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 June 30, 2003
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
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(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (800) 376-0022
--------------
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No __
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act).
Yes__ No /X/
Number of shares of each class of the registrant's common stock
outstanding as of August 6, 2003:
Class B, Common Stock, $0.01 par value 200
PEGASUS SATELLITE COMMUNICATIONS, INC.
Form 10-Q
Table of Contents
For the Quarterly Period Ended June 30, 2003
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets
June 30, 2003 and December 31, 2002 4
Consolidated Statements of Operations and Comprehensive Loss
Three months ended June 30, 2003 and 2002 5
Consolidated Statements of Operations and Comprehensive Loss
Six months ended June 30, 2003 and 2002 6
Condensed Consolidated Statements of Cash Flows
Six months ended June 30, 2003 and 2002 7
Notes to Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 20
Item 3. Quantitative and Qualitative Disclosures About Market Risk 32
Item 4. Controls and Procedures 32
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 34
Item 2. Changes in Securities and Use of Proceeds 34
Item 3. Defaults Upon Senior Securities 34
Item 6. Exhibits and Reports on Form 8-K 35
Signatures 36
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
3
Pegasus Satellite Communications, Inc.
Condensed Consolidated Balance Sheets
(In thousands)
June 30, December 31,
2003 2002
----------------- ----------------
(unaudited)
Currents assets:
Cash and cash equivalents $ 18,493 $ 13,023
Accounts receivable, net
Trade 22,467 27,163
Other 6,700 9,557
Deferred subscriber acquisition costs, net 12,157 15,706
Prepaid expenses 9,593 8,087
Other current assets 6,704 7,581
----------------- ----------------
Total current assets 76,114 81,117
Property and equipment, net 68,255 69,951
Intangible assets, net 1,506,969 1,564,874
Other noncurrent assets 137,002 143,208
----------------- ----------------
Total $ 1,788,340 $ 1,859,150
================= ================
Current liabilities:
Current portion of long term debt $ 3,807 $ 5,631
Accounts payable 14,334 15,886
Accrued interest 34,163 38,383
Accrued programming fees 52,474 57,196
Accrued commissions and subsidies 40,082 40,191
Other accrued expenses 28,362 31,778
Other current liabilities 13,582 7,201
----------------- ----------------
Total current liabilities 186,804 196,266
Long term debt 1,282,377 1,274,981
Note payable to parent 50,827 55,250
Other noncurrent liabilities 46,650 46,596
----------------- ----------------
Total liabilities 1,566,658 1,573,093
----------------- ----------------
Commitments and contingent liabilities (see Note 10)
Minority interest 506 2,157
Redeemable preferred stock 211,803 199,022
Common stockholder's equity:
Common stock - -
Other common stockholder's equity 9,373 84,878
----------------- ----------------
Total common stockholder's equity 9,373 84,878
----------------- ----------------
Total $ 1,788,340 $ 1,859,150
================= ================
See accompanying notes to consolidated financial statements
4
Pegasus Satellite Communications, Inc.
Consolidated Statements of Operations and Comprehensive Loss
(In thousands)
Three Months Ended June 30,
2003 2002
--------------- ----------------
(unaudited)
Net revenues:
Direct broadcast satellite $ 205,823 $ 216,447
Broadcast television 8,141 7,563
--------------- ----------------
Total net revenues 213,964 224,010
Operating expenses:
Direct broadcast satellite
Programming 92,483 96,016
Other subscriber related expenses 40,550 49,086
--------------- ----------------
Direct operating expenses (excluding depreciation and
amortization shown below) 133,033 145,102
Promotions and incentives 3,595 2,027
Advertising and selling 6,572 7,820
General and administrative 5,913 6,865
Depreciation and amortization 40,843 41,487
--------------- ----------------
Total direct broadcast satellite 189,956 203,301
Broadcast television (including depreciation and amortization of
$507 and $818, respectively) 7,529 7,607
Corporate expenses (including depreciation and amortization of $352
and $372, respectively) 3,604 4,072
Other operating expenses, net 8,263 5,490
--------------- ----------------
Income from operations 4,612 3,540
Interest expense (36,826) (36,113)
Interest income 65 116
Loss on impairment of marketable securities - (3,063)
Other nonoperating income, net 1,173 113
--------------- ----------------
Loss before income taxes and discontinued operations (30,976) (35,407)
Net (expense) benefit for income taxes (138) 13,648
--------------- ----------------
Loss before discontinued operations (31,114) (21,759)
Discontinued operations:
Loss from discontinued operations (including loss on disposal of
$2,430 in 2003), net of income tax benefit of $1,080 in 2002 (2,567) (1,761)
--------------- ----------------
Net loss (33,681) (23,520)
Other comprehensive loss:
Unrealized loss on marketable equity securities, net of income tax
benefit of $465 - (758)
Reclassification adjustment for accumulated unrealized loss on
marketable securities included in net loss, net of income tax
benefit of $1,164 - 1,899
--------------- ----------------
Net other comprehensive income - 1,141
--------------- ----------------
Comprehensive loss $ (33,681) $ (22,379)
=============== ================
See accompanying notes to consolidated financial statements
5
Pegasus Satellite Communications, Inc.
Consolidated Statements of Operations and Comprehensive Loss
(In thousands)
Six Months Ended June 30,
2003 2002
--------------- ----------------
(unaudited)
Net revenues:
Direct broadcast satellite $ 411,369 $ 431,171
Broadcast television 15,425 14,058
--------------- ----------------
Total net revenues 426,794 445,229
Operating expenses:
Direct broadcast satellite
Programming 185,739 192,334
Other subscriber related expenses 85,225 100,827
--------------- ----------------
Direct operating expenses (excluding depreciation and
amortization shown below) 270,964 293,161
Promotions and incentives 6,473 3,770
Advertising and selling 12,298 16,121
General and administrative 12,286 14,782
Depreciation and amortization 82,829 80,937
--------------- ----------------
Total direct broadcast satellite 384,850 408,771
Broadcast television (including depreciation and amortization of
$1,206 and $1,682, respectively) 15,134 14,867
Corporate expenses (including depreciation and amortization of $747
and $752, respectively) 7,360 8,523
Other operating expenses, net 14,580 13,526
--------------- ----------------
Income (loss) from operations 4,870 (458)
Interest expense (74,728) (71,967)
Interest income 129 305
Loss on impairment of marketable securities - (3,063)
Other nonoperating income, net 2,527 1,239
--------------- ----------------
Loss before income taxes and discontinued operations (67,202) (73,944)
Net (expense) benefit for income taxes (138) 28,109
--------------- ----------------
Loss before discontinued operations (67,340) (45,835)
Discontinued operations:
Income (loss) from discontinued operations (including net gain on
disposal of $5,209 in 2003), net of income tax (expense) benefit
of $1,929 in 2002 4,616 (3,145)
--------------- ----------------
Net loss (62,724) (48,980)
Other comprehensive loss:
Unrealized loss on marketable equity securities, net of income tax
benefit of $1,780 - (2,904)
Reclassification adjustment for accumulated unrealized loss on
marketable securities included in net loss, net of income tax
benefit of $1,164 - 1,899
--------------- ----------------
Net other comprehensive loss - (1,005)
--------------- ----------------
Comprehensive loss $ (62,724) $ (49,985)
=============== ================
See accompanying notes to consolidated financial statements
6
Pegasus Satellite Communications, Inc.
Condensed Consolidated Statements of Cash Flows
(In thousands)
Six Months Ended June 30,
2003 2002
-------------- --------------
(unaudited)
Net cash provided by operating activities $ 14,284 $ 34,064
-------------- --------------
Cash flows from investing activities:
Direct broadcast satellite equipment capitalized (9,511) (13,497)
Other capital expenditures (658) (2,456)
Sales of broadcast stations 21,593 -
Purchases of parent's common stock (3,688) -
Other 103 (1)
-------------- --------------
Net cash provided by (used for) investing activities 7,839 (15,954)
-------------- --------------
Cash flows from financing activities:
Proceeds from term loan facility - 63,156
Repayments of term loan borrowings (1,691) (1,375)
Repayment of revolving credit facility - (80,000)
Repayments of other long term debt (2,249) (5,852)
Net (repayments of) proceeds from note payable to parent (11,775) 113,732
Debt financing costs (2,840) (213)
Decrease in restricted cash 2,026 1,147
Distributions to parent (1) (167,803)
Other (123) (2)
-------------- --------------
Net cash used for financing activities (16,653) (77,210)
-------------- --------------
Net increase (decrease) in cash and cash equivalents 5,470 (59,100)
Cash and cash equivalents, beginning of year 13,023 144,350
-------------- --------------
Cash and cash equivalents, end of period $ 18,493 $ 85,250
============== ==============
See accompanying notes to consolidated financial statements
7
PEGASUS SATELLITE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. General
All references to "we," "us," and "our," refer to Pegasus Satellite
Communications, Inc., together with its direct and indirect subsidiaries.
"Pegasus Satellite" refers to Pegasus Satellite Communications, Inc.
individually as a separate entity. "Pegasus Communications" refers to Pegasus
Communications Corporation, the parent company of Pegasus Satellite. "Pegasus
Media" refers to Pegasus Media & Communications, Inc., a wholly owned subsidiary
of Pegasus Satellite. Other terms used are defined as needed where they first
appear.
Significant Risks and Uncertainties
We have a history of losses principally due to the substantial amounts
incurred for interest expense and depreciation and amortization. Net losses were
$109.4 million, $285.2 million, and $159.0 million for 2002, 2001, and 2000,
respectively.
We are highly leveraged. At June 30, 2003, we had a combined carrying
amount of long term debt, including the portion that is current, and redeemable
preferred stock outstanding of $1.5 billion. Our high leverage makes us more
vulnerable to adverse economic and industry conditions and limits our
flexibility in planning for, or reacting to, changes in our business and the
industries in which we operate. 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 and to fund the preferred
stock requirements of Pegasus Communications 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 and subscriber acquisition costs ("SAC"), 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 adversely impact us.
Our principal business is the direct broadcast satellite business. For
2002, 2001, and 2000, revenues for this business were 96%, 96%, and 94%,
respectively, of total consolidated revenues, and operating expenses for this
business were 91%, 92%, and 92%, respectively, of total consolidated operating
expenses. Total assets of the direct broadcast satellite business were 93% and
94% of total consolidated assets at December 31, 2002 and 2001, respectively. We
are in litigation against DIRECTV, Inc. An outcome in this litigation that is
unfavorable to us could adversely impact our direct broadcast satellite
business. See Note 10 for further information.
