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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the quarterly period ended September 30, 2002
------------------
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the transition period from__________ to __________
Commission File Number 0-21389
PEGASUS SATELLITE COMMUNICATIONS, INC.
(Exact name of Registrant as specified in its charter)
Delaware 51-0374669
-------- ----------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
c/o Pegasus Communications Management Company;
225 City Line Avenue, Suite 200, Bala Cynwyd, PA 19004
------------------------------------------------ -----
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (888) 438-7488
--------------
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___
Number of shares of each class of the Registrant's common stock
outstanding as of November 14, 2002:
Class B, Common Stock, $0.01 par value 200
PEGASUS SATELLITE COMMUNICATIONS, INC.
Form 10-Q
Table of Contents
For the Quarterly Period Ended September 30, 2002
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets
September 30, 2002 and December 31, 2001 4
Consolidated Statements of Operations and Comprehensive Loss
Three months ended September 30, 2002 and 2001 5
Consolidated Statements of Operations and Comprehensive Loss
Nine months ended September 30, 2002 and 2001 6
Condensed Consolidated Statements of Cash Flows
Nine months ended September 30, 2002 and 2001 7
Notes to Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 18
Item 3. Quantitative and Qualitative Disclosures About Market Risk 27
Item 4. Controls and Procedures 27
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 28
Item 3. Defaults Upon Senior Securities 28
Signature 29
Certifications
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
3
Pegasus Satellite Communications, Inc.
Condensed Consolidated Balance Sheets
(In thousands)
September 30, December 31,
2002 2001
----------------- ----------------
(unaudited)
Currents assets:
Cash and cash equivalents $ 21,756 $ 144,350
Restricted cash 8,223 9,987
Accounts receivable, net
Trade 20,266 34,727
Other 8,483 18,153
Deferred subscriber acquisition costs, net 17,152 15,194
Prepaid expenses 14,747 12,686
Other current assets 7,880 17,534
----------------- ----------------
Total current assets 98,507 252,631
Property and equipment, net 79,562 90,861
Intangible assets, net 1,596,702 1,692,817
Other noncurrent assets 121,382 112,727
----------------- ----------------
Total $ 1,896,153 $ 2,149,036
================= ================
Current liabilities:
Current portion of long term debt $ 5,781 $ 8,728
Accounts payable 13,046 10,537
Accrued interest 24,886 27,979
Accrued programming fees 57,316 67,225
Accrued commissions and subsidies 42,831 45,746
Other accrued expenses 31,888 30,279
Other current liabilities 4,031 4,755
----------------- ----------------
Total current liabilities 179,779 195,249
Long term debt 1,272,748 1,329,923
Note payable to parent 77,189 -
Other noncurrent liabilities 46,257 79,530
----------------- ----------------
Total liabilities 1,575,973 1,604,702
----------------- ----------------
Commitments and contingent liabilities (see Note 14)
Minority interest 2,007 1,315
Redeemable preferred stock 201,168 183,503
Common stockholder's equity:
Common stock - -
Other common stockholder's equity 117,005 359,516
----------------- ----------------
Total common stockholder's equity 117,005 359,516
----------------- ----------------
Total $ 1,896,153 $ 2,149,036
================= ================
See accompanying notes to consolidated financial statements
4
Pegasus Satellite Communications, Inc.
Consolidated Statements of Operations and Comprehensive Loss
(In thousands)
Three Months Ended September 30,
2002 2001
------------- --------------
(unaudited)
Net revenues:
DBS $ 216,363 $ 206,795
Other businesses 9,390 8,079
----------- -----------
Total net revenues 225,753 214,874
----------- -----------
Operating expenses:
DBS
Programming 94,584 89,660
Other subscriber related expenses 51,547 50,344
----------- -----------
Direct operating expenses (excluding depreciation and
amortization shown below) 146,131 140,004
Promotions and incentives 5,933 7,601
Advertising and selling 7,877 24,281
General and administrative 6,216 8,683
Depreciation and amortization 42,968 63,671
----------- -----------
Total DBS 209,125 244,240
----------- -----------
Other businesses
Programming 3,703 3,374
Other direct operating expenses 1,475 2,021
----------- -----------
Direct operating expenses (excluding depreciation and
amortization shown below) 5,178 5,395
Advertising and selling 1,801 1,694
General and administrative 1,054 1,217
Depreciation and amortization 948 1,286
----------- -----------
Total other businesses 8,981 9,592
----------- -----------
Corporate and development expenses 3,307 4,015
Corporate depreciation and amortization 373 368
Other operating expenses, net 7,087 5,710
----------- -----------
Loss from operations (3,120) (49,051)
Interest expense (38,278) (32,589)
Interest income 130 470
Loss on impairment of marketable securities - (34,205)
Other nonoperating income (expense), net 940 (2,165)
----------- -----------
Loss before income taxes, discontinued operations, and
extraordinary item (40,328) (117,540)
Benefit for income taxes (5,845) (35,004)
----------- -----------
Loss before discontinued operations and extraordinary item (34,483) (82,536)
Discontinued operations:
Income (loss) on operations, net of income tax (expense) benefit of
$(356) and $1,986 582 (3,240)
----------- -----------
Loss before extraordinary item (33,901) (85,776)
Extraordinary net gain from extinguishments of debt, net of income tax
expense of $5,967 9,736 -
----------- -----------
Net loss (24,165) (85,776)
----------- -----------
Other comprehensive (loss) income:
Unrealized loss on marketable securities, net of income tax benefit of
$57 and $2,521, respectively (94) (4,113)
Reclassification adjustment for accumulated unrealized loss on
marketable securities included in net loss, net of income tax
benefit of $12,998 - 21,207
----------- -----------
Net other comprehensive (loss) income (94) 17,094
----------- -----------
Comprehensive loss $ (24,259) $ (68,682)
=========== ===========
See accompanying notes to consolidated financial statements
5
Pegasus Satellite Communications, Inc.
Consolidated Statements of Operations and Comprehensive Loss
(In thousands)
Nine Months Ended September 30,
2002 2001
------------- -------------
(unaudited)
Net revenues:
DBS $ 647,534 $ 618,648
Other businesses 25,743 25,525
----------- -----------
Total net revenues 673,277 644,173
----------- -----------
Operating expenses:
DBS
Programming 286,918 265,594
Other subscriber related expenses 152,374 151,087
----------- -----------
Direct operating expenses (excluding depreciation and
amortization shown below) 439,292 416,681
Promotions and incentives 9,703 36,909
Advertising and selling 23,998 93,715
General and administrative 20,998 26,937
Depreciation and amortization 123,905 189,675
----------- -----------
Total DBS 617,896 763,917
----------- -----------
Other businesses
Programming 9,996 9,569
Other direct operating expenses 4,947 5,637
----------- -----------
Direct operating expenses (excluding depreciation and
amortization shown below) 14,943 15,206
Advertising and selling 5,375 5,721
General and administrative 3,055 3,493
Depreciation and amortization 2,925 3,872
----------- -----------
Total other businesses 26,298 28,292
----------- -----------
Corporate and development expenses 11,078 11,244
Corporate depreciation and amortization 1,125 1,059
Other operating expenses, net 20,613 20,055
----------- -----------
Loss from operations (3,733) (180,394)
Interest expense (110,245) (101,796)
Interest income 435 4,523
Loss on impairment of marketable securities (3,063) (34,205)
Other nonoperating income (expense), net 2,179 (5,511)
----------- -----------
Loss before income taxes, discontinued operations, and
extraordinary item (114,427) (317,383)
Benefit for income taxes (34,013) (104,053)
----------- -----------
Loss before discontinued operations and extraordinary item (80,414) (213,330)
Discontinued operations:
Loss on operations, net of income tax benefit of $1,514 and
$5,270, respectively (2,467) (8,598)
----------- -----------
Loss before extraordinary item (82,881) (221,928)
Extraordinary net gain (loss) from extinguishments of debt, net of
income tax (expense) benefit of $(5,967) and $604, respectively 9,736 (986)
----------- -----------
Net loss (73,145) (222,914)
----------- -----------
Other comprehensive (loss) income:
Unrealized loss on marketable securities, net of income tax benefit
of $1,837 and $5,658, respectively (2,998) (9,231)
Reclassification adjustment for accumulated unrealized loss on
marketable securities included in net loss, net of income tax
benefit of $1,164 and $12,998, respectively 1,899 21,207
----------- -----------
Net other comprehensive (loss) income (1,099) 11,976
----------- -----------
Comprehensive loss $ (74,244) $ (210,938)
=========== ===========
See accompanying notes to consolidated financial statements
6
Pegasus Satellite Communications, Inc.
Condensed Consolidated Statements of Cash Flows
(In thousands)
Nine Months Ended September 30,
2002 2001
------------------ ------------------
(unaudited)
Net cash provided by (used for) operating activities $ 22,234 $ (122,127)
------------------ ------------------
Cash flows from investing activities:
DBS equipment capitalized (20,149) (9,620)
Other capital expenditures (3,102) (17,363)
Purchases of intangible assets - (11,056)
Other (1,041) (889)
------------------ ------------------
Net cash used for investing activities (24,292) (38,928)
------------------ ------------------
Cash flows from financing activities:
Borrowings on term loan facility 63,156 -
Repayments of term loan facility (2,220) (37,062)
Proceeds from short term debt - 61,000
Net repayments of revolving credit facilities (80,000) -
Repayments of other long term debt (5,852) (7,077)
Purchases of outstanding notes (24,974) -
Proceeds from note payable to parent 113,732 -
Repayments of note payable to parent (36,543) -
Restricted cash, net of cash acquired 1,614 (14,900)
Debt financing costs (629) (4,491)
Distributions to parent (148,804) -
Other (16) 187
------------------ ------------------
Net cash used for financing activities (120,536) (2,343)
------------------ ------------------
Net decrease in cash and cash equivalents (122,594) (163,398)
Cash and cash equivalents, beginning of year 144,350 214,361
------------------ ------------------
Cash and cash equivalents, end of period $ 21,756 $ 50,963
================== ==================
See accompanying notes to consolidated financial statements
7
PEGASUS SATELLITE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. General
"We," "us," and "our" refer to Pegasus Satellite Communications, Inc.
together with its subsidiaries. "PSC" refers to Pegasus Satellite
Communications, Inc. individually as a separate entity. "PCC" refers to Pegasus
Communications Corporation, the parent company of PSC. "PM&C" refers to Pegasus
Media & Communications, Inc., a subsidiary of PSC. "DBS" refers to direct
broadcast satellite. Other terms used are defined as needed where they first
appear.
Significant Risks and Uncertainties
We are highly leveraged. At September 30, 2002, we had a combined
carrying amount of debt and redeemable preferred stock outstanding of $1.6
billion, including a note payable to PCC of $77.2 million. Because we are highly
leveraged, we are more vulnerable to adverse economic and industry conditions.
