<PAGE>
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 March 31, 1998
--------------
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934.
For the transition period from__________ to __________
333-36217
333-36217-01
Commission file number
DIGITAL TELEVISION SERVICES, INC.
DTS CAPITAL, INC.
---------------------------------------------------------------------
(Exact Name of Registrants as Specified in Their Respective Charters)
Delaware 06-1473713
Delaware 58-2332106
------------------------------ ----------------------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
c/o Pegasus Communications Management Company;
5 Radnor Corporate Center, Suite 454, Radnor, PA 19087
- ------------------------------------------------ ----------
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (888) 438-7488
--------------
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes __X__ No _____
The aggregate market value of the voting and non-voting common equity held by
non-affiliates of the Registrants: Not applicable; the Registrants have no
publicly traded equity securities. As of April 27, 1998, after giving effect to
the merger of Pegasus DTS Merger Sub, Inc. into Digital Television Services,
Inc., Digital Television Services, Inc. and DTS Capital, Inc. each had
outstanding 100 shares of Common Stock.
1
<PAGE>
Index to Form 10-Q
Part I - Financial Information
<TABLE>
<CAPTION>
Page
----
<S> <C> <C>
Item 1. Condensed Consolidated Balance Sheets...........................................................3
Condensed Consolidated Statements of Operations.................................................4
Condensed Consolidated Statements of Cash Flows.................................................5
Notes to Condensed Consolidated Financial Statements............................................6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations..........................................................................13
Item 3. Quantitative and Qualitative Disclosures About Market Risk.....................................18
Part II - Other Information
Item 5. Other Information..............................................................................19
Item 6. Exhibits and Reports on Form 8-K...............................................................19
Signatures.....................................................................................20
</TABLE>
2
<PAGE>
DIGITAL TELEVISION SERVICES, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31, 1997 March 31, 1998
----------------- -----------------
(Unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents .............................................. $ 39,113,152 $ 4,478,512
Restricted cash ........................................................ 19,006,386 18,651,307
Accounts receivable:
Trade, net of allowance for doubtful accounts of $190,647 and
$200,548 at December 31, 1997 and March 31, 1998, respectively ...... 4,629,539 5,334,990
Other, net .......................................................... 544,480 508,471
Inventory .............................................................. 2,229,918 1,487,370
Other .................................................................. 92,605 51,177
------------- -------------
Total current assets ............................................. 65,616,080 30,511,827
------------- -------------
RESTRICTED CASH ........................................................... 18,020,702 9,030,461
------------- -------------
PROPERTY AND EQUIPMENT, at cost ........................................... 3,474,754 3,815,851
Less accumulated depreciation .......................................... (554,537) (776,106)
------------- -------------
2,920,217 3,039,745
------------- -------------
CONTRACT RIGHTS AND OTHER ASSETS, NET ..................................... 171,105,067 176,600,122
------------- -------------
$ 257,662,066 $ 219,182,155
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable ....................................................... $ 4,495,937 $ 4,592,140
Accrued liabilities .................................................... 40,275,901 8,425,008
Unearned revenue ....................................................... 3,314,397 3,568,904
Current maturities of long-term debt ................................... 14,950,430 9,983,234
Other .................................................................. 299,766 364,588
------------- -------------
Total current liabilities ........................................ 63,336,431 26,933,874
------------- -------------
LONG-TERM DEBT, less current maturities ................................... 177,641,876 186,749,451
------------- -------------
OTHER LIABILITIES ......................................................... 46,646 46,646
------------- -------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value; 10,000,000 shares authorized; 1,404,056
issued and outstanding at December 31, 1997 and March 31, 1998 ....... 14,041 14,041
Common stock, $.01 par value; 10,000,000 shares authorized; 2,137,049
issued and outstanding at December 31, 1997 and March 31, 1998 ....... 21,370 21,370
Additional paid-in capital ............................................. 25,826,080 25,826,080
Retained deficit ....................................................... (9,224,378) (20,409,307)
------------- -------------
Total stockholders' equity ....................................... 16,637,113 5,452,184
------------- -------------
$ 257,662,066 $ 219,182,155
============= =============
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements.
3
<PAGE>
DIGITAL TELEVISION SERVICES, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended March 31,
--------------------------------------
1997 1998
---------------- -----------------
<S> <C> <C>
Revenues:
Basic and satellite service ............................... $ 4,492,124 $ 11,788,970
Premium services .......................................... 2,000,955 4,378,214
Other ..................................................... 483,912 948,609
------------ ------------
Total revenue ....................................... 6,976,991 17,115,793
Operating expenses:
Programming expense ....................................... 4,443,802 11,365,672
Marketing and selling ..................................... 1,143,769 3,876,093
General and administrative ................................ 860,902 1,376,006
Corporate expenses ........................................ 486,372 566,710
Depreciation and amortization ............................. 2,428,016 5,208,602
------------ ------------
Loss from operations ................................ (2,385,870) (5,277,290)
Interest expense .......................................... (1,546,599) (6,194,532)
Interest income ........................................... 33,719 452,392
Other income (expense) .................................... (108) (165,499)
------------ ------------
Net loss ................................................... $ (3,898,858) $(11,184,929)
============ ============
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements.
