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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 0-21389
PEGASUS SATELLITE COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
Delaware 51-0374669
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(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
c/o Pegasus Communications Management Company;
225 City Line Avenue, Suite 200, Bala Cynwyd, PA 19004
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(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (800) 376-0022
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Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No __
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act).
Yes__ No /X/
Number of shares of each class of the registrant's common stock
outstanding as of November 7, 2003:
Class B, Common Stock, $0.01 par value 200
PEGASUS SATELLITE COMMUNICATIONS, INC.
Form 10-Q
Table of Contents
For the Quarterly Period Ended 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 24
Item 3. Quantitative and Qualitative Disclosures About Market Risk 37
Item 4. Controls and Procedures 38
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 39
Item 2. Changes in Securities and Use of Proceeds 39
Item 3. Defaults Upon Senior Securities 39
Item 6. Exhibits and Reports on Form 8-K 40
Signatures 41
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
3
Pegasus Satellite Communications, Inc.
Condensed Consolidated Balance Sheets
(In thousands)
September 30, December 31,
2003 2002
------------- -------------
(unaudited)
Currents assets:
Cash and cash equivalents $ 9,586 $ 13,023
Restricted cash 62,202 293
Accounts receivable, net
Trade 13,732 27,163
Other 9,059 9,557
Deferred subscriber acquisition costs, net 11,863 15,706
Prepaid expenses 15,094 8,087
Other current assets 7,412 7,288
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Total current assets 128,948 81,117
Property and equipment, net 69,716 69,951
Intangible assets, net 1,478,007 1,564,874
Other noncurrent assets 145,927 143,208
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Total $ 1,822,598 $ 1,859,150
============= =============
Current liabilities:
Current portion of long term debt $ 3,425 $ 5,631
Accounts payable 15,231 15,886
Accrued interest 20,283 38,383
Accrued programming fees 54,291 57,196
Accrued commissions and subsidies 40,279 40,191
Other accrued expenses 27,671 31,778
Other current liabilities 7,574 7,201
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Total current liabilities 168,754 196,266
Long term debt 1,354,145 1,274,981
Note payable to parent 51,903 55,250
Mandatorily redeemable preferred stock 177,143 -
Other noncurrent liabilities 90,879 46,596
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Total liabilities 1,842,824 1,573,093
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Commitments and contingent liabilities (see Note 10)
Minority interest 530 2,157
Redeemable preferred stock - 199,022
Common stockholder's equity:
Common stock - -
Other common stockholder's equity (20,756) 84,878
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Total common stockholder's equity (20,756) 84,878
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Total $ 1,822,598 $ 1,859,150
============= ==============
See accompanying notes to consolidated financial statements
4
Pegasus Satellite Communications, Inc.
Consolidated Statements of Operations and Comprehensive Loss
(In thousands)
Three Months Ended September 30,
2003 2002
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(unaudited)
Net revenues:
Direct broadcast satellite $ 207,010 $ 216,363
Broadcast television 7,443 8,224
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Total net revenues 214,453 224,587
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 (including depreciation and amortization of
$706 and $778, respectively) 7,020 7,676
Corporate expenses (including depreciation and amortization of $355
and $373, respectively) 3,682 3,680
Other operating expenses, net 5,324 6,982
------------ ------------
Income (loss) from operations 53 (2,876)
Interest expense (44,895) (38,278)
Interest income 151 129
Other nonoperating income, net 208 16,643
------------ ------------
Loss before income taxes and discontinued operations (44,483) (24,382)
Net expense for income taxes (36) (478)
------------ ------------
Loss before discontinued operations (44,519) (24,860)
Discontinued operations:
Income from discontinued operations (including gain on disposal of
$4,783 in 2003) 4,985 695
------------ ------------
Net loss (39,534) (24,165)
Other comprehensive loss:
Unrealized loss on marketable equity securities, net of income tax
benefit of $57 - (94)
------------ ------------
Comprehensive loss $ (39,534) $ (24,259)
============ ============
See accompanying notes to consolidated financial statements
5
Pegasus Satellite Communications, Inc.