For the six months ended June 30, 2003 and 2002, the direct broadcast
satellite business had income from operations of $26.5 million and $22.4
million, respectively. We attribute the improvement in the current year to our
direct broadcast satellite business strategy. This strategy focuses on:
increasing the quality of new subscribers and the composition of our existing
subscriber base; enhancing the returns on investment in our subscribers;
generating free cash flow; and preserving liquidity. The primary focus of our
"Quality First" strategy is on improving the quality and creditworthiness of our
subscriber base. Our goal is to acquire and retain high quality subscribers, to
cause average subscribers to become high quality subscribers, and to reduce
acquisition and retention investments in low quality subscribers. To achieve
8
PEGASUS SATELLITE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
these goals, our subscriber acquisition, development, and retention efforts
focus on subscribers who are less likely to churn and who are more likely to
subscribe to more programming services, including local and network programming,
and to use multiple receivers. "Churn" refers to subscribers whose service has
terminated. Our strategy includes a significant emphasis on credit scoring of
potential subscribers, adding and upgrading subscribers in markets where DIRECTV
offers local channels, and who subscribe to multiple receivers. It is our
experience that these attributes are closely correlated with lower churn,
increased cash flow, and higher returns on investment. Our strategy also
includes the use of behavioral and predictive scores to group subscribers and to
design retention campaigns, upgrade offers, and consumer offers consistent with
our emphasis on acquiring and retaining high quality subscribers and reducing
our investment in lower quality subscribers.
Continued improvement in results from operations will in large part
depend upon our obtaining a sufficient number of quality subscribers, retention
of these subscribers for extended periods of time, and improving margins from
them. While our direct broadcast satellite business strategy has resulted in an
increase in income from operations, it has contributed to a certain extent to
the decrease in the number of our direct broadcast satellite subscribers of 76
thousand and the decrease of $19.8 million in direct broadcast satellite net
revenues for the six months ended June 30, 2003 compared to the six months ended
June 30, 2002. In the near term, our direct broadcast satellite business
strategy may result in further decreases in the number of our direct broadcast
satellite subscribers and our direct broadcast satellite net revenues when
compared to prior periods, but we believe that our results from operations for
the direct broadcast satellite business will not be significantly impacted. We
cannot make any assurances that this will be the case, however. If a
disproportionate number of subscribers churn relative to the number of quality
subscribers we enroll, we are not able to enroll a sufficient number of quality
subscribers, and/or we are not able to maintain adequate margins from our
subscribers, our results from operations may not improve or improved results
that do occur may not be sustained.
We have not declared or paid the semiannual dividends on our 12-3/4%
series preferred stock after January 1, 2002. See Note 3 for further
information.
2. Basis of Presentation
The unaudited financial statements herein include the accounts of
Pegasus Satellite 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
in the United States of America 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.
9
PEGASUS SATELLITE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
3. Redeemable Preferred Stock
The increase in the carrying amount from December 31, 2002 to June 30,
2003 was due to dividends accrued and accretion.
At the discretion of our board of directors as permitted by the
certificate of designation for the 12-3/4% cumulative exchangeable preferred
stock, our board of directors has not declared or paid any of the scheduled
semiannual dividends for this series after January 1, 2002. Dividends in arrears
at June 30, 2003 were $23.5 million, with accrued interest thereon of $2.6
million. 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, Pegasus Satellite may not, with certain exceptions, with
respect to capital stock junior to the series: 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 Pegasus Satellite. Of the
amount of dividends in arrears at June 30, 2003, $11.9 million, with interest
thereon of $1.3 million, was payable to Pegasus Communications on account of the
12-3/4% preferred stock shares held by Pegasus Communications.
4. Changes in Other Stockholder's Equity
The change in other stockholders' equity from December 31, 2002 to June
30, 2003 of $(75.5) million consisted of (in thousands):
Net loss $ (62,724)
Preferred stock dividends accrued and accretion (12,780)
Distribution to Pegasus Communications (1)
--------------
Total $ (75,505)
==============
5. Long Term Debt
All principal amounts borrowed by Pegasus Media under its revolving
credit facility were repaid during the six months ended June 30, 2003. Letters
of credit outstanding under the revolving credit facility, which reduce the
availability thereunder, were $61.4 million at June 30, 2003. After deducting
the letters of credit outstanding, net availability under our revolving credit
facility at June 30, 2003 was $79.2 million. Pegasus Media repaid $688 thousand
of principal outstanding under its term loan facility during the three months
ended June 30, 2003 as scheduled, thereby reducing the total principal amount
outstanding thereunder to $268.1 million. The weighted average variable rate of
interest including applicable margins on principal amounts outstanding under the
term loan facility was 4.6% and 5.3% at June 30, 2003 and December 31, 2002,
respectively. Pegasus Media repaid $158 thousand of principal outstanding under
its incremental term loan facility during the three months ended June 30, 2003
as scheduled, thereby reducing the total principal amount outstanding thereunder
to $62.5 million. The weighted average variable rate of interest including
applicable margins on principal amounts outstanding under the incremental term
loan facility was 4.6% and 5.3% at June 30, 2003 and December 31, 2002,
respectively. See below for actions we took after June 30, 2003 that impact all
three of the preceding facilities.
During the six months ended June 30, 2003, Pegasus Satellite decreased
the principal under its promissory note arrangement with Pegasus Communications
by $4.4 million. In the six months ended June 30, 2003, Pegasus Satellite
capitalized as principal outstanding under this note interest accrued on the
note of $5.0 million.
10
PEGASUS SATELLITE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
In a series of exchanges in the second quarter 2003, Pegasus Satellite
issued $94.0 million principal amount of 11-1/4% senior notes due January 2010
("11-1/4% notes") in exchange for an aggregate equivalent principal amount of
its other outstanding notes, consisting of $21.9 million of 9-5/8% senior notes
due October 2005 ("9-5/8% notes"), $28.6 million of 12-3/8% senior notes due
August 2006 ("12-3/8% notes"), $11.5 million of 9-3/4% senior notes due December
2006 ("9-3/4% notes"), and $32.0 million of 12-1/2% senior notes due August
2007. Interest accrued to the date of the exchanges aggregating $2.6 million on
the notes received in the exchanges was settled in cash. The principal effect of
this exchange was to extend the maturity of $94.0 million of principal
outstanding, with a net reduction in cash interest to be paid for the remainder
of 2003 of $1.3 million. The aggregate difference associated with all of the
notes exchanged in the amount of cash interest to be paid after 2003 and
interest expense for the remainder of 2003 through the date of the earliest
maturity of the notes received is favorable but not significant. However, the
incremental aggregate interest expense to be incurred and cash interest to be
paid after the maturity date of each respective note received in the exchanges
will increase by the amount of interest associated with the 11-1/4% notes issued
in the exchanges, as long as the 11-1/4% notes remain outstanding. The terms and
conditions of the 11-1/4% notes issued in the exchange are the same as those
contained in the indenture for the notes of this series already outstanding. No
gain or loss was recognized on the exchanges, as the exchanges do not represent
extinguishments of debt. The unamortized balances of debt issue costs
associated with the notes received in the exchanges will be amortized over the
remainder of the term of the new notes issued in the exchanges. The following
table shows debt outstanding at June 30, 2003 compared December 31, 2002 (in
thousands):
June 30, December 31,
2003 2002
--------------- ---------------
Note payable to Pegasus Communications due October 2004 $ 50,827 $ 55,250
Term loan facility of Pegasus Media due April 2005 268,125 269,500
12-1/2% senior subordinated notes of Pegasus Media due July 2005, net
of unamortized discount of $651 thousand and $813 thousand,
respectively 67,244 67,082
Incremental term loan facility of Pegasus Media due July 2005 62,525 62,841
9-5/8% senior notes of Pegasus Satellite due October 2005 93,091 115,000
12-3/8% senior notes of Pegasus Satellite due August 2006 166,390 195,000
9-3/4% senior notes of Pegasus Satellite due December 2006 88,455 100,000
13-1/2% senior subordinated discount notes of Pegasus Satellite due
March 2007, net of unamortized discount of $13.4 million and $22.7
million, respectively 147,865 138,515
12-1/2% senior notes of Pegasus Satellite due August 2007 123,021 155,000
11-1/4% senior notes of Pegasus Satellite due January 2010 269,043 175,000
Other notes due 2004, stated interest up to 6.75% 425 2,674
--------------- ---------------
1,337,011 1,335,862
Less current maturities 3,807 5,631
--------------- ---------------
Long term debt $ 1,333,204 $ 1,330,231
=============== ===============
In July 2003, Pegasus Satellite issued $67.6 million principal amount
of 11-1/4% notes in exchange for an aggregate principal amount of $69.8 million
of its other outstanding notes, consisting of $11.5 million of 9-5/8% notes,
$8.2 million of 12-3/8% notes, $17.4 million of 9-3/4% notes, $4.5 million of
12-1/2% notes, and $28.2 million of 13-1/2% senior subordinated notes due March
2007 that had a carrying amount of $26.1 million.
11
PEGASUS SATELLITE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
On August 1, 2003, Pegasus Satellite borrowed all of the $100.0 million
term loan financing available under an amended and restated term loan agreement
with a group of institutional lenders initially entered into in April 2003. This
term loan is senior to all existing and future indebtedness of Pegasus
Satellite. All unpaid principal and interest is due August 1, 2009. The rate of
interest on outstanding principal is 12.5%. Interest is payable quarterly, of
which 48% is payable in cash and 52% is added to principal. Interest added to
principal is subject to interest at the full 12.5% rate thereafter. Principal
may be repaid prior to its maturity date, but principal repaid within three
years from the initial date of borrowing bears a premium of 103% in the first
year, 102% in the second year, and 101% in the third year. Principal repaid may
not be reborrowed. The proceeds received from this borrowing were used as
follows: $69.3 million was placed in trust to redeem in September 2003 all of
the outstanding principal of Pegasus Media's 12-1/2% notes of $67.9 million that
had a carrying amount of $67.3 million and accrued interest on the notes to the
date of their redemption of $1.4 million; $2.5 million was used to pay for
additional costs associated with the term loan agreement; and $28.2 million to
fund cash collateral placed into a separate letter of credit facility (discussed
below). Other costs associated with this agreement that had been previously
incurred amounted to $2.0 million. In connection with the term loan agreement,
Pegasus Communications issued 1.0 million warrants to purchase 1.0 million
shares of nonvoting common stock to the group of institutional investors
providing the funds for the term loan financing. We expect that the fair value
of the warrants will be reflected as a discount of the amount of the term loan
borrowed, and that this discount will be charged to interest expense over the
term of the related debt.
On July 31, 2003, a newly formed, wholly owned subsidiary of Pegasus
Media (the "LC subsidiary") entered into a letter of credit facility with a bank
for a maximum amount of $59.0 million that terminates in July 2004. The bank
issues letters of credit under the facility on behalf of the LC subsidiary.