4
<PAGE>
DIGITAL TELEVISION SERVICES, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended March 31,
-------------------------------------
1997 1998
---------------- -----------------
<S> <C> <C>
Cash flows from operating activities:
Net loss ................................................................ $ (3,898,858) $(11,184,929)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization ........................................ 2,287,816 4,754,593
Amortization of capitalized debt costs and debt discount ............. 159,005 798,878
Amortization of deferred promotional costs ........................... 204,604 16,006
Changes in operating assets and liabilities, net of acquisitions:
Accounts receivable, net .......................................... (24,381) (369,508)
Inventory ......................................................... (108,824) 742,548
Other current assets .............................................. (480,570) 25,422
Accounts payable .................................................. 1,656,406 431,108
Accrued liabilities ............................................... 569,727 (4,519,057)
Unearned revenue and other liabilities ............................ 262,959 169,297
------------ ------------
Total adjustments ............................................. 4,526,742 2,049,287
------------ ------------
Net cash provided by (used in) operating activities ........... 627,884 (9,135,642)
------------ ------------
Cash flows from investing activities:
Purchases of property and equipment, net of acquisitions ................ (414,685) (341,097)
Decrease in restricted cash for payment of subordinated notes ........... -- 9,345,320
Purchase of contract rights and related net assets, net of amounts ...... (83,986,588) (37,172,504)
financed
Increase in other assets ................................................ (91,131) (369,179)
------------ ------------
Net cash used in investing activities ......................... (84,492,404) (28,537,460)
------------ ------------
Cash flows from financing activities:
Proceeds from bank credit facility ...................................... 60,600,000 13,000,000
Issuance of notes payable ............................................... 132,632 --
Repayment of seller notes and other notes payable ....................... (5,969,270) (9,583,090)
Capitalized financing fees .............................................. (1,133,655) (378,448)
Sale of Member Units .................................................... 32,059,000 --
Other, net .............................................................. (399,416) --
------------ ------------
Net cash provided by financing activities ..................... 85,289,291 3,038,462
------------ ------------
Net increase (decrease) in cash and cash equivalents ....................... 1,424,771 (34,634,640)
------------ ------------
Cash and cash equivalents at beginning of period ........................... 1,595,953 39,113,152
------------ ------------
Cash and cash equivalents at end of period ................................. $ 3,020,724 $ 4,478,512
============ ============
Supplemental Cash Flow Information:
Cash paid for interest .................................................. $ -- $ 10,368,718
============ ============
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements.
5
<PAGE>
DIGITAL TELEVISION SERVICES, INC.
AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. THE COMPANY
Digital Television Services, Inc. ("DTS"), a Delaware corporation, is
successor to Digital Television Services, LLC, a limited liability company
organized under the Delaware Limited Liability Act, and DBS Holdings, L.P., a
Delaware limited partnership originally formed on January 30, 1996 by Columbia
Capital Corporation and senior management of DTS. DTS and its wholly owned
subsidiaries (collectively, the "Company") were formed to acquire and operate
the exclusive rights to distribute direct broadcast satellite ("DBS") services
("DIRECTV Services") offered by DIRECTV, Inc. ("DIRECTV") in certain rural
markets (the "Rural DIRECTV Markets"). The Company obtained the rights to
distribute DIRECTV Services in its territories pursuant to agreements (the "NRTC
Member Agreements") with the National Rural Telecommunications Cooperative (the
"NRTC"). Under the provisions of the NRTC Member Agreements, the Company has the
exclusive right to provide DIRECTV Services within certain rural territories in
the United States. The Company completed its first acquisition of rights to
provide DIRECTV Services in March 1996 and has made a total of 18 acquisitions
through March 31, 1998.
DTS is a holding company which operates primarily through its
wholly-owned subsidiaries. The principal wholly-owned subsidiaries of DTS as of
March 31, 1998 consist of 11 entities (the "Operating Subsidiaries") which,
except for one subsidiary which is a Delaware limited liability company and one
subsidiary which is a New Mexico corporation, are limited liability companies
organized under the laws of the state of Georgia. The Operating Subsidiaries
have the right to provide DIRECTV Services. The sole member and manager of the
Operating Subsidiaries is DTS Management, LLC ("DTS Management"), a Georgia
limited liability company, which is a wholly-owned subsidiary of DTS. The
Company's other wholly-owned subsidiary, DTS Capital, Inc. ("DTS Capital"), was
formed in 1997 and currently has nominal assets and does not conduct any
operations. DTS Capital was formed to facilitate the issuance of $155.0 million
in senior subordinated notes (the "Notes") in July 1997 (see Note 4).