Consolidated Statements of Operations and Comprehensive Loss
(In thousands)
Nine Months Ended September 30,
2003 2002
------------- ------------
(unaudited)
Net revenues:
Direct broadcast satellite $ 618,379 $ 647,534
Broadcast television 22,868 22,282
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Total net revenues 641,247 669,816
Operating expenses:
Direct broadcast satellite
Programming 279,421 286,918
Other subscriber related expenses 132,989 152,374
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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 (including depreciation and amortization of
$1,912 and $2,460, respectively) 22,154 22,543
Corporate expenses (including depreciation and amortization of
$1,102 and $1,125, respectively) 11,042 12,203
Other operating expenses, net 19,904 20,508
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Income (loss) from operations 4,923 (3,334)
Interest expense (119,623) (110,245)
Interest income 280 434
Loss on impairment of marketable securities - (3,063)
Other nonoperating income, net 2,735 17,882
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Loss before income taxes and discontinued operations (111,685) (98,326)
Net (expense) benefit for income taxes (174) 27,895
------------- ------------
Loss before discontinued operations (111,859) (70,431)
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 (102,258) (73,145)
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 loss - (1,099)
------------- ------------
Comprehensive loss $ (102,258) $ (74,244)
============= ============
See accompanying notes to consolidated financial statements
6
Pegasus Satellite Communications, Inc.
Condensed Consolidated Statements of Cash Flows
(In thousands)
Nine Months Ended September 30,
2003 2002
----------- -----------
(unaudited)
Net cash provided by operating activities $ 10,141 $ 22,234
----------- -----------
Cash flows from investing activities:
Direct broadcast satellite equipment capitalized (16,528) (20,149)
Other capital expenditures (1,780) (3,102)
Sales of broadcast stations 21,593 -
Purchases of parent's common stock (5,509) -
Other 451 (1,041)
----------- -----------
Net cash used for investing activities (1,773) (24,292)
----------- -----------
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 (2,249) (5,852)
Repurchases of outstanding notes - (24,974)
Net (repayments of) proceeds from note payable to parent (11,226) 77,189
Cash received from exchange of notes 1,459 -
Restricted cash (60,129) 1,614
Debt financing costs (11,163) (629)
Distributions to parent - (148,804)
Other (28) (16)
----------- -----------
Net cash used for financing activities (11,805) (120,536)
----------- -----------
Net decrease in cash and cash equivalents (3,437) (122,594)
Cash and cash equivalents, beginning of year 13,023 144,350
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Cash and cash equivalents, end of period $ 9,586 $ 21,756
=========== ===========
See accompanying notes to consolidated financial statements
7
PEGASUS SATELLITE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. General
All references to "we," "us," and "our," refer to Pegasus Satellite
Communications, Inc., together with its direct and indirect subsidiaries.
"Pegasus Satellite" refers to Pegasus Satellite Communications, Inc.
individually as a separate entity. "Pegasus Communications" refers to Pegasus
Communications Corporation, the parent company of Pegasus Satellite. "Pegasus
Media" refers to Pegasus Media & Communications, Inc., a wholly owned subsidiary
of Pegasus Satellite. Other terms used are defined as needed where they first
appear.
Significant Risks and Uncertainties
We have a history of losses principally due to the substantial amounts
incurred for interest expense and depreciation and amortization. Net losses were
$109.4 million, $285.2 million, and $159.0 million for 2002, 2001, and 2000,
respectively. We have an accumulated deficit balance at September 30, 2003 of
$929.8 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 $1.6 billion. Our high leverage makes
us more vulnerable to adverse economic and industry conditions and limits our
flexibility in planning for, or reacting to, changes in our business and the
industries in which we operate. Our ability to make payments on and to refinance
indebtedness and redeemable preferred stock outstanding and to fund operations,
planned capital expenditures, and other activities and to fund the preferred
stock requirements of Pegasus Communications depends on our ability to generate
cash in the future. Our ability to generate cash depends on the success of our
business strategy, prevailing economic conditions, regulatory risks, competitive
activities by other parties, 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 91%, 92%, and 92%, respectively, of total consolidated operating
expenses. Total assets of the direct broadcast satellite business were 91% and
93% 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 SATELLITE COMMUNICATIONS, INC.