We dedicate a substantial portion of cash to pay amounts associated with debt.
In the first nine months of 2002, we paid interest of $93.4 million. We were
scheduled to begin paying cash dividends on PSC's 12-3/4% series preferred stock
in July 2002. However, we did not declare the scheduled semiannual dividend
payable July 1, 2002 for this series (see note 5). We have also used cash for
distributions to PCC and to purchase our debt and the common stock of PCC. PCC
has purchased a large amount of our preferred stock as well. See notes 5, 6, 7,
and 16 respectively, for a discussion of these transactions.
Using cash for the above noted payments reduces the availability of
funds to us for working capital, capital expenditures, and other activities, and
limits our flexibility in planning for, or reacting to, changes in our business
and the industries in which we operate, although we have reduced the amount of
cash paid and payable to nonaffiliates in connection with our debt repurchases
and our preferred stock purchased by PCC. Our ability to make payments on and to
refinance indebtedness and redeemable preferred stock outstanding and to fund
operations, planned capital expenditures, and other activities depends on our
ability to generate cash in the future. Our ability to generate cash depends on
the success of our business strategy, prevailing economic conditions, regulatory
risks, competitive activities by other parties, equipment strategies,
technological developments, level of programming costs, levels of interest
rates, and financial, business, and other factors that are beyond our control.
We cannot assure that our business will generate sufficient cash flow from
operations or that alternative financing will be available to us in amounts
sufficient to fund the needs previously specified. Our indebtedness and
preferred stock contain numerous covenants that, among other things, generally
limit the ability to incur additional indebtedness and liens, issue other
securities, make certain payments and investments, pay dividends, transfer cash,
dispose of assets, and enter into other transactions, and impose limitations on
the activities of our subsidiaries. Failure to make debt payments or comply with
covenants could result in an event of default that, if not cured or waived,
could have a material adverse effect on us.
We are involved in significant litigation. See note 14 for further
information.
2. Basis of Presentation
The unaudited financial statements herein include the accounts of PSC
and all of its subsidiaries on a consolidated basis. All intercompany
transactions and balances have been eliminated. The balance sheets and
statements of cash flows are presented on a condensed basis. These financial
statements are prepared in accordance with the instructions to Form 10-Q and
Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. The financial statements reflect all
adjustments consisting of normal recurring items that, in our opinion, are
necessary for a fair presentation, in all material respects, of our financial
position and the results of our operations and comprehensive loss and our cash
flows for the interim period. The interim results of operations contained herein
may not necessarily be indicative of the results of operations for the full
fiscal year. Prior year amounts have been reclassified where appropriate to
conform to the current year classification for comparative purposes.
8
PEGASUS SATELLITE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
3. Adoption of FAS 141
On January 1, 2002, we adopted in its entirety Statement of Financial
Accounting Standards No. 141 "Business Combinations." FAS 141, as well as FAS
142 discussed below, makes a distinction between intangible assets that are
goodwill and intangible assets that are other than goodwill. When we use the
term "intangible asset or assets," we mean it to be an intangible asset or
assets other than goodwill, and when we use the term "goodwill," we mean it to
be separate from intangible assets. The principal impact to us of adopting FAS
141 was the requirement to reassess at January 1, 2002 the classification on our
balance sheet of the carrying amounts of our goodwill and intangible assets
recorded in acquisitions we made before July 1, 2001. The adoption of FAS 141
did not have a significant impact on our financial position.
4. Adoption of FAS 142
In the first quarter 2002, effective on January 1, 2002, we adopted in
its entirety Statement of Financial Accounting Standards No. 142 "Goodwill and
Other Intangible Assets." A principal provision of the standard is that goodwill
and intangible assets that have indefinite lives are not subject to
amortization, but are subject to an impairment test at least annually. The
principal impacts to us of adopting FAS 142 were: 1) reassessing on January 1,
2002 the useful lives of intangible assets existing on that date that we had
recorded in acquisitions we made before July 1, 2001 and adjusting remaining
amortization periods as appropriate; 2) ceasing amortization of goodwill and
intangible assets with indefinite lives effective January 1, 2002; 3)
establishing reporting units as needed for the purpose of testing goodwill for
impairment; 4) testing on January 1, 2002 goodwill and intangible assets with
indefinite lives existing on that date for impairment; and 5) separating
goodwill from intangible assets. The provisions of this standard were not
permitted to be retroactively applied to periods before the date we adopted FAS
142.
We believe that the estimated remaining useful lives of our DBS rights
assets should be based on the estimated useful lives of the satellites at the
1010 west longitude orbital location available to provide DirecTV services under
the NRTC-DirecTV contract. The contract sets forth the terms and conditions
under which the lives of those satellites are deemed to expire, based on fuel
levels and transponder functionality. We estimate that the useful life of the
DirecTV satellite resources provided under the contract (without regard to
renewal rights) expires in November 2016. Because the cash flows for all of our
DBS rights assets emanate from the same source, we believe that it is
appropriate for all of the estimated useful lives of our DBS rights assets to
end at the same time. Prior to the adoption of FAS 142, our DBS rights assets
had estimated useful lives of 10 years from the date we obtained the rights.
Linking the lives of our DBS rights assets in such fashion extended the
amortization period for the unamortized carrying amount of the assets to
remaining lives of approximately 15 years from January 1, 2002. The lives of our
DBS rights are subject to litigation. See note 14 for information regarding this
litigation.
We determined that our broadcast licenses had indefinite lives because
under past and existing Federal Communications Commission's regulations the
licenses can be routinely renewed indefinitely with little cost. Ceasing
amortization on goodwill and broadcast licenses had no material effect on our
results of operations. The adoption of FAS 142 did not have a significant effect
on our other intangible assets other than those discussed above. Our industry
segments already established equate to the reporting units required under the
standard. We determined that there were no impairments to be recorded upon the
adoption of FAS 142.
9
PEGASUS SATELLITE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
At September 30, 2002 and December 31, 2001, intangible assets, net
consisted of the following (in thousands):
September 30, December 31,
2002 2001
--------------- ---------------
Assets subject to amortization:
Cost:
DBS rights assets $ 2,289,068 $ 2,259,231
Other 48,179 110,415
------------ ------------
2,337,247 2,369,646
------------ ------------
Accumulated amortization:
DBS rights assets 724,787 624,115
Other 30,982 52,714
------------ ------------
755,769 676,829
------------ ------------
Net assets subject to amortization 1,581,478 1,692,817
Assets not subject to amortization:
Broadcast licenses 15,224 -
------------ ------------
Intangible assets, net $ 1,596,702 $ 1,692,817
============ ============
At September 30, 2002 and December 31, 2001, total goodwill had a
carrying amount of $15.8 million and was entirely associated with our broadcast
operations. Because the carrying amount of goodwill is not significant, it is
included in other noncurrent assets on the balance sheet.
Loss before extraordinary items and net loss, each as adjusted for the
effects of applying FAS 142, for the three and nine months ended September 30,
2001 were as follows (in thousands):
For the three months ended:
Net loss, as adjusted $ (67,604)
For the nine months ended:
Loss before extraordinary items, as adjusted (169,692)
Net loss, as adjusted (170,678)
A reconciliation of net loss, as reported to net loss, as adjusted for
the three and nine months ended September 30, 2001 is as follows (in thousands):
For the three months ended:
Net loss, as reported $ (85,776)
Add back goodwill amortization 109
Add back amortization on broadcast licenses 81
Adjust amortization for a change in the useful life of DBS
rights assets 17,982
------------
Net loss, as adjusted $ (67,604)
============
For the nine months ended:
Net loss, as reported $ (222,914)
Add back goodwill amortization 313
Add back amortization on broadcast licenses 287
Adjust amortization for a change in the useful life of DBS
rights assets 51,636
------------
Net loss, as adjusted $ (170,678)
============
10
PEGASUS SATELLITE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Aggregate amortization expense for the nine months ended September 30,
2002 and 2001 was $88.4 million and $183.6 million, respectively. Aggregate
amortization expense for 2001 was $245.4 million. The estimated aggregate amount
of amortization expense for the remainder of 2002 and for each of the next five
years thereafter is $29.0 million, $115.9 million, $115.9 million, $113.9
million, $111.2 million, and $110.5 million, respectively.
5. Redeemable Preferred Stock
The number of shares of PSC's 12-3/4% cumulative exchangeable preferred
stock issued and outstanding was 183,978 and 172,952 at September 30, 2002 and
December 31, 2001, respectively. The increase in the number of shares resulted
from the $11.0 million semiannual dividend paid in January 2002 in like kind
shares. The increase in the carrying amount from December 31, 2001 to September
30, 2002 was due to accrued dividends and accretion of discount on the series.
Of the amount outstanding for this series at September 30, 2002, PCC owns shares
that have a carrying amount of $108.5 million, including accrued dividends of
$9.5 million (see Note 16).
At the discretion of our board of directors as permitted by the
certificate of designation for the 12-3/4% series, we did not declare the
scheduled semiannual dividend payable July 1, 2002 for this series. The amount
of the dividend scheduled to be declared was $11.7 million payable in cash.
Dividends not declared or paid accumulate in arrears and incur interest at a
rate of 14.75% per year until later declared and paid. Unless full cumulative
dividends in arrears on the 12-3/4% series have been paid or set aside for
payment, PSC may not, with certain exceptions, 1) declare, pay, or set aside
amounts for payment of future cash dividends or distributions, or 2) purchase,
redeem, or otherwise acquire for value any shares of its capital stock junior to
the 12-3/4% series. The amount of interest accrued and unpaid through September
30, 2002 on dividends in arrears was $432 thousand. Of the amounts of dividends
in arrears and interest thereon, amounts payable to PCC were $6.3 million and
$233 thousand. Despite the restrictions placed on PSC regarding cash dividend
payments discussed in the preceding paragraph, permissible means are available
to transfer funds to PCC while dividends on PSC's preferred stock are in
arrears.
6. Changes in Other Stockholder's Equity
The change in other stockholder's equity from December 31, 2001 to
September 30, 2002 consisted of (in thousands):
Net loss $ (73,145)
Dividends accrued and accretion associated with preferred
stock (17,664)
Net cash and noncash distributions to PCC (150,603)
Net change in accumulated other comprehensive loss (1,099)
In late June 2002, PSC distributed $122.4 million in cash to PCC in
anticipation of the dividends on PSC's preferred stock going into arrears on
July 1, 2002, of which $113.7 million was loaned back to PSC (see note 7).
