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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 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 0-32383
PEGASUS COMMUNICATIONS CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 23-3070336
-------- ----------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
c/o Pegasus Communications Management Company;
225 City Line Avenue, Suite 200, Bala Cynwyd, PA 19004
------------------------------------------------ -----
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (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 /X/ No __
Number of shares of each class of the registrant's common stock outstanding
as of November 10, 2003:
Class A, Common Stock, $0.01 par value 4,776,626
Class B, Common Stock, $0.01 par value 916,380
Non-Voting Common Stock, $0.01 par value -
PEGASUS COMMUNICATIONS CORPORATION
Form 10-Q
Table of Contents
For the Quarterly Period Ended September 30, 2003
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets
September 30, 2003 and December 31, 2002 4
Consolidated Statements of Operations and Comprehensive Loss
Three months ended September 30, 2003 and 2002 5
Consolidated Statements of Operations and Comprehensive Loss
Nine months ended September 30, 2003 and 2002 6
Condensed Consolidated Statements of Cash Flows
Nine months ended September 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 29
Item 3. Quantitative and Qualitative Disclosures About Market Risk 43
Item 4. Controls and Procedures 44
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 45
Item 2. Changes in Securities and Use of Proceeds 45
Item 3. Defaults Upon Senior Securities 46
Item 6. Exhibits and Reports on Form 8-K 46
Signatures 48
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
3
Pegasus Communications Corporation
Condensed Consolidated Balance Sheets
(In thousands)
September 30, December 31,
2003 2002
---------------- ---------------
(unaudited)
Currents assets:
Cash and cash equivalents $ 60,713 $ 59,814
Restricted cash 62,331 442
Accounts receivable, net
Trade 13,758 27,238
Other 9,078 9,521
Deferred subscriber acquisition costs, net 11,863 15,706
Prepaid expenses 15,203 8,204
Other current assets 7,412 7,288
----------- ------------
Total current assets 180,358 128,213
Property and equipment, net 84,893 85,062
Intangible assets, net 1,640,578 1,737,584
Other noncurrent assets 152,987 159,929
----------- ------------
Total $ 2,058,816 $ 2,110,788
=========== ============
Current liabilities:
Current portion of long term debt $ 3,554 $ 5,752
Accounts payable 15,474 16,773
Accrued interest 20,348 35,526
Accrued programming fees 54,291 57,196
Accrued commissions and subsidies 40,279 40,191
Other accrued expenses 28,407 32,692
Other current liabilities 7,574 7,201
----------- ------------
Total current liabilities 169,927 195,331
Long term debt 1,362,396 1,283,330
Mandatorily redeemable preferred stock 84,987 -
Other noncurrent liabilities 68,368 46,169
----------- ------------
Total liabilities 1,685,678 1,524,830
----------- ------------
Commitments and contingent liabilities (see Note 13)
Redeemable preferred stocks 219,848 209,211
Redeemable preferred stock of subsidiary - 96,526
Minority interest 530 2,157
Common stockholders' equity:
Common stock 63 61
Other common stockholders' equity 152,697 278,003
----------- ------------
Total common stockholders' equity 152,760 278,064
----------- ------------
Total $ 2,058,816 $ 2,110,788
=========== ============
See accompanying notes to consolidated financial statements
4
Pegasus Communications Corporation
Consolidated Statements of Operations and Comprehensive Loss
(In thousands, except per share amounts)
Three Months Ended September 30,
2003 2002
----------------- -----------------
(unaudited)
Net revenues:
Direct broadcast satellite $ 207,010 $ 216,363
Broadcast television and other operations 7,644 8,391
------------- -------------
Total net revenues 214,654 224,754
Operating expenses:
Direct broadcast satellite
Programming 93,682 94,584
Other subscriber related expenses 47,764 51,547
------------- -------------
Direct operating expenses (excluding depreciation and amortization shown
below) 141,446 146,131
Promotions and incentives 3,699 5,933
Advertising and selling 7,185 7,877
General and administrative 6,060 6,216
Depreciation and amortization 39,984 42,968
------------- -------------
Total Direct broadcast satellite 198,374 209,125
Broadcast television and other operations (including depreciation and
amortization of $761 and $833, respectively) 7,257 7,864
Corporate and development expenses (including depreciation and amortization of
$4,012 and $7,985, respectively) 7,915 12,025
Other operating expenses 5,969 8,585
------------- -------------
Loss from operations (4,861) (12,845)
Interest expense (40,922) (36,531)
Interest income 270 226
Other nonoperating income (loss), net 208 16,643
------------- -------------
Loss before equity in affiliates, income taxes, and discontinued operations (45,305) (32,507)
Equity in earnings (losses) of affiliates (784) 200
Net expense for income taxes (81) (6,323)
------------- -------------
Loss before discontinued operations (46,170) (38,630)
Discontinued operations:
Income from discontinued operations (including gain on disposal of $4,783 in
2003) 4,985 695
------------- -------------
Net loss (41,185) (37,935)
Other comprehensive loss:
Unrealized loss on marketable equity securities, net of income tax benefit of $57 - (94)
------------- -------------
Comprehensive loss $ (41,185) $ (38,029)
============= =============
Basic and diluted per common share amounts:
Loss from continuing operations, including $3,185 and $7,992, respectively,
representing preferred stock dividends and accretion $ (8.57) $ (7.73)
Discontinued operations 0.87 0.07
------------- -------------
Net loss applicable to common shares $ (7.70) $ (7.66)
============= =============
Weighted average number of common shares outstanding 5,759 5,998
============= =============
See accompanying notes to consolidated financial statements
5
Pegasus Communications Corporation
Consolidated Statements of Operations and Comprehensive Loss
(In thousands, except per share amounts)
Nine Months Ended September 30,
2003 2002
-------------- --------------
(unaudited)
Net revenues:
Direct broadcast satellite $ 618,379 $ 647,534
Broadcast television and other operations 23,570 22,968
------------- ------------
Total net revenues 641,949 670,502
Operating expenses:
Direct broadcast satellite
Programming 279,421 286,918
Other subscriber related expenses 132,989 152,374
------------- ------------
Direct operating expenses (excluding depreciation and amortization shown
below) 412,410 439,292
Promotions and incentives 10,172 9,703
Advertising and selling 19,483 23,998
General and administrative 18,346 20,998
Depreciation and amortization 122,813 123,905
------------- ------------
Total Direct broadcast satellite 583,224 617,896
Broadcast television and other operations (including depreciation and
amortization of $2,077 and $2,625, respectively) 22,843 23,149
Corporate and development expenses (including depreciation and amortization of
$12,082 and $23,900, respectively) 23,836 38,460
Other operating expenses 24,444 24,506
------------- ------------
Loss from operations (12,398) (33,509)
Interest expense (113,087) (108,893)
Interest income 587 662
Loss on impairment of marketable securities - (3,063)
Other nonoperating income, net 2,735 17,882
------------- ------------
Loss before equity in affiliates, income taxes, and discontinued operations (122,163) (126,921)
Equity in (losses) earnings of affiliates (3,686) 549
Net (expense) benefit for income taxes (219) 29,543
------------- ------------
Loss before discontinued operations (126,068) (96,829)
Discontinued operations:
Income (loss) from discontinued operations (including net gain on disposal of
$9,992 in 2003), net of income tax benefit of $1,665 in 2002 9,601 (2,714)
------------- ------------
Net loss (116,467) (99,543)
Other comprehensive loss:
Unrealized loss on marketable equity securities, net of income tax benefit of
$1,837 - (2,998)
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 - (1,099)
------------- ------------
Comprehensive loss $ (116,467) $ (100,642)
============= ============
Basic and diluted per common share amounts:
Loss from continuing operations, including $16,671 and $24,935, respectively,
representing preferred stock dividends and accretion $ (24.96) $ (20.30)
Discontinued operations 1.68 (0.45)
------------- ------------
Net loss applicable to common shares $ (23.28) $ (20.75)
============= ============
Weighted average number of common shares outstanding 5,719 5,999
============= ============
See accompanying notes to consolidated financial statements
6
Pegasus Communications Corporation
Condensed Consolidated Statements of Cash Flows
(In thousands)
Nine Months Ended September 30,
2003 2002
-------------------- -------------------
(unaudited)
Net cash provided by operating activities $ 4,065 $ 9,349
------------ -------------
Cash flows from investing activities:
Direct broadcast satellite receiver equipment capitalized (16,528) (20,149)
Other capital expenditures (2,102) (4,160)
Sales of broadcast television stations 21,593 -
Other 151 (346)
------------ -------------
Net cash provided by (used for) investing activities 3,114 (24,655)
------------ -------------
Cash flows from financing activities:
Borrowings on term loan facilities 100,000 63,156
Repayments of term loan borrowings (4,074) (2,220)
Repayment of notes (67,895) -
Net borrowings on (repayments of) revolving credit facility 43,500 (80,000)
Repayments of other long term debt (2,339) (5,934)
Cash received from exchange of notes 1,459 -
Purchases of common stock (5,509) -
Purchases of outstanding notes - (24,974)
Restricted cash (60,269) 1,644
Debt financing costs (11,163) (2,049)
Repurchase of preferred stock - (23,192)
Redemption of preferred stock - (5,717)
Other 10 (1,664)
------------ -------------
Net cash used for financing activities (6,280) (80,950)
------------ -------------
Net increase (decrease) in cash and cash equivalents 899 (96,256)
Cash and cash equivalents, beginning of year 59,814 144,673
------------ -------------
Cash and cash equivalents, end of period $ 60,713 $ 48,417
============ =============
See accompanying notes to consolidated financial statements
7
PEGASUS COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. General
All references to "we," "us," and "our" refer to Pegasus Communications
Corporation, together with its direct and indirect subsidiaries. "Pegasus
Communications" refers to Pegasus Communications Corporation individually as a
separate entity. "Pegasus Satellite" refers to Pegasus Satellite Communications,
Inc., one of our direct subsidiaries. "Pegasus Media" refers to Pegasus Media &
Communications, Inc., a wholly owned subsidiary of Pegasus Satellite. Other
terms used are defined 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
$153.6 million, $278.4 million, and $159.0 million for 2002, 2001, and 2000,
respectively. We have an accumulated deficit balance at September 30, 2003 of
$981.4 million.
We are highly leveraged. At September 30, 2003, we had a combined
carrying amount of long term debt, including the portion that is current, and
redeemable preferred stock outstanding of $1.7 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 preferred stock
requirements 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,
the business strategies of DIRECTV, Inc. and the National Rural
Telecommunications Cooperative, equipment strategies, technological
developments, levels 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 87%, 92%, and 92%, respectively, of total consolidated operating
expenses. Total assets of the direct broadcast satellite business were 81% and
82% of total consolidated assets at September 30, 2003 and December 31, 2002,
respectively.
For the nine months ended September 30, 2003 and 2002, the direct
broadcast satellite business had income from operations of $35.2 million and
$29.6 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
8
PEGASUS COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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.
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, that strategy along with other very
significant factors, has contributed to a certain extent to the decrease in the
number of our direct broadcast satellite subscribers of 108 thousand for the
nine months ended September 30, 2003 and the decrease of $29.2 million in direct
broadcast satellite net revenues during the nine months ended September 30, 2003
compared to the nine months ended September 30, 2002. The other very significant
factors include a significant competitive disadvantage that we experience in
several of our territories in which a competing direct broadcast satellite
provider provides local channels but DIRECTV does not; competition from a
competing direct broadcast satellite provider other than with respect to local
channels; competition from digital cable providers; and the effect of general
economic conditions on our subscribers and potential subscribers. We believe
that the number of territories in which we are disadvantaged by a lack of local
channel service will increase during the fourth quarter 2003 and the first two
quarters of 2004 because of DIRECTV's delay in launching a satellite to provide
local channels in markets where a competing direct broadcast satellite provider
offers local channels and DIRECTV's failure to provision certain of our key
markets with local channels. 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 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 13 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.
9
PEGASUS COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
2. Basis of Presentation
The unaudited financial statements herein include the accounts of
Pegasus Communications 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.