Letters of credit issued are in favor of amounts owed to the National Rural
Telecommunications Cooperative ("NRTC") by subsidiaries of Pegasus Media other
than the LC subsidiary. The facility pays a quarterly fee of 1.75% of the amount
of letters of credit outstanding at the beginning of each quarterly payment
period. Outstanding letters of credit are secured with cash provided by the LC
subsidiary in an amount equal to 105% of the letters of credit outstanding. The
LC subsidiary is entitled to all earnings earned by the cash collateral. Cash
collateral provided by the LC subsidiary will be reported as restricted cash on
the consolidated balance sheets. On August 1, 2003, letters of credit were
issued aggregating $59.0 million, and the LC subsidiary provided cash collateral
of $61.9 million.
In July 2003, Pegasus Media amended its credit agreement and
obtained consents from the lenders thereunder with respect to the Pegasus
Satellite term loan facility discussed above. The effective date of the
amendment was August 1, 2003. On the effective date: 1) the commitment under the
revolving credit facility was permanently reduced by $60.0 million to $80.6
million; 2) the permanent quarterly commitment reductions under the revolving
credit facility were changed to $12.2 million on September 30, 2003 and $13.7
million every quarterly period ended thereafter until the facility's expiration
date of October 31, 2004; 3) letters of credit in favor of amounts owed to the
NRTC associated with the revolving credit facility prior to the amendment that
had the effect of reducing the availability of the facility are not associated
with the facility after the amendment; and 4) $1.9 million of term loan
principal and $468 thousand of incremental term principal, along with associated
accrued interest for each, were repaid. Aggregate costs incurred to amend the
credit agreement and for consent fees amounted to $1.5 million. Also on August
1, 2003, $17.0 million was borrowed under the revolving credit facility to fund
cash collateral under the letter of credit facility discussed above.
12
PEGASUS SATELLITE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
6. Supplemental Cash Flow Information
Significant noncash investing and financing activities were as follows
(in thousands):
Six Months
Ended June 30,
2003 2002
------------- ----------
Preferred stock dividends accrued and accretion $12,780 $ 11,776
Capitalization of interest accrued on note with Pegasus Communications 5,019 -
Payment of preferred stock dividends with like kind shares - 11,026
Net change in other comprehensive loss - 1,005
7. Income Taxes
For continuing operations, we had income tax expense of $138 thousand
for each of the three and six months ended June 30, 2003, compared to an income
tax benefit of $13.6 million and $28.1 million for the three and six months
ended June 30, 2002, respectively. The $138 thousand represents expense for
state income taxes payable. At June 30, 2003, we had a net deferred income tax
asset balance of $46.7 million, offset by a valuation allowance in the same
amount. The valuation allowance increased by $12.8 million and $23.8 million for
the three and six months ended June 30, 2003, respectively. These increases to
the valuation allowance were charged to income taxes for continuing operations
in the respective periods, thereby completely offsetting the benefits of
deferred income tax benefits generated during these periods and resulting in no
deferred income tax expense or benefit for the three and six months ended 2003.
We believed that a valuation allowance sufficient to bring the net
deferred income tax asset balance to zero at June 30, 2003 was necessary
because, based on our history of losses, it was more likely than not that the
benefits of the net deferred income tax asset will not be realized. Excluding
the effect of $138 thousand expense for state income taxes payable, our
effective income tax rate for continuing operations for each of the three and
six months ended June 30, 2003 was zero, compared to the overall effective
income tax rate for continuing operations for the year 2002 of 22.67%. The
effective rate for 2002 had been impacted by valuation allowances in 2002 that
generated the low rate for that year. No income taxes were attributed to
discontinued operations in 2003 because our overall deferred income tax expense
for 2003 is zero and there were no state income taxes payable associated with
these operations.
8. Dispositions
In March 2003, we completed the sale of our Mobile, Alabama broadcast
television station to an unaffiliated party. Cash received from the sale was
$11.0 million, and we recognized a gain on the sale of $7.6 million, net of
costs related to the sale. The operations and sale of this station are
classified as discontinued in the statement of operations and comprehensive loss
for all periods presented.
In April 2003, we entered into an agreement to sell our two broadcast
television stations located in Mississippi to an unaffiliated party for an
aggregate amount of $13.4 million in cash. The sale of tangible and intangible
property, other than the Federal Communications Commission ("FCC") licenses and
specific equipment associated with the licenses (collectively the "nonFCC
assets") of the two stations, closed on April 30, 2003. We received cash of $5.1
million in the sale of the nonFCC assets, and recognized a loss of $2.4 million,
net of costs related to the sale. Closing of the sale of the FCC licenses and
related equipment (collectively the "FCC assets") for the two stations is
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PEGASUS SATELLITE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
pending approval by the FCC of the transfer of the licenses to the buyer. We
expect that the close of the sale of the FCC assets will occur by the end of
2003. At the close of the sale of the nonFCC assets, we received $5.6 million
from the buyer related to the FCC assets, consisting of $5.5 million
nonrefundable prepayment on the assets and $108 thousand for a local marketing
arrangement with the buyer related to the operation of the stations pending
transfer of the FCC licenses. We will receive an additional $2.7 million upon
the close of the sale of the FCC assets. When the sale of the FCC assets is
completed, we expect that we will recognize a gain on this portion of the sale
of $4.8 million, net of costs related to the sale. The operations and recognized
sale portion of the Mississippi stations are classified as discontinued in the
statement of operations and comprehensive loss for all periods presented.
In a separate but concurrent transaction to the sale of the Mississippi
stations, we waived our rights under an option agreement to acquire a broadcast
television construction permit held by KB Prime Media and consented to the sale
of the permit by KB Prime Media to an unaffiliated party. As consideration for
our waiver and consent, we received $1.2 million in April 2003 that we recorded
as other nonoperating income. We will receive an additional $200 thousand for
our waiver and consent when the sale of the permit is completed. In association
with this transaction, $2.1 million of our cash collateralizing certain debt of
KB Prime Media was released, and an additional $600 thousand will be released
when the sale of the permit is completed. The sale of the permit will be
completed when the FCC approves the transfer of the permit by KB Prime Media to
the buyer of the permit. We expect the sale of permit to be completed by the end
of 2003. Pegasus Satellite is party to an option agreement 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. Mr. Butcher is the
stepfather of Marshall W. Pagon, chairman of the board of directors and chief
executive officer of Pegasus Satellite and Pegasus Communications. KB Prime
Media is one of the KB Companies.
Aggregate assets and liabilities associated with the broadcast
television stations above were not significant to our financial position to show
separately as held for sale on the balance sheet, but such have been classified
as other current and noncurrent assets and liabilities as appropriate.
We ceased operating our Pegasus Express business in 2002. Accordingly,
the operations for this business for 2002 were classified as discontinued in the
statement of operations and comprehensive loss. There were no assets or
liabilities of this business contained in the balance sheet at December 31,
2002.
Aggregate revenues for and pretax income (loss) from discontinued
operations were as follows (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
------------ ------------ ----------- ------------
Revenues $ 380 $ 2,461 $ 1,533 $ 4,959
Pretax income (loss) (2,567) (2,841) 4,616 (5,074)
In the pretax income (loss) from discontinued operations for the three
and six months ended 2003 above was a net loss of $2.4 million and a net gain of
$5.2 million, respectively, from the sale of the applicable assets. In the
pretax income (loss) from discontinued operations for the three and six months
ended 2002 above is an aggregate $1.7 million for impairment losses associated
with the broadband business. No income taxes were attributed to discontinued
operations in 2003 because our overall deferred income tax expense for 2003 is
zero and there were no state income taxes payable associated with these
operations.
14
PEGASUS SATELLITE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
9. Industry Segments
Our only reportable segment at June 30, 2003 was our direct broadcast
satellite business. Information on the direct broadcast satellite business'
revenue and how it contributed 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. The direct broadcast satellite
business derived all of its revenues from external customers for each period
presented. Identifiable total assets for the direct broadcast satellite business
were approximately $1.7 billion at June 30, 2003, which were not significantly
different from those at December 31, 2002. We evaluate the direct broadcast
satellite business segment based on its EBITDA, which we define as the direct
broadcast satellite business' net operating revenue less its operating expenses
(excluding depreciation and amortization), as derived from the statements of
operations and comprehensive loss, excluding $4.5 million for a contract
termination fee reversal in 2003 included in other subscriber related costs in
the statement of operations and comprehensive loss.
10. 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 NRTC that participate through agreements
in the NRTC's direct broadcast satellite program. "DIRECTV" refers to the
programming services provided by DIRECTV, Inc.
On June 3, 1999, the NRTC filed a lawsuit in United States District
Court, Central District of California against DIRECTV, Inc. seeking a court
order to enforce the NRTC's contractual rights to obtain from DIRECTV, Inc.
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, Inc. filed a
counterclaim seeking judicial clarification of certain provisions of DIRECTV,
Inc.'s contract with the NRTC. On August 26, 1999, the NRTC filed a separate
lawsuit in United States District Court, Central District of California against
DIRECTV, Inc. claiming that DIRECTV, Inc. had failed to provide to the NRTC its
share of launch fees and other benefits that DIRECTV, Inc. and its affiliates
have received relating to programming and other services. The NRTC and DIRECTV,
Inc. have also filed indemnity claims against one another that pertain to the
alleged obligation, if any, of the NRTC to indemnify DIRECTV, Inc. 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.
DIRECTV, Inc. is seeking as part of its counterclaim a declaratory
judgment that the term of the NRTC's agreement with DIRECTV, Inc. is measured
only by the life of DBS-1, the first DIRECTV satellite launched, and not the
orbital lives of the other DIRECTV satellites at the 101(degree) W orbital
location. If DIRECTV, Inc. were to prevail on its counterclaim, any failure of
DBS-1 could adversely impact our DIRECTV rights. On May 22, 2003, the Court
issued an order denying DIRECTV, Inc.'s motion for summary judgment relating to
the term of the agreement. While the NRTC has a right of first refusal to
receive certain services after the term of NRTC's agreement with DIRECTV, Inc.,
the scope and terms of this right of first refusal are also being disputed as
part of DIRECTV, Inc.'s counterclaim. On December 29, 1999, DIRECTV, Inc. filed
a motion for partial summary judgment seeking an order that the right of first
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PEGASUS SATELLITE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
refusal does not include programming services and is limited to 20 program
channels of transponder capacity. On January 31, 2001, the Court issued an order
denying DIRECTV Inc.'s motion for partial summary judgment relating to the right
of first refusal.
On July 3, 2002, the Court granted a motion for partial summary
judgment filed by DIRECTV, Inc., holding that the NRTC is liable to indemnify
DIRECTV, Inc. for the costs of defense and liabilities that DIRECTV, Inc. incurs
in a patent case filed by Pegasus Development Corporation ("PDC"), a subsidiary
of Pegasus Communications, and Personalized Media Communications, L.L.C.