On January 8, 1998, the Company entered into an Agreement and Plan of
Merger with Pegasus Communications Corporation ("Pegasus") providing for the
acquisition of the Company by Pegasus (see Note 5).
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited consolidated financial statements have been
prepared in accordance with the instructions to Form 10-Q and do not include all
of the information and footnotes required by generally accepted accounting
principles for complete financial statements. The consolidated financial
statements include the accounts of the Company. All significant intercompany
transactions and balances have been eliminated.
The unaudited consolidated financial statements reflect all adjustments
consisting of normal recurring items which are, in the opinion of management,
necessary for a fair presentation, in all material respects, of the financial
position of the Company and the results of its operations and its cash flows for
the interim period.
6
<PAGE>
DIGITAL TELEVISION SERVICES, INC.
AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Revenue Recognition
The Company earns programming revenue by providing DIRECTV Services to
its subscribers. Programming revenue include DIRECTV Services purchased by
subscribers in monthly, quarterly, or annual subscriptions; additional premium
programming available on an a la carte basis; sports programming available under
monthly, annual, or seasonal subscriptions; and movies and events programming
available on a pay-per view basis. Programming purchased on a monthly,
quarterly, annual, or seasonal basis, including premium programming, is billed
in advance and is recorded as unearned revenue.
Restricted Cash
The Company has restricted cash held in escrow to cover the first four
semi-annual interest payments on the Notes.
Inventories
The Company maintains inventories consisting of DSS(R) equipment and
related accessories. Inventory is valued at the lower of cost or market,
generally on a specific identification basis.
Concentration of Credit Risk
Concentration of credit risk with respect to accounts receivable is
limited due to the large number of geographically dispersed subscribers. As a
result, at March 31, 1998, management does not believe any significant
concentration of credit risk exists.
7
<PAGE>
DIGITAL TELEVISION SERVICES, INC.
AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Property and Equipment
Property and equipment are stated at cost. Major property additions,
replacements, and betterments are capitalized, while maintenance and repairs
which do not extend the useful lives of these assets are expensed currently.
Depreciation for property and equipment is provided using the straight-line
method over the estimated useful lives of five years for leasehold improvements
and three to seven years for furniture and equipment. Upon retirement or
disposal of assets, the cost and related accumulated depreciation are removed
from the balance sheet and any gain or loss is reflected in earnings.
Property and equipment, at cost, consist of the following:
March 31,
1998
-------------
Leasehold improvements.......................... $ 328,844
Furniture and equipment......................... 3,487,007
-------------
$ 3,815,851
=============
Contract Rights and Other Assets
Contract rights and other assets consist of the following:
March 31,
1998
------------
Contract rights, net............................. $162,478,669
Organization costs, net.......................... 915,520
Debt issuance costs, net......................... 3,741,196
Bond issuance costs, net......................... 7,462,062
Subscriber acquisition receivable................ 821,579
Capitalized merger costs......................... 601,036
Other, net....................................... 580,060
------------
$176,600,122
=============
8
<PAGE>
DIGITAL TELEVISION SERVICES, INC.
AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
3. ACQUISITIONS
On January 30, 1998, the Company acquired the rights to provide DIRECTV
Services in certain counties in Georgia for $9.5 million from Ocmulgee
Communications, Inc. The purchase price was allocated to the fair values of the
net assets acquired as follows (in thousands):
Current assets............................ $ 206
Contract rights........................... 9,526
Current liabilities....................... (243)
-----
Total consideration............. $ 9,489
=======
4. LONG-TERM DEBT
Long-term debt consisted of the following:
March 31, 1998
--------------------------------
Unamortized
Principal Discount
---------------- -------------
Senior subordinated notes.......... $155,000,000 $ 2,015,207
Credit facility.................... 28,500,000 -
Seller notes and commitments....... 17,367,976 2,384,265
Installment notes.................. 264,181 -
---------------- -------------
201,132,157 4,399,472
Less current maturities........... 11,260,848 1,277,614
---------------- -------------
$189,871,309 $ 3,121,858
================ =============
Senior Subordinated Notes
On July 30, 1997, the Company sold the Notes in a transaction exempt from
registration under the Securities Act of 1933, as amended (the "Securities
Act"). The Notes are the joint and several obligations of the Company and DTS
Capital. DTS Capital has nominal assets, does not conduct any operations and
will not provide any additional security for the Notes. DTS Capital was formed
solely to provide a corporate co-issuer in addition to a limited liability
company issuer (the Company). Accordingly, financial information for DTS Capital
is not provided. The Notes mature in 2007 and bear interest at 12 1/2%, payable
semi-annually on February 1 and August 1. The Company raised approximately
$146.0 million, net of underwriting discount and estimated expenses, through the
issuance of the Notes. The Company used the net proceeds to fund an interest
escrow account for the first four semi-annual interest payments and to repay
outstanding indebtedness under the Credit Facility (as defined below).