We account for stock options and restricted stock issued using the
intrinsic value method. The following table illustrates the estimated pro forma
effect on our net loss and basic and diluted per common share amounts for net
loss applicable to common shares if we had applied the fair value method in
recognizing stock based employee compensation (in thousands, except per share
amounts):
Three Months
Ended September 30,
2003 2002
------------- ------------
Net loss, as reported $(41,185) $(37,935)
Stock based employee compensation expense, net of income tax, determined
under fair value method (993) (1,638)
--------- ---------
Net loss, pro forma $(42,178) $(39,573)
========= =========
Basic and diluted per common share amounts (see Note 8):
Net loss applicable to common shares, as reported $(7.70) $(7.66)
Net loss applicable to common shares, pro forma (7.88) (7.93)
Nine months
Ended September 30,
2003 2002
-------------- -------------
Net loss, as reported $(116,467) $ (99,543)
Stock based employee compensation expense, net of income tax, determined
under fair value method (3,365) (5,741)
---------- ----------
Net loss, pro forma $(119,832) $(105,284)
========== ==========
Basic and diluted per common share amounts (see Note 8):
Net loss applicable to common shares, as reported $(23.28) $(20.75)
Net loss applicable to common shares, pro forma (23.87) (21.71)
No actual stock based employee compensation expense with respect to
stock options had been recorded within the periods included in the table.
10
PEGASUS COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
3. Redeemable Preferred Stocks
The net increase in the aggregate carrying amount from December 31,
2002 to September 30, 2003 was principally due to dividends accrued during the
period of $9.5 million. The remainder of the increase of $1.1 million was due to
the issuance of 20,682 shares of 6-1/2% Series C convertible preferred stock
("Series C") in June 2003 in exchange for shares of Pegasus Satellites's 12-3/4%
cumulative exchangeable preferred stock ("12-3/4% Series") (see Note 4). The
$1.1 million represented the fair value of the Series C shares issued, adjusted
for consideration received and given in the exchange. The Series C shares issued
included accumulated dividends accrued and unpaid from February 1, 2002 to the
date of the exchange of $184 thousand. The aggregate par value of the Series C
shares issued was $2.1 million. The certificate of designation for the series
does not provide for any mandatory redemption requirements or dates and does not
state any specific redemption available at the option of holders. However, there
may be situations in which redemption of Series C may be required that are not
in our control and, accordingly, we classify this series as redeemable preferred
stock. Since redemption of Series C is uncertain, the difference of $1.0 million
between the par value of and the amount recorded for the shares issued in
September 2003 is not being accreted to the shares' carrying amount or included
for purposes of determining the preferred stock dividend requirement in per
share computations. Accretion of the difference will commence when redemption of
the series is probable.
At the election of the holder and in accordance with the terms of
Series E, 28 shares of Series E junior convertible participating ("Series E")
with a liquidation par value of $28 thousand were converted into 44 shares of
Pegasus Communications' Class A common stock in September 2003, and the holder
received $2 thousand representing accumulated dividends to the date of the
conversion. In October 2003, at the election of the holder and in accordance
with the terms of the Series E, 7,000 shares of Series E with a liquidation par
value of $7.0 million were converted into 11,226 shares of Pegasus
Communications' Class A common stock, and the holder received $510 thousand
representing accumulated dividends to the date of the conversion.
As permitted by the certificate of designation for the Series C, our
board of directors has the discretion to declare or not to declare any scheduled
quarterly dividends for this series. Since January 31, 2002, the board of
directors has only declared a dividend of $100 thousand on the series which was
paid with shares of Pegasus Communications' Class A common stock. The total
amount of dividends in arrears on Series C at September 30, 2003 was $17.7
million. The dividend on this series scheduled to be declared on October 31,
2003 of $3.0 million was not declared. Dividends not declared accumulate in
arrears until paid.
While dividends are in arrears on preferred stock senior to the Series
D junior convertible participating ("Series D") and Series E preferred stocks,
our board of directors may not declare dividends for and we may not redeem
shares of these series. Pegasus Communications' Series C preferred stock and
Pegasus Satellite's 12-3/4% cumulative exchangeable preferred stock (12-3/4%
series) are senior to these series. Because dividends on Series C and the
12-3/4% series are in arrears, the annual dividends scheduled to be declared for
Series D and E on January 1, 2003 of $500 thousand and $400 thousand,
respectively, were not declared and became in arrears on that date. Dividends
not declared accumulate in arrears until paid.
We have received notice of redemption from holders of $3.0 million
liquidation par value of Series E preferred stock after the dividends on Series
C and the 12-3/4% series became in arrears. Additionally, in February 2003,
6,125 shares of Series D amounting to $6.1 million of liquidation par value
became eligible for redemption at the election of holders. We are not permitted
nor obligated to
11
PEGASUS COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
redeem the shares of Series D and E while dividends on Series C are in arrears.
Under these circumstances, our inability to redeem Series D and E shares is not
an event of default.
4. Mandatorily Redeemable Preferred Stock and Redeemable Preferred Stock of
Subsidiary
The Financial Accounting Standards Board ("FASB") issued Statement No.
150 "Accounting for Certain Financial Instruments with Characteristics of Both
Liabilities and Equity" ("FAS 150") in May 2003. FAS 150 established 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. FAS 150 also requires that amounts paid or to be paid for those
instruments as returns on the instruments, for example, "dividends," are
required to be reported as interest costs. Restatement of periods prior to the
adoption of FAS 150 presented in financial statements issued after its adoption
is not permitted. For mandatorily redeemable financial instruments, "dividends"
and other amounts paid or accrued prior to reclassification of the instrument as
a liability are not to be reclassified as interest cost upon adoption of the
statement.
Pegasus Satellite's 12-3/4% series preferred stock is mandatorily
redeemable on January 1, 2007 at its liquidation par value, plus accrued and
unpaid dividends on that date. This series of preferred stock is a financial
instrument within the scope of FAS 150 that has the characteristics of a
liability as specified therein. Accordingly, we classified the combined
liquidation par value of and unamortized original issue discount for the series
of $84.5 million on the date of our adoption of FAS 150 on July 1, 2003 as a
noncurrent liability in "Mandatorily redeemable preferred stock" on the balance
sheet. Also, we classified the dividends accrued and unpaid balance for the
series of $17.6 million on the date of adoption of FAS 150 as a separate other
noncurrent liability. Dividends accrued and accretion of discount associated
with this series on and after the date of our adoption of FAS 150 have been
charged to interest expense, with accrued and unpaid dividends being classified
to a noncurrent liability. The dividends for this series are classified as
noncurrent because we have the ability and intent to not declare or pay the
dividends within the next 12 months. In the periods presented prior to our
adoption of FAS 150, the 12-3/4% series was presented on the balance sheet as
"Redeemable preferred stock of subsidiary" between liabilities and stockholders'
equity for the combined amount of its liquidation par value, dividends accrued
and unpaid thereon, and unamortized discount. Dividends accrued and accretion of
discount for the series in periods prior to our adoption of FAS 150 were charged
to additional paid in capital and included in preferred dividend requirements
for per share calculations.
The combined balance of the 12-3/4% series at September 30, 2003 was
$105.5 million, consisting of $85.0 million of mandatorily redeemable preferred
stock and $20.5 million of accrued and unpaid dividends in other noncurrent
liabilities, compared to the balance of the series at December 31, 2002 of $96.5
million in redeemable preferred stock of subsidiary. The change was primarily
due to dividends accrued of $8.6 million and accretion of discount of $1.6
million, reduced by $1.2 million liquidation par value for 1,250 shares that we
received in exchange for 20,682 shares of our Series C preferred stock that were
issued in the exchange that took place in June 2003 (see Note 3). The 1,250
shares of the 12-3/4% series we received included accrued interest of $16
thousand on the accumulated dividends associated with the shares. We accounted
for the 12-3/4% series shares received as if they were constructively retired.
In the exchange for and retirement of the 12-3/4% series shares, we recognized
an increase of $240 thousand in additional paid in capital for the differential
between the aggregate fair value of and accumulated dividends associated with
the Series C shares issued and the
12
PEGASUS COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
aggregate par value of, accumulated dividends, and accrued interest associated
with the 12-3/4% series shares received.
As permitted by the certificate of designation for this series, our
board of directors has the discretion to declare or not to declare any scheduled
quarterly dividends for this series. The board of directors has not declared any
of the scheduled semiannual dividends for this series since January 1, 2002.
Dividends in arrears to unaffiliated parties at September 30, 2003 were $17.7
million, with accrued interest thereon of $1.9 million. Dividends not declared
accumulate in arrears and incur interest at a rate of 14.75% per year until
paid.
5. Common Stock
The number of shares of Pegasus Communications' Class A common stock at
September 30, 2003 was 5,418,860 issued and 4,790,356 outstanding, and at
December 31, 2002 was 5,173,788 issued and 4,842,744 outstanding. The change in
the number of shares outstanding during the nine months ended September 30, 2003
was as follows:
Shares issued for employee benefit and award plans 237,769
Shares issued upon exercise of stock options 3,779
Shares purchased and held in treasury (297,460)
Shares issued for preferred stock converted 3,168
Other 356
The aggregate amount paid for Class A common shares purchased during
the nine months ended September 30, 2003 was $5.5 million. We purchased 33,600
shares for $610 thousand since September 30, 2003. No dividends were declared
for common stocks during the nine months ended September 30, 2003.
6. Changes in Other Stockholders' Equity
The net change in other stockholders' equity from December 31, 2002 to
September 30, 2003 of consisted of (in thousands):
Net loss $(116,467)
Increase (decrease) to additional paid in capital for:
Common stock issued 5,995
Preferred stock dividends accrued and accretion (16,488)
Exchange and retirement of preferred stock 240
Common stock repurchased and held in treasury (5,509)
Value attributed to warrants issued 8,784
Unamortized deferred compensation associated with restricted
stock (1,861)
----------
Total $(125,306)
==========
In August 2003, we issued 1.0 million warrants to purchase 1.0 million
shares of nonvoting common stock of Pegasus Communications in connection with
Pegasus Satellite's $100.0 million term loan facility that it entered into in
August 2003 (see Note 7). The warrants have an exercise price of $16.00 per
share and expire seven years from their date of issuance. The number of shares
into which the warrants are exercisable and the exercise price of the warrants
are subject to certain antidilution
13
PEGASUS COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
adjustments. In certain circumstances, the nonvoting common stock received upon
exercise of the warrants may be exchanged for an equal number of shares of Class
A common stock. Pursuant to the warrant agreement, holders of nonvoting common
stock from the exercise of the warrants can require Pegasus Communications to,
at its option, either repurchase their shares or exchange them for Pegasus
Communications' most marketable capital stock, as defined in the warrant
agreement, if the nonvoting common stock is not Pegasus Communications' most
marketable capital stock. A portion of the proceeds of the loan amounting to
$8.8 million was attributed to the warrants based on the warrants' relative fair
value to the overall consideration in the transaction. This amount was recorded
as additional paid in capital and as a discount of the amount of the term loan
borrowed.
7. Long Term Debt
During the three months ended September 30, 2003, Pegasus Media
borrowed $65.5 million and repaid $22.0 million under its revolving credit
facility. Principal outstanding under the facility at September 30, 2003 was
$43.5 million, and availability thereunder at that date was $10.1 million. This
facility was terminated in October 2003 (see below). Pegasus Media repaid $1.9
million of principal outstanding under its initial term loan facility during the
three months ended September 30, 2003, reducing the total principal amount
outstanding thereunder to $266.2 million. Pegasus Media repaid $451 thousand of
principal outstanding under its incremental term loan facility during the three
months ended September 30, 2003, reducing the total principal amount outstanding
thereunder to $62.1 million. All of these facilities are under the PM&C credit
agreement. This credit agreement was amended (see below).
In August 2003, Pegasus Satellite borrowed all of the $100.0 million
term loan financing available under a term loan agreement with a group of
institutional lenders. 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
accrues 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. Proceeds of the borrowing
were used as follows: $69.3 million to redeem in September 2003 all of the
outstanding principal and associated accrued interest of Pegasus Media's 12-1/2%
notes (see below); $2.5 million for costs associated with the term loan
agreement; and $28.2 million to fund cash collateral placed into a separate
letter of credit facility (see below). The total debt financing costs incurred
for this agreement were $5.5 million, which have been deferred and will be
amortized and charged to interest expense over the term of the agreement. 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
(see Note 6). A portion of the proceeds of the loan amounting to $8.8 million
was attributed to the warrants based on the warrants' relative fair value to the
overall consideration in the transaction. This amount was recorded as a discount
to the amount of the term loan borrowed, and will be amortized and charged to
interest expense over the term of the term loan facility. The amount of interest
capitalized as principal during the 3 months ended was $1.1 million, making the
total principal outstanding for the term loan of $101.1 million at September 30,
2003.
