, consummated the sale of $150.0
million in gross proceeds of 13% Senior Notes due 2003. As a result
and pursuant to the merger agreement, Wireless One repaid the $10
million of notes from the proceeds of the offerings. As a result of
the initial public offering of Wireless One, the Company's investment
in Wireless One increased by $8,967,000 and its ownership interest
decreased to approximately 26%. Such increase (net of tax of
$3,318,000) has been recorded by the Company as additional paid-in
capital in the accompanying 1995 consolidated statement of
stockholders' equity. During 1996, Wireless One completed additional
equity transactions which increased the Company's investment in
Wireless One by $7.9 million and decreased its ownership interest to
approximately 20%. Such increase (net of tax of $2.9 million) has
been recorded by the Company as additional paid-in capital in the
accompanying 1996 consolidated statement of stockholders' equity.
(Continued)
F - 22
56
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(tables in thousands, except per share data)
(c) CableMaxx, AWS and Technivision Acquisitions
Effective February 23, 1996, the Company acquired all the assets and
liabilities and succeeded to the businesses of American Wireless
Systems, Inc. and CableMaxx, Inc. and acquired substantially all of
the assets and certain of the liabilities and succeeded to all of the
businesses of Fort Worth Wireless Cable T.V. Associates, Wireless
Cable TV Associates #38 and Three Sixty Corp., the successor to
Technivision, Inc., for an aggregate of 6,757,000 shares of the
Company's common stock (the aforementioned five transactions are
collectively referred to herein as the "CableMaxx, AWS and
Technivision Acquisitions").
The CableMaxx, AWS and Technivision Acquisitions were accounted for as
a purchase. The aggregate purchase price of approximately $190
million has been allocated to the net assets acquired based on
management's estimates of the fair values of assets acquired and
liabilities assumed. Excess purchase price over the fair value of net
assets acquired will be amortized on a straight-line basis over 15
years.
(d) CS Wireless Transaction
Effective February 23, 1996, immediately following the closing of the
CableMaxx, AWS and Technivision Acquisitions, the Company, CAI
Wireless Systems, Inc. ("CAI") and CS Wireless consummated the CS
Wireless Participation Agreement pursuant to which the Company
contributed a substantial portion of the assets received in the
CableMaxx, AWS and Technivision Acquisitions and certain other assets
to CS Wireless (the "CS Wireless Transaction"). Simultaneously with
the contribution of such assets by the Company to CS Wireless, CAI
also contributed to CS Wireless certain wireless cable television
assets.
In connection with the CS Wireless Transaction, the Company received
(i) shares of CS Wireless common stock constituting approximately 35%
of the outstanding shares of CS Wireless common stock, (ii)
approximately $28.3 million in cash paid at closing, (iii) a
promissory note in the principal sum of $25.0 million payable on or
before nine months from the closing and secured by proceeds of a
contemplated issuance by CS Wireless of senior discount notes (which
note has been prepaid) and (iv) a promissory note in the sum of $15.0
million (the "CS Wireless Note") payable ten years from closing and
prepayable from asset sales and certain other events. The interest
rate on the CS Wireless Note increases from 10% to 15% if such note is
not repaid within one year of issuance, with interest accruing and
added to the balance annually. No cash interest will be paid on the
CS Wireless Note until the senior discount notes of CS Wireless have
been paid in full. CS Wireless, CAI and the Company are in the
process of completing certain post-closing net working capital
calculations. Components of such calculations include the relative
accounts payable, accounts receivable and related working capital
assets of the contributed systems, the number of granted channels
represented and actually contributed to CS Wireless for each market,
the amount of any increase or decrease in the number of subscribers in
each contributed system from the number of
(Continued)
F - 23
57
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(tables in thousands, except per share data)
subscribers stated in the CS Wireless Participation Agreement and
related factors. On November 8, 1996, CS Wireless made an initial
payment of $5 million in cash to the Company that will be applied to
the final amount owed to the Company pursuant to the CS Wireless
Transaction. Following the completion of all calculations, additional
payments of cash and/or shares of CS Wireless common stock are
expected to be made to the Company by CS Wireless and/or CAI.