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 10 of the Notes to Consolidated Financial Statements for information
regarding this litigation.
Because we are a distributor of DIRECTV, we may be adversely affected
by any material adverse changes in the assets, financial condition, programming,
technological capabilities, or services of DIRECTV, Inc.
9
PEGASUS SATELLITE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
2. Basis of Presentation
The unaudited financial statements herein include the accounts of
Pegasus Satellite and all of its subsidiaries on a consolidated basis. All
intercompany transactions and balances have been eliminated. The balance sheets
and statements of cash flows are presented on a condensed basis. These financial
statements are prepared in accordance with the instructions to Form 10-Q and
Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
in the United States of America for complete financial statements. The financial
statements reflect all adjustments consisting of normal recurring items that, in
our opinion, are necessary for a fair presentation, in all material respects, of
our financial position and the results of our operations and comprehensive loss
and our cash flows for the interim period. The interim results of operations
contained herein may not necessarily be indicative of the results of operations
for the full fiscal year. Prior year amounts have been reclassified where
appropriate to conform to the current year classification for comparative
purposes.
3. Mandatorily Redeemable Preferred Stock
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.
Our 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 $176.6 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 $35.2 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"
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.
10
PEGASUS SATELLITE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
The combined balance of the 12-3/4% series at September 30, 2003 was
$218.2 million, consisting of $177.1 million of mandatorily redeemable preferred
stock and $41.1 million of accrued and unpaid dividends in other noncurrent
liabilities, compared to the balance of the series at December 31, 2002 of
$199.0 million in redeemable preferred stock. The change was primarily due to
dividends accrued of $17.6 million and accretion of discount of $1.6 million.
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 at September 30, 2003 were $35.2 million, with accrued
interest thereon of $3.9 million. Dividends not declared accumulate in arrears
and incur interest at a rate of 14.75% per year until paid. Of the amount of
dividends in arrears at September 30, 2003, $17.7 million, with interest thereon
of $1.9 million, was payable to Pegasus Communications on account of the 12-3/4%
preferred stock shares held by Pegasus Communications.
4. Changes in Other Stockholder's Equity
The net change in other stockholders' equity from December 31, 2002 to
September 30, 2003 consisted of (in thousands):
Net loss $(102,258)
Preferred stock dividends accrued and accretion (12,781)
Contributions from Pegasus Communications 9,405
-----------
Total $(105,634)
===========
The contributions from Pegasus Communications consisted of $8.8 million for the
portion of the proceeds from a term loan borrowing attributed to warrants issued
by Pegasus Communications in connection with a new term loan facility that
Pegasus Satellite entered into in the third quarter 2003 and employee benefits
funded in the third quarter 2003 in the form of restricted common stock of
Pegasus Communications.
5. Long Term Debt
The outstanding principal balance under Pegasus Satellite's promissory
note with Pegasus Communications at September 30, 2003 of $51.9 million includes
interest capitalized as principal of $6.6 million.
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
11
PEGASUS SATELLITE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
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 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
12
PEGASUS SATELLITE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
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. 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.
13
PEGASUS SATELLITE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
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):
September 30, December 31,
2003 2002
----------- -----------
Note payable to Pegasus Communications due October 2004 $ 51,903 $ 55,250
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
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
Other notes due 2004, stated interest up to 6.75% 425 2,674
----------- -----------
1,409,473 1,335,862
Less current maturities 3,425 5,631
----------- -----------
Long term debt $ 1,406,048 $ 1,330,231
=========== ===========
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
14
PEGASUS SATELLITE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
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 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.
6. 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 accretion $ 12,781 $ 17,664
Payment of preferred stock dividends with like kind shares - 11,026
Value of common stock warrants issued by Pegasus Communications recorded
as a debt discount 8,784 -
7. Income Taxes
For continuing operations, we had income tax expense of $36 thousand
and $174 thousand for the three and nine months ended September 30, 2003,
respectively, compared to an income tax expense of $478 thousand and an income
tax benefit of $27.9 million for the three and nine months ended September 30,
2002, respectively. The income tax expense in each period for 2003 and the third
quarter 2002 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 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 $61.5 million, offset by a valuation allowance in the same amount. The
valuation allowance increased by $14.8 million and $38.6 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
15
PEGASUS SATELLITE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
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 22.67% 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.