In connection with an amendment to its credit agreement that became
effective on August 1, 2003, Pegasus Media repaid an aggregate of $2.4 million
of term loan principal outstanding under the credit agreement, along with
associated accrued interest therein of $10 thousand, was repaid. The repayment
of the principal was sufficient to cover the quarterly payments scheduled to be
paid for these
14
PEGASUS COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
loans on September 30, 2003 and December 31, 2003. Aggregate costs incurred to
amend the credit agreement and for associated consent fees amounted to $1.6
million, which have been deferred and will be amortized and charged to interest
expense over the term of the agreement.
In July 2003, we entered into a new 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 us. Letters of
credit issued are in favor of amounts owed to the National Rural
Telecommunications Cooperative by subsidiaries of Pegasus Media. We pay an
annual fee of 1.75% prorated quarterly of the amount of letters of credit
outstanding for this facility. Outstanding letters of credit are collateralized
by cash provided by us in an amount equal to 105% of the letters of credit
outstanding. We are entitled to all earnings earned by the cash collateral. Cash
collateral provided by us is reported as restricted cash within current assets
on the consolidated balance sheets. The amount of restricted cash for this
facility was $61.9 million at September 30, 2003.
In September 2003, all of the remaining outstanding principal of
Pegasus Media's 12-1/2% senior subordinated notes due July 2005 ("12-1/2%
notes") of $67.9 million was redeemed, and accrued interest associated with the
notes to the date of redemption of $1.4 million was paid. The carrying amount of
the notes of $67.3 million and unamortized debt issue costs for the notes of
$456 thousand were written off upon redemption of the notes, and a loss of $1.1
million on the redemption was recorded in other nonoperating expenses on the
statement of 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
("12-1/2% notes"). Interest accrued to the date of the exchanges aggregating
$2.6 million on the previously outstanding notes received in the exchanges was
paid in cash. In a series of exchanges in the third quarter 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. Cash interest begins to
accrue on the 13-1/2% notes on March 1, 2004, and only one interest payment is
due on these notes in 2004 in September. Interest accrued to the date of the
exchanges aggregating $929 thousand on the previously outstanding notes received
in the exchanges was paid in cash.
In summary of the above exchanges through September 30, 2003, we issued
an aggregate $161.6 million principal amount of 11-1/4% notes for $163.8 million
principal amount of previously outstanding notes, consisting of $33.4 million of
9-5/8% notes, $28.9 million of 9-3/4% notes, $36.5 million of 12-1/2% notes,
$36.8 million of 12-3/8% notes, and $28.2 million of 13-1/2% notes. The
principal effect of these exchanges was to extend the maturity of $161.6 million
and reduce the amount of another $2.2 million principal outstanding. As a result
of the exchanges, in 2003 we will experience a net reduction in cash interest
paid of $2.3 million and a net reduction in interest expense of $203 thousand.
Excluding the exchanges for 13-1/2% notes, the aggregate effect of the exchanges
on cash interest to be paid and interest expense to be incurred in 2004 is a net
increase of about $60 thousand. However, the aggregate annual net effect
thereafter will be an incremental increase to cash interest to be paid and
interest expense to be incurred, after giving effect to what would have been the
maturity date of each respective previously outstanding note received in the
exchanges and the interest associated with the principal amount of the 11-1/4%
notes issued in their place, for as long as the 11-1/4% notes remain
outstanding.
15
PEGASUS COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
With respect to the exchanges involving the 13-1/2% notes, in 2004 we will
experience a net reduction in interest expense to be incurred of about $850
thousand and an increase in cash interest to be paid of $1.2 million,
principally due to two interest payments due on the 11-1/4% notes and only one
interest payment that would have been due on the 13-1/2% notes. Thereafter until
what would have been the maturity date of the 13-1/2% notes, we will experience
an annual net reduction in cash interest to be paid and interest expense to be
incurred of about $800 thousand.
All of the above exchanges except one were accounted for as exchanges
because the net present values of the cash flows of the respective series in
these exchanges were not substantially different. Accordingly, no gain or loss
was recognized. The unamortized balances of debt issue costs associated with the
previously outstanding notes received in these exchanges remained as previously
recorded and are being amortized to interest expense over the remainder of the
term of the new notes issued in these exchanges. Generally, in exchanges of debt
that are not extinguishments there is no change in the net carrying amount of
debt recorded before and after the exchanges. However, in one of the exchanges
not accounted for as an extinguishment we received cash of $1.5 million that
lead to an increase in the carrying amount of the 11-1/4% notes issued relative
to the carrying amount of the previously outstanding notes received that
contributed to the recording of a premium of $1.2 million.
One of the above exchanges was recorded as an extinguishment because
the net present values of the cash flows of the respective series in the
exchange were substantially different. In this exchange, we issued $9.1 million
principal amount of 11-1/4% notes with a fair value of $8.6 million for $9.5
million aggregate principal amount of 9-3/4% notes and 13-1/2% notes with an
aggregate carrying amount of $9.2 million plus aggregate unamortized debt issue
costs of $142 thousand. We recorded a gain of $543 thousand in other
nonoperating income on the statement of operations in the third quarter 2003 for
this extinguishment.
The following table shows the debt outstanding at September 30, 2003
compared to December 31, 2002, after giving effect to activity described above
(in thousands):
16
September 30, December 31,
2003 2002
----------------- ------------------
Initial term loan facility of Pegasus Media due April 2005 $ 266,193 $ 269,500
Revolving loan facility of Pegasus Media due October 2004 43,500 -
12-1/2% senior subordinated notes of Pegasus Media due July 2005, net of
unamortized discount of $651 thousand and $813 thousand,
respectively - 67,082
Incremental term loan facility of Pegasus Media due July 2005 62,074 62,841
Term loan facility of Pegasus Satellite due August 2009 92,557 -
9-5/8% senior notes of Pegasus Satellite due October 2005 81,591 115,000
12-3/8% senior notes of Pegasus Satellite due August 2006 158,205 195,000
9-3/4% senior notes of Pegasus Satellite due December 2006 71,055 100,000
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 126,030 138,515
12-1/2% senior notes of Pegasus Satellite due August 2007 118,521 155,000
11-1/4% senior notes of Pegasus Satellite due January 2010 337,419 175,000
Mortgage payable due 2010, interest at 9.25% 8,380 8,470
Other notes due 2004, stated interest up to 6.75% 425 2,674
---------- ----------
1,365,950 1,289,082
Less current maturities 3,554 5,752
---------- ----------
Long term debt $1,362,396 $1,283,330
========== ==========
The table reflects classification as noncurrent amounts outstanding at
September 30, 2003 that were due within 12 months of that date because those
amounts were refinanced with amounts due after 12 months of that date. Those
amounts were repaid in October 2003 with proceeds of the Tranche D financing
discussed below, except for $3.0 million that represents the amount of the
Tranche D borrowing that will be due within 12 months of the borrowing.
On October 22, 2003, Pegasus Media amended and restated its credit
agreement. Among other things, this amendment created a new $300.0 million
Tranche D term loan facility. Pegasus Media borrowed the full $300.0 million,
less a discount of 1.5%, or $4.5 million, for net proceeds of $295.5 million.
Proceeds of the borrowing were used as follows: 1) repay outstanding initial
term loan principal under the credit agreement of $190.6 million, plus accrued
interest thereon of $539 thousand; 2) repay outstanding incremental term loan
principal under the credit agreement of $44.4 million, plus accrued interest
thereon of $126 thousand; 3) repay the entire amount outstanding for the
revolving credit facility under the credit agreement of $52.0 million, plus
accrued interest thereon and other amounts related to the facility of $166
thousand; and 4) pay costs associated with the financing of $5.4 million. The
remaining proceeds of $2.2 million were used for working capital and general
corporate purposes. The payments of outstanding principal under the term and
incremental term loans were applied to amounts scheduled to be paid quarterly
from March 31, 2004 to March 31, 2005 for the initial term loan and to June 30,
2005 for the incremental term loan. The initial and incremental term loans were
subject to interest rates based on either the prime rate plus a margin of 2.5%
or LIBOR plus a margin of 3.5%. The debt financing costs incurred for this
borrowing aggregating $9.4 million and the discount incurred on the amount
borrowed will be amortized and charged to interest expense over the term of the
loan. Outstanding principal is required to be repaid quarterly at .25%, or $750
thousand, of the total facility
17
PEGASUS COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
amount commencing December 31, 2003, with the balance and any accrued and unpaid
interest due at the maturity of the facility of July 31, 2006. We may elect an
interest rate for outstanding principal on Tranche D at either 1) 7.00% plus the
greater of (i) the LIBOR rate and (ii) 2.0% or 2) the prime rate plus 6.00%.
Interest on outstanding principal borrowed under base rates is due and payable
quarterly and interest on outstanding principal borrowed under LIBOR rates is
due and payable the earlier of the end of the contracted interest rate period or
three months. Outstanding principal for Tranche D is not permitted to be repaid
until all amounts for the initial and incremental term loans are paid in full.
Thereafter, principal for Tranche D 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. Additionally, the above
amendment amended certain covenants within the agreement and terminated the
revolving credit facility under the credit agreement and all commitments and
letters of credit related thereto. As a result of this amendment, the repayment
schedule for aggregate debt outstanding under the credit agreement is $750
thousand in 2003, $3.0 million in 2004, $96.3 million in 2005, and $293.3
million in 2006.
In October 2003, we exchanged $4.3 million principal amount of 11-1/4%
notes for a like principal amount of 13-1/2% notes that was recorded as an
extinguishment with a gain of $1.1 million.
8. Per Common Share Amounts
Basic and diluted per common share and related weighted average number
of common share amounts were the same within each period reported because
potential common shares were antidilutive and excluded from the computation due
to our loss from continuing operations. The number of shares of potential common
stock derived from convertible preferred stocks, warrants, and stock options at
September 30, 2003 was 2.4 million.
Dividends and accretion on preferred stocks adjust net income or loss
and results from continuing operations to arrive at the amount applicable to
common shares. Such amounts for the periods presented were as follows (in
thousands):
Three Months Ended Nine months Ended
September 30, September 30,
2003 2002 2003 2002
--------- --------- --------- ---------
Accrued dividends $3,185 $7,969 $15,620 $26,436
Deemed dividends - - - (1,572)
Accretion - 23 1,051 71
-------- ------- ------- --------
$3,185 $7,992 $16,671 $24,935
======== ======= ======= ========
18
PEGASUS COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
9. Supplemental Cash Flow Information
Significant noncash investing and financing activities were as follows
(in thousands):
Nine months
Ended September 30,
2003 2002
------------- ------------
Preferred stock dividends, accrued and deemed, and accretion $16,671 $ 24,935
Payment of preferred stock dividends with shares of stock 99 16,233
Net additional paid in capital from repurchase, exchange, conversion
and/or redemption of preferred stock 240 166,710
Conversion of preferred stock into common stock 28 7,723
Common stock issued for employee benefits and awards 5,832 1,750
Deferred compensation in equity for restricted stock awarded (2,481) -
Value of common stock warrants applied to debt discount 8,784 -
10. Income Taxes
For continuing operations, we had income tax expense of $81 thousand
and $219 thousand for the three and nine months ended September 30, 2003,
respectively, compared to an income tax expense of $6.3 million and an income
tax benefit of $29.5 million for the three and nine months ended September 30,
2002, respectively. The income tax expense in each period for 2003 represents
expense for state income taxes payable. The third quarter 2002 was the period in
which we transitioned into a deferred income tax asset position. The net income
tax expense for the third quarter 2002 reflects the effects of this transition
that included an adjustment to the deferred income tax asset valuation allowance
for temporary excess deferred income tax assets existing in the prior quarter.
The income tax benefit for the nine months 2002 for continuing and discontinued
operations reflects the reduction in the net deferred income tax liability
balance during that period.
At September 30, 2003, we had a net deferred income tax asset balance
of $84.7 million, offset by a valuation allowance in the same amount. The
valuation allowance increased by $13.6 million and $42.2 million for the three
and nine months ended September 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 nine months ended 2003. We
believed that a valuation allowance sufficient to bring the net deferred income
tax asset balance to zero at September 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 expense for state
income taxes payable, our effective income tax rate for continuing operations
for each of the three and nine months ended September 30, 2003 was zero,
compared to the overall effective income tax rate for continuing operations for
2002 of 17.04% at December 31, 2002. The effective rate for 2002 had been
impacted by valuation allowances that commenced in the third quarter 2002. No
income taxes were attributed to discontinued operations in 2003 or for the third
quarter 2002 because of the net deferred income tax position in the respective
periods and no current tax expense was attributed to discontinued operations.