(e) Other Acquisitions/Dispositions
In December 1994, the Company acquired an operating wireless cable
system in the Lindsay, Oklahoma market for $2.3 million in cash. In
May 1995, the Company purchased an operating wireless cable system in
the Lubbock, Texas market for approximately $5.4 million in cash and
wireless cable channel rights in the Tulsa, Oklahoma market for
approximately $2 million in cash and forgiveness of a $2 million note
receivable (see note 10).
In July 1995, the Company privately placed 1,029,707 shares of its
common stock to RuralVision Joint Venture in exchange for $20,000,000
in cash. Immediately subsequent to the issuance of the shares to
RuralVision Joint Venture, the Company acquired substantially all of
the remaining assets of RuralVision Joint Venture, consisting
primarily of wireless cable systems located in Lykens, Ohio;
Paragould, Arkansas; Sikeston, Missouri and channel rights in
additional markets located in five states for $20,000,000 in cash (the
"Cross Country Acquisition").
In January 1996, the Company acquired an operating wireless cable
television system in Champaign, Illinois for approximately $2.1
million in cash and sold two nonoperating wireless cable markets for
approximately $2.2 million in cash. No gain or loss was recognized on
the sale of the two nonoperating markets.
In May 1996, the Company consummated the sale of the Memphis and
Flippin, Tennessee wireless cable markets for approximately $5.4
million in cash, resulting in a gain of $.4 million related to the
sale of the Flippin market. No gain or loss was recognized on the
sale of the Memphis market.
In June 1996, the Company sold the wireless cable channel rights in
Los Angeles, California for $8.95 million in cash at closing and
$750,000 in notes and deferred payments. The notes and deferred
payments were paid subsequent to December 31, 1996. No gain or loss
was recognized on the sale of the Los Angeles wireless cable channel
rights.
In June 1996, the Company acquired operating wireless cable systems in
George West and Kingsville, Texas for $350,000 in cash and 126,601
unregistered shares of the Company's common stock.
(Continued)
F - 24
58
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(tables in thousands, except per share data)
In July 1996, the Company consummated the sale of wireless cable
channel rights in Adairsville, Powers Crossroads and Rutledge, Georgia
to CS Wireless for total consideration of approximately $7.2 million
in cash, resulting in a gain of $4.8 million.
In August 1996, the Company acquired an operating wireless cable
system in Gainesville/Rosston, Texas for approximately $1 million in
cash and $1.4 million in notes secured by the assets acquired.
All acquisitions have been accounted for as purchases, and operations
of the companies and businesses acquired have been included in the
accompanying consolidated financial statements from their respective
dates of acquisition.
The Company allocated the purchase prices of the acquisitions
consummated in 1996, 1995 and 1994 discussed above to the assets
acquired and liabilities assumed based on estimated fair values of
such assets and liabilities as follows:
1996 1995 1994
--------- ---------- -----------
Working capital (deficit) $(19,790) $ 858 $ 88
Assets held for sale 11,819 - 12,638
Systems and equipment 19,489 6,784 1,912
License and leased license investment
and goodwill 88,292 43,856 1,662
Deferred income taxes (24,851) (1,404) -
-------- --------- -----------
Total purchase price $ 74,959 $50,094 $16,300
======== ========= ===========
(f) Pro Forma Information (Unaudited)
Summarized below is the unaudited pro forma information for the years
ended December 31, 1996 and 1995 as if the acquisitions/transactions
discussed above had been consummated as of the beginning of 1996 and
1995, after giving effect to certain adjustments, including
amortization of intangibles and selected income tax effects. The pro
forma information does not purport to represent what the Company's
results of operations actually would have been had such transactions
or events occurred on the dates specified, or to project the Company's
results of operations for any future period.