("Personalized Media") in December 2000 in the United States District Court,
District of Delaware against DIRECTV, Inc., Hughes Electronics Corporation,
Thomson Consumer Electronics, and Philips Electronics North America Corporation.
Personalized Media is a company with which PDC has a licensing arrangement. In
February 2003, the United States District Court, District of Delaware granted
PDC's and Personalized Media's motion for leave to amend the complaint to
exclude relief for the delivery nationwide, using specified satellite capacity,
of services carried for the NRTC, plus any other services delivered through the
NRTC to subscribers in the NRTC's territories. The NRTC filed a motion with the
United States District Court, Central District of California to reconsider its
July 3, 2002 decision that the NRTC indemnify DIRECTV, Inc. for DIRECTV, Inc.'s
costs of defense and liabilities from the patent litigation. The motion was
heard by the Court on June 2, 2003. On June 10, 2003, the Court granted the
NRTC's motion for reconsideration, reversed the partial summary judgment
previously granted to DIRECTV, Inc., and granted partial summary judgment in
favor of the NRTC. The Court's ruling provides that the NRTC has no obligation
to indemnify DIRECTV, Inc. for the costs of defense or liabilities that DIRECTV,
Inc. incurs in the patent litigation, based on the allegations of the amended
complaint.
PDC 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 PDC is an exclusive
licensee within a field of use. The technologies covered by PDC'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, Inc. to provide services
to its subscribers. We are unable to predict the possible effects of this
litigation on our relationship with DIRECTV, Inc.
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, Inc. 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, Inc.'s
failure to provide the NRTC with certain premium programming, and on DIRECTV,
Inc.'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, and withdrew the class action
allegations to allow a new class action to be filed on behalf of the members and
affiliates of the NRTC. The amended complaint also added claims regarding
DIRECTV Inc.'s failure to allow distribution through the NRTC of various
advanced services, including Tivo. 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, Inc. filed a counterclaim against PST and GSS, as well
as the class members, seeking two claims for relief: 1) a declaratory judgment
whether DIRECTV, Inc. is under a contractual obligation to provide PST and GSS
with services after the expiration of the term of their agreements with the NRTC
and 2) an order that DBS-1 is the satellite (and the only satellite) that
16
PEGASUS SATELLITE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
measures the term of PST's and GSS' agreements with the NRTC. On October 29,
2001, the Court denied DIRECTV Inc.'s motion for partial summary judgment on its
term counterclaim. On June 20, 2001, PST and GSS filed a second amended
complaint, updating the claims asserted in the earlier complaints.
On June 22, 2001, DIRECTV, Inc. 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, Inc. and PST and GSS. On July 13, 2001, PST and GSS
terminated the seamless marketing agreement. The seamless marketing agreement
provided seamless marketing and sales for DIRECTV retailers and distributors. On
July 16, 2001, PST and GSS filed a cross complaint against DIRECTV, Inc.
alleging, among other things, that 1) DIRECTV, Inc. breached the seamless
marketing agreement and 2) DIRECTV, Inc. engaged in unlawful and/or unfair
business practices, as defined in Section 17200, et seq. of the California
Business and Professions Code. This suit has since been removed to the United
States District Court, Central District of California. On September 16, 2002,
PST and GSS filed first amended counterclaims against DIRECTV, Inc. Among other
things, the first amended counterclaims added claims for 1) rescission of the
seamless marketing agreement on the ground of fraudulent inducement, 2) specific
performance of audit rights, and 3) 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
tortious interference that were alleged in the initial cross complaint. On
November 5, 2002 the Court granted DIRECTV, Inc.'s motion to dismiss 1) the
specific performance claim and 2) the punitive damages allegations on the breach
of the implied covenant of good faith claim. The Court denied DIRECTV, Inc.'s
motion to dismiss the implied covenant of good faith claim in its entirety.
DIRECTV, Inc. filed four summary judgment motions on September 11, 2002
against the 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 1)
the term of the agreement between the NRTC and DIRECTV, Inc., 2) the right of
first refusal as it relates to PST and GSS, 3) the right to distribute the
premiums, and 4) damages relating to the premiums, launch fees, and advanced
services claims. These motions were argued on May 5, 2003 and decided on May 22,
2003, and were then the subject of a motion for reconsideration argued on June
2, 2003 and decided on June 5, 2003.
As a result of these and earlier rulings, the term of the agreement,
the content of the right of first refusal, and plaintiffs rights to launch fees
and advanced services and to distribute premiums will all be determined at
trial. The Court dismissed PST's tort and punitive damage claims and the
restitution aspects of PST's unfair business practices claim other than with
respect to launch fees. The Court did not dismiss the injunctive relief portions
of the unfair business practices claim. The Court also ruled that DIRECTV, Inc.
has no obligation to provide PST with services after the Member Agreements
between PST and the NRTC expire, except that the ruling does not affect: (1)
obligations the NRTC has or may have to PST under the Member Agreements or
otherwise; (2) obligations DIRECTV, Inc. has or may have in the event it steps
into the shoes of the NRTC as the provider of services to PST; or (3) fiduciary
or cooperative obligations to deliver services owed PST by DIRECT, Inc. through
the NRTC.
On July 25, 2003, the Court ruled on motions in limine filed by all
parties. While the rulings narrowed certain issues to be presented to the Court,
it did not materially alter any of the parties' causes of action. The Court also
denied DIRECTV, Inc.'s motion to dismiss PST and GSS, among others, on
jurisdictional grounds.
The lawsuits described above, including both lawsuits brought by the
NRTC, the class action and PST's and GSS' lawsuit (but excluding the indemnity
and seamless marketing lawsuits) were set to be tried in phases before the same
17
PEGASUS SATELLITE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
judge beginning August 14, 2003. The first phase of the trial was to include
issues relating to term and the right of first refusal. However, the Court was
informed of a conditional settlement reached among DIRECTV, Inc., the NRTC and
the class relating to all of their claims; and, on August 12, 2003, the Court
vacated the trial date and set a status conference for September 4, 2003. The
Court also ordered further settlement proceedings between DIRECTV, Inc. and PST.
The announced settlement among DIRECTV, Inc., the NRTC and the class is
conditioned on a satisfactory "fairness hearing" conducted by the Court relating
to the class claims, the date of which has not been set but is anticipated to be
held in approximately 75 to 90 days. We do not believe that the proposed
settlement will resolve the pending claims between DIRECTV, Inc. and PST and
GSS. PST and GSS are in the process of evaluating the settlement. We have filed
copies of the proposed settlement with a Form 8-K dated August 11, 2003.
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. We believe
that the ultimate liability, if any, with respect to these claims will not have
a material effect on our consolidated operations, cash flows, or financial
position.
Commitments
Customer Relationship Management Services:
In the second quarter 2002, we recorded a termination fee liability of
$4.5 million and associated expense to the direct broadcast satellite business'
other subscriber related expense with respect to an agreement for customer
relationship management services that we intended to terminate early. The
termination fee was to be paid and the termination was to be effective in July
2003. During the second quarter 2003, we amended this agreement and the
termination fee was no longer payable. Accordingly, during the second quarter
2003 we reversed the termination fee liability and reduced direct broadcast
satellite's other subscriber related expenses by $4.5 million. The amended
agreement does not require any minimum annual services amount, whereas the
agreement prior to the amendment required a prorated minimum annual services
amount of $10.9 million for 2003.
11. Related Party Transactions
During the six months ended June 30, 2003, Pegasus Satellite purchased
202,960 shares of Pegasus Communications' Class A common stock for an aggregate
amount of $3.7 million.
12. New Accounting Pronouncements
On April 30, 2003, the Financial Accounting Standards Board ("FASB")
issued Statement No. 149 "Amendment of Statement 133 on Derivative Instruments
and Hedging Activities" ("FAS 149"). FAS 149 amends and clarifies various items
and issues related to derivative instruments. There was no material impact to us
upon the adoption of this statement.
The FASB issued Statement No. 150 "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity" ("FAS 150") in
May 2003. FAS 150 establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both liabilities
and equity. It requires that an issuer classify a financial instrument within
its scope as a liability (or an asset in some circumstances). Many of those
instruments were previously classified as equity. FAS 150 requires, among other
18
PEGASUS SATELLITE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
things, an issuer to classify a financial instrument issued in the form of
shares that is mandatorily redeemable as a liability. We believe that our
redeemable preferred stocks will be subject to the requirements of FAS 150 and
may need to be classified as liabilities. However, we are still studying the
provisions of the statement to determine the exact impact. Because the
instruments covered by FAS 150 are far reaching, it is possible that we may have
other instruments subject to the statement for which we continue to study the
provisions of the statement to determine what, if any, further impact there may
be to us. FAS 150 is effective for us in the third quarter 2003.
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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, although not all forward looking statements contain these
identifying words. 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 the risks described
elsewhere in this report and, among others, 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 third parties like DIRECTV, Inc. and the
National Rural Telecommunications Cooperative; litigation with DIRECTV, Inc.;
the potential sale of DIRECTV, Inc.; demographic changes; existing government
regulations, and changes in, or the failure to comply with, government
regulations; competition, including our ability to offer local programming in
our direct broadcast satellite markets; 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 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 other reports 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, 2002. Readers are cautioned not
to place undue reliance on these forward looking statements, which speak only as
of the date hereof. 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 results of operations should be read in
conjunction with the consolidated financial statements and related notes herein.
General
All references to "we," "us," and "our" refer to Pegasus Satellite
Communications, Inc., together with its direct and indirect subsidiaries.
"Pegasus Satellite" refers to Pegasus Satellite Communications, Inc.
individually as a separate entity. "Pegasus Communications" refers to Pegasus
Communications Corporation, the parent company of Pegasus Satellite. "Pegasus
Media" refers to Pegasus Media & Communications, Inc., a wholly owned subsidiary
of Pegasus Satellite. Other terms used are defined as needed where they first
appear.
We have a history of losses principally due to the substantial amounts
incurred for interest expense and depreciation and amortization. Net losses were
$109.4 million, $285.2 million, and $159.0 million for 2002, 2001, and 2000,
respectively.
Our principal business is the direct broadcast satellite business. For
2002, 2001, and 2000, revenues for this business were 96%, 96%, and 94%,
respectively, of total consolidated revenues, and operating expenses for this
business were 91%, 92%, and 92%, respectively, of total consolidated operating
expenses. Total assets of the direct broadcast satellite business were 93% and
94% of total consolidated assets at December 31, 2002 and 2001, respectively.
The following sections focus on our direct broadcast satellite business, as this
is our only significant business segment.