7. Long Term Debt
During the three months ended September 30, 2002, amounts borrowed by
PM&C under its revolving credit facility during the period were repaid during
the period. No principal amount was outstanding under the revolving credit
facility at September 30, 2002, compared to $80.0 million outstanding at
December 31, 2001. Letters of credit outstanding under the revolving credit
facility, which reduce the availability thereunder, were $60.1 million at
September 30, 2002 and $63.2 million at December 31, 2001. At September 30,
2002, the commitment for the revolving credit facility was permanently reduced
by $8.4 million to $177.2 million as scheduled. The commitment for the revolving
credit facility is scheduled to be permanently reduced by another $8.4 million
in December 2002. Availability under the revolving credit facility at September
30, 2002 was $116.9 million.
PM&C repaid $688 thousand of principal under PM&C's term loan facility
during the third quarter 2002, as scheduled, thereby reducing the total
principal amount outstanding thereunder to $270.2 million. The weighted average
variable rate of interest including applicable margins on principal amounts
outstanding under the term facility was 5.3% and 5.4% at September 30, 2002 and
December 31, 2001, respectively.
11
PEGASUS SATELLITE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
In June 2002, PM&C borrowed $63.2 million in incremental term loans
under its credit agreement. Principal amounts outstanding under the incremental
term loan facility are payable quarterly in increasing increments over the
remaining term of the facility that began September 30, 2002. All unpaid
principal and interest outstanding under the incremental term loans are due July
31, 2005. Amounts repaid under the incremental term loan facility may not be
reborrowed. Margins on incremental term loans are 2.5% for base rates and 3.5%
for LIBOR rates. Interest on outstanding principal borrowed under base rates is
due and payable quarterly and interest on outstanding principal borrowed under
LIBOR rates is due and payable the earlier of the end of the contracted interest
rate period or three months. We repaid $158 thousand of principal during the
third quarter as scheduled, thereby reducing the total principal amount
outstanding thereunder to $63.0 million. We are scheduled to pay another $158
thousand of principal in December 2002. Total annual repayments of principal
scheduled over the remaining term of the facility are $632 thousand in 2003,
$16.3 million in 2004, and $45.9 million in 2005. The weighted average rate of
interest including applicable margins on principal amounts outstanding under the
incremental loan term facility at September 30, 2002 was 5.3%. There is no
availability under the incremental term loan facility.
In connection with the incremental term loan borrowed in June 2002,
PM&C entered into two additional interest rate cap agreements with the same
financial institution in August 2002. Each cap has a notional amount of $15.8
million. The cap rate under one agreement is 9.00% and the cap rate under the
other is 4.00%. Both caps terminate September 2005. Payment under each cap is
determined quarterly based on the three month LIBOR rate in effect at the
beginning of each three month resetting period. Under these caps, we receive
interest from the contracting institution when the applicable market LIBOR rate
exceeds the applicable cap rate at each resetting date. The premium we paid to
enter into these agreements was not significant.
In June 2002, PSC borrowed $113.7 million cash from PCC in the form of
a promissory note. The cash lent by PCC was connected to the $122.4 million cash
previously distributed by PSC to PCC in June 2002 (see note 6). All amounts
outstanding under the promissory note are due June 30, 2005. The interest rate
on the note will be based on the interest rate with margins incurred by PM&C on
its term loan facility, plus an additional 1%. Interest is payable quarterly.
Principal of the note may be repaid in whole or in part at any time without
penalty. In the third quarter 2002, PSC repaid $36.5 million of principal on the
note, leaving a principal balance on the note of $77.2 million at September 30,
2002. The weighted average interest rate on the note during the third quarter
2002 and at September 30, 2002 was 6.375%.
In July 2002, PSC purchased $17.1 million in maturity value of PM&C's
12-1/2% senior subordinated notes due July 2005 for $17.1 million in a
negotiated transaction with an unaffiliated holder. The carrying amount of the
notes at the date of purchase was $16.7 million, net of associated unamortized
discount and deferred financing fees. The notes were not cancelled but were
considered to be constructively retired for PSC's consolidated financial
statements. As a result, a loss of $262 thousand, net of income taxes of $160
thousand, was recognized and included in extraordinary net gain from
extinguishments of debt on the statement of operations and comprehensive loss.
In August 2002, PSC purchased $30.1 million in maturity value of its
13-1/2% senior subordinated discount notes due March 2007 for $7.9 million in
negotiated transactions with unaffiliated holders. The aggregate carrying amount
of the notes at their dates of purchase was $24.0 million, net of associated
unamortized discount and deferred financing fees. As a result, a gain of $10.0
million, net of income taxes of $6.1 million, was recognized and included in
extraordinary net gain from extinguishments of debt on the statement of
operations and comprehensive loss.
12
PEGASUS SATELLITE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
8. Supplemental Cash Flow Information
Significant noncash investing and financing activities were as follows
(in thousands):
Nine Months
Ended September 30,
2002 2001
-------------- --------------
Preferred stock dividends accrued and accretion on preferred stock $ 17,664 $ 16,175
Payment of 12-3/4% series preferred stock dividends in like kind shares 11,026 20,109
Payment of other preferred stock dividends with common stock - 6,072
NRTC patronage capital investment accrued 13,780 14,434
Net change in other comprehensive loss 1,099 11,976
Proceeds of debt borrowing withheld as collateral - 14,000
Transfer of investment in affiliates and reduction of additional paid in
capital resulting from the corporate reorganization - 209,639
Reduction of preferred stock and increase in additional paid in capital
resulting from the corporate reorganization - 328,715
9. Loss on Impairment of Marketable Securities
Based on the significance and duration of the loss in fair value, at
June 30, 2002, we determined that our sole investment in marketable securities
held had incurred an other than temporary decline in fair market value.
Accordingly, we wrote down the cost basis in the marketable securities to their
fair market value at June 30, 2002 and charged earnings in the amount of $3.1
million. The income tax benefit recorded in income taxes for continuing
operations associated with this charge was $1.2 million. Concurrently, we made a
reclassification adjustment to other comprehensive loss and other stockholder's
equity at June 30, 2002 amounting to $1.9 million, net of income tax benefit of
$1.2 million, to remove all of the net unrealized losses on the marketable
securities accumulated at that date that had been charged to earnings. The
remaining balance of this investment is not significant at September 30, 2002.
10. Income Taxes
At September 30, 2002, we recorded a valuation allowance of $8.8
million against the net deferred income tax asset balance existing at September
30, 2002 because we believe at the present time that it is more likely than not
that the benefits of this net tax asset balance will not be realized. We charged
income taxes on the loss from continuing operations in the third quarter 2002 in
the amount of the valuation allowance. This valuation allowance lowered our
effective income tax rate on continuing operations to 14.5% and 29.7% for the
three and nine months ended September 30, 2002, respectively.
11. Discontinued Operations
We have entered into a definitive agreement to sell our Mobile, Alabama
broadcast television station to an unaffiliated party for $11.5 million in cash.
The sale is contingent upon conditions typical of sales of this nature,
including final approval by the Federal Communications Commission of the
transfer of the station's broadcast license to the buyer. It is anticipated that
the sale will occur in the first quarter of 2003. We have classified the
operations of this station as discontinued for all periods presented.
In August 2002, we completed the transfer of the subscribers and
equipment inventory for our Pegasus Express two way satellite internet access
business that were sold to an unaffiliated party. We anticipate that the cash
proceeds from the sale of the subscribers will be about $1.5 million. The
ultimate proceeds will be based on the number of the transferred subscribers
that ultimately are authorized into the buyer's service no later than February
2003. Our estimate of the ultimate proceeds factor in an estimate for
subscribers that may not be authorized into the buyer's service. We sold the
equipment for $2.6 million cash. With the sale of the subscribers and equipment,
we no longer operate the Pegasus Express business and, accordingly, have
classified this business as discontinued for all periods presented.
13
PEGASUS SATELLITE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Aggregate revenues and pretax loss of discontinued operations were as
follows (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
2002 2001 2002 2001
---------- --------- ----------- ----------
Revenues $ 755 $ 641 $ 3,419 $ 808
Pretax income (loss) 938 (5,226) (3,981) (13,868)
Included in the pretax amount for the three and nine months ended 2002
is a gain of $1.5 million for the Pegasus Express subscribers sold and within
the nine months 2002 a loss of $837 thousand on the Pegasus Express equipment
inventory sold. Also included in discontinued operations for the nine months
2002 is an aggregate loss of $847 thousand for other assets associated with the
Pegasus Express business that were written off because they had no use outside
of the business. Assets and liabilities associated with the broadcast station
are not significant to our financial position and are not shown separately on
the balance sheet, and there were no assets held subject to sale or related
liabilities for the Pegasus Express business at September 30, 2002.
12. Impairment of Programming Rights
In the third quarter 2002, we recognized an impairment loss of $1.4
million associated with programming rights of our broadcast operations. This
loss is contained within other operating expenses on the statements of
operations. The fair value of the affected programming rights and the impairment
and amount of the loss were based upon the present value of the expected cash
flows associated with the related programming agreements that provide the
rights.
13. Industry Segments
Our only reportable segment at September 30, 2002 was the DBS business.
Information on DBS' revenue and measure of profit/loss and how these contribute
to our consolidated loss from continuing operations before income taxes for each
period reported is as presented on the statements of operations and
comprehensive loss. DBS derived all of its revenues from external customers for
each period presented. Identifiable total assets for DBS were approximately $1.8
billion at September 30, 2002, which did not change significantly from the total
DBS assets at December 31, 2001.
14. Commitments and Contingent Liabilities
Legal Matters
DIRECTV Litigation:
National Rural Telecommunications Cooperative
Our subsidiaries, Pegasus Satellite Television ("PST") and Golden Sky
Systems ("GSS"), are affiliates of the National Rural Telecommunications
Cooperative ("NRTC") that participate through agreements in the NRTC's direct
broadcast satellite program. "DIRECTV" refers to the programming services
provided by DirecTV, Inc. ("DirecTV").
On June 3, 1999, the NRTC filed a lawsuit in United States District
Court, Central District of California against DirecTV seeking a court order to
enforce the NRTC's contractual rights to obtain from DirecTV certain premium
programming formerly distributed by United States Satellite Broadcasting
Company, Inc. for exclusive distribution by the NRTC's members and affiliates in
their rural markets. On July 22, 1999, DirecTV filed a counterclaim seeking
judicial clarification of certain provisions of DirecTV's contract with the
NRTC. As part of the counterclaim, DirecTV is seeking a declaratory judgment
that the term of the NRTC's agreement with DirecTV is measured only by the
orbital life of DBS-1, the first DIRECTV satellite launched, and not by the
orbital lives of the other DIRECTV satellites at the 101(degree)W orbital
location. While the NRTC has a right of first refusal to receive certain
services from any successor DIRECTV satellite, the scope and terms of this right
of first refusal are also being disputed in the litigation, as discussed below.