19
PEGASUS COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
11. Dispositions
In March 2003, we completed the sale of our Mobile, Alabama broadcast
television station to an unaffiliated party for $11.5 million cash. 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 of the two stations, closed on
April 30, 2003. We received cash of $5.1 million on this sale, and recognized a
loss of $2.4 million, net of costs related to the sale. At the close of this
sale, we received $5.6 million from the buyer related to the FCC licenses and
related equipment, consisting of a $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.
The FCC approved the transfer of the licenses in September 2003, and we closed
the sale of the FCC licenses and related equipment in September 30, 2003. We
recognized a gain on the sale of $4.8 million, net of costs related to the sale,
and received an additional $2.7 million in cash for this sale in October 2003.
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 $290 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 estimated additional $525 thousand may be
released when the sale is closed. In October, the FCC approved the transfer of
the permit, and the sale is expected to close in the latter part of November
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 at December 31, 2002, 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.
20
PEGASUS COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Aggregate revenues for and pretax income (loss) from discontinued
operations were as follows (in thousands):
Three Months Ended Nine months Ended
September 30, September 30,
2003 2002 2003 2002
-------- -------- -------- ---------
Revenues $ - $1,921 $1,533 $ 6,880
Pretax income (loss) 4,985 695 9,601 (4,379)
In the pretax income (loss) from discontinued operations for the three
and nine months ended 2003 above was a net gain of $4.8 million and $10.0
million, respectively, from the sale of the applicable assets. In the pretax
income (loss) from discontinued operations for the three and nine 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 or for the third quarter 2002 because of the net deferred
income tax position in the respective periods and no current tax expense was
attributed to discontinued operations. The income tax benefit for the nine
months 2002 for discontinued operations reflects the reduction in the overall
net deferred income tax liability balance during that period that was attributed
to discontinued operations.
12. Industry Segments
Our only reportable segment at September 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 September 30, 2003, which
were not significantly different from those at December 31, 2002. Our chief
operating decision maker uses the measure "DBS operating profit (loss) before
depreciation and amortization," as adjusted for special items, to evaluate our
DBS segment. This is calculated 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, as adjusted for the special item of $4.5 million for a contract
termination fee within other subscriber related expenses in the statement of
operations and comprehensive loss. The contract termination fee was initially
recorded in the third quarter 2002 that increased other subscriber related
expenses, and was reversed in the second quarter 2003 because the related
contract was amended that nullified the fee that decreased other subscriber
related expenses. The calculation of the measure for 2003 adds back the reversal
of the fee and for 2002 deducts the initial recording of the fee.
21
PEGASUS COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
13. Commitments and Contingent Liabilities
Legal Matters
DIRECTV Litigation:
DBS Rights Litigation
Our subsidiaries, Pegasus Satellite Television and Golden Sky Systems
(together, "PST"), are affiliates of the NRTC that participate through
agreements in the NRTC's direct broadcast satellite program. DIRECTV, Inc. and
NRTC are parties to an agreement called the DBS Distribution Agreement, as
amended. PST and GSS are parties to agreements with the NRTC called the
NRTC/Member Agreement for the Marketing and Distribution of DBS Services, as
amended. "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 the initial term of DIRECTV,
Inc.'s contract with the NRTC, and rights after the initial term. 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 entered into a conditional settlement
which is described more fully below.
On January 10, 2000, PST filed a class action lawsuit in federal court
in Los Angeles against DIRECTV, Inc. as representative 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 rights after term. 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 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 (as well as the class members), seeking claims for
relief relating to the initial term of PST's agreements with the NRTC, and
DIRECTV, Inc.'s obligations to PST after the initial term.
The initial term of NRTC's agreement with DIRECTV, Inc. and our
agreements with NRTC is not stated according to a period of years, but is based
on the lives of a satellite or satellites. We believe that it is governed by the
lives of the satellite resources available to DIRECTV, Inc. at the 101 degree
west longitude orbital location for delivery of services under those agreements.
DIRECTV, Inc. is seeking as part of its counterclaims against the NRTC, and PST
(and the class members), declaratory judgments that the initial term of the
DIRECTV, Inc.'s agreement with the NRTC, and the NRTC's agreements with PST (as
well as the class members) 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
22
PEGASUS COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
west orbital location. According to publicly available documents of DIRECTV,
Inc., DBS-1 has an estimated fuel life through 2009. If DIRECTV, Inc. were to
prevail on its counterclaims, the initial term of our DIRECTV rights would
likely be shorter than a term based on other satellite(s) at the 101 degree west
longitude orbital location providing us programming services, which we believe
measure(s) the initial term. Moreover, any premature failure of DBS-1 could
adversely impact our DIRECTV rights.
During the course of the litigation, DIRECTV, Inc. has twice filed
summary judgment motions on the issue of term, both under the agreement between
DIRECTV, Inc. and the NRTC, and the agreements between the NRTC and PST (and the
class members). The first motion sought a declaration that the satellite
described in the agreements between the NRTC and PST (and the class members) is
DBS-1. That motion was denied by an order of the court dated October 29, 2001.
The second motion sought a declaration that the term of the agreement between
the NRTC and DIRECTV, Inc. is measured by DBS-1. That motion was denied by an
order of the court dated May 22, 2003.
While the NRTC obtained a right of first refusal to receive certain
services after the term of the 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 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. DIRECTV, Inc.'s counterclaim also seeks a declaratory judgment
whether DIRECTV, Inc. is under a contractual obligation to provide PST with
services after the expiration of the term of its agreements with the NRTC. On
May 22, 2003, the Court granted a summary judgment motion of DIRECTV, Inc.
ruling 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
specifically 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 DIRECTV, Inc. through the NRTC.
Previously, the Court had dismissed the tort and punitive damages
claims of PST (and the class members), but did not dismiss the injunctive relief
portions of the unfair business practices claim. DIRECTV, Inc. also filed
summary judgment motions against the NRTC, and PST (as well as the class
members) on a variety of other issues in the case, including the right to
distribute the premiums, and damages relating to the premiums, launch fees, and
advanced services claims. These motions were 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 initial
term of the agreements, the content of the right of first refusal, and
plaintiffs' rights to launch fees and to distribute premiums and advanced
services remain for determination at trial.
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. 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 ("Pegasus
Development"), one of our subsidiaries, 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 ("Hughes"), Thomson Consumer Electronics ("Thomson"), and Philips
Electronics North America Corporation ("Philips"). See below for further
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PEGASUS COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
information on this litigation. In February 2003, the United States District
Court, District of Delaware granted Pegasus Development'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.
The lawsuits described above, including both lawsuits brought by the
NRTC, the class action and PST's lawsuit (but excluding the indemnity lawsuits)
were set to be tried in phases before the same 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. 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. We have filed copies of the proposed settlement with a Form
8-K dated August 11, 2003.
Among other things, the settlement purports to amend the agreement
between DIRECTV and the NRTC to: (i) change the expiration date of initial term
of that agreement to the later of the date that DBS-1 is removed from its
assigned orbital location under certain specified conditions or June 30, 2008;
(ii) eliminate the contractually provided rights after term but provide a term
extension through either December 31, 2009 or June 30, 2011 at the election of
the participating class member and subject to acceptance by the participating
class member of certain conditions; (iii) eliminate the contractually provided
right to provide the premiums as exclusive distributor and replace it with a
right to provide the premiums on an agency basis; (iv) redefine the
contractually provided rights to launch fees and advertising revenues; (v)
relinquish claims relating to past damages and restitution on account of the
premiums, launch fees and advertising revenues; and (vi) accept an agency role
for the sale of certain advanced services, including Tivo.
On September 23, 2003, counsel for the class filed an ex parte
application for preliminary approval of the proposed settlement. The application
sought the Court's permission to send notice of the proposed settlement to class
members. On October 2, 2003, PST filed an amicus brief suggesting changes to the
notice, but the Court struck the submission October 17 on the ground that PST
lacked standing. The Court held that the proposed settlement does not bar PST
from litigating any claims against parties to the settlement, and the proposed
settlement does not determine PST's rights.
On November 6, 2003, the Court granted class counsel leave to send
notice of the proposed settlement to class members, and set a schedule for
consideration of the proposed settlement as follows: (1) Class counsel is to
mail notice to class members by November 12; (2) Briefs in support of the
proposed settlement are to be filed by November 26; (3) Class members who wish
to object to the proposed settlement must do so in writing by December 10; (4)
Reply briefs in support of the proposed settlement must be filed by December 24;
(5) The hearing to consider the fairness of the proposed settlement will be held
January 5, 2004.
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PEGASUS COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
On September 24, 2003, PST moved to intervene in the DIRECTV/NRTC
litigation for the limited purpose of objecting to the proposed settlement. The
motion was heard on November 3, 2003, and the Court entered an order denying the
motion on November 13, 2003. The Court ruled that PST's rights under its
agreements with the NRTC are not affected by the proposed settlement and that
notwithstanding the proposed settlement, PST is free to seek to enforce its
rights under those agreements. The Court has also scheduled a status conference
call for January 8, 2004 to determine what motions may be necessary in the DBS
rights litigation discussed above, and to set a trial date.
Based upon the foregoing, it is our belief that the settlement does not
affect our rights under our agreements with the NRTC including our right to
services for a term based on the estimated remaining useful lives of the
satellites at the 101 degree location providing our programming services. We are
in the process of evaluating our litigation strategies to secure this result in
light of the conditional settlement.
The estimated useful life that DBS-1 could have for purposes of our DBS
rights may be disputed, but according to public documents of DIRECTV, Inc.,
DBS-1's useful life is currently estimated to expire in 2009. An unfavorable
ruling in the litigation that the initial term of our agreements with the NRTC
is determined by DBS-1 could lead to a reassessment of the carrying amount of
our DBS rights, as the underlying assumptions regarding estimated future cash
flows associated with those rights could change (ignoring any renewal rights or
alternatives to generate cash flows from our subscriber base). Likewise, if we
are able to, and elect to, participate in the conditional settlement reached
among DIRECTV, Inc, the NRTC, and the class and use estimates of future cash
flows through June 30, 2011 instead of 2016, we could reassess the carrying
amounts of our DBS rights. In the case of an unfavorable litigation result
relating to the term of our agreements or participation in the conditional
settlement, we currently estimate that we could record an impairment loss with
respect to our DBS rights of approximately $425 million to $600 million, and
that annual amortization expense for DBS rights could increase by $12 million to
$35 million.
Seamless Marketing Litigation
On June 22, 2001, DIRECTV, Inc. brought suit against PST 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. On July 13, 2001, PST terminated the seamless
marketing agreement. The seamless marketing agreement provided seamless
marketing and sales for DIRECTV retailers and distributors. On July 16, 2001,
PST filed a cross complaint against DIRECTV, Inc. alleging, among other things,
that (i) DIRECTV, Inc. breached the seamless marketing agreement and (ii)
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 was removed to the United States District Court, Central District of
California. On September 16, 2002, PST filed first amended counterclaims against
DIRECTV, Inc. Among other things, the first amended counterclaims added claims
for (i) rescission of the seamless marketing agreement on the ground of
fraudulent inducement, (ii) specific performance of audit rights, and (iii)
punitive damages on the breach of the implied covenant of good faith claim. In
addition, the first amended counterclaims deleted the business and professions
code claim and the claims for tortious interference that were alleged in the
initial cross complaint. On November 5, 2002 the Court granted DIRECTV, Inc.'s
motion to dismiss the specific performance claim and 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.
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PEGASUS COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
On November 6, 2003, the Court held a status conference for the purpose
of setting pretrial and trial dates. At that time, the Court set the case for
trial on March 23, 2004. In addition, the Court set December 22, 2003 as the
hearing date for motions in limine, and February 9, 2004 as the date for the
pretrial conference.
Patent Infringement Litigation:
On December 4, 2000, Pegasus Development and Personalized Media filed a
patent infringement lawsuit in the United States District Court, District of
Delaware against DIRECTV, Inc., Hughes, Thomson, and Philips. Personalized Media
is a company with which Pegasus Development has a licensing arrangement. Pegasus
Development and Personalized Media are seeking injunctive relief and monetary
damages for the defendants' alleged patent infringement and unauthorized
manufacture, use, sale, offer to sell, and importation of products, services,
and systems that fall within the scope of Personalized Media's portfolio of
patented media and communications technologies, of which Pegasus Development is
an exclusive licensee within a field of use. The technologies covered by Pegasus
Development's exclusive license include services distributed to consumers using
certain Ku band BSS frequencies and Ka band frequencies, including frequencies
licensed to affiliates of Hughes 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.