9
<PAGE>
DIGITAL TELEVISION SERVICES, INC.
AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The Company filed to exchange the Notes with new senior subordinated notes
(the "Exchange Notes") registered under the Securities Act. The terms of the
Exchange Notes are identical in all material respects (including principal
amount, interest rate, maturity, security and ranking) to the terms of the
Private Notes (which they replace), except that the Exchange Notes: (i) bear a
Series B designation, (ii) have been registered under the Securities Act and,
therefore, do not bear legends restricting their transfer, and (iii) are not
entitled to certain registration rights and certain liquidated damages which
were applicable to the Notes in certain circumstances under a registration
rights agreement entered into by the Company in connection with the sale of the
Notes.
The Exchange Notes are unconditionally guaranteed, on a senior
subordinated basis, as to payment of principal, premium, if any, and interest,
jointly and severally, by all direct and indirect subsidiaries of DTS (the
"Guarantors"). The Guarantors consist of all of the subsidiaries of DTS, except
DTS Capital, which is a co-issuer of the Exchange Notes and has no separate
assets or operations. DTS does not have assets or operations apart from the
assets and operations of its Operating Subsidiaries. Accordingly, separate
financial information for the Guarantors is not provided because management of
the Company has determined that such information would not be material to
investors. On January 26, 1998, the Company completed the exchange of the Notes
with the Exchange Notes. Credit Facility
The Company is a party to a credit agreement dated November
27, 1996, as amended and restated on July 30, 1997 (the "Credit Facility") by
and among the Company, the banks and other lenders party from time to time
thereto, CIBC, as Administrative Agent, CIBC Wood Gundy Securities Corp., as
Arranger, J.P. Morgan, as Syndication Agent, and Fleet Bank, as Documentation
Agent, which provides for a revolving credit facility in the amount of $70.0
million, with a $50.0 million sublimit for letters of credit, and a $20.0
million term loan facility. The proceeds of the Credit Facility may be used (i)
to refinance certain existing indebtedness, (ii) prior to December 31, 1998, to
finance the acquisition of certain Rural DIRECTV Markets and related costs and
expenses, (iii) to finance capital expenditures of the Company and its Operating
Subsidiaries and (iv) for the general corporate purposes and working capital
needs of the Company and its Operating Subsidiaries. As of March 31, 1998, $33.4
million was available under the Credit Facility.
The $20.0 million term loan facility must be drawn no later
than July 30, 1998 and any amounts not so drawn by that date will be cancelled.
The term loan shall be repaid in 20 consecutive quarterly installments of
$200,000 each commencing September 30, 1998 with the remaining balance due July
31, 2003. Borrowings under the revolving credit facility established pursuant to
the Credit Facility are available to the Company until July 31, 2003; however,
if the then unused portion of the commitments exceeds $10.0 million on December
31, 1998, the commitments will be reduced on such date by an amount equal to the
unused portion of such commitments minus $10.0 million. Thereafter, the
commitments thereunder will reduce quarterly commencing on September 30, 1999 at
a rate of 3.509%
10
<PAGE>
DIGITAL TELEVISION SERVICES, INC.
AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
through 1999, 5.75% in 2000, 7.0% in 2001, 9.09% in 2002 and 3.09% until June
30, 2003. All of the loans outstanding will be repayable on July 31, 2003.
Borrowings by the Company under the Credit Facility are
unconditionally guaranteed by each of the Company's direct and indirect
subsidiaries, and such borrowings are secured by (i) an equal and ratable pledge
of all of the equity interests in the Company's subsidiaries, (ii) a first
priority security interest in all of their assets, and (iii) a collateral pledge
of the Company's NRTC Member Agreements.
Seller Notes and Commitments
In connection with the acquisition of the Company's California
rural DIRECTV Market, one of the Operating Subsidiaries, Digital Television
Services of California, LLC ("DTS California"), entered into a promissory note
dated April 1, 1996, as modified as of December 31, 1996 (as so modified, the
"DTS California Note"), in favor of Pacific Coast DBS, Inc. ("Pacific").
Pursuant to the DTS California Note, DTS California is obligated to pay to
Pacific the sum of (i) $480,000, payable in 24 equal monthly installments
commencing May 1, 1996, and (ii) an amount payable on October 1, 1998 equal to
the greater of $4.0 million or the Contingent Payment Amount. The Contingent
Payment Amount is determined by multiplying the number of subscribers to DIRECTV
Services in DTS California's rural DIRECTV market as of October 1, 1998 by
certain dollar amounts. As of March 31, 1998, the Contingent Payment Amount is
recorded as $6,629,400, which is based on subscriber levels at March 31, 1998.
The DTS California Note is classified as current maturities in the accompanying
balance sheet at March 31, 1998.