If DirecTV were to prevail on its counterclaim, any failure of DBS-1 could have
a material adverse effect on our DIRECTV rights. On August 26, 1999, the NRTC
filed a separate lawsuit in federal court against DirecTV claiming that DirecTV
had failed to provide to the NRTC its share of launch fees and other benefits
that DirecTV and its affiliates have received relating to programming and other
services. On November 15, 1999, the court granted a motion by DirecTV and
dismissed the portion of this lawsuit asserting tort claims, but left in place
the remaining claims asserted by the NRTC. The NRTC and DirecTV have also filed
indemnity claims against one another that pertain to the alleged obligation, if
any, of the NRTC to indemnify DirecTV for costs incurred in various lawsuits
described herein. These claims have been severed from the other claims in the
case and will be tried separately.
14
PEGASUS SATELLITE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
On July 3, 2002, the court granted a motion for summary judgment filed
by DirecTV, holding that NRTC is liable to indemnify DirecTV for the costs of
defense and liabilities that DirecTV incurs in a patent case filed by Pegasus
Development Corporation ("Pegasus Development"), a subsidiary of PCC, and
Personalized Media Communications, L.L.C. ("Personalized Media") in December
2000 in the United States District Court, District of Delaware against DirecTV,
Hughes Electronics Corporation, Thomson Consumer Electronics and Philips
Electronics North America Corporation. Personalized Media is a company in which
Pegasus Development has an investment in and licensing arrangement with. Pegasus
Development and Personalized Media are seeking injunctive relief and monetary
damages for the defendants' alleged patent infringement and unauthorized
manufacture, use, sale, offer to sell and importation of products, services, and
systems that fall within the scope of Personalized Media's portfolio of patented
media and communications technologies, of which Pegasus Development is an
exclusive licensee within a field of use. The technologies covered by Pegasus
Development's exclusive license include services distributed to consumers using
certain Ku band BSS frequencies and Ka band frequencies, including frequencies
licensed to affiliates of Hughes Electronics and used by DirecTV to provide
services to its subscribers.
Pegasus Satellite Television and Golden Sky Systems
On January 10, 2000, PST and GSS filed a class action lawsuit in
federal court in Los Angeles against DirecTV as representatives of a proposed
class that would include all members and affiliates of the NRTC that are
distributors of DIRECTV. The complaint contained causes of action for various
torts, common counts and declaratory relief based on DirecTV's failure to
provide the NRTC with certain premium programming, and on DirecTV's position
with respect to launch fees and other benefits, term and right of first refusal.
The complaint sought monetary damages and a court order regarding the rights of
the NRTC and its members and affiliates. On February 10, 2000, PST and GSS filed
an amended complaint which added new tort claims against DirecTV for
interference with PST's and GSS' relationships with manufacturers, distributors
and dealers of direct broadcast satellite equipment. The class action
allegations PST and GSS previously filed were withdrawn to allow a new class
action to be filed on behalf of the members and affiliates of the NRTC. The new
class action was filed on February 29, 2000. The court certified the plaintiff's
class on December 28, 2000. On March 9, 2001, DirecTV filed a counterclaim
against PST and GSS, as well as the class members. In the counterclaim, DirecTV
seeks two claims for relief: (i) a declaratory judgment that PST and GSS have no
right of first refusal in their agreements with the NRTC to have DirecTV provide
any services after the expiration of the term of these agreements, and (ii) an
order that DBS-1 is the satellite (and the only satellite) that measures the
term of PST's and GSS' agreements with the NRTC.
On June 22, 2001, DirecTV brought suit against PST and GSS in Los
Angeles County Superior Court for breach of contract and common counts. The
lawsuit pertains to the seamless marketing agreement dated August 9, 2000, as
amended, between DirecTV and PST and GSS. On July 13, 2001, PST and GSS
terminated the seamless marketing agreement. On July 16, 2001, PST and GSS filed
a cross complaint against DirecTV alleging, among other things, that (i) DirecTV
has breached the seamless marketing agreement, and (ii) DirecTV has engaged in
unlawful and/or unfair business practices, as defined in Section 17200, et seq.
of California Business and Professions Code. This suit has since been moved to
the United States District Court, Central District of California. On September
16, 2002, PST and GSS filed first amended counterclaims against DirecTV. Among
other things, the first amended counterclaims added claims for (i) rescission of
the seamless marketing agreement on the ground of fraudulent inducement, (ii)
specific performance of audit rights, and (iii) punitive damages on the breach
of the implied covenant of good faith claim. In addition, the first amended
counterclaims deleted the business and professions code claim and the claims for
tortuous interference that were alleged in the initial cross complaint. On
November 5, 2002 the court granted DirecTV's motion to dismiss (i) the specific
performance claim, and (ii) the punitive damages allegations on the breach of
the implied covenant of good faith claim. The court denied DirecTV's motion to
dismiss the implied covenant of good faith claim in its entirety.
DirecTV filed four summary judgment motions on September 11, 2002
against NRTC, the class members, and PST and GSS on a variety of issues in the
case. The motions cover a broad range of claims in the case, including (i) the
term of the agreement between NRTC and DirecTV, (ii) the right of first refusal
as it relates to PST and GSS, (iii) the right to distribute the premiums, and
(iv) damages relating to the premiums, launch fees and advanced services claims.
The court has set a hearing date of December 16, 2002 for the summary judgment
motions.
Both of the NRTC's lawsuits against DirecTV have been consolidated for
discovery and pretrial purposes. All five lawsuits discussed above, including
both lawsuits brought by the NRTC, the class action, and PST's and GSS' lawsuit,
are pending before the same judge. The court has set a trial date of April 1,
2003, although, as noted above, it is not clear whether all the lawsuits will be
tried together.
15
PEGASUS SATELLITE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Patent Infringement Litigation:
In December 2001, we (along with DirectTV, Inc., Hughes Electronics
Corporation, EchoStar Communications Corporation, and others) were served with a
complaint in a patent infringement lawsuit by Broadcast Innovations, L.L.C.
("Broadcast Innovations"). The precise nature of the plaintiff's claims is not
clear from the complaint. However, the plaintiff claims in response to
interrogatories that the satellite broadcast systems and equipment of
defendants, including those used for DIRECTV programming services, infringe its
patent. The defendants named in the complaint have denied the allegation and
have raised defenses of patent invalidity and noninfringement. In October 2002,
we entered into a settlement agreement with Broadcast Innovations pursuant to
which all claims and counterclaims between us and Broadcast Innovations were
dismissed with prejudice.
Other Legal Matters:
In addition to the matters discussed above, from time to time we are
involved with claims that arise in the normal course of our business. In our
opinion, the ultimate liability, if any, with respect to these claims will not
have a material adverse effect on our operations, cash flows, or financial
position.
Commitments
We negotiated a new agreement with our provider of communication
services commencing in the first quarter 2002. Under this new agreement, our
annual minimum commitment was reduced to $6.0 million over the three year term
of the agreement, from $7.0 million under the prior agreement.
In July 2002, we gave notice to terminate a contract for call center
services provided to us that will terminate at the end of 12 months from the
date of notice. We will pay a termination fee of $4.5 million at the agreement
termination date. We accrued a liability for this fee in the third quarter 2002
and charged DBS' other subscriber related expenses on the statement of
operations and comprehensive loss for this amount.
15. New Accounting Pronouncements
Statement of Financial Accounting Standards No. 143 "Accounting for
Asset Retirement Obligations" addresses financial accounting and reporting for
obligations associated with the retirement of tangible long lived assets and the
associated asset retirement costs. FAS 143 becomes effective for us on January
1, 2003. Entities are required to recognize the fair values of liabilities for
asset retirement obligations in the period in which the liabilities are
incurred. Liabilities recognized are to be added to the cost of the asset to
which they relate. Legal liabilities that exist on the date of adoption of FAS
143 are to be recognized on that date. We continue to study our long lived
assets to determine if any legal liabilities are connected with them that need
to be recognized upon the adoption of this statement.
16
PEGASUS SATELLITE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Statement of Financial Accounting Standards No. 145 "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections" becomes effective for us on January 1, 2003. A principal provision
of FAS 145 is the reporting in the statement of operations of gains and losses
associated with extinguishments of debt. FAS 145 rescinds the present required
classification of extinguishments of debt as extraordinary. Instead, FAS 145
states that extinguishments of debt be considered for extraordinary treatment in
light of already established criteria used to determine whether events are
extraordinary. For an event to be extraordinary, the established criteria are
that it must be both unusual and infrequent. Once FAS 145 becomes effective, all
debt extinguishments classified as extraordinary in the statement of operations
issued prior to the effective date of FAS 145 that do not satisfy the criteria
for extraordinary treatment may not be reported as extraordinary in statements
of operations issued after that date. We have extinguished debt a number of
times in the past, and may do so in the future. Regarding our debt
extinguishments occurring prior to January 1, 2003 that are properly reported as
extraordinary under accounting standards in effect until that time, we expect
that they will not be events that qualify for extraordinary treatment after that
date. As a result, we believe that our extinguishments of debt reported as
extraordinary prior to January 1, 2003 will not be reported as extraordinary
after that date. Rather, these extinguishments will be reported as a component
of nonoperating gains and losses within continuing operations in the statement
of operations. We believe that extinguishments of debt occurring after that date
will be classified similarly. We do not expect such a change in classification
to have any effect on our operations, cash flows, financial position, or
covenants related to our existing credit agreement and note indentures.
Statement of Financial Accounting Standards No. 146 "Accounting for
Costs Associated with Exit or Disposal Activities" becomes effective for us on
January 1, 2003. FAS 146 requires companies to recognize costs associated with
exit or disposal activities, costs to terminate contracts that are not capital
leases, and costs to consolidate facilities or relocate employees when they are
incurred rather than at the date of a commitment to engage in these activities
as permitted under existing accounting standards. FAS 146 is to be applied
prospectively to the activities covered by the statement that are initiated
after December 31, 2002. We will apply the requirements of FAS 146 after its
effective date when we engage in any of the covered activities.
16. Additional Related Party Transactions
From May 2002 through August 2002 PCC, purchased in a series of
negotiated transactions with unaffiliated holders an aggregate 99,041 shares of
PSC's preferred stock for $17.1 million. The aggregate liquidation preference
value of these shares at September 30, 2002 was $108.5 million, including
dividends accrued and in arrears through that date of $9.5 million. These shares
remain legally outstanding for PSC. PCC's current plans are to hold onto all of
the shares purchased.
Commencing in July 2002 and through September 30, 2002, PSC purchased
an aggregate of 1,125,200 shares of PCC's Class A common stock for
approximately $1.0 million, and recorded the purchases as an investment in PCC.