DIRECTV, Inc. also filed a counterclaim against Pegasus Development
alleging unfair competition under the federal Lanham Act. In a separate
counterclaim, DIRECTV, Inc. alleged that both Pegasus Development's and
Personalized Media's patent infringement lawsuit constitutes "abuse of process."
Those counterclaims have since been dismissed by the Court or voluntarily by
DIRECTV, Inc. Separately, Thomson has filed counterclaims against Pegasus
Development, Personalized Media, Gemstar-TV Guide, Inc. (and two Gemstar-TV
Guide affiliated companies, TVG-PMC, Inc. and Starsight Telecast, Inc.),
alleging violations of the federal Sherman Act and California unfair competition
law as a result of alleged licensing practices.
The Judicial Panel on Multidistrict Litigation subsequently transferred
Thomson's antitrust/unfair competition counterclaims to an ongoing Multidistrict
Litigation in the United States District Court for the Northern District of
Georgia. The Panel found that these counterclaims presented common questions of
fact with actions previously consolidated for pretrial proceedings in the
Northern District of Georgia and that including Thomson's claims in the
coordinated pretrial proceedings would promote the just and efficient conduct of
the litigation.
The Court decided several important motions in favor of Pegasus
Development and Personalized Media. The Court granted Pegasus Development and
Personalized Media's motion for leave to amend the complaint to limit the relief
sought and it also granted their motion to bifurcate the trial into two
proceedings to address the patent and antitrust issues separately. The Court
denied a motion originally brought by DIRECTV, Inc. and Hughes, which was later
joined by Thomson and Philips, for partial summary judgment under the doctrine
of prosecution laches.
In March 2003, a hearing was held before a special master appointed by
the Delaware district court to recommend constructions of disputed terms in the
patent claims in suit. On March 24, 2003, the special master issued his report,
recommending claim constructions largely favorable to the plaintiffs. The report
of the special master is subject to review by the district judge.
In April 2003, the United States Patent and Trademark Office granted a
petition filed by defendant Thomson seeking reexamination of one of the patents
in suit in the Delaware litigation.
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PEGASUS COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Additional petitions seeking reexamination of other patents in suit have either
already been filed by Thomson, or are anticipated to be filed in the near
future. On April 14, 2003, the defendants filed a motion in the Delaware
district court seeking a stay of the patent litigation pending completion of
reexamination proceedings. On May 14, 2003, the Delaware district court granted
defendants' motion pending a disposition of the United States Patent and
Trademark Office's reexamination of several of the patents in suit. Also on May
14, 2003, the Delaware district court denied all pending motions without
prejudice. The parties may refile those motions following the stay and upon the
entry of a new scheduling order.
Thomson's antitrust counterclaims against Pegasus Development,
Personalized Media, and Gemstar (the "Thomson claims"), which were transferred
to the Northern District of Georgia pursuant to an order of the Judicial Panel
on Multidistrict Litigation, have not been stayed. Discovery has closed on the
merits of the Thomson claims and briefing on Pegasus Development's summary
judgment motion on those claims will be completed on November 19, 2003. The
Georgia Court has deferred discovery with respect to damages until after a
ruling on the summary judgment motion on liability. Gemstar and Thomson have
settled the Thomson claims brought against Gemstar, and Thomson has dismissed
these claims, as to Gemstar only, with prejudice.
Other Legal Matters:
In addition to the matters discussed above, from time to time we are
involved with claims that arise in the normal course of our business. 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 third quarter 2002, we recorded a termination fee liability of
$4.5 million and associated expense to the direct broadcast satellite business'
other subscriber related expenses 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 nullified. 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.
14. New Accounting Pronouncements
Interpretation No. 46 "Consolidation of Variable Interest Entities"
("FIN 46") was issued by the Financial Accounting Standards Board ("FASB") in
January 2003. This interpretation clarifies the need for primary beneficiaries
of variable interest entities to consolidate the variable interest entities into
their financial statements. Variable interest entities are entities in which
equity investors do not have the characteristics of a controlling financial
interest or do not have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support from other parties.
The FASB has deferred the effective date for applying the provisions of this
interpretation to the end of the first interim or annual period ending after
December 15, 2003 for public entities that have interests in variable interest
entities that were created before February 1, 2003 and the public entity has not
issued financial
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PEGASUS COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
statements reporting that variable interest entity in accordance with the
interpretation. We have identified certain interests in potential variable
interest entities. These potential variable interest entities were created prior
to February 1, 2003, and we have not issued any financial statements that
reported these interests in accordance with the interpretation. Accordingly, we
continue to study the effects, if any, of the interpretation during this
deferral period. We believe that the aggregate of these interests would not have
a significant effect on our financial position, results of operations, or cash
flows should they in fact be interests in variable interest entities that we
consolidate.
On April 30, 2003, the 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.
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PEGASUS COMMUNICATIONS CORPORATION
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; an
inability to obtain intellectual property licenses and to avoid committing
intellectual property infringement; the ability to attract and retain qualified
personnel; our significant indebtedness; the availability and terms of capital
to fund the expansion of our businesses; and other factors referenced in this
report and in 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 Communications
Corporation, together with its direct and indirect subsidiaries. "Pegasus
Communications" refers to Pegasus Communications Corporation individually as a
separate entity. "Pegasus Satellite" refers to Pegasus Satellite Communications,
Inc., one of our direct subsidiaries. "Pegasus Media" refers to Pegasus Media &
Communications, Inc., a wholly owned subsidiary of Pegasus Satellite. Other
terms used are defined 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
$153.6 million, $278.4 million, and $159.0 million for 2002, 2001, and 2000,
respectively. We have an accumulated deficit balance at September 30, 2003 of
$981.4 million.
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 87%, 92%, and 92%, respectively, of total consolidated
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PEGASUS COMMUNICATIONS CORPORATION
operating expenses. Total assets of the direct broadcast satellite business were
81% and 82% of total consolidated assets at September 30, 2003 and December 31,
2002, respectively. The following sections focus on our direct broadcast
satellite business, as this is our only significant business segment.
Significant Risks and Uncertainties
We are highly leveraged. At September 30, 2003, we had a combined
carrying amount of long term debt, including the portion that is current, and
redeemable preferred stock outstanding of $1.7 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 preferred stock
requirements 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,
the business strategies of DIRECTV, Inc. and the National Rural
Telecommunications Cooperative, equipment strategies, technological
developments, levels 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. Our litigation with DIRECTV,
Inc. may have a bearing on our estimation of the useful lives of our direct
broadcast satellite rights assets. The estimated useful life that DBS-1 could
have for purposes of our DBS rights may be disputed, but according to public
documents of DIRECTV, Inc., DBS-1's useful life is currently estimated to expire
in 2009. An unfavorable ruling in the litigation that the initial term of our
agreements with the National Rural Telecommunications Cooperative ("NRTC") is
determined by DBS-1 could lead to a reassessment of the carrying amount of our
DBS rights, as the underlying assumptions regarding estimated future cash flows
associated with those rights could change (ignoring any renewal rights or
alternatives to generate cash flows from our subscriber base). Likewise, if we
are able to, and elect to, participate in the conditional settlement reached
among DIRECTV, Inc, the NRTC, and the class and use estimates of future cash
flows through June 30, 2011 instead of 2016, we could reassess the carrying
amounts of our DBS rights. In the case of an unfavorable litigation result
relating to the term of our agreements or participation in the conditional
settlement, we currently estimate that we could record an impairment loss with
respect to our DBS rights of approximately $425 million to $600 million, and
that annual amortization expense for DBS rights could increase by $12 million to
$35 million. See Note 13 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 nine months ended September 30, 2003 and 2002, the direct
broadcast satellite business had income from operations of $35.2 million and
$29.6 million, respectively. We attribute the improvement in the current year to
our direct broadcast satellite business strategy. This strategy focuses
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PEGASUS COMMUNICATIONS CORPORATION
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.
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, that strategy along with other very
significant factors, has contributed to a certain extent to the decrease in the
number of our direct broadcast satellite subscribers of 108 thousand for the
nine months ended September 30, 2003 and the decrease of $29.2 million in direct
broadcast satellite net revenues during the nine months ended September 30, 2003
compared to the nine months ended September 30, 2002. The other very significant
factors include a significant competitive disadvantage that we experience in
several of our territories in which a competing direct broadcast satellite
provider provides local channels but DIRECTV does not; competition from a
competing direct broadcast satellite provider other than with respect to local
channels; competition from digital cable providers; and the effect of general
economic conditions on our subscribers and potential subscribers. We believe
that the number of territories in which we are disadvantaged by a lack of local
channel service will increase during the fourth quarter 2003 and the first two
quarters of 2004 because of DIRECTV's delay in launching a satellite to provide
local channels in markets where a competing direct broadcast satellite provider
offers local channels and DIRECTV's failure to provision certain of our key
markets with local channels. 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.
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PEGASUS COMMUNICATIONS CORPORATION
Results of Operations
In this section, amounts and changes specified are for the three and
nine months ended September 30, 2003 compared to the three and nine months ended
September 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
Subscribers:
We had 1,200,458 subscribers at September 30, 2003, a net decrease of
108,012 from the number of subscribers at December 31, 2002. The average number
of subscribers outstanding was 1,214,098 and 1,253,983 during the three and nine
months ended September 30, 2003, respectively, and 1,356,095 and 1,370,074
during the three and nine months ended September 30, 2002, respectively. The
average number of subscribers outstanding during the three months ended June 30,
2003 was 1,254,436. Gross subscriber additions were 42,886 and 113,453 for the
three and nine months ended September 30, 2003, respectively, and 55,038 and
169,849 for the three and nine months ended September 30, 2002, respectively.
Gross subscriber additions were 31,577 for the three months ended June 30, 2003.
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. We believe that the number of territories in which we are
disadvantaged by a lack of local channel service will increase during the fourth
quarter 2003 and the first two quarters of 2004 because of DIRECTV's delay in
launching a satellite to provide local channels in markets where a competing
direct broadcast satellite provider offers local channels and DIRECTV's failure
to provision certain of our key markets with local channels. Additionally, we
believe that all other factors cited above contributing to our subscriber losses
will continue over the near term.
Revenues:
Revenues decreased $9.4 million to $207.0 million and $29.2 million to
$618.4 million for the three and nine 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 $7.1 million and $29.6
million, respectively, and decreases in pay per view revenues of $2.1 million
and $10.0 million, respectively. The decrease for the nine months 2003 was
offset by $10.0 million of 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") 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 $53.18 in 2002 to $56.83 in 2003 for the three months
ended, and from $52.51 in 2002 to $54.79 in 2003 for the
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PEGASUS COMMUNICATIONS CORPORATION
nine months ended. ARPU for core, a la carte, and premium programming increased
from $43.55 in 2002 to $46.70 in 2003 for the three months ended, and from
$44.13 in 2002 to $45.59 in 2003 for the nine months ended. A rate increase to
certain a la carte and premium package offerings in the second quarter 2003, a
rate increase to core package offering in the third quarter 2003, and our
ability to keep subscribers in and upgrade subscribers into higher retail priced
packages, contributed to the increases in ARPU.
Revenues for the third quarter 2003 increased $1.2 million to $207
million, compared to the second quarter 2003. This increase was primarily due to
a $3.9 million increase in sports subscription revenue, substantially all
related to the commencement of our "NFL Ticket" programming season, partially
offset by a $2.6 million decrease in our recurring subscription revenue from our
core, a la carte, and premium package offerings. The decrease 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 ARPU in the third quarter 2003. Total ARPU increased from $54.69 in the
second quarter 2003 to $56.83 in the third quarter 2003. ARPU from our core, a
la carte, and premium package offerings increased from $45.88 in the second
quarter 2003 to $46.70 in the third quarter 2003. A rate increase to our core
package offerings in third 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 $902 thousand to $93.7 million and $7.5
million to $279.4 million for the three and nine 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 $2.1 million and
$8.3 million, respectively; and decreases in the cost of our pay per view
programming of $1.0 million and $4.3 million, respectively. Additionally for the
nine months ended 2003, we recorded a credit to programming expenses of $1.2
million for a one time adjustment for expenses allocable to a party that has a
minority interest in one of our subsidiaries. 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 in part 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. The net decreases to programming expense were also
partially offset by our estimate of patronage to be received from the NRTC being
$2.3 million and $8.7 million less for the three and nine months 2003,
respectively, compared to the corresponding 2002 periods. The NRTC patronage is
a reduction to programming expense.