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PEGASUS SATELLITE COMMUNICATIONS, INC.
Significant Risks and Uncertainties
We are highly leveraged. At June 30, 2003, we had a combined carrying
amount of long term debt, including the portion that is current, and redeemable
preferred stock outstanding of $1.5 billion. Our high leverage makes us more
vulnerable to adverse economic and industry conditions and limits our
flexibility in planning for, or reacting to, changes in our business and the
industries in which we operate. 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 and to fund the preferred
stock requirements of Pegasus Communications 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 and subscriber acquisition costs ("SAC"), 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 adversely impact us.
We are in litigation against DIRECTV, Inc. An outcome in this
litigation that is unfavorable to us could adversely impact our direct broadcast
satellite business. Our litigation with DIRECTV, Inc. may have a bearing on our
estimation of the useful lives of our direct broadcast satellite rights assets.
See Note 10 of the Notes to Consolidated Financial Statements for information
regarding this litigation.
Because we are a distributor of DIRECTV, we may be adversely affected
by any material adverse changes in the assets, financial condition, programming,
technological capabilities, or services of DIRECTV, Inc.
For the six months ended June 30, 2003 and 2002, the direct broadcast
satellite business had income from operations of $26.5 million and $22.4
million, respectively. We attribute the improvement in the current year to our
direct broadcast satellite business strategy. This strategy focuses on:
increasing the quality of new subscribers and the composition of our existing
subscriber base; enhancing the returns on investment in our subscribers;
generating free cash flow; and preserving liquidity. The primary focus of our
"Quality First" strategy is on improving the quality and creditworthiness of our
subscriber base. Our goal is to acquire and retain high quality subscribers, to
cause average subscribers to become high quality subscribers, and to reduce
acquisition and retention investments in low quality subscribers. To achieve
these goals, our subscriber acquisition, development, and retention efforts
focus on subscribers who are less likely to churn and who are more likely to
subscribe to more programming services, including local and network programming,
and to use multiple receivers. "Churn" refers to subscribers whose service has
terminated. Our strategy includes a significant emphasis on credit scoring of
potential subscribers, adding and upgrading subscribers in markets where DIRECTV
offers local channels, and who subscribe to multiple receivers. It is our
experience that these attributes are closely correlated with lower churn,
increased cash flow, and higher returns on investment. Our strategy also
includes the use of behavioral and predictive scores to group subscribers and to
design retention campaigns, upgrade offers, and consumer offers consistent with
our emphasis on acquiring and retaining high quality subscribers and reducing
our investment in lower quality subscribers.
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PEGASUS SATELLITE COMMUNICATIONS, INC.
Continued improvement in results from operations will in large part
depend upon our obtaining a sufficient number of quality subscribers, retention
of these subscribers for extended periods of time, and improving margins from
them. While our direct broadcast satellite business strategy has resulted in an
increase in income from operations, it has contributed to a certain extent to
the decrease in the number of our direct broadcast satellite subscribers of 76
thousand and the decrease of $19.8 million in the direct broadcast satellite
business' net revenues during the six months ended June 30, 2003 compared to the
six months ended June 30, 2002. In the near term, our direct broadcast satellite
business strategy may result in further decreases in the number of our direct
broadcast satellite subscribers and our direct broadcast satellite business' net
revenues when compared to prior periods, but we believe that our results from
operations for the direct broadcast satellite business will not be significantly
impacted. We cannot make any assurances that this will be the case, however. If
a disproportionate number of subscribers churn relative to the number of quality
subscribers we enroll, we are not able to enroll a sufficient number of quality
subscribers, and/or we are not able to maintain adequate margins from our
subscribers, our results from operations may not improve or improved results
that do occur may not be sustained.
Results of Operations
In this section, amounts and changes specified are for the three and
six months ended June 30, 2003 compared to the three and six months ended June
30, 2002, respectively, unless indicated otherwise. With respect to our results
from operations, we focus on our direct broadcast satellite business, as this is
our only significant business.
Direct Broadcast Satellite Business
We had 1,232,744 subscribers at June 30, 2003, a net decrease of 75,726
from the number of subscribers at December 31, 2002. The average number of
subscribers outstanding was 1,254,436 and 1,273,926 during the three and six
months ended June 30, 2003, respectively, and 1,375,249 and 1,377,063 during the
three and six months ended June 30, 2002, respectively. Gross subscriber
additions were 31,577 and 70,567 for the three and six months ended June 30,
2003, respectively, and 50,262 and 114,811 for the three and six months ended
June 30, 2002, respectively. We believe that the primary reasons for the net
decreases in the number of subscribers during the 2003 periods were: a
significant competitive disadvantage that we experienced in several of our
territories in which a competing direct broadcast satellite provider provides
local channels but DIRECTV does not; our continued focus in 2003 on enrolling
more creditworthy subscribers; our unwillingness to aggressively invest
retention amounts in low margin subscribers; competition from digital cable
providers; competition from a competing direct broadcast satellite provider
other than with respect to local channels; the effect of general economic
conditions on our subscribers and potential subscribers; and a reduction in the
number of new subscribers we obtain from national retail chains with which we do
not have compensation arrangements.
Revenues:
Revenues decreased $10.6 million to $205.8 million and $19.8 million to
$411.4 million for the three and six months 2003, respectively. These decreases
were primarily due to decreases in our recurring subscription revenue from our
core, a la carte, and premium package offerings of $10.6 million and $22.5
million, respectively, and decreases in pay per view revenues of $4.1 million
and $7.8 million, respectively. The revenue decreases were partially offset by
$5.2 million and $10.4 million for the three and six months 2003 in revenues
from a royalty fee introduced in July 2002 that passes on to subscribers a
portion of the royalty costs charged to us in providing DIRECTV service. The
decreases from our core, a la carte, and premium package offerings were
primarily due to the net reduction in total subscribers described above, offset
in part by increased average monthly revenue generated per subscriber ("ARPU")
22
PEGASUS SATELLITE COMMUNICATIONS, INC.
in each 2003 period compared to the corresponding 2002 period. ARPU is direct
broadcast satellite revenues for the period divided by the average number of
subscribers during the period, divided by the number of months in the period.
Total ARPU increased from $52.46 in 2002 to $54.69 in 2003 for the three months
ended, and from $52.18 in 2002 to $53.52 in 2003 for the six months ended. ARPU
for core, a la carte, and premium programming increased from $44.42 in 2002 to
$45.88 in 2003 for the three months ended, and from $44.41 in 2002 to $45.05 in
2003 for the six months ended. A rate increase to certain a la carte and premium
programming in second quarter 2003, as well as our ability to keep subscribers
in and upgrade subscribers into higher retail priced packages, contributed to
the increases in ARPU.
Revenues for the second quarter 2003 were flat compared to the first
quarter 2003 primarily due to a decrease in subscribers in the second quarter
offset by increased average monthly revenue generated per subscriber in the
second quarter. Total ARPU increased from $52.97 in the first quarter 2003 to
$54.69 in the second quarter 2003. ARPU for core, a la carte, and premium
programming increased from $44.25 in the first quarter 2003 to $45.88 in the
second quarter 2003. A rate increase to certain a la carte and premium
programming in second quarter 2003, as well as our ability to keep subscribers
in and upgrade subscribers into higher retail priced packages contributed to the
increases in ARPU.
Direct Operating Expenses:
Programming expense decreased $3.5 million to $92.5 million and $6.6
million to $185.7 million for the three and six months 2003, respectively. These
decreases were primarily due to: decreases in the cost of our recurring core, a
la carte, and premium package subscription offerings of $2.7 million and $6.3
million, respectively; and decreases in the cost of our pay per view programming
of $1.8 million and $3.3 million, respectively. The decreases in the cost of our
core, a la carte, and premium package offerings were primarily due to the net
reduction in total subscribers, offset by a 7% increase, effective January 2003,
in certain per subscriber programming costs charged to us by the National Rural
Telecommunications Cooperative ("NRTC"). We also experienced a 10% increase,
effective January 2003, in certain pay per view programming costs charged to us
by the NRTC. These net decreases to programming expense were also partially
offset by our estimate of patronage to be received from the NRTC being $3.1
million and $6.4 million less for the three and six months 2003, respectively,
compared to the corresponding 2002 periods. The NRTC patronage is a reduction to
programming expense.
Other subscriber related expenses decreased $8.5 million to $40.6
million and $15.6 million to $85.2 million for the three and six months 2003,
respectively. Within each 2003 period was a reduction of expenses of $4.5
million for the reversal in the second quarter 2003 of a contract termination
fee recorded in 2002 and scheduled to be paid in July 2003 for a contract
intended to be terminated in July 2003. However, in the second quarter 2003 the
associated agreement was amended and continued. The remaining decreases were
primarily due to decreases in bad debt expense of $3.3 million and $9.8 million,
respectively, mainly due to our continued focus on improving the quality of our
subscriber base that we obtain and retain and improved account collection
efforts.
Other Operating Expenses:
Promotion and incentives and advertising and selling expenses on our
statement of operations and comprehensive loss constitute expensed SAC. Expensed
SAC is the gross amount of SAC we incur less amounts of SAC deferred and/or
capitalized. Commissions, subsidies, and promotional programming are costs
included in SAC that are incurred only when new subscribers are enrolled.
Commissions and subsidies are the substantial cost elements within our SAC.
Amounts associated with SAC are contained in the following table:
23
PEGASUS SATELLITE COMMUNICATIONS, INC.
Three Months Ended Six Months Ended
SAC (in thousands): June 30, June 30,
Expensed: 2003 2002 2003 2002
----------- ----------- ----------- ------------
Promotions and incentives $ 3,595 $ 2,027 $ 6,473 $ 3,770
Advertising and selling 6,572 7,820 12,298 16,121
----------- ----------- ----------- ------------
Total expensed 10,167 9,847 18,771 19,891
Deferred 4,368 7,719 10,569 17,326
Capitalized 4,684 7,458 10,114 13,497
----------- ----------- ----------- ------------
Gross SAC incurred $ 19,219 $ 25,024 $ 39,454 $ 50,714
=========== =========== =========== ============
Gross SAC decreased in the 2003 periods primarily due to a lesser
amount of gross subscriber additions in the 2003 periods compared to the
respective corresponding 2002 periods. Promotions and incentives expense
increased in the 2003 periods because in 2002 a greater percentage of the
related costs were eligible for either deferral or capitalization. In accordance
with our policy whereby we expense SAC in excess of amounts eligible to be
deferred, we incurred more of these excess promotions and incentive costs in the
2003 periods than in the respective corresponding 2002 periods. Based on gross
subscriber additions for the respective 2003 and 2002 periods noted above, total
SAC per gross subscriber added was $609 and $559 for the three and six months
2003, respectively, and $498 and $458 for the three and six months 2002,
respectively. The increases in the 2003 periods compared to the corresponding
2002 periods were primarily due to: the disproportionate impact our sales
administration costs and other indirect SAC expenses have on the SAC per gross
subscriber addition metric when divided by a substantially lesser number of
gross subscriber additions; a greater percentage of our gross subscriber
additions taking more than one receiver that adds incrementally to the per
subscriber cost; a lesser percentage in 2003 compared to 2002 of our gross
subscriber additions coming from national retailers with which we do not have
compensation arrangements; and the higher per subscriber costs associated with
enrolling more creditworthy subscribers and the proportionately greater number
of such subscribers enrolled in 2003 than in 2002.