Since September 30, 2002, PSC has purchased an additional 251,700 shares in the
aggregate for $353 thousand million. PSC's current plans are to hold onto all of
the shares purchased.
PSC has an arrangement with W.W. Keen Butcher, certain entities
controlled by Mr. Butcher (the "KB Companies"), and the owner of a minority
interest in the KB Companies under which PSC agrees to provide and maintain cash
collateral for certain of the principal amount of bank loans loaned to these
individuals and entities. Mr. Butcher, the KB Companies, and the minority owner
are required to lend or contribute the proceeds of those bank loans to one or
more of the KB Companies in connection with the acquisition of television
broadcast licenses and the operation of television broadcast stations to be
programmed by us pursuant to local marketing and similar agreements. The maximum
amount of collateral to be provided and maintained under the arrangement was
increased from $8.0 million to $9.5 million in June 2002 in anticipation of the
KB Companies acquiring a 50% ownership interest from a third party with respect
to an entity which holds a television license and which the KB Companies already
held the other 50% ownership interest. W.W. Keen Butcher is the stepfather of
Marshall W. Pagon, chairman of the board of directors and chief executive
officer of PSC.
17
PEGASUS SATELLITE COMMUNICATIONS, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This report contains certain forward looking statements (as such term
is defined in the Private Securities Litigation Reform Act of 1995) and
information relating to us that are based on our beliefs, as well as assumptions
made by and information currently available to us. When used in this report, the
words "estimate," "project," "believe," "anticipate," "hope," "intend,"
"expect," and similar expressions are intended to identify forward looking
statements. Such statements reflect our current views with respect to future
events and are subject to unknown risks, uncertainties, and other factors that
may cause actual results to differ materially from those contemplated in such
forward looking statements. Such factors include, among other things, the
following: general economic and business conditions, both nationally,
internationally and in the regions in which we operate; catastrophic events,
including acts of terrorism; relationships with and events affecting other
parties like DirecTV, Inc. and the National Rural Telecommunications
Cooperative; litigation with DirecTV; the proposed merger of Hughes Electronics
Corporation with EchoStar Communications Corporation or the acquisition by a
third party of the DirecTV business and the related confusion in the
marketplace; demographic changes; existing government regulations and changes
in, or the failure to comply with government regulations; competition, including
the provision of local channels by a competing direct broadcast satellite
provider in markets where DirecTV does not offer local channels and deceptive
sales practices by agents of the competing direct broadcast satellite provider;
the loss of any significant numbers of subscribers or viewers; changes in
business strategy or development plans; the cost of pursuing new business
initiatives; an expansion of land based communications systems; technological
developments and difficulties; the ability to obtain intellectual property
licenses and to avoid committing intellectual property infringement; the ability
to attract and retain qualified personnel; our significant indebtedness; the
availability and terms of capital to fund the expansion of our businesses; and
other factors referenced in this report and in reports and registration
statements filed from time to time with the Securities and Exchange Commission,
including our Annual Report on Form 10-K for the fiscal year ended December 31,
2001. Readers are cautioned not to place undue reliance on these forward looking
statements, which speak only as of the date of this report. We do not undertake
any obligation to publicly release any revisions to these forward looking
statements to reflect events or circumstances after the date hereof or to
reflect the occurrence of unanticipated events.
The following discussion of our financial condition, results of
operations, and liquidity and capital resources should be read in conjunction
with the consolidated financial statements and related notes herein.
General
"We," "us," and "our" refer to Pegasus Satellite Communications, Inc.
together with its subsidiaries. "PSC" refers to Pegasus Satellite
Communications, Inc. individually as a separate entity. "PCC" refers to Pegasus
Communications Corporation, the parent company of PSC. "PM&C" refers to Pegasus
Media & Communications, Inc., a subsidiary of PSC. "DBS" refers to direct
broadcast satellite. Other terms used are defined as needed where they first
appear.
Approximately 96% of our consolidated revenues and 91% of the expenses
within consolidated loss from operations for the nine months ended September 30,
2002, and 94% of our assets at September 30, 2002 were associated with our DBS
business that provides multichannel DIRECTV(R) audio and video services as an
independent DIRECTV provider. DIRECTV is a service of DirectTV, Inc.
("DirecTV"). We may be adversely affected by any material adverse changes in the
assets, financial condition, programming, technological capabilities, or
services of DirecTV. Separately, we are involved in litigation with DirecTV. An
outcome in this litigation that is unfavorable to us could have a material
adverse effect on our DBS business. See Note 14 of the Notes to Consolidated
Financial Statements for information on the litigation.
Hughes Electronics Corporation, which is the parent company of DirecTV,
and EchoStar Communications Corporation, which owns the only other nationally
branded DBS programming service in the United States, have agreed to merge,
subject to regulatory approval. However, recently the Federal Communications
Commission declined to approve the merger and the Department of Justice along
with 23 states filed a lawsuit to block the merger. At this time, we are unable
to predict the effect of our litigation with DirecTV on our financial position,
results of operations, cash flows, and future operations. We also do not know at
this time whether EchoStar and Hughes will continue to seek regulatory approval
for their proposed merger or not, and the resulting impact thereof.
18
PEGASUS SATELLITE COMMUNICATIONS, INC.
Results of Operations
In this section, amounts and changes specified are for the three and
nine months ended September 30, 2002 compared to the corresponding periods of
2001, unless indicated otherwise. With respect to our income or loss from
operations, we focus on our DBS business, as this is our only significant
business.
DBS Business
Revenues:
Revenues increased $9.6 million to $216.4 million and $28.9 million to
$647.5 million for the three and nine months, respectively, primarily due to the
rate increase for our core packages that we instituted in the fourth quarter
2001 and, effective July 1, 2002, a royalty fee that passes on to subscribers a
portion of the royalty costs charged to us in providing DIRECTV service. Revenue
increases were partially offset by revenue decreases from a reduction in the
number of subscribers, a reduction in on demand viewing, and subscribers
downgrading to a less expensive mix of programming offered by us primarily, we
believe, as the result of the effect of general economic conditions on our
subscribers.
Direct Operating Expenses:
Programming expense increased $4.9 million to $94.6 million and $21.3
million to $286.9 million for the three and nine months, respectively, primarily
due to a broad rate increase commencing January 2002 and a targeted increase to
certain programming rates commencing August 2002 charged to us by the National
Rural Telecommunications Cooperative ("NRTC"), through which we receive our
DIRECTV programming. Also contributing to the increases was our lowered
expectations of the amount of patronage that we are to receive from the NRTC for
2002 compared to that received in 2001. Patronage from the NRTC reduces the
programming expense we incur. Increased costs incurred by the NRTC in 2002
combined with our loss of subscribers in 2002 (discussed below) have factored
into our lowered patronage expectations. The increases in programming expense
were offset in part by the loss of subscribers in 2002.
Other subscriber related expenses increased $1.2 million to $51.5
million and $1.3 million to $152.4 million for the three and nine months,
respectively, primarily due to a one time contract termination fee of $4.5
million, offset in part by a decrease in bad debt expense. We accrued a
liability in the third quarter 2002 for the termination fee connected with a
contract for call center services for which we gave notice of termination during
the quarter. The decrease in bad debt expense was mainly due to our focus in
2002 on improving the quality of the subscriber base that we obtain and retain
over the quality of the subscriber base that existed prior to 2002.
Operating Margins:
Our operating margin is the difference between net revenues and direct
operating expenses (excluding depreciation and amortization). Operating margins
for the three and nine months ended September 30, 2002 and 2001 were $70.2
million and $66.8 million, and $208.2 million and $202.0 million, respectively.
The operating margin ratio percent for the respective periods ended September
30, 2002 and 2001 was 32.5% and 32.3% for the three months and 32.2% and 32.6%
for the nine months. Excluding the one time contract termination fee of $4.5
million referred to above, the operating margin for the three and nine months
ended September 30, 2002 was $74.7 million and $212.7 million, respectively, and
the operating margin ratio for the three and nine months ended September 30,
2002 were 34.5% and 32.9%, respectively. The increase in the current quarter
operating margin ratio, as adjusted to exclude the contract termination fee,
reflects the revenue rate increase and royalty fee pass through discussed under
revenues above, and the decrease in bad debt expense discussed under direct
operating expenses above. The increase in the current quarter adjusted ratio had
an incremental effect in increasing the current nine month ratio, as adjusted to
exclude the contract termination fee.
19
PEGASUS SATELLITE COMMUNICATIONS, INC.
Other Operating Expenses:
Promotion and incentives and advertising and selling costs constitute
our expensed subscriber acquisition costs ("SAC"). Equipment and installation
subsidies and commissions form a substantial portion of promotions and
incentives and advertising and selling, respectively. Subsidies and commissions
are direct and incremental costs incurred with respect to our DIRECTV
subscription plans. We incur subsidies and commissions only when subscribers are
added. We are able to defer subsidies and commissions for plans that have
minimum service commitment periods and early termination fees, with amounts
deferred not to exceed the amount of the termination fees. Subsidies and
commissions deferred are amortized over the 12 month commitment period to which
the termination fees apply and charged to amortization expense. Also, we are
able to capitalize equipment subsidies as fixed assets under our subscription
plans in which we retain or take title to the equipment delivered to
subscribers. Equipment subsidies capitalized are depreciated over their
estimated useful lives of three years and charged to depreciation expense.
Subsidies and commissions that are not deferred or capitalized are expensed as
promotion and incentives expense and advertising and selling expense,
respectively.
Gross SAC costs decreased by $14.5 million to $27.5 million and $70.6
million to $78.1 million for the three and nine months, respectively, primarily
due to reduced gross subscriber additions this year compared to last year.
Additionally, commissions for the nine months ended September 30, 2001 were
higher due to amounts incurred under the seamless marketing agreement with
DirecTV that was in effect during 2001. That agreement was terminated in July
2001, and is the subject of litigation. See Note 14 of the Notes to Consolidated
Financial Statements for information on the litigation.
SAC costs deferred increased $297 thousand to $7.0 million and $15.8
million to $24.3 million for the three and nine months, respectively. The
increase for the nine months was primarily due to substantially all of the
subscription plans sold through our controlled channels in 2002 containing
provisions, as described above, that enabled us to defer costs, whereas for
2001, plans with such provisions principally commenced in the third quarter
2001. Our controlled channels consist of our independent dealer and distributor
network and direct sales channels, which are our predominant sales channels. SAC
costs capitalized increased $3.3 million to $6.7 million and $10.5 million to
$20.1 million for the three and nine months, respectively, primarily due to a
greater number of plans in place in 2002 than 2001 under which equipment was
eligible to be capitalized.