In connection with the acquisition of one of the Company's
Rural DIRECTV Markets in South Carolina, one of the Operating Subsidiaries,
Digital Television Services of South Carolina 1, LLC, entered into a promissory
note dated November 26, 1996 payable to Pee Dee Electricom, Inc. in the amount
of $7,955,000, of which $3,265,000 was paid in January 1997. The balance was
paid on January 2, 1998.
In connection with the acquisition of the Company's Rural
DIRECTV Markets in Georgia (the "Georgia Rural DIRECTV Markets"), one of the
Operating Subsidiaries, Digital Television Services of Georgia, LLC ("DTS
Georgia"), issued three promissory notes, each of which represents a portion of
the purchase price for one of the Georgia Rural DIRECTV Markets. DTS Georgia
issued (i) a promissory note dated May 9, 1997 ("the Planters Note") payable to
Planters Electric Membership Corporation in the amount of approximately
$850,000, (ii) a promissory note dated May 9, 1997 (the "Mitchell Note") payable
to Mitchell Electric Membership Corporation ("Mitchell") in the amount of
approximately $9.4 million and (iii) a promissory note dated May 9, 1997 (the
"Washington Note") payable to Washington Electric Membership Corporation
("Washington") in the amount of approximately $5.2 million. The principal amount
of the Planters Note was paid on January 2, 1998. The principal amount of each
of the Mitchell Note and the Washington Note is payable in annual installments
beginning January 2, 1998 through January 2, 2001. The obligations of DTS
Georgia with respect to the Georgia Notes are secured by two irrevocable letters
of credit issued pursuant to the Credit Facility, each of which has been issued
for the benefit of one of Mitchell and Washington.
11
<PAGE>
DIGITAL TELEVISION SERVICES, INC.
AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Installment Notes
The installment notes represent notes payable to certain
financial institutions for certain property and equipment. The notes are payable
in equal monthly installments through May 2000.
5. Commitments and Contingent Liabilities
Legal Matters:
From time to time the Company is involved with claims that arise in the
normal course of business. In the opinion of management, the ultimate liability
with respect to these claims will not have a material adverse effect on the
consolidated operations, liquidity, cash flows or financial position of the
Company.
6. SUBSEQUENT EVENTS
The Acquisition of the Company
On April 27, 1998, the Company merged (the "Merger") with Pegasus DTS
Merger Sub, Inc., a wholly-owned subsidiary of Pegasus. In connection with the
Merger, the Company exchanged all of its outstanding capital stock for
approximately 5.5 million shares of Pegasus' Class A Common Stock, and became a
wholly-owned subsidiary of Pegasus. Pegasus did not assume, guarantee or
otherwise have any liability for the Notes or any other liability of the Company
or its subsidiaries. After the Merger, except to the extent permitted under the
terms of the Notes, the Company did not assume, guarantee or otherwise have any
liability for any indebtedness or other liability of Pegasus or any of its
subsidiaries.
Effective with the Merger, a change of control occurred and, as a result,
the Company will be required to make an offer to purchase the Notes at 101% of
the principal amount thereof, plus accrued and unpaid interest thereon, if any,
to the date of the purchase. The Company has entered into a commitment letter
with CIBC Oppenheimer Corp. ("CIBCC") under which CIBCC has agreed to purchase
the Notes tendered in response to the offer to purchase the Notes. CIBCC's
commitment is subject to the execution of definitive documentation and customary
closing conditions. There can be no assurance that such alternative arrangements
will be available or, if available, will be on terms satisfactory to the
Company.
The Company has been informed by the management of Pegasus that Pegasus
would use the purchase method of accounting to record the acquisition of the
Company and would "push down" the effects of the purchase price which would
increase the Company's intangible assets by approximately $163.1 million.
Accordingly, the Company's amortization expense would be increased with respect
to periods subsequent to the Merger.
12
<PAGE>
DIGITAL TELEVISION SERVICES, INC.
AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
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 the company that are based on the beliefs of the
management of the Company, as well as assumptions made by and information
currently available to the Company's management. When used in this Report, the
words "estimate," "project," "believe," "anticipate," "intend," "expect" and
similar expressions are intended to identify forward-looking statements. Such
statements reflect the current views of the Company with respect to future
events and are subject to risks and uncertainties that could cause actual
results to differ materially from those contemplated in such forward-looking
statements. For a discussion of such risks, see the information contained in the
section captioned "Risk Factors" (pages 13 - 22) of the Company's Prospectus
dated December 24, 1997, filed as part of the Company's Registration Statement
in Form S-1, File No. 333-36217 (the "Prospectus"), which section is
incorporated by reference herein. Readers are cautioned not to place undue
reliance on these forward-looking statements, which speak only as of the date
hereof. The Company does 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.