Depreciation of capitalized SAC was $4.4 million and $8.8 million for
the three and six months 2003, respectively, and $3.3 million and $6.0 million
for the three and six months 2002, respectively. Amortization of deferred SAC
was $6.5 million and $14.1 million for the three and six months 2003,
respectively, and $7.7 million and $13.5 million for the three and six months
2002, respectively. Depreciation of capitalized SAC and amortization of deferred
SAC are included in depreciation and amortization.
General and administrative expenses decreased $952 thousand to $5.9
million and $2.5 million to $12.3 million for the three and six months 2003,
respectively, primarily due to reduced expenditures for communication services
resulting from a renegotiation at the end of March 2002 of the related contract
for such services and continuing cost reduction efforts in the 2003 periods that
realized incremental cost reductions over the corresponding 2002 periods.
Depreciation and amortization decreased $644 thousand to $40.8 million
for the three months 2003 and increased $1.9 million to $82.8 million for the
six months 2003. The changes in depreciation and amortization year over year for
the corresponding periods are primarily due to the amounts of deferred SAC
amortized in those periods. Deferred SAC is amortized over 12 months from the
date it is incurred, which is when a new subscriber is added. The decrease in
depreciation and amortization for the three months 2003 is primarily due to a
lesser amount of deferred SAC eligible for amortization during the period
compared to the corresponding 2002 period resulting from a decreased number of
24
PEGASUS SATELLITE COMMUNICATIONS, INC.
subscribers added in the four quarters ended with the second quarter 2003
compared to the four quarters ended with the second quarter 2002.
Other Statement of Operations and Comprehensive Loss Items
Corporate expenses decreased $468 thousand to $3.6 million and $1.2
million to $7.4 million for the three and six months ended 2003, respectively,
primarily due to cost reduction measures that began in but were not yet fully
effected in the second quarter 2003. Other operating expenses, net increased
$2.8 million to $8.3 million and $1.1 million to $14.6 million for the three and
six months ended 2003, respectively. The increase in the three months ended 2003
was primarily due to increased incentive compensation of $3.9 million, offset in
part by reduced DIRECTV, Inc. litigation costs of $464 thousand and severance
costs of $792 thousand recorded in 2002. The increase in the six months ended
2003 was primarily due to increased incentive compensation of $5.5 million,
offset in part by severance costs of $1.9 million and write off of asset costs
due to impairment of $1.7 million in 2002.
Interest expense increased $713 thousand to $36.8 million and $2.8
million to $74.7 million for the three and six months 2003, respectively. These
increases were primarily due to interest of $978 thousand and $2.1 million,
respectively, incurred on Pegasus Satellite's promissory note with Pegasus
Communications and $865 thousand and $1.7 million, respectively, of interest
accrued on dividends in arrears, offset in part by a reduction of $569 thousand
and $1.1 million, respectively, associated with notes of Pegasus Media that we
repurchased in the third quarter 2002. The three months 2003 increase was also
partially offset by a reduction of $576 thousand due to a net reduction of
interest associated with our credit facilities, including the effect of our
interest rate swaps that terminated in the first quarter 2003.
The loss on impairment of marketable securities for the three and six
months 2002 was due to the write off of an investment in the common stock of
another entity we owned at the time to the stock's then fair market value. The
increase in other nonoperating income, net of $1.1 million and $1.3 million for
the three and six months 2003, respectively, was primarily due to the cash
income of $1.2 million we received from the waiver of our rights over and our
consent to sell a broadcast television construction permit held by another
party.
For continuing operations, we had income tax expense of $138 thousand
for each of the three and six months ended 2003, compared to an income tax
benefit of $13.6 million and $28.1 million for the three and six months ended
2002, respectively. The $138 thousand represents expense for state income taxes
payable. At June 30, 2003, we had a net deferred income tax asset balance of
$46.7 million, offset by a valuation allowance in the same amount. The valuation
allowance increased by $12.8 million and $23.8 million for the three and six
months ended June 30, 2003, respectively. These increases to the valuation
allowance were charged to income taxes for continuing operations in the
respective periods, thereby completely offsetting the benefits of deferred
income tax benefits generated during these periods and resulting in no deferred
income tax expense or benefit for the three months and six months 2003. We
believed that a valuation allowance sufficient to bring the net deferred income
tax asset balance to zero at June 30, 2003 was necessary because, based on our
history of losses, it was more likely than not that the benefits of the net
deferred income tax asset will not be realized. Excluding the effect of $138
thousand expense for state income taxes payable, our effective income tax rate
for continuing operations for each of the three and six months ended June 30,
2003 was zero, compared to the overall effective income tax rate for continuing
operations for the year 2002 of 22.67%. The effective rate for 2002 had been
impacted by valuation allowances in 2002 that generated the low rate for that
year.
25
PEGASUS SATELLITE COMMUNICATIONS, INC.
Discontinued operations for 2003 and 2002 consisted of a broadcast
television station located in Mobile, Alabama and two stations located in
Mississippi, and for 2002, our Pegasus Express business that we ceased in 2002.
In March 2003, we completed the sale of our Alabama station, and recognized a
gain on the sale of $7.6 million, net of costs related to the sale. The
operations and sale of this station are classified as discontinued in the
statement of operations and comprehensive loss for all periods presented. In
April 2003, we sold tangible and intangible property, other than the Federal
Communications Commission ("FCC") licenses and specific equipment associated
with the licenses for the Mississippi stations and recognized a loss of $2.4
million, net of costs related to the sale. Closing of the sale of the FCC
licenses and related equipment (collectively the "FCC assets") of these two
stations is pending approval by the FCC of the transfer of the licenses to the
buyer. We expect that the close of the sale of the FCC assets will occur by the
end of 2003. When the sale of the FCC assets is completed, we expect that we
will recognize a gain on this portion of the sale of $4.8 million, net of costs
related to the sale. The operations and recognized sale portion of the
Mississippi stations are classified as discontinued in the statement of
operations and comprehensive loss for all periods presented. We ceased operating
our Pegasus Express business in 2002. Accordingly, the operations for this
business for 2002 were classified as discontinued in the statement of operations
and comprehensive loss. Aggregate revenues for and pretax income (loss) from
discontinued operations were as follows (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
------------ ------------ ----------- ------------
Revenues $ 380 $ 2,461 $ 1,533 $ 4,959
Pretax income (loss) (2,567) (2,841) 4,616 (5,074)
In the pretax income (loss) from discontinued operations for the three
and six months ended 2003 above was a net loss of $2.4 million and a net gain of
$5.2 million, respectively, from the sale of the applicable assets. In the
pretax income (loss) from discontinued operations for the three and six months
ended 2002 above is an aggregate $1.7 million for impairment losses associated
with the broadband business. No income taxes were attributed to discontinued
operations in 2003 because our overall deferred income tax expense for 2003 is
zero and there were no state income taxes payable associated with these
operations.
In a series of exchanges in the second quarter 2003, Pegasus Satellite
issued $94.0 million principal amount of 11-1/4% senior notes due January 2010
("11-1/4% notes") in exchange for an aggregate equivalent principal amount of
its other outstanding notes, consisting of $21.9 million of 9-5/8% senior notes
due October 2005 ("9-5/8% notes"), $28.6 million of 12-3/8% senior notes due
August 2006 ("12-3/8% notes"), $11.5 million of 9-3/4% senior notes due December
2006 ("9-3/4% notes"), and $32.0 million of 12-1/2% senior notes due August
2007. The aggregate difference associated with all of the notes exchanged in the
amount of interest expense for the remainder of 2003 through the date of the
earliest maturity of the notes received is favorable but not significant.
However, the incremental aggregate interest expense to be incurred after the
maturity date of each respective note received in the exchanges will increase by
the amount of interest associated with the 11-1/4% notes issued in the
exchanges, as long as the 11-1/4% notes remain outstanding. No gain or loss was
recognized on the exchanges, as the exchanges do not represent extinguishments
of debt.
In July 2003, Pegasus Satellite issued $67.6 million principal amount
of 11-1/4% notes in exchange for an aggregate principal amount of $69.8 million
of its other outstanding notes, consisting of $11.5 million of 9-5/8% notes,
$8.2 million of 12-3/8% notes, $17.4 million of 9-3/4% notes, $4.5 million of
12-1/2% notes, and $28.2 million of 13-1/2% senior subordinated notes due March
2007.
26
PEGASUS SATELLITE COMMUNICATIONS, INC.
On August 1, 2003, Pegasus Satellite borrowed $100.0 million in term
loans that bear interest at 12.5% and are due August 2009 from which was repaid
all of the $67.9 million principal outstanding of Pegasus Media's 12-1/2% notes
due July 2005 that will have an incremental effect on future interest expense.
In connection with the term loan agreement, Pegasus Communications issued 1.0
million warrants to purchase 1.0 million shares of nonvoting common stock to the
group of institutional investors providing the funds for the term loan
financing. We expect that the fair value of the warrants will be reflected as a
discount of the amount of the term loan borrowed, and that this discount will be
charged to interest expense over the term of the related debt.
DBS EBITDA
EBITDA for our direct broadcast satellite business ("DBS EBITDA") was
$52.2 million and $54.6 million for three months ended June 30, 2003 and 2002,
respectively, and $104.8 million and $103.3 million for the six months ended
June 30, 2003 and 2002, respectively. We present DBS EBITDA because the direct
broadcast satellite business is our only significant business and this business
forms the principal portion of our results of operations. The calculation of DBS
EBITDA and a reconciliation of DBS EBITDA to its most comparable GAAP financial
measure of net loss follows (in thousands). All amounts are as contained on our
consolidated statement of operations and comprehensive loss.