Primarily as a result of the reduced subscriber additions and increased
amounts deferred and capitalized noted above, aggregate promotions and
incentives and advertising and selling expenses decreased $18.1 million to $13.8
million and $96.9 million to $33.7 million for the three and nine months,
respectively. Also contributing to a decrease in advertising and selling
expenses was a reduction in advertising expenses of $8.2 million primarily due
to a focused cost reduction initiative. Amounts we expend for advertising are
discretionary on our part.
General and administrative expenses decreased $2.5 million to $6.2
million and $5.9 million to $21.0 million for the three and nine months,
respectively, due to a broad based cost reduction effort that we have undertaken
in 2002.
Depreciation and amortization decreased $20.7 million to $43.0 million
and $65.8 million to $123.9 million for the three and nine months, respectively,
primarily due to our adoption in first quarter 2002 of Statement of Financial
Accounting Standards No. 142 "Goodwill and Other Intangible Assets" in its
entirety on January 1, 2002. In accordance with FAS 142, we reassessed the
estimated lives of our intangible assets. We believe that the estimated
remaining useful lives of our DBS rights assets should be based on the estimated
useful lives of the satellites at the 101(Degree) west longitude orbital
location available to provide DirecTV services under the NRTC-DirecTV contract.
The contract sets forth the terms and conditions under which the lives of those
satellites are deemed to expire, based on fuel levels and transponder
functionality. We estimate that the useful life of the DirecTV satellite
resources provided under the contract (without regard to renewal rights) expires
in November 2016. Because the cash flows for all of our DBS rights assets
emanate from the same source, we believe that it is appropriate for all of the
estimated useful lives of our DBS rights assets to end at the same time. Prior
to the adoption of FAS 142, our DBS rights assets had estimated useful lives of
10 years from the date we obtained the rights. Linking the lives of our DBS
rights assets in such fashion extended the amortization period for the
unamortized carrying amount of the assets to remaining lives of approximately 15
years from January 1, 2002. The lives of our DBS rights are subject to
litigation. See Note 14 of the Notes to Consolidated Financial Statements for
information on the litigation.
20
PEGASUS SATELLITE COMMUNICATIONS, INC.
Included in depreciation and amortization for the nine months ended
September 30, 2002 and 2001 was aggregate depreciation and amortization of
promotions and incentives costs capitalized or deferred and advertising and
selling costs deferred of $32.2 million and $3.6 million, respectively. The
difference is due to the increased amount of costs deferred and capitalized in
the current year, as discussed above.
Subscribers:
Our number of subscribers at September 30, 2002 was 1,341,000. We have
experienced a net reduction in the number of subscribers in the nine months
ended September 30, 2002 as the number of subscribers that have churned exceeded
the number of subscribers that we have added by approximately 40,000. This net
decrease excludes the one time adjustment to decrease our subscriber count that
was made and reported in the first quarter 2002 of 138,000. We believe that the
reasons for the net 40,000 decrease are: 1) our focus on enrolling more
creditworthy subscribers; 2) competition from digital cable providers and a
competing direct broadcast satellite provider in the territories we serve,
including the provision of local channels by this competing direct broadcast
satellite provider in several markets where DirecTV does not offer local
channels; 3) our service becoming less affordable as a result of our royalty
cost pass through to subscribers; 4) the effect of general economic conditions
on our subscribers and potential subscribers; 5) deceptive sales practices by
agents of the competing direct broadcast satellite provider; 6) the departure of
subscribers due to the effect that the replacement of DIRECTV system access
cards had on subscribers that had been pirating a portion of their services; and
7) a reduction in the number of new subscribers we obtain from DirecTV's
national retail chains.
We will continue to face intensive competition from other providers for
the foreseeable future, most notably as a result of the local into local
programming provided by the competing direct broadcast satellite provider in
certain markets where DirecTV does not offer such programming. We believe that
the deceptive sales practices by agents of the competing direct broadcast
satellite provider may subside as a result of the aforementioned regulatory
rulings surrounding the proposed EchoStar and Hughes merger, although the
practices have continued into the fourth quarter. For the foreseeable future, we
expect to continue to see a decrease in subscribers obtained from DirecTV's
national retail chains. Reduction in the number of subscribers from national
retail chains under arrangements directly with DirecTV results from efforts by
DirecTV to minimize certain subscriber acquisition costs that they have paid to
national retail chains for their enrollment of subscribers who reside in our
exclusive territories.
We will continue to focus on adding high quality, creditworthy
subscribers. Our subscriber acquisition efforts in 2002 and beyond now include:
1) the diversification of our sales and distribution channels; 2) the alignment
of channel economics more closely to expected quality and longevity of
subscribers; and 3) the refinement and expansion of our offers and promotions to
consumers. Our subscriber screening policies may generate a lesser number of
subscriber additions, but we expect that the subscribers added will be of a
higher quality. We expect that this will have an immediate favorable impact on
our cash flows due to a reduction in SAC costs. We also believe that this will
have a longer term favorable impact on our cash flows due to an overall
extension of subscriber lives, thereby leading to a more favorable churn
experience. We manage our subscriber base to maximize cash flow generation. To
the extent that net subscriber reductions resulting from our recent churn
experience continue and unfavorably impact our cash flow generation, our
subscriber retention efforts and investments will be increased accordingly. We
believe that net reductions in our number of subscribers will not have a
significant effect on our operating margins for 2002.
Other Statement of Operations and Comprehensive Loss Items
For the three and nine months ended September 30, 2002 and 2001, our
other businesses primarily consisted of our continuing broadcast operations. Our
Pegasus Express business had been included with our other businesses until the
second quarter 2002 when we first reported the business as discontinued for all
periods presented in our statements of operations and comprehensive loss. The
discontinued Pegasus Express business is discussed below. The continuing
broadcast operations had revenues for the respective periods ended September 30,
2002 and 2001 of $9.4 million and $7.8 million for the three months and $25.7
million and $24.6 million for the nine months. Results from continuing
operations for the respective periods ended September 30, 2002 and 2001 were
income of $409 thousand and loss of $1.6 million for the three months and losses
of $555 thousand and $3.1 million for the nine months. We provide this
information with respect to the broadcast operations for context purposes only,
for we believe that these operations are not significant relative to the overall
scope and understanding of our operations.
21
PEGASUS SATELLITE COMMUNICATIONS, INC.
Other operating expenses, net primarily consisted of amounts incurred
in our litigation with DirecTV for the respective periods ended September 30,
2002 and 2001 of $3.4 million and $4.6 million for the three months and $10.1
million and $14.7 million for the nine months.
Interest expense increased $5.7 million to $38.3 million and $8.4
million to $110.2 million for the three and nine months, respectively. The
increase for the three months was primarily due to: 1) $4.9 million for PSC's
11-1/4% notes issued in December 2001; 2) $1.7 million for PSC's note payable
issued to PCC in June 2002; and 3) $867 thousand for increased interest incurred
with respect to our swap instruments. The increase for the three months was
offset in part by $2.2 million for lower average amounts outstanding at lower
average variable rates of interest under PM&C's term and revolving credit
facilities in 2002 versus 2001. The increase for the nine months was primarily
for the same reasons as for the three months, amounting to $14.7 million, $1.7
million, and $2.2 million for 1), 2), and 3) above, respectively, plus $1.3
million for incremental accretion of the discount on our 13-1/2% senior discount
notes and $1.5 million in increased amortization of deferred financing fees
resulting from additional fees associated with debt added since September 30,
2001. The increase for the nine months was offset in part by $3.5 million for
repayment of all principal amounts outstanding under Golden Sky Systems' credit
facility in June 2001 with the concurrent termination of the facility and $8.9
million for lower average amounts outstanding at lower average variable rates of
interest under PM&C's term and revolving credit facilities in 2002 versus 2001.
Borrowings under our credit facilities are generally subject to short term LIBOR
rates that vary with market conditions. The interest we have incurred in 2002 on
these borrowings has benefited from relatively low market LIBOR rates available
throughout 2002. We have swap instruments that exchange the market LIBOR rates
incurred on our credit facilities based on an aggregate notional amount of $72.1
million for fixed rates of interest specified in the swap contracts. The purpose
of the swaps is to protect us from an increase in market LIBOR rates above the
contracted fixed rates. Since our swaps are a hedge against rising interest
rates, we pay additional interest when the applicable market LIBOR rates are
less than the fixed rates. The applicable LIBOR rates have been less than the
related fixed swap rates for all of 2002. As a result, we incurred additional
cash interest expense of $2.6 million in the nine months ended September 30,
2002 for the difference between the market rates and the fixed rates.
The decrease in interest income for the nine months of $4.1 million to
$435 thousand was primarily due to reduced cash amounts available for earning
interest income and much lower interest rates available during 2002 compared to
2001.
Based on the significance and duration of the loss in fair value, at
June 30, 2002, we determined that our sole investment in marketable securities
held had incurred an other than temporary decline in fair market value.
Accordingly, we wrote down the cost basis in the marketable securities to their
fair market value at June 30, 2002 and charged earnings in the amount of $3.1
million for the impairment loss realized. We had incurred an other than
temporary decline in fair market value in this investment in the third quarter
2001 for which we realized an impairment loss of $34.2 million.
For other nonoperating income/expense, net, for the three months ended
September 2002 and 2001 we had income of $940 thousand and an expense of $2.2
million, respectively, and for the nine months ended September 30, 2002 and 2001
we had income of $2.2 million and an expense of $5.5 million, respectively. The
differences in the comparable periods year over year were primarily due to the
increase in the fair value of our interest rate instruments for the three and
nine months 2002 of $1.1 million and $2.3 million, respectively, compared to a
decrease in the fair value of these instruments for the three and nine months
2001 of $1.7 million and $4.5 million, respectively. The fair values of our
interest rate instruments are based on the amounts that the related contracts
could be settled at on any designated day, as computed by the institutions that
are party to the contracts. No cash is exchanged on these assumed settlement
dates, but we record gains for increases and losses for decreases in fair values
between assumed settlement dates, which occur on each calendar quarter end
month.
The income tax benefit on the loss from continuing operations decreased
$29.2 million to $5.8 million and $70.0 million to $34.0 million for the three
and nine months, respectively, due to lower pretax losses in the current year
periods compared to the corresponding prior year periods and a valuation
allowance of $8.8 million recorded in the third quarter 2002 against the net
deferred income tax asset balance existing at September 30, 2002. We recorded
the valuation allowance and charged income taxes on the loss from continuing
operations in the same amount because we believe at the present time that it is
more likely than not that the benefits of this net tax asset balance will not be
realized. The effect of the valuation allowance lowered our effective income tax
rate on continuing operations to 14.5% and 29.7% for the three and nine months
ended September 30, 2002.
22
PEGASUS SATELLITE COMMUNICATIONS, INC.
We have entered into a definitive agreement to sell our Mobile, Alabama
broadcast television station to an unaffiliated party for $11.5 million in cash.