8. 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.
16
PEGASUS SATELLITE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
We ceased operating our Pegasus Express business in 2002. Accordingly,
the operations for this business for 2002 were classified as discontinued in the
statement of operations and comprehensive loss. There were no assets or
liabilities of this business contained in the balance sheet at December 31,
2002.
Aggregate revenues for and pretax income (loss) from discontinued
operations were as follows (in thousands):
Three Months Ended 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.
9. 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.
17
PEGASUS SATELLITE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
10. 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
18
PEGASUS SATELLITE COMMUNICATIONS, INC.
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, Thomson Consumer Electronics, and Philips Electronics North America
Corporation. Personalized Media is a company with which PDC has a
19
PEGASUS SATELLITE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
licensing arrangement. 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.
20
PEGASUS SATELLITE COMMUNICATIONS, INC.
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.
PDC and Personalized Media are seeking injunctive relief and monetary
damages for the defendants' alleged patent infringement and unauthorized
manufacture, use, sale, offer to sell, and importation of products, services,
and systems that fall within the scope of Personalized Media's portfolio of
patented media and communications technologies, of which PDC is an exclusive
licensee within a field of use. The technologies covered by PDC's exclusive
license include services distributed to consumers using certain Ku band BSS
frequencies and Ka band frequencies, including frequencies licensed to
affiliates of Hughes Electronics and used by DIRECTV, Inc. to provide services
to its subscribers. We are unable to predict the possible effects of this
litigation on our relationship with DIRECTV, Inc.
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
21
PEGASUS SATELLITE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
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.
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.
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.
..
11. Related Party Transactions
During the nine months ended September 30, 2003, Pegasus Satellite
purchased 297,460 shares of Pegasus Communications' Class A common stock for an
aggregate amount of $5.5 million. We purchased 29,100 shares for $532 thousand
since September 30, 2003.
12. 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
22
PEGASUS SATELLITE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
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, 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.
23
PEGASUS SATELLITE COMMUNICATIONS, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This report contains certain forward looking statements (as such term
is defined in the Private Securities Litigation Reform Act of 1995) and
information relating to us that are based on our beliefs, as well as assumptions
made by and information currently available to us. When used in this report, the
words "estimate," "project," "believe," "anticipate," "hope," "intend,"
"expect," and similar expressions are intended to identify forward looking
statements, although not all forward looking statements contain these
identifying words. Such statements reflect our current views with respect to
future events and are subject to unknown risks, uncertainties, and other factors
that may cause actual results to differ materially from those contemplated in
such forward looking statements. Such factors include the risks described
elsewhere in this report and, among others, the following: general economic and
business conditions, both nationally, internationally, and in the regions in
which we operate; catastrophic events, including acts of terrorism;
relationships with and events affecting third parties like DIRECTV, Inc. and the
National Rural Telecommunications Cooperative; litigation with DIRECTV, Inc.;
the potential sale of DIRECTV, Inc.; demographic changes; existing government
regulations, and changes in, or the failure to comply with, government
regulations; competition, including our ability to offer local programming in
our direct broadcast satellite markets; the loss of any significant numbers of
subscribers or viewers; changes in business strategy or development plans; the
cost of pursuing new business initiatives; an expansion of land based
communications systems; technological developments and difficulties; 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 Satellite
Communications, Inc., together with its direct and indirect subsidiaries.
"Pegasus Satellite" refers to Pegasus Satellite Communications, Inc.
individually as a separate entity. "Pegasus Communications" refers to Pegasus
Communications Corporation, the parent company of Pegasus Satellite. "Pegasus
Media" refers to Pegasus Media & Communications, Inc., a wholly owned subsidiary
of Pegasus Satellite. Other terms used are defined as needed where they first
appear.