General
The Company was formed on January 30, 1996, to acquire, own and manage
rights to distribute DIRECTV Services to residential households and commercial
establishments in the Rural DIRECTV Markets. On January 30, 1998, the Company
acquired the rights to provide DIRECTV Services to approximately 37,000
households in Georgia for approximately $9.5 million in cash, or $257 per
household. As of March 31, 1998, the Company had acquired the rights to provide
DIRECTV Services to approximately 1,669,000 households for a total of
approximately $180.4 million or $108 per household, excluding adjustments
recorded to reflect the discount of certain of the Company's seller notes at the
9% interest rate under the Credit Facility. Of the total purchase price,
approximately $138.6 million was paid in cash and approximately $41.8 million
was financed through the issuance of promissory notes of the Company in favor of
the sellers.
The Company generates revenues by providing DIRECTV Services to its
subscribers. DIRECTV Services consist of programming purchased in a monthly or
annual subscription, additional premium programming available on an a la carte
basis, sports programming available under a monthly, yearly or seasonal
subscription, and movies and events programming available on a pay per view
basis.
The Company subsidizes DSS(R) equipment to further stimulate the
demand for DIRECTV Services. The retail sales price of DSS(R) equipment ranged
from $125 to $399 during the quarters ended March 31, 1997 and 1998, depending
upon the type of equipment sold. These sales prices were approximately $25 to
$135 below the Company's cost for such equipment.
13
<PAGE>
The Company's major cost of providing DIRECTV Services to its
subscribers is the direct wholesale cost of purchasing related program offerings
from DIRECTV, which averaged approximately 48% and 51% of programming revenues
for the quarters ending March 31, 1997 and 1998, respectively. Additionally, the
Company purchases other contract services from DIRECTV through the NRTC. These
costs consist of recurring monthly subscriber maintenance fees, including
security fees, ground services fees, system authorization fees and fees for
subscriber billing.
Since inception through March 31, 1998, the Company has invested
significant working capital to implement extensive distribution networks and
promotional programs to stimulate the acquisition of new subscribers. Costs
associated with subscriber acquisition are a significant component of the
Company's operating expenses. These expenses include variable commission
expenses, fixed and variable promotional expenses and marketing salaries and
benefits. As discussed above, the Company also subsidizes the cost of DSS(R)
equipment to the subscriber, thereby incurring a loss on the sale of satellite
receivers and related equipment sold. The Company's policy is to expense all
subscriber acquisition costs at the time the sale is made or, in the case of
cash back promotions on annual subscriptions, to amortize the promotion expense
over 12 months. The Company anticipates that it will continue to incur a
significant level of subscriber acquisition costs in conjunction with the growth
of its subscriber base, and that these costs could increase as a result of
increased competition and a downward pressure on the retail price of satellite
equipment sold. Potential increases in subscriber acquisition costs as well as
significant subscriber growth is expected to have a short term negative impact
on operating cash flow of the Company.
General and administrative costs include administrative costs
associated with the Company's sales and subscriber service operations, as well
as accounting and general administration. Although these expenses will continue
to increase as the Company's scope of operations increases, such expenses are
primarily fixed in nature and, accordingly, should not increase directly in
proportion to the future increase to the Company's subscriber base.
The Company has yet to achieve positive operating cash flow due to cash
expended in implementing its sales and administrative infrastructure, marketing
expenses associated with adding new subscribers and interest and other debt
servicing costs associated with financing activities. The Company expects to
continue its focus on increasing its subscriber base, which is expected to have
a negative impact on short-term operating results. In addition, a changing
competitive environment may increase the marketing expenditures necessary to
acquire new subscribers. There can be no assurance that the Company's subscriber
base and revenues will continue to increase or that the Company will be able to
achieve or sustain profitability or positive operating cash flow.
Results of Operations
Three Months Ended March 31, 1998 Compared to Three Months Ended March 31, 1997
The Company's net revenues increased by approximately $12.5 million or
168% for the three months ended March 31, 1998 (the "1998 Period") as compared
to the three month period ended March 31, 1997 (the "1997 Period"). Programming
revenue was approximately $17.1 million for the 1998 Period compared to
approximately $7.0 million for the 1997 Period, an increase of approximately
14
<PAGE>
$10.1 million or 144%. This increase resulted primarily from revenue generated
from subscribers acquired in conjunction with the Company's acquisitions during
and subsequent to the 1997 Period and, from net subscribers added during the
twelve month period ending March 31, 1998 from the Company's sales and marketing
activities. As of March 31, 1998, the Company had approximately 144,000
subscribers, representing approximately 8.6% penetration of households served,
compared to approximately 56,000 subscribers as of March 31, 1997, or 4.4%
penetration. During and subsequent to the 1997 Period, the Company added
approximately 65,000 subscribers through acquisitions. During the twelve month
period ending March 31, 1998, the Company added approximately 36,000 net
subscribers, consisting of approximately 51,000 new subscribers from sales and
marketing activities offset by approximately 15,000 disconnects. Average monthly
programming revenue per subscriber during the 1998 Period was approximately $42
as compared to approximately $40 during the 1997 Period. This increase resulted
from an improved mix of premium package programming subscriptions.