Other subscriber related expenses decreased $3.8 million to $47.8
million and $19.4 million to $133.0 million for the three and nine months 2003,
respectively. A portion of the decrease for the three and nine months ended 2003
was due to a contract termination fee liability and related expense that we
recorded in the third quarter 2002 of $4.5 million. The termination fee
liability was reversed in the second quarter 2003 which reduced other subscriber
related expenses, because we amended the related contract that nullified the
liability. These transactions had a $4.5 million impact on the three months
ended 2003 and a $9.0 million impact on the nine months ended 2003. The related
contract was for outsourced customer care services. Also contributing to the
decreased other subscriber related expenses, were decreases in our customer care
costs of $2.2 million and $4.6 million for the three and nine months ended 2003,
primarily as a result of renegotiated rates in this amended contract. Finally,
bad debt expense decreased $1.7 million and $11.5 million for the three and nine
months ended 2003. These decreases are partially offset by increases of $5.3
million and $11.1 million in the costs of equipment,
33
PEGASUS COMMUNICATIONS CORPORATION
installation services, programming, and promotional campaigns, related to our
efforts to retain and upgrade our existing subscribers.
Other Operating Expenses:
Promotion and incentives and advertising and selling expenses in 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. Under certain of our subscription plans for DIRECTV programming, we
take title to receivers provided to subscribers, and we capitalize the related
SAC. Direct and incremental SAC associated with subscriptions plans for DIRECTV
programming that contain minimum service commitment periods and subscription
early termination fees that are not capitalized is deferred in the aggregate not
to exceed the amounts of applicable termination fees. 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. Receiver subsidies, equipment fulfillment costs,
and equipment installation subsidies that are expensed are classified in
promotions and incentives expenses. Dealer commissions, advertising and
marketing costs, and selling costs that are expensed are classified in
advertising and selling expenses. Amounts associated with SAC are contained in
the following table:
Three Months Ended Nine Months Ended
SAC (in thousands): September 30, September 30,
2003 2002 2003 2002
------------ ------------- ------------ ------------
Gross SAC incurred $24,464 $27,454 $ 63,919 $ 78,167
Capitalized (7,185) (6,653) (17,300) (20,149)
Deferred (6,395) (6,991) (16,964) (24,317)
------------ ------------- ------------ ------------
Expensed $10,884 $13,810 $ 29,655 $ 33,701
============ ============= ============ ============
Promotions and incentives $ 3,699 $ 5,933 $10,172 $ 9,703
Advertising and selling 7,185 7,877 19,483 23,998
------------ ------------- ------------ ------------
Total expensed $10,884 $13,810 $29,655 $33,701
============ ============= ============ ============
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. Capitalized SAC increased by $532
thousand for the three months 2003 and decreased by $2.8 million for the nine
months 2003 as a result of an approximate six thousand increase and 24 thousand
decrease in the number of receivers delivered to new subscribers that we took
title to for the respective three and nine months ended 2003 periods. Deferred
SAC decreased in both current year periods as a result of an approximate seven
thousand and 31 thousand decrease in the number of gross subscriber additions
for which certain direct and incremental SAC costs were eligible for deferral
for the respective three and nine months ended 2003 periods.
Based on gross subscriber additions for the respective 2003 and 2002
periods noted above, total SAC per gross subscriber added was $570 and $563 for
the three and nine months 2003, respectively, and $499 and $472 for the three
and nine 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 costs, including
advertising and marketing costs, have on the SAC per gross subscriber addition
metric when divided by a substantially lesser number of gross subscriber
additions, an impact of $51 per gross subscriber addition and $46 per gross
subscriber addition for the three and nine months ended 2003, respectively; a
greater percentage of our gross subscriber
34
PEGASUS COMMUNICATIONS CORPORATION
additions taking more than one receiver that adds incrementally to the receiver
and installation per subscriber cost, an impact of approximately $36 per gross
subscriber addition and $43 per gross subscriber addition for the three and nine
months ended 2003, respectively; greater costs of programming provided to new
gross subscriber additions at discounted rates as part of promotional
introductory campaigns, an impact of $17 per gross subscriber addition for the
three and nine month period ended 2003 (the cost of such programming is recorded
as subscriber acquisition costs); and 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. These per gross subscriber increases
were partially offset by decreased aggregate dealer commission costs of $33 per
gross subscriber addition and $14 per gross subscriber addition for the three
and nine months ended 2003, respectively, primarily the result of
differentiating compensation plans based upon the creditworthiness of new
subscribers enrolled.
Depreciation of capitalized SAC was $4.7 million and $13.5 million for
the three and nine months 2003, respectively, and $3.8 million and $9.8 million
for the three and nine months 2002, respectively. Amortization of deferred SAC
was $5.4 million and $19.5 million for the three and nine months 2003,
respectively, and $8.8 million and $22.4 million for the three and nine months
2002, respectively. Depreciation of capitalized SAC and amortization of deferred
SAC are included in depreciation and amortization.
General and administrative expenses decreased $156 thousand to $6.1
million and $2.7 million to $18.3 million for the three and nine months 2003,
respectively. The decrease for the nine months 2003 was primarily due to reduced
expenditures for communication services resulting from several renegotiations of
the related contract for such services, as well as reduced customer call volume
from the lesser average number of subscribers in the current year.
Depreciation and amortization decreased $3.0 million to $40.0 million
for the three months 2003 and decreased $1.1 million to $122.8 million for the
nine 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 decreases in
depreciation and amortization for the three and nine months 2003 were primarily
due to a lesser amount of deferred SAC eligible for amortization during the
periods compared to the corresponding 2002 period resulting from a decreased
number of subscribers added in the four quarters ended with the third quarter
2003 compared to the four quarters ended with the third quarter 2002.
Other Statement of Operations and Comprehensive Loss Items
Corporate and development expenses decreased $4.1 million to $7.9
million and $14.6 million to $23.8 million for the three and nine months 2003,
respectively, primarily due to less amortization of certain licenses held by our
subsidiaries Pegasus Development Corporation ("Pegasus Development") and Pegasus
Guard Band in 2003 compared to 2002. Other operating expenses decreased $2.6
million to $6.0 million and $62 thousand to $24.4 million for the three and nine
months 2003, respectively. The decrease for the three months 2003 was primarily
due to an impairment recorded in the third quarter 2002 for programming rights
of $1.4 million. The principal expenses within other operating expenses were for
those incurred in the DIRECTV, Inc. and patent litigations aggregating $4.2
million and $13.9 million for the three and nine months 2003, respectively, and
$5.0 million and $11.7 million for the three and nine months 2002, respectively.
The loss on impairment of marketable securities for the nine 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 decrease in other
nonoperating income, net of $16.4 million and $15.1 million for the three and
nine months 2003, respectively, was primarily due to a net gain on the
35
PEGASUS COMMUNICATIONS CORPORATION
retirement of debt recorded in the third quarter 2002 of $15.7 million. The
decrease of $4.2 million in equity in losses of affiliates for the nine months
2003 was primarily due to an adjustment in the capital accounts of the
respective partners of a partnership in which Pegasus Development is a partner
that reduced Pegasus Development's share in the equity of the partnership by
$3.3 million.
Interest expense increased $4.4 million to $40.9 million and $4.2
million to $113.1 million for the three and nine months 2003, respectively,
primarily due to interest in each period of $3.5 million associated with our
12-3/4% preferred stock that was classified as a liability commencing July 1,
2003 upon our adoption on that date of Statement of Financial Accounting
Standards No. 150, and interest of $435 thousand and $1.3 million for the three
and nine months 2003, respectively, on dividends in arrears for our 12-3/4%
preferred stock. See below for further commentary related to transactions in our
debt that will impact future interest expense.
For continuing operations, we had income tax expense of $81 thousand
and $219 thousand for the three and nine months ended September 30, 2003,
respectively, compared to an income tax expense of $6.3 million and an income
tax benefit of $29.5 million for the three and nine months ended September 30,
2002, respectively. The income tax expense in each period for 2003 represents
expense for state income taxes payable. The third quarter 2002 was the period in
which we transitioned into a deferred income tax asset position. The net income
tax expense for the third quarter 2002 reflects the effects of this transition
that included an adjustment to the deferred income tax asset valuation allowance
for temporary excess deferred income tax assets existing in the prior quarter.
The income tax benefit for the nine months 2002 for continuing and discontinued
operations reflects the reduction in the net deferred income tax liability
balance during that period. At September 30, 2003, we had a net deferred income
tax asset balance of $84.7 million, offset by a valuation allowance in the same
amount. The valuation allowance increased by $13.6 million and $42.2 million for
the three and nine months ended September 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 nine months ended
2003. We believed that a valuation allowance sufficient to bring the net
deferred income tax asset balance to zero at September 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 expense for state income taxes payable, our effective income tax rate for
continuing operations for each of the three and nine months ended September 30,
2003 was zero, compared to the overall effective income tax rate for continuing
operations for 2002 of 17.04% at December 31, 2002. The effective rate for 2002
had been impacted by valuation allowances that commenced in the third quarter
2002. No income taxes were attributed to discontinued operations in 2003 or for
the third quarter 2002 because of the net deferred income tax position in the
respective periods and no current tax expense was attributed to discontinued
operations.
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. In September 2003, we closed on the
sale of the FCC licenses and related equipment for the Mississippi stations and
recognized a gain of $4.8 million, net of costs related to the sale. The
operations and sale portions of the Mississippi stations are classified as
discontinued in the statement of operations and
36
PEGASUS COMMUNICATIONS CORPORATION
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 Nine months Ended
September 30, September 30,
2003 2002 2003 2002
-------- -------- -------- ---------
Revenues $ - $1,921 $1,533 $ 6,880
Pretax income (loss) 4,985 695 9,601 (4,379)
In the pretax income (loss) from discontinued operations for the three
and nine months ended 2003 above was a net gain of $4.8 million and $10.0
million, respectively, from the sale of the applicable assets. In the pretax
income (loss) from discontinued operations for the three and nine 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 or for the third quarter 2002 because of the net deferred
income tax position in the respective periods and no current tax expense was
attributed to discontinued operations. The income tax benefit for the nine
months 2002 for discontinued operations reflects the reduction in the overall
net deferred income tax liability balance during that period that was attributed
to discontinued operations.
We completed a series of exchanges in the second and third quarters of
2003 in which we issued an aggregate $161.6 million principal amount of 11-1/4%
senior notes due January 2010 ("11-1/4% notes") in exchange for an aggregate
$163.8 million principal amount of previously outstanding notes, consisting of
$33.4 million of 9-5/8% senior notes due October 2005 ("9-5/8% notes"), $28.9
million of 9-3/4% senior notes due December 2006 ("9-3/4% notes"), $36.5 million
of 12-1/2% senior notes due August 2007 ("12-1/2% notes"), $36.8 million of
12-3/8% senior notes due August 2006 ("12-3/8% notes"), and $28.2 million of
13-1/2% senior subordinated notes due March 2007 ("13-1/2% notes"). The
principal effect of these exchanges was to extend the maturity of $161.6 million
and reduce the amount of another $2.2 million principal outstanding. As a result
of the exchanges, in 2003 we will experience a net reduction in interest expense
of $203 thousand. Excluding the exchanges for 13-1/2% notes, the aggregate
effect of the exchanges on interest expense to be incurred in 2004 is a net
increase of about $60 thousand. However, the aggregate annual net effect
thereafter will be an incremental increase to interest expense to be incurred,
after giving effect to what would have been the maturity date of each respective
previously outstanding note received in the exchanges and the interest
associated with the principal amount of the 11-1/4% notes issued in their place,
for as long as the 11-1/4% notes remain outstanding. With respect to the
exchanges involving the 13-1/2% notes, in 2004 we will experience a net
reduction in interest expense to be incurred of about $850 thousand. Thereafter
until what would have been the maturity date of the 13-1/2% notes, we will
experience an annual net reduction in interest expense to be incurred of about
$800 thousand.
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.