We have a history of losses principally due to the substantial amounts
incurred for interest expense and depreciation and amortization. Net losses were
$109.4 million, $285.2 million, and $159.0 million for 2002, 2001, and 2000,
respectively. We have an accumulated deficit balance at September 30, 2003 of
$929.8 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 91%, 92%, and 92%, respectively, of total consolidated
24
PEGASUS SATELLITE COMMUNICATIONS, INC.
operating expenses. Total assets of the direct broadcast satellite business were
91% and 93% 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 $1.6 billion. Our high leverage makes
us more vulnerable to adverse economic and industry conditions and limits our
flexibility in planning for, or reacting to, changes in our business and the
industries in which we operate. Our ability to make payments on and to refinance
indebtedness and redeemable preferred stock outstanding and to fund operations,
planned capital expenditures, and other activities and to fund the preferred
stock requirements of Pegasus Communications depends on our ability to generate
cash in the future. Our ability to generate cash depends on the success of our
business strategy, prevailing economic conditions, regulatory risks, competitive
activities by other parties, 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 10 of the Notes to Consolidated Financial Statements for
information regarding this litigation
Because we are a distributor of DIRECTV, we may be adversely affected
by any material adverse changes in the assets, financial condition, programming,
technological capabilities, or services of DIRECTV, Inc.
For the 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
25
PEGASUS SATELLITE COMMUNICATIONS, INC.
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.
26
PEGASUS SATELLITE COMMUNICATIONS, INC.
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 SATELLITE COMMUNICATIONS, INC.
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,
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PEGASUS SATELLITE COMMUNICATIONS, INC.
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
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PEGASUS SATELLITE COMMUNICATIONS, INC.
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
Other operating expenses decreased $1.7 million to $5.3 million and
$604 thousand to $19.9 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. litigation of $3.7 million and $10.0 million for the three and
nine months 2003, respectively, and $3.4 million and $10.1 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 retirement of debt recorded in the third
quarter 2002 of $15.7 million.
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PEGASUS SATELLITE COMMUNICATIONS, INC.
Interest expense increased $6.6 million to $44.9 million and $9.4
million to $119.6 million for the three and nine months 2003, respectively,
primarily due to interest in each period of $6.4 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 additionally for the nine months 2003 interest of $2.6
million 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 $36 thousand
and $174 thousand for the three and nine months ended September 30, 2003,
respectively, compared to an income tax expense of $478 thousand and an income
tax benefit of $27.9 million for the three and nine months ended September 30,
2002, respectively. The income tax expense in each period for 2003 and the third
quarter 2002 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 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 $61.5 million, offset by a valuation
allowance in the same amount. The valuation allowance increased by $14.8 million
and $38.6 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 22.67% 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 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):
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PEGASUS SATELLITE COMMUNICATIONS, INC.
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 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.
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PEGASUS SATELLITE COMMUNICATIONS, INC.
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
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.
33
PEGASUS SATELLITE COMMUNICATIONS, INC.
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 $9.6
million, compared to $13.0 million at December 31, 2002 and $21.8 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 $10.1 million and $22.2
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; and 2) cash received in 2002 of $1.6
million for DBS receiver inventory sold. 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 $1.8 million and $24.3 million was used for investing
activities for the nine months ended September 30, 2003 and 2002, respectively.
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, purchases of Pegasus
Communications Class A common stock of $5.5 million, and other capital
expenditures of $1.8 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 $3.1 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 $11.8 million and $120.5 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 $6.3 million; 3)
costs of $11.2 million incurred for new financing arrangements; 4) the net
change in restricted cash of $60.1 million, of which $61.9 million was for
collateral for a letter of credit facility; and 5) net repayments of the note
payable to Pegasus Communications of $11.2 million. 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 4)
received $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 $8.1 million; 3) repurchases of outstanding notes of $25.0 million; and
4) distributions to Pegasus Communications aggregating $148.8 million. The
primary receipts for financing activities for 2002 were: 1) proceeds of $63.2
million from an incremental term loan facility; and 2) net proceeds from a note
payable to Pegasus Communications of $77.2 million.
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.
34
PEGASUS SATELLITE COMMUNICATIONS, INC.