Year ended December 31
------------------------
1996 1995
----------- -----------
Revenues $ 58,353 $ 16,584
Net loss (82,594) (17,546)
Net loss per common share (4.17) (1.40)
(Continued)
F - 25
59
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(tables in thousands, except per share data)
(g) Pending Acquisitions
The Company has entered into a nonbinding letter of intent to acquire
one wireless cable operating system in Iowa and wireless cable assets
in one market in each of Nebraska and Montana from CS Wireless. In
addition, the Company has agreed to sell to CAI certain wireless cable
assets in Portsmouth, New Hampshire. The Company will receive
approximately 267,000 shares of common stock of CS Wireless as its
portion of the consideration for such assets. Also, the Company has
entered into an agreement with a third-party in which the parties
agreed to exchange certain wireless cable channel rights and related
assets. Each of the above agreements is subject to customary closing
conditions. The Company anticipates that these agreements will be
consummated on or before June 30, 1997, although there can be no
assurance that any of these transactions will be consummated.
(9) Investments in Affiliates
Investments in affiliates consists of approximately 20% of the common stock
of Wireless One and approximately 34% of the common stock of CS Wireless.
Wireless One and CS Wireless develop, own and operate wireless cable
television systems primarily in the southeast and central United States,
respectively. The unamortized portion of the difference between the
Company's investment in CS Wireless and the Company's share of net assets
of CS Wireless is $7.2 million at December 31, 1996. Such amount is being
amortized over 15 years based on CS Wireless' estimated useful life of
license and leased license investment. As of December 31, 1996, the
Company's investment in CS Wireless includes amounts due to the Company
from CS Wireless for certain BTAs (see note 3) and an additional
receivable, in the amount of $4.4 million and $.4 million, respectively.
Summary combined financial information for Wireless One and CS Wireless as
of and for the years ended December 31, 1996 and 1995 follows:
1996 1995
---------- ----------
Current assets $ 241,560 $ 129,363
Current liabilities 30,071 7,279
--------- ---------
Working capital 211,489 122,084
Systems and equipment 125,592 14,267
Other assets 439,855 70,170
Long-term debt (570,386) (150,871)
--------- ---------
Stockholders' equity $ 193,428 $ 55,650
========= =========
(Continued)
F - 26
60
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(tables in thousands, except per share data)
`
1996 1995
---------- -----------
Revenues $34,103 $1,410
========== ===========
Net loss $68,197 $7,692
========== ===========
(10) Related Party Transactions
The Company leases office space from entities owned by certain current and
former officers and directors of the Company for which the expense amounted
to approximately $187,000 in 1996, $66,000 in 1995 and $22,000 in 1994.
The Company paid $97,000 in 1996, $52,000 in 1995 and $51,000 in 1994 to an
affiliate of an officer and director of the Company for certain
administrative services. During 1995, an entity owned by a director of the
Company was paid $44,000 for certain marketing services. The Company paid
$57,000 in 1995 to an entity owned by a director for certain consulting
services. The Company paid $244,000 in 1994 to various affiliates for
services performed in connection with the development of wireless cable
television systems or the acquisition of wireless cable channel rights.
In 1996, in exchange for the delivery of certain equipment and receipt of
a promissory note in the principal amount of $400,000, the Company
acquired a 10% interest in a limited liability company formed to acquire
and operate wireless cable channel rights and operating systems in Chile.
An affiliate of a former employee of the Company holds a 22% interest in
such limited liability company.
In 1996, the Company purchased a paging franchise and related equipment
for intra-Company use from an entity owned by certain current and former
directors and officers of the Company for $123,000.
In December 1994, the Company entered into an agreement with a stockholder
and its affiliate pursuant to which the Company loaned $2 million to the
stockholder secured by 300,000 shares of the Company's common stock owned
by the stockholder and all of the affiliate's assets in and to the Tulsa,
Oklahoma wireless cable market. The loan bore interest at 12% per annum
with all accrued interest and the outstanding principal balance being
repaid in June 1995. In addition, in December 1994, the affiliate granted
to the Company an option for the Company to acquire the Tulsa, Oklahoma
wireless cable market. The purchase price of $4 million paid upon the
exercise of the option in May 1995 included forgiveness of the note
receivable (see note 8).