Additionally, a discount of $8.8 million recorded in the issuance of these term
loans will be amortized and charged to interest expense over the term of the
notes. The total debt financing costs incurred for these loans was $5.5 million,
which has been deferred and will be amortized and charged to interest expense
over the term of the agreement. Further, aggregate costs of $1.6 million were
incurred to amend Pegasus Media's credit agreement and for associated consent
fees in connection with this term
37
PEGASUS COMMUNICATIONS CORPORATION
loan financing and other matters associated with the credit agreement. These
costs have been deferred and will be amortized and charged to interest expense
over the remaining term of the agreement.
On October 22, 2003, Pegasus Media amended and restated its credit
agreement that created a new $300.0 million Tranche D term loan facility.
Pegasus Media borrowed the full $300.0 million, less a discount of 1.5%, or $4.5
million, for net proceeds of $295.5 million. Any unpaid loan balance is due July
31, 2006. We may elect an interest rate for outstanding principal on Tranche D
at either 1) 7.00% plus the greater of (i) the LIBOR rate and (ii) 2.0% or 2)
the prime rate plus 6.00%. A portion of the proceeds of the borrowing was used
to repay an aggregate of $235.0 million of initial and incremental term loan
principal outstanding under the credit agreement scheduled for repayment in 2004
and 2005. The initial and incremental term loans were subject to interest rates
based on either the prime rate plus a margin of 2.5% or LIBOR plus a margin of
3.5%. Another portion of the proceeds was used to repay $52.0 million principal
amount outstanding under our revolving credit facility, and the facility was
terminated. The amounts borrowed under the revolving credit facility were
subject to interest rates based on either the prime rate plus a margin of 1% to
2% or LIBOR plus a margin of 2% to 3%. The debt financing costs incurred for
this borrowing aggregating $9.4 million and the discount incurred on the amount
borrowed will be amortized and charged to interest expense over the term of the
loan.
DBS Operating Profit before Depreciation and Amortization
"DBS operating profit before depreciation and amortization," as
adjusted for special items, is a GAAP measure used by our chief operating
decision maker to evaluate our DBS segment. This measure was $48.6 million and
$54.7 million for three months ended September 30, 2003 and 2002, respectively,
and $153.5 million and $158.0 million for the nine months ended September 30,
2003 and 2002, respectively. This measure was calculated 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, as adjusted for the special item of $4.5 million for a
contract termination fee within other subscriber related expenses in the
statement of operations and comprehensive loss. The contract termination fee was
initially recorded in the third quarter 2002 that increased other subscriber
related expenses, and was reversed in the second quarter 2003 because the
related contract was amended that nullified the fee, that decreased other
subscriber related expenses. The calculation of the measure for 2003 adds back
the reversal of the fee and for 2002 deducts the initial recording of the fee.
New Accounting Pronouncements
Interpretation No. 46 "Consolidation of Variable Interest Entities"
("FIN 46") was issued by the Financial Accounting Standards Board ("FASB") in
January 2003. This interpretation clarifies the need for primary beneficiaries
of variable interest entities to consolidate the variable interest entities into
their financial statements. Variable interest entities are entities in which
equity investors do not have the characteristics of a controlling financial
interest or do not have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support from other parties.
The FASB has deferred the effective date for applying the provisions of this
interpretation to the end of the first interim or annual period ending after
December 15, 2003 for public entities that have interests in variable interest
entities that were created before February 1, 2003 and the public entity has not
issued financial statements reporting that variable interest entity in
accordance with the interpretation. We have identified certain interests in
potential variable interest entities. These potential variable interest entities
were created prior to February 1, 2003, and we have not issued any financial
statements that reported these interests in accordance with the interpretation.
Accordingly, we continue to study the effects, if any, of the interpretation
during this deferral period. We believe that the aggregate of these interests
38
PEGASUS COMMUNICATIONS CORPORATION
would not have a significant effect on our financial position, results of
operations, or cash flows should they in fact be interests in variable interest
entities that we consolidate.
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.
Liquidity and Capital Resources
We had cash and cash equivalents on hand at September 30, 2003 of $60.7
million, compared to $59.8 million at December 31, 2002 and $48.4 million at
September 30, 2002. The changes in cash for the nine months ended September 30,
2003 and 2002 are discussed below in terms of the amounts shown on our statement
of cash flows.
Net cash provided by operating activities was $4.1 million and $9.3
million for the nine months ended September 30, 2003 and 2002, respectively. The
principal reasons for the decrease in the 2003 period was due to: 1) the timing
of interest payments associated with our 11-1/4% notes resulting in $9.8 million
in increased cash interest paid in 2003; 2) cash received in 2002 of $1.6
million for DBS receiver inventory sold; and 3) reduced expenditures in 2003 of
$7.4 million for SAC that was deferred. The interest on the 11-1/4% notes are
payable 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 due to working capital needs.
Cash of $3.1 million was provided by investing activities for the nine
months ended September 30, 2003 and cash of $24.7 million was used for investing
activities for the nine months ended September 30, 2002. The 2003 period
primarily reflects cash received of $21.6 million from sales of three broadcast
television stations, and cash utilized for direct broadcast satellite receiver
equipment capitalized of $16.5 million and other capital expenditures of $2.1
million. The 2002 period primarily consisted of cash utilized for direct
broadcast satellite receiver equipment capitalized of $20.1 million and other
capital expenditures of $4.2 million. We received $2.7 million in cash in early
October from the close of the final portion of the sale of our Mississippi
broadcast television stations.
For the nine months ended September 30, 2003 and 2002, net cash was
used for financing activities of $6.3 million and $81.0 million, respectively.
The primary expenditures for financing activities for 2003 were: 1) redemption
of all of the outstanding principal of Pegasus Media's 12-1/2% notes due July
2005 of $67.9 million; 2) repayments of other long term debt of $6.4 million; 3)
purchases of 297,460 shares of our Class A common stock for $5.5 million; 4)
costs of $11.2 million incurred for new financing arrangements; and 5) the net
change in restricted cash of $60.3 million, of which $61.9 million was for
collateral for a letter of credit facility. The primary receipts for financing
activities for 2003 were: 1) $100.0 million in term loan financing; 2) net
borrowing of $43.5 million under our revolving credit facility; and 3) $1.5
million in an exchange of our notes. The primary expenditures for financing
activities for 2002 were: 1) repayment of amounts outstanding under our
revolving credit facility of $80.0 million; 2) repayments of other long term
debt of $8.2 million; 3) aggregate redemptions and repurchases of our preferred
stock of $28.9 million; and 4) an aggregate repurchases of outstanding notes of
$25.0 million. The primary receipts for financing activities for 2002 were
proceeds of $63.2 million from an incremental term loan facility.
In June 2003, we reacquired $1.3 million par value of Pegasus
Satellite's 12-3/4% cumulative exchangeable preferred stock ("12-3/4% series")
that is mandatorily redeemable in 2007 in exchange for
39
PEGASUS COMMUNICATIONS CORPORATION
$2.1 million par value of our 6-1/2% Series C convertible preferred stock
("Series C") that is not mandatorily redeemable. An accrued contract termination
fee that had been scheduled for payment in July 2003 of $4.5 million was
reversed in the second quarter 2003 due to an amendment of the related contract
that nullified the fee. 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.
We completed a series of exchanges in the second and third quarters of
2003 in which we issued an aggregate $161.6 million principal amount of 11-1/4%
notes in exchange for $163.8 million principal amount of previously outstanding
notes, consisting of $33.4 million of 9-5/8% notes, $28.9 million of 9-3/4%
notes, $36.5 million of 12-1/2% notes, $36.8 million of 12-3/8% notes, and $28.2
million of 13-1/2% notes. The principal effect of these exchanges was to extend
the maturity of $161.6 million and reduce the amount of another $2.2 million
principal outstanding. As a result of the exchanges, in 2003 we will experience
a net reduction in cash interest paid of $2.3 million. Excluding the exchanges
for 13-1/2% notes, the aggregate effect of the exchanges on cash interest to be
paid is a net increase of about $60 thousand. However, the aggregate annual net
effect thereafter will be an incremental increase to cash interest to be paid,
after giving effect to what would have been the maturity date of each respective
previously outstanding note received in the exchanges and the interest
associated with the principal amount of the 11-1/4% notes issued in their place,
for as long as the 11-1/4% notes remain outstanding. With respect to the
exchanges involving the 13-1/2% notes, in 2004 we will experience an increase in
cash interest to be paid of $1.2 million, principally due to two interest
payments due on the 11-1/2% notes and only one interest payment that would have
been due on the 13-1/2% notes. Thereafter until what would have been the
maturity date of the 13-1/2% notes, we will experience an annual net reduction
in cash interest to be paid of about $800 thousand. In October 2003, we
exchanged $4.3 million principal amount of 11-1/4% notes for a like principal
amount of 13-1/2% notes.
On August 1, 2003, Pegasus Satellite borrowed all of the $100.0 million
term loan financing available under a term loan agreement. The rate of interest
on outstanding principal is 12.5%. Interest accrues 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. A portion of the
proceeds were used to redeem all of the remaining outstanding principal of
Pegasus Media's 12-1/2% senior subordinated notes due July 2005 ("12-1/2%
notes") of $67.9 million in September 2003.
Pegasus Media amended its credit agreement in connection with Pegasus
Satellite's $100.0 million term loan financing that had an effective date of
August 1, 2003. On the effective date, we repaid an aggregate of $2.4 million of
term loan principal outstanding under the credit agreement. The repayment of the
principal was sufficient to cover the quarterly payments scheduled to be paid
for these loans on September 30, 2003 and December 31, 2003.
We entered into a new letter of credit facility with a bank that became
effective August 1, 2003. We pay an annual fee of 1.75% prorated quarterly of
the amount of letters of credit outstanding for this facility. Outstanding
letters of credit are collateralized by cash in an amount equal to 105% of the
letters of credit outstanding. We have $61.9 million in restricted cash at
September 30, 2003 as collateral for letters of credit under this facility.
On October 22, 2003, Pegasus Media amended and restated its credit
agreement. Among other things, this amendment created a new $300.0 million
Tranche D term loan facility. Pegasus Media
40
PEGASUS COMMUNICATIONS CORPORATION
borrowed the full $300.0 million, less a discount of 1.5%, or $4.5 million, for
net proceeds of $295.5 million. A portion of the proceeds was used to repay an
aggregate of $235.0 million of initial and incremental term loan principal
outstanding under the credit agreement scheduled for repayment in 2004 and 2005
and to repay the entire amount outstanding for the revolving credit facility
under the credit agreement of $52.0 million. Outstanding principal is required
to be repaid quarterly at .25%, or $750 thousand, of the total facility amount
commencing December 31, 2003, with the balance and any accrued and unpaid
interest due at the maturity of the facility of July 31, 2006. We may elect an
interest rate for outstanding principal on Tranche D at either 1) 7.00% plus the
greater of (i) the LIBOR rate and (ii) 2.0% or 2) the prime rate plus 6.00%.
Interest on outstanding principal borrowed under base rates is due and payable
quarterly and interest on outstanding principal borrowed under LIBOR rates is
due and payable the earlier of the end of the contracted interest rate period or
three months. Outstanding principal for Tranche D is not permitted to be repaid
until all amounts for the initial and incremental term loans are paid in full.
Thereafter, principal for Tranche D 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. Additionally, the above
amendment amended certain covenants within the agreement and terminated the
revolving credit facility under the credit agreement and all commitments and
letters of credit related thereto. As a result of this amendment, the repayment
schedule for aggregate debt outstanding under the credit agreement is $750
thousand in 2003, $3.0 million in 2004, $96.3 million in 2005, and $293.3
million in 2006.
The transactions discussed above with respect to the: 1) sale of
broadcast television stations; 2) reacquisition of 12-3/4% preferred stock that
is mandatorily redeemable; 3) amendment of the customer relationship management
services agreement; 4) note exchanges; 5) Pegasus Satellite term loan financing;
and 6) amendments to Pegasus Media's credit agreement, in the aggregate
significantly impacted the timing and amount 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 on a pro forma basis to reflect the
transactions that have taken place in 2003 (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 $1,452,551 $ 5,656 $181,591 $770,155 $495,149
Redeemable preferred stock 91,822 91,822
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 $1,587,512 $18,836 $200,248 $868,231 $500,197
============== ============ ============= ============ ============
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PEGASUS COMMUNICATIONS CORPORATION
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 $1,312,625 $ 5,752 $512,556 $611,579 $182,738
Redeemable preferred stock 93,072 93,072
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 $1,465,481 $35,015 $531,729 $710,951 $187,786
============== ============ ============= ============ ============
As permitted by the certificate of designation for the Series C, our
board of directors has the discretion to declare or not to declare any scheduled
quarterly dividends for this series. Since January 31, 2002, the board of
directors has only declared a dividend of $100 thousand on the series which was
paid with shares of Pegasus Communications' Class A common stock. The total
amount of dividends in arrears on Series C at September 30, 2003 was $17.7
million. The dividend on this series scheduled to be declared on October 31,
2003 of $3.0 million was not declared. Dividends not declared accumulate in
arrears until paid.