Costs directly associated with providing programming, equipment sales
and installation revenue totaled approximately $13.6 million during the 1998
Period compared with approximately $4.5 million during the 1997 Period. These
costs increased in direct proportion to the increase in the number of
subscribers subscribing to DIRECTV Services and the increase in DSS(R) units
sold between years. For the 1998 Period, the gross profit on programming revenue
after recurring service fees was approximately 39% compared with approximately
43% during the 1997 Period. Gross profit declined as a percentage of revenue
between periods due to an increase in programming costs associated with the
Government mandated copyright fee increases for the DBS industry, effective
January 9, 1998. The Company elected to subsidize this cost increase for all
package subscriptions containing super station programming. Recurring service
fees remained constant between periods on a per subscriber basis. During the
1998 Period, the Company sold DSS(R) equipment installed at average prices of
approximately 11% below the Company's cost as compared to 9% during the 1997
Period. This marginal subsidy increase resulted from increased promotional
activity on installed equipment sales. The average cost to the Company of DSS(R)
equipment remained relatively stable between periods. The Company expects to
continue to subsidize the cost of DSS(R) equipment, and anticipates increased
subsidies as retail prices may decline as a result of increased competition.
The Company incurred direct selling expenses of approximately $3.7
million during the 1998 Period as compared to approximately $1.0 million during
the 1997 Period. These costs included advertising and promotion expenses, sales
commissions to both the Company's employee and dealer distribution channels, and
marketing salaries and benefits. Selling expenses per subscriber addition
increased between periods due to increased promotional activity. During the 1998
Period, the Company offered a $75 equipment rebate on all DSS(R) equipment sales
15
<PAGE>
under its "Great Rebate of '98" promotional campaign. In addition, the Company
offered two months free Total Choice(R) programming for each new subscriber
added during November and December 1997 under DirecTv's national Total Choice(R)
promotion. The associated cost of the Total Choice(R) promotion was recorded as
a selling expense during the 1998 Period.
General and administrative expenses totaled approximately $2.8 million
during the 1998 Period or approximately 14% of revenues compared with
approximately $1.7 million or 23% of revenues for the 1997 Period. These
expenses consisted primarily of salaries and expenses associated with customer
service operations, retail store and installation facility expenses, general
office expenses, and other general administrative expenses. General and
administrative expenses are expected to continue to further decline as a percent
of total revenues in 1998 as the majority of these expenses are fixed in nature.
Depreciation expense totaled approximately $223,000 for the 1998 Period
compared to approximately $63,000 during the 1997 Period, and has increased in
conjunction with the addition of furniture and equipment at the Company's new
customer call center in Kentucky, other general office assets, retail store
assets, and the purchase of installation service vehicles. Amortization expense
totaled approximately $4.5 million for the 1998 Period compared with
approximately $2.4 million during the 1997 Period. Of the 1998 Period amount,
approximately $4.4 million relates to the acquisition of contract rights by the
Company.
The Company generated a Consolidated Operating Cash Flow deficit
pursuant to the terms of the Notes Indenture of approximately $53,000 for the
1998 Period compared with a surplus of approximately $246,000 for the 1997
Period. Operating Cash Flow performance decreased between periods as a result of
increased selling and promotional expenses associated with subscriber additions.
Interest expense for the 1998 Period, including amortization of debt
discount and debt issuance costs, totaled approximately $6.6 million as compared
to approximately $1.7 million for the 1997 Period. This increase was due to
interest associated with the Notes issued in July 1997. During the 1998 Period,
the Company also earned interest revenue totaling approximately $452,000 on the
over funded portion of the Notes.
Liquidity and Capital Resources
The Company has required significant capital since its formation in
order to acquire the rights to provide DIRECTV Services, to implement the
infrastructure to support its operations, and to increase its subscriber base.
The Company has financed acquisitions and its other capital needs through the
proceeds received from the private sale of equity securities, the issuance of
seller notes, through borrowings under the Credit Facility and issuance of the
Notes. Cash flows from financing activities for the 1997 Period totaled
approximately $93.4 million, including $60.6 million borrowed under the Credit
Facility, approximately $133,000 from the issuance of installment notes, and
approximately $32.1 million from the sale of equity interests and approximately
$628,000 from operations. Cash flows from financing activities during the 1998
Period totaled approximately $13.0 million, consisting entirely of borrowings
under the Credit Facility.