(11) Commitments and Contingencies
The Company has entered into a series of noncancellable agreements to
purchase entertainment programming for retransmission which expire through
2000. The agreements generally require monthly payments based upon the
number of subscribers to the Company's systems, subject to certain
minimums.
The Company is a party to legal proceedings incidental to its business
which, in the opinion of management, are not expected to have a material
adverse effect on the Company's consolidated financial position, liquidity
or operating results.
(Continued)
F - 27
61
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(tables in thousands, except per share data)
(12) Fair Value of Financial Instruments
The following table presents the carrying amounts and estimated fair values
of the Company's financial instruments at December 31, 1996 and 1995. The
fair value of a financial instrument is defined as the amount at which the
instrument could be exchanged in a current transaction between willing
parties.
1996 1995
---------------------- ----------------------
Carrying Fair Carrying Fair
amount value amount value
---------- ---------- ---------- ----------
Restricted assets - investments
in debt securities $ 30,007 $ 28,802 $ 18,739 $ 18,626
Note receivable from affiliate 16,275 16,275 - -
Long-term debt (303,538) (303,538) (141,652) (170,745)
The following methods and assumptions were used to estimate the fair value
of each class of financial instrument:
Cash and cash equivalents, accounts receivable and accounts payable:
The carrying amounts of these assets and liabilities approximate fair
value because of the short maturity of these instruments.
Investments in debt securities: The fair values of debt securities
are based on quoted market prices at the reporting date for those
investments.
Long-term debt: The fair values of the Company's 13% Senior Notes,
14% Senior Notes and Convertible Notes are based on market quotes
obtained from dealers.
Note receivable from affiliates: The carrying amount of this asset
approximates fair value since the interest rates equate to market rate
of interest.
(Continued)
F - 28
62
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(tables in thousands, except per share data)
(13) Quarterly Financial Data (Unaudited)
The following summarizes the Company's unaudited quarterly results of
operations for 1996:
March 31 June 30 September 30 December 31
-------- --------- ------------ -----------
Year ended December 31, 1996:
Revenues $ 9,512 $ 13,801 $15,651 $ 17,053
Operating loss (3,410) (5,644) (7,176) (30,766)
Loss before extraordinary item (8,244) (10,404) (5,443) (26,546)
Net loss (8,244) (10,404) (5,443) (36,970)
Loss per share before extraordinary item (.54) (.54) (.28) (1.36)
Net loss per share (.54) (.54) (.28) (1.89)
During the fourth quarter of 1996, the Company recorded bad debt expense
and associated depreciation of nonrecoverable costs of $5.2 million and
$5.2 million, respectively, related to certain subscribers with past due
balances which the Company has disconnected or intends to disconnect during
the first quarter of 1997. In addition, during the fourth quarter of 1996,
the Company recorded additional expense of $2.5 million related to changes
in estimated programming costs, a write-down of certain subscriber
equipment of $2.3 million and a write-down of license and leased license
investment of $1.6 million.
F - 29
63
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report on its behalf
by the undersigned, thereunto duly authorized, on the 29th day of March, 1997.
HEARTLAND WIRELESS COMMUNICATIONS, INC.
By: /s/ JOHN A. FANNING
----------------------------------------------
John A. Fanning
Interim President and Chief Executive Officer,
Acting Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed on the 29th day of March, 1997, by the following
persons in the capacities indicated:
Signature Title
- ----------------------- -----------------------------------------------------
/s/ JOHN A. FANNING Interim President and Chief Executive Officer and
- ----------------------- Acting Chief Financial Officer (Principal
John A. Fanning Executive Officer and Principal Financial Officer)
/s/ DAVID D. HAGEY Vice President, Controller and Assistant Secretary
- ----------------------- (Principal Accounting Officer)
David D. Hagey
/s/ J. R. HOLLAND, JR. Director
- -----------------------
J. R. Holland, Jr.
/s/ ALVIN H. LANE Director
- -----------------------
Alvin H. Lane
/s/ DENNIS M. O'ROURKE Director
- -----------------------
Dennis M. O'Rourke
Director
- -----------------------
John A. Sprague
/s/ L. ALLEN WHEELER Director
- -----------------------
L. Allen Wheeler
64
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Heartland Wireless Communications, Inc.:
Under the date of March 24, 1997, we reported on the consolidated balance
sheets of Heartland Wireless Communications, Inc. and subsidiaries as of
December 31, 1996 and 1995 and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the years in the
three-year period ended December 31, 1996, which are included in the Company's
annual report on Form 10-K. In connection with our audits of the
aforementioned consolidated financial statements, we also audited the related
financial statement schedule as listed in the accompanying index. This
financial statement schedule is the responsibility of the Company's management.