The sale is contingent upon conditions typical of sales of this nature,
including final approval by the Federal Communications Commission of the
transfer of the station's broadcast license to the buyer. It is anticipated that
the sale will occur in the first quarter of 2003. We have classified the
operations of this station as discontinued for all periods presented. In August
2002, we completed the transfer of the subscribers and equipment inventory for
our Pegasus Express two way satellite internet access business that were sold to
an unaffiliated party. We anticipate that the cash proceeds from the sale of the
subscribers will be about $1.5 million. The ultimate proceeds will be based on
the number of the transferred subscribers that ultimately are authorized into
the buyer's service no later than February 2003. Our estimate of the ultimate
proceeds factor in an estimate for subscribers that may not be authorized into
the buyer's service. We sold the equipment for $2.6 million cash. With the sale
of the subscribers and equipment, we no longer operate the Pegasus Express
business and, accordingly, have classified this business as discontinued for all
periods presented. Aggregate revenues and pretax loss of discontinued operations
were as follows (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
2002 2001 2002 2001
---------- --------- ----------- ----------
Revenues $ 755 $ 641 $ 3,419 $ 808
Pretax income (loss) 938 (5,226) (3,981) (13,868)
Included in the pretax amount for the three and nine months ended 2002 is a gain
of $1.5 million for the Pegasus Express subscribers sold and within the nine
months 2002 a loss of $837 thousand on the Pegasus Express equipment inventory
sold. Also included in discontinued operations for the nine months 2002 is an
aggregate loss of $847 thousand for other assets associated with the Pegasus
Express business that were written off because they had no use outside of the
business.
New Accounting Pronouncements
Statement of Financial Accounting Standards No. 143 "Accounting for
Asset Retirement Obligations" addresses financial accounting and reporting for
obligations associated with the retirement of tangible long lived assets and the
associated asset retirement costs. FAS 143 becomes effective for us on January
1, 2003. Entities are required to recognize the fair values of liabilities for
asset retirement obligations in the period in which the liabilities are
incurred. Liabilities recognized are to be added to the cost of the asset to
which they relate. Legal liabilities that exist on the date of adoption of FAS
143 are to be recognized on that date. We continue to study our long lived
assets to determine if any legal liabilities are connected with them that need
to be recognized upon the adoption of this statement.
Statement of Financial Accounting Standards No. 145 "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections" becomes effective for us on January 1, 2003. A principal provision
of FAS 145 is the reporting in the statement of operations of gains and losses
associated with extinguishments of debt. FAS 145 rescinds the present required
classification of extinguishments of debt as extraordinary. Instead, FAS 145
states that extinguishments of debt be considered for extraordinary treatment in
light of already established criteria used to determine whether events are
extraordinary. For an event to be extraordinary, the established criteria are
that it must be both unusual and infrequent. Once FAS 145 becomes effective, all
debt extinguishments classified as extraordinary in the statement of operations
issued prior to the effective date of FAS 145 that do not satisfy the criteria
for extraordinary treatment may not be reported as extraordinary in statements
of operations issued after that date. We have extinguished debt a number of
times in the past, and may do so in the future. Regarding our debt
extinguishments occurring prior to January 1, 2003 that are properly reported as
extraordinary under accounting standards in effect until that time, we expect
that they will not be events that qualify for extraordinary treatment after that
date. As a result, we believe that our extinguishments of debt reported as
extraordinary prior to January 1, 2003 will not be reported as extraordinary
after that date. Rather, these extinguishments will be reported as a component
of nonoperating gains and losses within continuing operations in the statement
of operations. We believe that extinguishments of debt occurring after that date
will be classified similarly. We do not expect such a change in classification
to have any effect on our operations, cash flows, financial position, or
covenants related to our existing credit agreement and note indentures.
23
PEGASUS SATELLITE COMMUNICATIONS, INC.
Statement of Financial Accounting Standards No. 146 "Accounting for
Costs Associated with Exit or Disposal Activities" becomes effective for us on
January 1, 2003. FAS 146 requires companies to recognize costs associated with
exit or disposal activities, costs to terminate contracts that are not capital
leases, and costs to consolidate facilities or relocate employees when they are
incurred rather than at the date of a commitment to engage in these activities
as permitted under existing accounting standards. FAS 146 is to be applied
prospectively to the activities covered by the statement that are initiated
after December 31, 2002. We will apply the requirements of FAS 146 after its
effective date when we engage in any of the covered activities.
Liquidity and Capital Resources
We are highly leveraged. At September 30, 2002, we had a combined
carrying amount of debt and redeemable preferred stock outstanding of $1.6
billion. This amount included a note payable to PCC of $77.2 million and $108.5
million of carrying amount, including accrued dividends of $9.5 million, of
preferred stock owned by PCC. Because we are highly leveraged, we are more
vulnerable to adverse economic and industry conditions. We dedicate a
substantial portion of cash to pay amounts associated with debt. In the first
nine months of 2002, we paid interest of $93.4 million. We have also used cash
for distributions to PCC and to purchase our debt and the common stock of PCC,
as further discussed below. We may engage in further transactions from time to
time in which we purchase and/or exchange the securities of PSC, PM&C, and/or
PCC. Such transactions may be made in the open market or in privately negotiated
transactions. The amount and timing of such transactions, if any, will depend on
market conditions and other considerations.
We were scheduled to begin paying cash dividends on PSC's 12-3/4%
series preferred stock in July 2002. However, we did not declare the scheduled
semiannual dividend payable July 1, 2002 for this series. See the discussion
below concerning the nondeclaration of dividends on this series and for other
uses of our cash.
In July 2002, we gave notice to terminate a contract for call center
services provided to us that will terminate at the end of 12 months from the
date of notice. We will pay a termination fee of $4.5 million at the agreement
termination date.
Using cash for the above noted payments or potential payments reduces
the availability of funds for working capital, capital expenditures, and other
activities, and limits our flexibility in planning for, or reacting to, changes
in our business and the industries in which we operate, although we have reduced
the amount of cash paid and payable to nonaffiliates in connection with our debt
repurchases and with respect to our preferred stock purchased by PCC. Our
ability to make payments on and to refinance indebtedness and redeemable
preferred stock outstanding and to fund operations, planned capital expenditures
and other activities depends on our ability to generate cash in the future. Our
ability to generate cash depends on the success of our business strategy,
prevailing economic conditions, regulatory risks, competitive activities by
other parties, equipment strategies, technological developments, level of
programming costs, levels of interest rates, and financial, business, and other
factors that are beyond our control. We cannot assure that our business will
generate sufficient cash flow from operations or that alternative financing will
be available to us in amounts sufficient to service needs previously specified.
Our indebtedness and preferred stock contain numerous covenants that, among
other things, generally limit the ability to incur additional indebtedness and
liens, issue other securities, make certain payments and investments, pay
dividends, transfer cash, dispose of assets, and enter into other transactions,
and impose limitations on the activities of our subsidiaries. Failure to make
debt payments or comply with covenants could result in an event of default that,
if not cured or waived, could have a material adverse effect on us.
24
PEGASUS SATELLITE COMMUNICATIONS, INC.
At the discretion of our board of directors as permitted by the
certificate of designation of the 12-3/4% series, we did not declare the
scheduled semiannual dividend payable July 1, 2002 for this series. The amount
of the dividend scheduled to be declared was $11.7 million payable in cash.
Dividends not declared or paid accumulate in arrears and incur interest at a
rate of 14.75% per year until later declared and paid. Unless full cumulative
dividends in arrears on the 12-3/4% series have been paid or set aside for
payment, PSC may not, with certain exceptions, 1) declare, pay, or set aside
amounts for payment of future cash dividends or distributions, or 2) purchase,
redeem, or otherwise acquire for value any shares of its capital stock junior to
the 12-3/4% series. The amount of interest accrued and unpaid through September
30, 2002 on dividends in arrears was $432 thousand. Of the amounts of dividends
in arrears and interest thereon, amounts payable to PCC were $6.3 million and
$233 thousand. Foregoing paying dividends on the 12-3/4% series increases the
current availability of funds for working capital, capital expenditures, and
other activities.
Despite the restrictions placed on PSC regarding cash dividend payments
discussed in the preceding paragraph, permissible means are available to
transfer funds to PCC while dividends on PSC's preferred stock are in arrears.
In August 2002, a major rating agency reduced the ratings on all of our
notes, bank debt, preferred stock, and senior implied and unsecured issuer
ratings to a lower grade. We believe that these downgradings will not have much
of an impact on our liquidity and capital resources because: 1) capital markets
in general have tightened, given general economic conditions, and in particular
for the cable and satellite sector, in which we operate, given uncertainties and
developments within the sector, and 2) our ratings before the downgrade were
generally considered speculative grade securities.
We had cash and cash equivalents on hand at September 30, 2002 of $21.8
million compared to $144.4 million at December 31, 2001. The change in cash is
discussed below in terms of the amounts shown in our cash flow statement. At
September 30, 2002, the commitment for PM&C's revolving credit facility was
permanently reduced by $8.4 million to $177.2 million as scheduled under the
terms of the credit agreement. The commitment for the revolving credit facility
is scheduled to be permanently reduced by another $8.4 million in December 2002.
Availability under the revolving credit facility at September 30, 2002 was
$116.9 million, after reduction for letter of credits of $60.1 million
associated with the facility. We believe that these cash resources combined with
cash projected to be provided by operations in the next 12 months are sufficient
to meet our liquidity and capital resource needs for the next 12 months.
However, we cannot provide any assurance as to the amount or sufficiency of cash
that will be provided by our operations within the next 12 months.
In June 2002, PM&C borrowed $63.2 million in incremental term loans
under its credit agreement. There is no further availability under this
facility. Principal amounts outstanding under the incremental term loan facility
are payable quarterly in increasing increments over the remaining term of the
facility that began September 30, 2002. All unpaid principal and interest
outstanding under the incremental term loans are due July 31, 2005. Amounts
repaid under the incremental term loan facility may not be reborrowed. Margins
on incremental term loans are 2.5% for base rates and 3.5% for LIBOR rates.
Interest on outstanding principal borrowed under base rates is due and payable
quarterly and interest on outstanding principal borrowed under LIBOR rates is
due and payable the earlier of the end of the contracted interest rate period or
three months. We repaid $158 thousand of principal on the loan in the third
quarter 2002, and are scheduled to repay principal of $158 thousand in December
2002. Total annual repayments of principal on the loan scheduled after 2002 are
$632 thousand in 2003, $16.3 million in 2004, and $45.9 million in 2005.