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 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
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PEGASUS SATELLITE COMMUNICATIONS, INC.
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) amendment of the customer relationship
management services agreement; 3) note exchanges; 4) Pegasus Satellite term loan
financing; and 5) 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 $ 1,495,953 $ 5,535 $ 181,283 $ 769,821 $ 539,314
Redeemable preferred stock 183,978 183,978
Operating leases 17,235 3,670 6,589 4,353 2,623
Broadcast programming rights 12,404 3,510 4,568 1,901 2,425
Purchase commitments 13,500 6,000 7,500
------------- --------- ---------- ---------- ----------
Total $ 1,723,070 $ 18,715 $ 199,940 $ 960,053 $ 544,362
============= ========= ========== ========== ==========
For comparative purposes, our contractual obligations outstanding at
December 31, 2002 as reported in our 2002 Form 10-K were as follows (in
thousands):
Payments due by period
Less than More than
Contractual Obligations Total 1 year 1-3 Years 3-5 Years 5 Years
- ----------------------------------- ------------ --------- ---------- ---------- ----------
Long term debt $ 1,359,405 $ 5,631 $ 567,529 $ 611,245 $ 175,000
Redeemable preferred stock 183,978 183,978
Operating leases 17,235 3,670 6,589 4,353 2,623
Broadcast programming rights 13,620 4,164 5,084 1,947 2,425
Purchase commitments 28,929 21,429 7,500
------------ --------- ---------- ---------- ----------
Total $ 1,603,167 $ 34,894 $ 586,702 $ 801,523 $ 180,048
============ ========= ========== ========== ==========
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 $35.2 million,
36
PEGASUS SATELLITE COMMUNICATIONS, INC.
with accrued interest thereon of $3.9 million. Dividends not declared accumulate
in arrears and incur interest at a rate of 14.75% per year until paid.
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.
37
PEGASUS SATELLITE COMMUNICATIONS, INC.
(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.
38
PEGASUS SATELLITE COMMUNICATIONS, INC.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
For information relating to litigation with DIRECTV, Inc. and others,
we incorporate by reference herein the disclosure reported under Note 10 to the
Notes to Consolidated Financial Statements. The Notes to Consolidated Financial
Statements can be found under Part I, Item 1 of this Quarterly Report on Form
10-Q. We have previously filed reports during the fiscal year disclosing some or
all of the legal proceedings referenced above. In particular, we have reported
on such proceedings in our Annual Report on Form 10-K for the year ended
December 31, 2002, our Quarterly Report on Form 10-Q for the quarterly periods
ended March 31, 2003 and June 30, 2003, and our Current Reports on Form 8-K
dated May 14, 2003, May 22, 2003, and June 10, 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.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
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 $35.2
million, with accrued interest thereon of $3.9 million. Dividends not declared
accumulate in arrears and incur interest at a rate of 14.75% per year until
paid. Of the amount of dividends in arrears at September 30, 2003, $17.7
million, with interest thereon of $1.9 million, was payable to Pegasus
Communications on account of the 12-3/4% preferred stock shares held by Pegasus
Communications.
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PEGASUS SATELLITE COMMUNICATIONS, INC.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits
Exhibit
Number
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. (which is incorporated herein by
reference to Exhibit 10.1 to the Quarterly Report on Form 10-Q for the
fiscal quarter ended September 30, 2003 of Pegasus Communications
Corporation). (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.
b) Reports on Form 8-K
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.
40
PEGASUS SATELLITE COMMUNICATIONS, INC.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, Pegasus Satellite Communications, Inc. has duly caused this Report
to be signed on its behalf by the undersigned thereunto duly authorized.
Pegasus Satellite Communications, Inc.
November 14, 2003 By: /s/ Joseph W. Pooler, Jr.
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Date Joseph W. Pooler, Jr.
Senior Vice President of Finance
(Chief financial and accounting officer)
41
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. (which is incorporated herein by
reference to Exhibit 10.1 to the Quarterly Report on Form 10-Q for the
fiscal quarter ended September 30, 2003 of Pegasus Communications
Corporation). (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.