Our responsibility is to express an opinion on this financial statement
schedule based on our audits.
In our opinion, such schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, present fairly, in all
material respects, the information set forth therein.
KPMG Peat Marwick LLP
Dallas, Texas
March 24, 1997
S - 1
65
Schedule II
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
Valuation and Qualifying Accounts
(In thousands)
Additions
------------------------
Balance at Charged to Balance at
beginning costs and Charged to end of
Description of period expenses other Deductions period
- ----------------------- ---------- ---------- ------------ ---------- ----------
Year ended December 31,
1996:
Allowance for
doubtful accounts $ 961 $7,295 $ 169(a) $(2,957) $5,468
========== ========== ========= ========= ==========
Valuation allowance
for deferred tax
assets $3,981 $ - $5,319(b) $ - $9,300
========== ========== ========= ========= ==========
Year ended December 31,
1995:
Allowance for
doubtful accounts $ 123 $ 838 $ - $ - $ 961
========== ========== ========= ========= ==========
Valuation allowance
for deferred tax
assets $ 791 $ - $3,190(b) $ - $3,981
========== ========== ========= ========= ==========
Year ended December 31,
1994:
Allowance for
doubtful accounts $ 25 $ 72 $ 26(c) $ - $ 123
========== ========== ========= ========= ==========
Valuation allowance
for deferred tax
assets $ 183 $ - $ 608(b) $ - $ 791
========== ========== ========= ========= ==========
(a) Allocation of assets from the CableMaxx and Technivision acquisitions.
(b) Recognized as a component of federal income tax benefit.
(c) Allocation of assets from the purchase of certain assets from RuralVision.
S -2
66
EXHIBIT INDEX
EXHIBIT
NO. DESCRIPTION
- ------- -----------
2.1 Letter Agreement regarding formation of the Registrant (filed as Exhibit
2.1 as the Registrant's Registration Statement on Form S-1, FIle No.
33-74244 (the "Form S-1"), and incorporated herein by reference)
2.2 Supplement to Letter Agreement regarding formation of the Registrant
(filed as Exhibit 2.2 to the Form S-1 and incorporated herein by
reference)
3.1 Restated Certificate of Incorporation of the Registrant (filed as
Exhibit 3.1 to the Form S-1 and incorporated herein by reference)
3.2 Restated By-laws of the Registrant (filed as Exhibit 3.2 to the Form S-1
and incorporated herein by reference)
4.1 1994 Employee Stock Option Plan of the Registrant (filed as Exhibit 4.1
to the Registrant's Registration Statement on Form S-8 (File No.
333-04263) and incorporated herein by reference
4.2 Revised Form of Nontransferable Incentive Stock Option Agreement under
the 1994 Employee Stock Option Plan of the Registrant (filed as Exhibit
4.2 to the Registrant's Registration Statement on Form S-4, File No.