For the Three Months For the Six Months
Ended June 30, Ended June 30,
2003 2002 2003 2002
-------------- ------------- -------------- -------------
Direct broadcast satellite net revenues $ 205,823 $ 216,447 $ 411,369 $ 431,171
Direct broadcast satellite operating
expenses, excluding depreciation and
amortization and contract termination fee
reversal (153,613) (161,814) (306,521) (327,834)
-------------- ------------- -------------- -------------
DBS EBITDA 52,210 54,633 104,848 103,337
Direct broadcast satellite depreciation and
amortization (40,843) (41,487) (82,829) (80,937)
Contract termination fee reversal 4,500 - 4,500 -
Broadcast and other operations, net 612 (44) 291 (809)
Corporate and development expenses (3,604) (4,072) (7,360) (8,523)
Other operating expenses, net (8,263) (5,490) (14,580) (13,526)
-------------- ------------- -------------- -------------
(Income) loss from operations 4,612 3,540 4,870 (458)
Interest expense (36,826) (36,113) (74,728) (71,967)
Interest income 65 116 129 305
Other nonoperating income (expenses), net 1,173 (2,950) 2,527 (1,824)
Net income tax (expense) benefit for
continuing operations (138) 13,648 (138) 28,109
Discontinued operations, net (2,567) (1,761) 4,616 (3,145)
-------------- ------------- -------------- -------------
Net loss $ (33,681) $ (23,520) $ (62,724) $ (48,980)
============== ============= ============== =============
We use DBS EBITDA as a measurement of earnings generated by the direct
broadcast satellite business that are available to reinvest in the business via
investments in deferred SAC and capital expenditures, to fund our debt service,
to potentially fund equity dividends, and to potentially fund other development
projects. We also use DBS EBITDA as a percentage of revenue as a measurement of
27
PEGASUS SATELLITE COMMUNICATIONS, INC.
operating efficiency, especially as benchmarked against competitors in the
industry. Further, we use DBS EBITDA as the denominator in measuring a modified
value to earnings multiple, to assess our enterprise value, and growth thereof
over time, especially as benchmarked against comparables in the industry.
Finally, we use DBS EBITDA as the denominator in measuring our leverage at
various points throughout our capital structure, and improvements made thereto
over time, especially as benchmarked against comparables in the industry. We
believe that investors, analysts, lenders, and other interested parties who
follow our industry use DBS EBITDA for the same reasons that we do. Investors,
analysts, lenders, and other interested parties who follow our industry rely on
the DBS EBITDA measure to make informed decisions, especially by benchmarking
against comparables in the industry. Our ability and desire to reinvest in the
DBS business, to fund debt service of the enterprise, to potentially fund equity
dividends, and to potentially fund other development projects is largely
dependent upon our ability to generate DBS EBITDA. We believe that the
limitation associated with the use of DBS EBITDA, as compared to net income, is
the number of items included or not included in DBS EBITDA that are included in
net income. However, we believe this limitation is not significant and mitigated
by the fact that, generally, all reconciling items are contained on the face of
our statement of operations and comprehensive loss. DBS EBITDA is not, and
should not be considered, an alternative to income from operations, net income,
or any other measure for determining our operating performance, as determined
under generally accepted accounting principles. Although EBITDA is a common
measure used by other companies, our calculation of DBS EBITDA may not be
comparable with that of others.
New Accounting Pronouncements
On April 30, 2003, the FASB issued Statement No. 149 "Amendment of
Statement 133 on Derivative Instruments and Hedging Activities" ("FAS 149").
This FAS amends and clarifies various items and issues related to derivative
instruments. There was no material impact to us upon the adoption of this
statement.
The FASB issued Statement No. 150 "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity" ("FAS 150") in
May 2003. FAS 150 establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both liabilities
and equity. It requires that an issuer classify a financial instrument within
its scope as a liability (or an asset in some circumstances). Many of those
instruments were previously classified as equity. FAS 150 requires, among other
things, an issuer to classify a financial instrument issued in the form of
shares that is mandatorily redeemable as a liability. We believe that our
redeemable preferred stocks will be subject to the requirements of FAS 150 and
may need to be classified as liabilities. However, we are still studying the
provisions of the statement to determine the exact impact. Because the
instruments covered by FAS 150 are far reaching, it is possible that we may have
other instruments subject to the statement for which we continue to study the
provisions of the statement to determine what, if any, further impact there may
be to us. FAS 150 is effective for us in the third quarter 2003.
Liquidity and Capital Resources
We had cash and cash equivalents on hand at June 30, 2003 of $18.5
million compared to $13.0 million at December 31, 2002. The change in cash is
discussed below in terms of the amounts shown in our statement of cash flows.
Net cash provided by operating activities was $14.3 million and $34.1
million for the six months ended June 30, 2003 and 2002, respectively. The
principal reason for the decrease in the 2003 period was due to the timing of
interest payments associated with our 11-1/4% notes resulting in $9.8 million in
increased cash interest paid in 2003. The interest on these notes are payable
28
PEGASUS SATELLITE COMMUNICATIONS, INC.
semiannually in January and July. These notes were first issued in December 2001
with the first interest payment due July 2002. The remaining decrease in cash
provided was primarily due to a reduction in accounts payable and accrued
expense of $15.3 million in 2003, offset in part by a reduction in deferred SAC
of $6.8 million in 2003 that reflected a lesser number of subscribers added in
2003 than in the corresponding period of 2002. The reduction in accounts payable
and accrued expense was primarily due to a lesser amount of programming fees
incurred in 2003 compared to 2002 resulting from a decreased subscriber base in
2003 and reduced other operating costs in 2003 resulting from cost reduction
initiatives largely started in the second half of 2002 that were continued into
2003.
Cash of $7.8 million was provided by investing activities for the six
months ended June 30, 2003, and cash of $16.0 million was used for investing
activities for the six months ended June 30, 2002. The 2003 period primarily
consisted of net proceeds of $21.6 million from the sale of three broadcast
television stations, partially offset by cash utilized for direct broadcast
satellite equipment capitalized of $9.5 million and cash used to purchase shares
of Pegasus Communications' Class A common stock of $3.7 million. The 2002 period
consisted of cash utilized for direct broadcast satellite equipment capitalized
of $13.5 million and other capital expenditures of $2.5 million. We have yet to
close on the final portion of the sale of two of the above noted stations, from
which we will receive an additional $2.7 million. We expect this portion of the
sale to close by the end of 2003.
For the six months ended June 30, 2003 and 2002, net cash was used for
financing activities of $16.7 million and $77.2 million, respectively. The
primary financing activities in the 2003 period were net repayments of $11.8
million from a promissory note arrangement with Pegasus Communications,
repayments of other long term debt of $3.9 million, and costs of $2.8 million
incurred for new financing arrangements, partially offset by a release of
restricted cash of $2.0 million. Restricted cash of $2.1 million was released
for our use in connection with the waiver of our rights over and our consent to
sell a broadcast television construction permit held by another party, for which
we received $1.2 million that is included in cash provided by operating
activities. We will receive an additional $200 thousand for our waiver and
consent and an additional $600 thousand of restricted cash will be released when
the sale of the permit is completed, which we expect to occur by the end of
2003. The primary financing activities in the 2002 period were repayments of
amounts outstanding under our revolving credit facility of $80.0 million, net
borrowings of $61.8 million from our term loan facilities, proceeds of $113.7
million from a promissory note arrangement with Pegasus Communications,
distributions to Pegasus Communications of $167.8 million, and repayments of
other long term debt of $7.2 million.
At June 30, 2003, after deducting the letters of credit outstanding of
$61.4 million, net availability under our revolving credit facility was $79.2
million at June 30, 2003. See below for actions we took after June 30, 2003 that
impact this facility.
An accrued contract termination fee scheduled to be paid in July 2003
of $4.5 million was reversed in the second quarter 2003 due to the amendment and
continuation of the associated customer relationship management services
agreement during the quarter. Additionally, this amended agreement does not
require any minimum annual services amount, whereas the agreement prior to the
amendment required a prorated minimum annual services amount of $10.9 million
for 2003.
In a series of exchanges in the second quarter 2003, Pegasus Satellite
issued $94.0 million principal amount of 11-1/4% senior notes due January 2010
("11-1/4% notes") in exchange for an aggregate equivalent principal amount of
its other outstanding notes, consisting of $21.9 million of 9-5/8% senior notes
due October 2005 ("9-5/8% notes"), $28.6 million of 12-3/8% senior notes due
August 2006 ("12-3/8% notes"), $11.5 million of 9-3/4% senior notes due December
2006 ("9-3/4% notes"), and $32.0 million of 12-1/2% senior notes due August
2007. The principal effect of this exchange was to extend the maturity of $94.0
29
PEGASUS SATELLITE COMMUNICATIONS, INC.
million of principal outstanding, with a net reduction in cash interest to be
paid for the remainder of 2003 of $1.3 million. The aggregate difference
associated with all of the notes exchanged in the amount of cash interest to be
paid after 2003 through the date of the earliest maturity of the notes received
is favorable but not significant. However, the incremental aggregate cash
interest to be paid after the maturity date of each respective note received in
the exchanges will increase by the amount of interest associated with the
11-1/4% notes issued in the exchanges, as long as the 11-1/4% notes remain
outstanding.
In July 2003, Pegasus Satellite issued $67.6 million principal amount
of 11-1/4% notes in exchange for an aggregate principal amount of $69.8 million
of its other outstanding notes, consisting of $11.5 million of 9-5/8% notes,
$8.2 million of 12-3/8% notes, $17.4 million of 9-3/4% notes, $4.5 million of
12-1/2% notes, and $28.2 million of 13-1/2% senior subordinated notes due March
2007.
On August 1, 2003, Pegasus Satellite borrowed all of the $100.0 million
term loan financing available under an amended and restated term loan. The rate
of interest on outstanding principal is 12.5%. Interest is payable quarterly, of
which 48% is payable in cash and 52% is added to principal. Interest added to
principal is subject to interest at the full 12.5% rate thereafter. All unpaid
principal and interest is due August 1, 2009. Principal may be repaid prior to
its maturity date, but principal repaid within three years from the initial date
of borrowing bears a premium of 103% in the first year, 102% in the second year,
and 101% in the third year. Principal repaid may not be reborrowed. The proceeds
received from this borrowing were used as follows: $69.3 million was placed in
trust to redeem in September 2003 all of the outstanding principal of Pegasus
Media's 12-1/2% notes due July 2005 of $67.9 million and accrued interest on the
notes to the date of their redemption of $1.4 million; $2.5 million to pay
additional costs associated with the term loan agreement; and $28.2 million to
fund cash collateral placed into a separate letter of credit facility (discussed
below). Other costs associated with this agreement that had been previously
incurred amounted to $2.0 million.