In June 2002, PSC borrowed $113.7 million cash from PCC in the form of
a promissory note. The cash lent by PCC was connected to the $122.4 million cash
previously distributed by PSC to PCC in June 2002. All amounts outstanding under
the promissory note are due June 30, 2005. The interest rate on the note will be
based on the interest rate with margins incurred by PM&C on its term loan
facility, plus an additional 1%. Interest is payable quarterly. Principal of the
note may be repaid in whole or in part at any time without penalty. PSC repaid
$36.5 million of principal on the note in the third quarter, leaving a principal
balance on the note of $77.2 million at September 30, 2002.
25
PEGASUS SATELLITE COMMUNICATIONS, INC.
Net cash was provided by operating activities for the nine months ended
September 30, 2002 of $22.2 million compared to net cash used by operating
activities of $122.1 million for the nine months ended September 30, 2001. The
principal reasons for the change were: 1) much less subscriber acquisition costs
paid in the current year period compared to the prior year period primarily as a
result of reduced gross subscriber additions in the current year; 2) taxes paid
in 2001 for the sale of our cable operations in 2000; and 3) increased operating
margins in the current year period compared to the prior year period that
provided greater net cash inflows.
For the nine months ended September 30, 2002 and 2001, net cash used
for investing activities was $24.3 million and $38.9 million, respectively. The
primary investing activity for 2002 was for costs incurred with DBS equipment
capitalized of $20.1 million. In 2002, we also purchased PCC's Class A common
stock at various times for an aggregate of approximately $1.0 million. In 2001,
the primary investing activities were for: 1) DBS equipment capitalized of $9.6
million; 2) other capital expenditures of $17.4 million primarily for a new call
center and capital improvements to existing buildings; and 3) purchases of
intangible assets of $11.1 million, consisting of additional guardband licenses
and costs incurred to acquire subscribers of a cable system going out of
business.
For the nine months ended September 30, 2002 and 2001, net cash used
for financing activities was $120.5 million and $2.3 million, respectively. The
primary financing activities for 2002 were: 1) $60.9 million borrowed under term
loans, net of principal repaid of $2.2 million; 2) borrowings under a note
payable to PCC of $77.2 million, net of principal repaid of $36.5 million; 3)
$80.0 million repayments of amounts outstanding under our revolving credit
facility; 4) net distributions to PCC of $148.8 million; 5) repurchases of our
outstanding notes of $25.0 million; and 6) repayments of other long term debt of
$5.9 million. The primary financing activities for 2001 were: 1) proceeds from
short term debt borrowed of $61.0 million; 2) $37.1 million net repayments of
amounts outstanding under our revolving credit facilities in place in 2001; 3)
$14.0 million in restricted cash that was used as collateral for a letter of
credit connected with the short term debt incurred; and 4) repayments of other
long term debt of $7.7 million. In late June 2002, PSC distributed $122.4
million in cash to PCC in anticipation of the dividends on PSC's preferred stock
going into arrears on July 1, 2002, of which $113.7 million was loaned back to
PSC in the same month.
Premarketing cash flow of our DBS business was $191.7 million and
$175.0 million for the nine months ended September 30, 2002 and 2001,
respectively. EBITDA for our DBS business was $158.0 million and $44.4 million
for the nine months ended September 30, 2002 and 2001, respectively. DBS
premarketing cash flow is calculated by subtracting DBS direct operating
expenses (excluding depreciation and amortization), as adjusted to exclude the
one time contract termination fee therein of $4.5 million, and general and
administrative expenses from DBS revenues. DBS EBITDA is DBS premarketing cash
flow less DBS promotions and incentives and advertising and selling expenses. We
present DBS premarketing cash flow and DBS EBITDA because the DBS business is
our only significant segment and this business forms the principal portion of
our results of operations and cash flows.
DBS premarketing cash flow and DBS EBITDA are not, and should not be
considered, alternatives to income from operations, net income, net cash
provided by operating activities, or any other measure for determining our
operating performance or liquidity, as determined under generally accepted
accounting principles. DBS premarketing cash flow and DBS EBITDA also do not
necessarily indicate whether our cash flow will be sufficient to fund working
capital, capital expenditures, or to react to changes in our industry or the
economy generally. We believe that DBS premarketing cash flow and DBS EBITDA are
important because people who follow our industry frequently use them as measures
of financial performance and ability to pay debt service, and they are measures
that we, our lenders, and investors use to monitor our financial performance and
debt leverage. Although EBITDA is a common measure used by other companies, our
calculation of EBITDA may not be comparable with that of others.
Adjusted operating cash flow for the 12 months ended September 30, 2002
was $230.8 million. Adjusted operating cash flow is operating cash flow of the
DBS business for the current quarter times four, plus operating cash flow from
other operating divisions for the last four quarters. Operating cash flow, for
the purpose of only calculating adjusted operating cash flow, is income or loss
from operations, adding back depreciation, amortization, and other noncash items
therein, and subscriber acquisition costs. We present this measure for purpose
of compliance with our debt indenture, and such measure is not required to be
presented on a comparative basis.
26
PEGASUS SATELLITE COMMUNICATIONS, INC.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our principal market risk continues to be exposure to variable market
rates of interest associated with borrowings under our credit facilities.
Borrowings under our credit facilities are generally subject to short term LIBOR
rates that vary with market conditions. The amount of interest we incur also
depends upon the amount of borrowings outstanding. The interest we have incurred
in 2002 on these borrowings has benefited from relatively low market LIBOR rates
available throughout 2002. The way we manage our interest rate risks did not
change during the nine months ended September 30, 2002.
We have swap instruments that exchange the market LIBOR rates incurred
on our credit facilities based on an aggregate notional amount of $72.1 million
for fixed rates of interest specified in the swap contracts. The purpose of the
swaps is to protect us from an increase in market LIBOR rates above the
contracted fixed rates. Since our swaps are a hedge against rising interest
rates, we pay additional interest when the applicable market LIBOR rates are
less than the fixed rates. The applicable LIBOR rates have been less than the
related fixed swap rates for all of 2002. As a result, we incurred additional
cash interest expense of $2.6 million in the nine months ended September 30,
2002 for the difference between the market rates and the fixed rates. The
additional interest had the effect of adding 116 basis points in arriving at our
aggregate combined weighted average variable interest rate associated with
amounts outstanding under our credit agreement for the nine months ended
September 30, 2002 of 6.63%, including applicable margins.
The fair values of our swaps are based on the amounts that the swap
contracts could be settled at on any designated day, as computed by the
institutions that are party to the swaps. No cash is exchanged on these assumed
settlement dates, but we record gains for increases and losses for decreases in
fair values between assumed settlement dates, which occur on each calendar
quarter end month. The fair values of our swaps at September 30, 2002 were
higher than those at December 31, 2001 by $2.3 million, and as a result, we
recorded a gain in this amount for the nine months ended September 30, 2002.
In connection with the incremental term loan borrowed in June 2002,
PM&C entered into two additional interest rate cap agreements with the same
financial institution in August 2002. Each cap has a notional amount of $15.8
million. The cap rate under one agreement is 9.00% and the cap rate under the
other is 4.00%. Both caps terminate September 2005. Payment under each cap is
determined quarterly based on the three month LIBOR rate in effect at the
beginning of each three month resetting period. Under these caps, we receive
interest from the contracting institution when the applicable market LIBOR rate
exceeds the applicable cap rate at each resetting date. The premium we paid to
enter into these agreements was not significant.
Including the two new agreements, we have four interest rate cap
agreements in place at September 30, 2002. These caps have not had any effect on
our effective interest rates or the amount of interest incurred, and only
nominal effect in the amount of gains and losses recorded for the changes in the
fair values of these agreements during 2002.
ITEM 4. CONTROLS AND PROCEDURES
Within the 90 days prior to the filing date of this report on Form
10-Q, we carried out an evaluation under the supervision and with the
participation of our management, including our Chief Executive Officer and Vice
President - Finance and Controller (the principal financial officer), to
determine the effectiveness of our disclosure controls and procedures. Based on
this evaluation, the Chief Executive Officer and the Vice President - Finance
and Controller concluded that these controls and procedures are effective in
their design to ensure that information required to be disclosed by the
registrant in reports that it files or submits under the Securities Exchange Act
of 1934 is recorded, processed, summarized, and reported within the time periods
specified in the Securities and Exchange Commission's rules and forms, and that
such information has been accumulated and communicated to the management of the
registrant, including the above indicated officers, as appropriate to allow
timely decisions regarding the required disclosures. There have not been any
significant changes in the registrant's internal controls or in other factors
that could significantly affect these controls subsequent to the date of this
evaluation, including any corrective actions with regard to significant
deficiencies and material weaknesses.
27
PEGASUS SATELLITE COMMUNICATIONS, INC.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
For information relating to litigation with DirecTV, Inc. and others,
we incorporate by reference herein the disclosure reported under Note 14 to the
Notes to Consolidated Financial Statements. The Notes to Consolidated Financial
Statements can be found under Part I, Item 1 of this Quarterly Report on Form
10-Q. We have previously filed reports during the fiscal year disclosing some or
all of the legal proceedings referenced above. In particular, we have reported
on such proceedings in our Annual Report on Form 10-K for the year ended
December 31, 2001 and in our Quarterly Report on Form 10-Q for the quarterly
periods ended March 31, 2002 and June 30, 2002.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
At the discretion of our board of directors as permitted by the
certificate of designation for the 12-3/4% cumulative exchangeable preferred
stock of Pegasus Satellite Communications, Inc., we did not declare the
scheduled semiannual dividend payable July 1, 2002 for this series. The amount
of the dividend in arrears was $11.7 million. Dividends in arrears on this
series accrue interest at a rate of 14.75%. Interest accrued and unpaid through
September 30, 2002 on dividends in arrears was $432 thousand. Of the amounts of
dividends in arrears and interest thereon, amounts payable to PCC were $6.3
million and $233 thousand.
28
PEGASUS SATELLITE COMMUNICATIONS, INC.
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, Pegasus Satellite Communications, Inc. has duly caused this Report
to be signed on its behalf by the undersigned thereunto duly authorized.
Pegasus Satellite Communications, Inc.
November 14, 2002 By: /s/ Joseph W. Pooler, Jr.
- ------------------------------------ -------------------------------
Date Joseph W. Pooler, Jr.
Vice President - Finance and Controller
(Principal Financial and Accounting
Officer)
29
CERTIFICATION
I, Marshall W. Pagon, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Pegasus Satellite
Communications, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of the registrant's board of directors:
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
November 14, 2002
By: /s/ Marshall W. Pagon
Marshall W. Pagon
Chief Executive Officer
CERTIFICATION
I, Joseph W. Pooler, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Pegasus Satellite
Communications, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of the registrant's board of directors:
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
November 14, 2002
By: /s/ Joseph W. Pooler
Joseph W. Pooler
Vice President - Finance and Controller