33-91930 (the "February 1996 Form S-4")and incorporated herein by
reference)
4.3 Revised Form of Nontransferable Non-Qualified Stock Option Agreement
under the 1994 Employee Stock Option Plan of the Registrant (filed as
Exhibit 4.3 to the February 1996 Form S-4 and incorporated herein by
reference)
4.4 1994 Stock Option Plan for Non-Employee Directors of the Registrant
(filed as Exhibit 4.4 to the Form S-1 and incorporated herein by
reference)
4.5 Form of Stock Option Agreement under the 1994 Stock Option Plan for
Non-Employee Directors of the Registrant (filed as Exhibit 4.5 to the
Form S-1 and incorporated herein by reference)
4.6 Indenture between the Registrant and First Trust of New York, National
Association , as Trustee (the "Trustee") (filed as Exhibit 4.20 to the
Registrant's Registration Statement on Form S-4, File No. 333-12577 (the
"December 1996 Form S-4") and incorporated herein by reference)
4.7 Supplemental Indenture dated as of December 9, 1996, between the
Registrant and the Trustee (filed as Exhibit 4.21 to the December 1996
Form S-4 and incorporated herein by reference)
4.8 Heartland Wireless Communications, Inc. 401(k) Plan (filed as Exhibit
4.3 to the Registrant's Registration Statement on Form S-8 (File No.
333-05943) and incorporated herein by reference)
*10.1 Standard Form of MMDS License Agreement
*10.2 Standard Form of ITFS License Agreement
10.3 Form of Indemnity Agreement between the Registrant and each of its
directors (filed as Exhibit 10.3 to the Form S-1 and incorporated herein
by reference)
10.4 Noncompetition Agreement between the Registrant and J.R. Holland, Jr.
(filed as Exhibit 10.4 to the Form S-1 and incorporated herein by
reference)
67
EXHIBIT
NO. DESCRIPTION
- ------- -----------
10.5 Noncompetition Agreement between the Registrant and David E. Webb
(filed as Exhibit 10.5 to the Form S-1 and incorporated herein by
reference)
10.6 Noncompetition Agreement between the Registrant and John R. Bailey
(filed as Exhibit 10.6 to the Form S-1 and incorporated herein by
reference)
10.7 Noncompetition Agreement between the Registrant and Randy R. Hendrix
(filed as Exhibit 10.7 to the Form S-1 and incorporated herein by
reference)
10.8 Noncompetition Agreement between the Registrant and L. Allen Wheeler
(filed as Exhibit 10.9 to the Form S-1 and incorporated herein by
reference)
10.9 Building Lease Agreement dated June 1, 1990, between Wireless
Communications, Inc. and The Federal Building, Inc. (filed as Exhibit
10.13 to the 1994 Form 10-K and incorporated herein by reference)
10.10 Building Lease Agreement dated January 2, 1995, between the Registrant
and W&W Commercial Group, L.L.C. (filed as Exhibit 10.14 to the 1994
Form 10-K and incorporated herein by reference)
10.11 Building Lease Agreement dated May 1, 1994, between Wireless
Communications, Inc. and The Federal Building, Inc.
10.12 Purchase Agreement among the Registrant, BT Securities and Lazard (filed
as Exhibit 10.17 to the February 1995 Form S-4 and incorporated herein
by reference)
10.13 Building Lease Agreement dated November 20, 1995, between the registrant
and the Federal Building, Inc. (filed as Exhibit 10.18 to the February
1996 Form S-4 and incorporated herein by reference)
10.14 Office Lease dated April 10, 1996 between Merit Office Portfolio Limited
Partnership and the Registrant for the Registrant's Plano, Texas office
(filed as Exhibit 10.1 to the Form 10-Q Quarterly Report for the quarter
ended June 30, 1996 ("June 1996 Form 10-Q") and incorporated herein by
reference)
10.15 Sublease Agreement dated June 14, 1996 between the Registrant and CS
Wireless (filed as Exhibit 10.2 to the June 1996 Form 10-Q and
incorporated herein by reference)
*10.16 Building Lease Agreement dated February 1, 1996, as amended June 1,
1996, between Registrant and National Horizon Development, L.C.
*21 List of Subsidiaries
*23 Consent of KPMG Peat Marwick LLP
*27 Financial Data Schedule
* Filed herewith.
(b) Reports on Form 8-K
During the fourth quarter of the year ended December 31, 1996, the Company
filed the following reports on Form 8-K:
(i) Current Report on Form 8-K dated December 20, 1996 with respect
to the sale of $125 million of its 14% Senior Notes.
(ii) Current Report on Form 8-K dated November 22, 1996 regarding
third quarter financial results.