While dividends are in arrears on preferred stock senior to our Series
D junior convertible participating ("Series D") and Series E junior convertible
participating ("Series E") preferred stocks, our board of directors may not
declare dividends for and we may not redeem shares of these series. Our Series C
preferred stock and Pegasus Satellite's 12-3/4% cumulative exchangeable
preferred stock are senior to these series. Because dividends on Series C and
the 12-3/4% series are in arrears, the annual dividends scheduled to be declared
for Series D and E on January 1, 2003 of $500 thousand and $400 thousand,
respectively, were not declared and became in arrears on that date. Dividends
not declared accumulate in arrears until paid.
We have received notice of redemption from holders of $3.0 million
liquidation par value of Series E preferred stock after the dividends on Series
C and the 12-3/4% series became in arrears. Additionally, in February 2003,
6,125 shares of Series D amounting to $6.1 million of liquidation par value
became eligible for redemption at the election of holders. We are not permitted
nor obligated to redeem the shares of Series D and E while dividends on Series C
are in arrears. Under these circumstances, our inability to redeem Series D and
E shares is not an event of default.
In October 2003, at the election of the holder and in accordance with
the terms of the Series E, 7,000 shares of Series E with a liquidation par value
of $7.0 million were converted into 11,226 shares of Pegasus Communications'
Class A common stock. In accordance with the terms of the series, accumulated
dividends to the date of the conversion on the Series E shares of $510 thousand
were paid to the holder.
As permitted by the certificate of designation for the 12-3/4% series
preferred stock, our board of directors has the discretion to declare or not to
declare any scheduled quarterly dividends for this series. The board of
directors has not declared any of the scheduled semiannual dividends for this
series since January 1, 2002. Dividends in arrears to unaffiliated parties at
September 30, 2003 were $17.7 million, with accrued interest thereon of $1.9
million. Dividends not declared accumulate in arrears and incur interest at a
rate of 14.75% per year until paid.
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PEGASUS COMMUNICATIONS CORPORATION
At this time, we believe that our capital resources and liquidity are
sufficient to meet our contractual obligations for at least the next 20 to 24
months. 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 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
Because of our high leverage and need from time to time to restructure
our borrowings or seek new or additional sources of funding, our principal
market risk is exposure to market rates of interest. Although we manage our
overall debt service on a continual basis, our principal exposure had been
variable rates of interest associated with borrowings under our credit
facilities, consisting of revolving credit and term loans. Market variable rates
of interest have for the most part stabilized over the last seven quarters at
their historic lowest rates. As a result, our variable rates of interest, plus
applicable margins thereon, have stabilized over this period as well. Commencing
in the second quarter 2003, we have focused our attention to extending
maturities of our debt. During 2003, we issued $165.9 million principal amount
of our 11-1/4% notes due 2010 in exchange for $168.1 million principal amount of
various series of our outstanding notes with maturities in 2005 to 2007. In
August 2003, we borrowed $100.0 million principal amount at 12.5% due 2009 and
from the proceeds repaid all of the remaining $67.9 million principal amount,
all but $3.7 million of which is due in 2006, of our 12-1/2% notes due 2005. In
October 2003, we borrowed $300.0 million principal amount in Tranche D term
loans subject to variable rates of interest, and from the proceeds repaid an
aggregate $235.0 million principal amount due in 2004 and 2005 of our initial
and incremental term loans that were subject to variable rates of interest. The
variable rates for Tranche D are subject to margins of 7%, whereas the variable
rates for the initial and incremental term loans are subject to margins of 2.5%
to 3.5%.
As a result of the transactions that occurred through September 30,
2003, the aggregate principal amount of our notes and credit facilities
outstanding at September 30, 2003 was $1.37 billion, at a weighted average rate
of interest of 9.86%, compared to aggregate principal amount outstanding for
this debt at December 31, 2002 of $1.30 billion, at a weighted average rate of
interest of 10.14%. The following table is intended to give an indication of the
effect of the transactions that have occurred in 2003 on the aggregate principal
amount outstanding for our notes and under our credit facilities relative to the
aggregate principal amount outstanding for this debt at December 31, 2003. The
table presents the aggregate amount of principal outstanding at December 31,
2004 to 2008 and thereafter in the aggregate, along with the related weighted
average interest rate for the respective periods, based on the transactions in
2003 indicated above, compared to the aggregate principal amount outstanding for
this debt for these periods based on amounts outstanding at December 31, 2002.
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PEGASUS COMMUNICATIONS CORPORATION
(dollars in thousands) 2004 2005 2006 2007 2008 Thereafter
----------- ------------- ----------- ----------- ----------- -----------
Based on principal outstanding:
After 2003 activity $1,399,096 $1,229,078 $714,354 $475,348 $484,230 $489,649
At December 31, 2002 1,142,961 786,245 491,245 175,000 175,000 175,000
Weighted average interest rate:
After 2003 activity 10.67% 11.20% 12.00% 11.46% 11.48% 11.63%
At December 31, 2002 10.81% 12.05% 12.38% 11.25% 11.25% 11.25%
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
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.
44
PEGASUS COMMUNICATIONS CORPORATION
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 13 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 periods
ended March 31, 2003 and June 30, 2003, and our Current Reports on Form 8-K
dated May 14, 2003, May 22, 2003, June 10, 2003, and August 11, 2003.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
During the third quarter of 2003, Pegasus Satellite issued to
institutional investors an aggregate of $67.6 million principal amount of its
11-1/4% senior notes due January 2010 in exchange for principal amounts of its
outstanding notes, consisting of:
o $11.5 million principal amount of 9-5/8% senior notes due October 2005
exchanged on July 7, 2003;
o $8.2 million principal amount of 12-3/8% senior notes due August 2006
exchanged on July 14, 2003;
o $17.4 million principal amount of 9-3/4% senior notes due December 2006
exchanged on July 14, 2003;
o $28.2 million principal amount of 13-1/2% senior notes due March 2007
of which $12.8 million was exchanged on July 14, 2003 and $15.4 million
was exchanged on August 1, 2003; and
o $4.5 million principal amount of 12-1/2% senior notes due August 2007
exchanged on August 6, 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.
On August 1, 2003, in connection with entering into a credit
agreement with Pegasus Satellite, the lenders of Pegasus Satellite's credit
facility were issued warrants to purchase up to 1,000,000 shares of nonvoting
common stock of Pegasus Communications Corporation with an exercise price of
$16.00 per share of nonvoting common stock. The nonvoting common stock received
on exercise of the warrants may, in certain circumstances, be exchanged for an
equal number of shares of Pegasus Communications Corporation Class A common
stock. The warrants were issued in a private placement exempt from registration
under the Securities Act of 1933 pursuant to Section 4(2) of the Act.
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PEGASUS COMMUNICATIONS CORPORATION
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
As permitted by the certificate of designation for the 6-1/2% Series C
convertible preferred stock ("Series C"), our board of directors has the
discretion to declare or not to declare any scheduled quarterly dividends for
this series. Since January 31, 2002, the board of directors has only declared a
dividend of $100 thousand on the series which was paid with shares of Pegasus
Communications' Class A common stock. The total amount of dividends in arrears
on Series C at September 30, 2003 was $17.7 million. The dividend on this series
scheduled to be declared on October 31, 2003 of $3.0 million was not declared.
Dividends not declared accumulate in arrears until paid.
While dividends are in arrears on preferred stock senior to our Series
D junior convertible participating ("Series D") and Series E junior convertible
participating ("Series E") preferred stocks, our board of directors may not
declare dividends for and we may not redeem shares of these series. Our Series C
preferred stock and Pegasus Satellite's 12-3/4% cumulative exchangeable
preferred stock are senior to these series. Because dividends on Series C and
the 12-3/4% series are in arrears, the annual dividends scheduled to be declared
for Series D and E on January 1, 2003 of $500 thousand and $400 thousand,
respectively, were not declared and became in arrears on that date. Dividends
not declared accumulate in arrears until paid.
As permitted by the certificate of designation for Pegasus Satellite's
12-3/4% cumulative exchangeable preferred stock ("12-3/4% Series"), our board of
directors has the discretion to declare or not to declare any scheduled
quarterly dividends for this series. The board of directors has not declared any
of the scheduled semiannual dividends for this series since January 1, 2002.
Dividends in arrears to unaffiliated parties at September 30, 2003 were $17.7
million, with accrued interest thereon of $1.9 million. Dividends not declared
accumulate in arrears and incur interest at a rate of 14.75% per year until
later paid.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits
Exhibit
Number
10.1* Fourth Amendment and Restatement of Credit Agreement dated as of
October 22, 2003 by and among Pegasus Media & Communications, Inc., the
several lenders from time to time parties thereto, Banc of America
Securities LLC, as sole lead arranger, Deutsche Bank Trust Company
Americas, as resigning agent, and Bank of America, N.A., as
administrative agent for the Lenders. (Schedules have been omitted but
will be provided upon request to the Securities and Exchange
Commission.)
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.
46
PEGASUS COMMUNICATIONS CORPORATION
b) Reports on Form 8-K
We filed a Current Report on Form 8-K dated July 11, 2003
reporting under Item 5 an announcement of our next Annual Meeting of
Stockholders scheduled for August 9, 2003.
We filed a Current Report on Form 8-K dated July 23, 2003
reporting under Item 5 the following: 1) Consent of lenders to our
subsidiary Pegasus Media & Communications Inc.'s ("PM&C") credit
facility in connection with a $100 million, six year, senior secured
term loan agreement of our subsidiary Pegasus Satellite Communications,
Inc ("PSC"); 2) PM&C's intention to seek commitments for new senior
secured credit facilities; and 3) A series of exchanges by PSC in which
were issued an aggregate of $141.8 million principal amount of its
11-1/4% senior notes due January 2010 for an aggregate of $143.9
million principal amount of a number of series of its other outstanding
notes.
We filed a Current Report on Form 8-K dated August 1, 2003
reporting under Item 5 the following items: 1) The closing of PSC's
$100.0 million senior secured term loan financing; 2) Consent of
lenders to PM&C's credit facility in connection with PSC's $100.0
million senior secured term loan; 3) receipt of indications from a
syndicate of lenders regarding the terms of a new credit facility for
PM&C; 4) Redemption of all of the outstanding 12-3/4% senior
subordinated notes due 2005 of PM&C; and 5) Postponement of the annual
meeting of stockholders scheduled for August 9, 2003.
We filed a Current Report on Form 8-K dated August 11, 2003
reporting under Item 5 to report a conditional settlement reached by a
number of parties, other than us, involved in the litigation with
DIRECTV, Inc.
We filed a Current Report on Form 8-K dated August 12, 2003
reporting under Item 9 showing summarized financial information with
respect to our adjusted operating cash flow financial measure pursuant
to indentures relating to notes issued by PSC and PM&C and Item 12
regarding our results of operations for the three and six months ended
June 30, 2003.
We filed a Current Report on Form 8-K dated August 25, 2003
reporting under Item 5 that PM&C announced that it was terminating a
senior loan financing that it had previously announced on July 23,
2003.
47
PEGASUS COMMUNICATIONS CORPORATION
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, Pegasus Communications Corporation has duly caused this Report to
be signed on its behalf by the undersigned thereunto duly authorized.
Pegasus Communications Corporation
November 14, 2003 By: /s/ Joseph W. Pooler, Jr.
- ------------------------------------ ------------------------------
Date Joseph W. Pooler, Jr.
Senior Vice President of Finance
Chief financial and accounting officer)
48
Exhibit Index
Exhibit Number
10.1* Fourth Amendment and Restatement of Credit Agreement dated as of
October 22, 2003 by and among Pegasus Media & Communications, Inc., the
several lenders from time to time parties thereto, Banc of America
Securities LLC, as sole lead arranger, Deutsche Bank Trust Company
Americas, as resigning agent, and Bank of America, N.A., as
administrative agent for the Lenders. (Schedules have been omitted but
will be provided upon request to the Securities and Exchange
Commission.)
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.
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* Filed herewith.