In July 2003, Pegasus Media amended its credit agreement that had an
effective date of August 1, 2003 and obtained certain consents from the lenders
thereunder. On the effective date: 1) the commitment under the revolving credit
facility was permanently reduced by $60.0 million to $80.6 million; 2) the
permanent quarterly commitment reductions under the revolving credit facility
were changed to $12.2 million on September 30, 2003 and $13.7 million every
quarterly period ended thereafter until the facility's expiration date of
October 31, 2004; 3) letters of credit in favor of amounts owed to the NRTC
associated with the revolving credit facility prior to the amendment that had
the effect of reducing the availability of the facility are not associated with
the facility after the amendment; and 4) $1.9 million of term loan principal and
$468 thousand of incremental term principal, along with associated accrued
interest for each, were repaid. Aggregate costs incurred to amend the credit
agreement and for consent fees amounted to $1.5 million. Also on August 1, 2003,
$17.0 million was borrowed under the revolving credit facility to fund cash
collateral under a letter of credit facility.
The transactions before and after June 30, 2003 discussed above with
respect to the: 1) sale of broadcast television stations; 2) amendment of our
customer relationship management services agreement; 3) note exchanges; 4) new
Pegasus Satellite term loan financing; and 5) amendment of Pegasus Media's
credit agreement, in the aggregate significantly impacted the timing of cash
flows associated with our contractual obligations outstanding at December 31,
2002 from that last reported in our 2002 Form 10-K. The following table shows
our outstanding contractual obligations at December 31, 2002 to reflect the
transactions in 2003 (in thousands):
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PEGASUS SATELLITE COMMUNICATIONS, INC.
Payments due by period
Less than More than
Contractual Obligations Total 1 year 1-3 Years 3-5 Years 5 Years
- ----------------------------------- -------------- ----------- ------------- ------------ ------------
Long term debt $1,386,864 $22,631 $446,737 $480,822 $436,674
Redeemable preferred stock 183,978 183,978
Operating leases 17,235 3,670 6,589 4,353 2,623
Broadcast programming rights 12,404 3,510 4,568 1,901 2,425
Purchase commitments 13,500 6,000 7,500
-------------- ----------- ------------- ------------ ------------
Total $1,613,981 $35,811 $465,394 $671,054 $441,722
============== =========== ============= ============ ============
Included in the less than 1 year column is $17.0 million borrowed under
Pegasus Media's revolving credit facility to fund cash collateral under a letter
of credit facility.
For comparative purposes, our contractual obligations outstanding at
December 31, 2002 as reported in our 2002 Form 10-K were as follows (in
thousands):
Payments due by period
Less than More than
Contractual Obligations Total 1 year 1-3 Years 3-5 Years 5 Years
- ----------------------------------- -------------- ----------- ------------- ------------ ------------
Long term debt $1,359,405 $5,631 $567,529 $611,245 $175,000
Redeemable preferred stock 183,978 183,978
Operating leases 17,235 3,670 6,589 4,353 2,623
Broadcast programming rights 13,620 4,164 5,084 1,947 2,425
Purchase commitments 28,929 21,429 7,500
-------------- ----------- ------------- ------------ ------------
Total $1,603,167 $34,894 $586,702 $801,523 $180,048
============== =========== ============= ============ ============
On July 31, 2003, a newly formed, wholly owned subsidiary of Pegasus
Media (the "LC subsidiary") entered into a letter of credit facility with a
bank. The facility pays a quarterly fee of 1.75% of the amount of letters of
credit outstanding at the beginning of each quarterly payment period.
Outstanding letters of credit are secured with cash provided by the LC
subsidiary in an amount equal to 105% of the letters of credit outstanding. On
August 1, 2003, letters of credit were issued aggregating $59.0 million, and the
LC subsidiary provided cash collateral of $61.9 million. Cash collateral
provided by the LC subsidiary will be reported as restricted cash on the
consolidated balance sheets. The LC subsidiary is entitled to all earnings
earned by the cash collateral.
We are in the process of seeking commitments for a new senior secured
credit facility for our subsidiary Pegasus Media. Proceeds from any new credit
facility would be used to repay all outstanding indebtedness of Pegasus Media
and for working capital.
At the discretion of our board of directors as permitted by the
certificate of designation for the 12-3/4% cumulative exchangeable preferred
stock, our board of directors has not declared or paid any of the scheduled
semiannual dividends for this series after January 1, 2002. Dividends in arrears
at June 30, 2003 were $23.5 million, with accrued interest thereon of $2.6
million. 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, Pegasus Satellite may not, with certain exceptions, with
respect to capital stock junior to the series: 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 Pegasus Satellite. Of the
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PEGASUS SATELLITE COMMUNICATIONS, INC.
amount of dividends in arrears at June 30, 2003, $11.9 million, with interest
thereon of $1.3 million, was payable to Pegasus Communications on account of the
12-3/4% preferred stock shares held by Pegasus Communications.
At this time, we cannot determine with any certainty what capital
resources, other than those discussed above, will be available to us or the
sources and sufficiency of liquidity to meet our contractual obligations beyond
the next 12 months. We are seeking a new credit facility to replace the existing
credit facility that has significant outstanding principal repayments starting
in the third quarter 2004 through the third quarter 2005. We may seek to issue
new debt and/or equity securities, refinance existing debt and/or preferred
stock outstanding, continue to extend maturities of existing debt by issuing
debt with later maturities in exchange for debt with nearer maturities, like the
exchanges discussed above, or secure some other form of financing in meeting our
longer term needs. Our financing options and opportunities will be impacted by
general and industry specific economic and capital market conditions over which
we have no control, as well as the outcome of our litigation with DIRECTV, Inc.
As indicated above and previously disclosed, we have engaged in
transactions from time to time that involve the purchase, sale, and/or exchange
of our securities and those of Pegasus Communications, and we may further do so
in the future. Such transactions may be made in the open market or in privately
negotiated transactions and may involve cash or the issuance of new securities
or securities that we received upon purchase or exchange. The amount and timing
of such transactions, if any, will depend on market conditions and other
considerations.
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 under these facilities. The
interest rates we have incurred in 2003 on these borrowings have decreased
slightly relative to the rates in 2002 in response to lower market LIBOR rates
available in general in 2003 compared to 2002.
Our two interest rate swaps expired in March 2003. As a result,
starting in the second quarter 2003 we have been able to take full advantage of
the lowered variable interest rates we incur, for the swaps had the effect of
fixing interest rates for us at an effective rate greater than the market
variable rates available to us. Other than the expiration of the swaps, which we
did not renew or replace, the way we manage our interest rate risks did not
change during the six months ended June 30, 2003 from the way such risks were
managed at December 31, 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
Senior Vice President of Finance (the principal financial officer), to determine
the effectiveness of our disclosure controls and procedures. Based on this
evaluation, the Chief Executive Officer and the Senior Vice President of Finance
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
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PEGASUS SATELLITE COMMUNICATIONS, INC.
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.
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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 10 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, 2002, our Quarterly Report on Form 10-Q for the quarterly period
ended March 31, 2003, and our Current Report on Form 8-K dated June 10, 2003.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
During the second quarter of 2003, Pegasus Satellite issued to
institutional investors an aggregate of $94.0 million principal amount of its
11-1/4% senior notes due January 2010 in exchange for an aggregate equivalent
principal amount of its outstanding notes, consisting of:
o $21.9 million principal amount of 9-5/8% senior notes due October 2005
exchanged on May 13, 2003;
o $28.6 million principal amount of 12-3/8% senior notes due August 2006
of which $13.8 million was exchanged on May 13, 2003, $4.3 million was
exchanged on June 12, 2003, $7.5 million was exchanged on June 17, 2003
and $3.0 million was exchanged on June 23, 2003;
o $11.5 million principal amount of 9-3/4% senior notes due December 2006
of which $1.7 million was exchanged on May 13, 2003, $4.0 million was
exchanged on June 12, 2003 and $5.8 million was exchanged on June 17,
2003; and
o $32.0 million principal amount of 12-1/2% senior notes due August 2007
of which $29.1 million was exchanged on May 13, 2003, $1.7 million was
exchanged on June 12, 2003 and $1.2 million was exchanged on June 17,
2003.
The terms and conditions of the 11-1/4% notes issued in the exchanges
are the same as those contained in the indenture for the notes of this series
already outstanding. The 11-1/4% notes were issued without registration in
reliance on Section 4(2) of the Securities Act of 1933 and are eligible for
resale under Rule 144A promulgated under the Securities Act of 1933.
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, our board of directors has not declared or paid any of the scheduled
semiannual dividends for this series after January 1, 2002. Dividends in arrears
at June 30, 2003 were $23.5 million, with accrued interest thereon of $2.6
million. 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, Pegasus Satellite may not, with certain exceptions, with
respect to capital stock junior to the series: 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 Pegasus Satellite. Of the
amount of dividends in arrears at June 30, 2003, $11.9 million, with interest
thereon of $1.3 million, was payable to Pegasus Communications on account of the
12-3/4% preferred stock shares held by Pegasus Communications.
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PEGASUS SATELLITE COMMUNICATIONS, INC.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits
Exhibit
Number
31.1* Certification Pursuant to Section 302 of the Sarbanes-Oxley Act.
31.2* Certification Pursuant to Section 302 of the Sarbanes-Oxley Act.
32.1* Certification Pursuant to Section 906 of the Sarbanes-Oxley Act.
32.2* Certification Pursuant to Section 906 of the Sarbanes-Oxley Act.
- -----------------
* Filed herewith.
b) Reports on Form 8-K
On April 3, 2003, we filed a Current Report on Form 8-K dated
April 2, 2003 reporting under Item 5 that a newly formed subsidiary of
ours received a commitment for up to $100.0 million in term loan
financing from a group of institutional lenders. We included exhibits
to the Form the loan documents governing the commitment and the text of
the press release describing the terms of the financing.
On June 18, 2003, we filed a Current Report on Form 8-K dated
June 10, 2003 reporting under Item 5 an update of our litigation with
DIRECTV, Inc. with respect to decisions rendered on certain summary
judgment motions filed by DIRECTV, Inc. We also disclosed the date set
by the Court for the first phase of the trial. We also provided an
updated description of (i) the DIRECTV, Inc. litigation and (ii) the
patent infringement lawsuit filed by our subsidiary Pegasus Development
Corporation and Personalized Media Communications, L.L.C.
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PEGASUS SATELLITE COMMUNICATIONS, INC.
SIGNATURES
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.
August 14, 2003 By: /s/ Joseph W. Pooler, Jr.
- ---------------------------------- ------------------------------
Date Joseph W. Pooler, Jr.
Senior Vice President of Finance
(Chief financial and accounting officer)
36
Exhibit Index
Exhibit Number
31.1* Certification Pursuant to Section 302 of the Sarbanes-Oxley Act.
31.2* Certification Pursuant to Section 302 of the Sarbanes-Oxley Act.
32.1* Certification Pursuant to Section 906 of the Sarbanes-Oxley Act.
32.2* Certification Pursuant to Section 906 of the Sarbanes-Oxley Act.
- -----------------
* Filed herewith.
37