The Company used proceeds from the financings during the 1997 Period
(i) to consummate acquisitions of certain Rural DIRECTV Markets for
approximately $83.2 million, (ii) to pay approximately $750,000 in deposits
toward acquisitions subsequent to the 1997 Period, (iii) to pay
16
<PAGE>
certain fees totaling approximately $1.6 million incurred in conjunction with
the Company's formation and fees associated with debt financing, (iv) to repay
approximately $6.0 million of seller notes and other notes payable, and (v) for
capital expenditures totaling approximately $415,000. The Company used proceeds
from the financings during the 1998 Period (i) to consummate acquisitions of
certain Rural DIRECTV Markets for approximately $37.2 million (ii) to repay
approximately $9.6 million of certain seller notes and other notes payable,
(iii) to pay certain fees and expenses totaling approximately $747,000
associated with the procurement of debt financing and company formation, (iv)
for capital expenditures totaling approximately $341,000, and (v) for operating
cash needs totaling approximately $9.1 million.
On July 30, 1997, the Company raised approximately $146.0 million, net
of underwriting discount and expenses, through the issuance of $155.0 million of
the Notes, which were sold in a transaction exempt from registration under the
Securities Act. On January 26, 1998, the Company filed the Exchange Notes
registered under the Securities Act. The terms of the Exchange Notes are
identical in all material respects (including principal amount, interest rate,
maturity, security and ranking) to the terms of the Notes (which they replace),
except that the Exchange Notes: (i) bear a Series B designation, (ii) are
registered under the Securities Act and, therefore, do not bear legends
restricting their transfer, and (iii) are not entitled to certain registration
rights and certain liquidated damages which were applicable to the Notes. The
Exchange Notes are unconditionally guaranteed, on a senior subordinated basis,
as to payment of principal, premium, if any, and interest, jointly and
severally, by the Guarantors. The Guarantors consist of all of the subsidiaries
of the Company, except DTS Capital, which is a co-issuer of the Exchange Notes
and has no separate assets or operations. The Company does not have assets or
operations apart from the assets and operations of its subsidiaries.
On January 8, 1998, the Company entered into an Agreement and Plan of
Merger with Pegasus providing for the acquisition of the Company by Pegasus. In
conjunction therewith, the Company amended its Credit Facility allowing for the
Merger to occur without an event of default (due to a change in control of the
Company). The companies completed the Merger on April 27, 1998. The consummation
of the Merger also caused a change of control to occur under the terms of the
Notes Indenture, and the Company is required to make an offer to purchase the
Notes at 101% of the principal amount hereof, plus accrued and unpaid interest
thereon, if any, to the date of purchase. The Company has entered into a
commitment letter with CIBCC under which CIBCC has agreed to purchase the Notes
tendered in response to the offer to purchase the Notes. CIBCC's commitment is
subject to the execution of definitive documentation and customary closing
conditions. There can be no assurance that such alternative arrangements will be
available or, if available will be on terms satisfactory to the Company.
The Company's cash and financing needs for the remainder of 1998 and
beyond will be dependent on the Company's level of subscriber growth and the
related marketing costs to acquire new subscribers, and the working capital
needs necessary to support such growth. For the remainder of 1998, the Company
has principal repayment obligations on its Credit Facility, seller notes and
installment notes totaling approximately $7.0 million, and commitments under
various operating leases for office space and equipment. The Company expects to
make capital expenditures of approximately $750,000 during the remainder of
1998. Capital expenditures will be primarily for leasehold improvements,
furniture and equipment and software enhancements associated with the Company's
centralized customer call center and the opening of retail stores. The Company
plans to fund these obligations and operating cash requirements using borrowings
under the Credit Facility and cash generated from operations. At March 31, 1998,
the Company had approximately $33.4 million of
17
<PAGE>
borrowings immediately available under the Credit Facility. The Company believes
that the available borrowings under the Credit Facility will provide sufficient
funds to enable the Company to make additional acquisitions and fund debt
service and operations through the maturity date of the Credit Facility in 2003.
The Company believes that consummation of the Merger will not adversely affect
the ability of the Company to fund debt service and operations through such
period. The Company's business strategy contemplates additional acquisitions of
Rural DIRECTV Markets which will require additional capital. The Company's
operations do not currently generate positive cash flow. While the Company
anticipates funding any additional acquisitions through borrowings under the
Credit Facility, seller financing in connection with such acquisitions,
additional debt and/or equity offerings and cash from operations, there can be
no assurance that such funding would be available at the time of such
acquisitions or available on favorable terms.
Other
The Company has reviewed all of its system as to the Year 2000 issue.
The Company relies on outside vendors for the operation of its DBS satellite
control and billing systems, including DIRECTV, the NRTC and their respective
vendors. The Company has established a policy to ensure that its vendors are
currently in compliance with the Year 2000 issue or have a plan in place to be
in compliance with the Year 2000 issue by the first quarter of 1999. Costs to be
incurred beyond March 31, 1998 relating to the Year 2000 issue are not expected
to be significant.
The Company's ability to incur additional indebtedness is limited under
the terms of the Senior Subordinated Notes Indenture and the Credit Facility.
These limitations primarily take the form of certain leverage ratios and are
dependent upon certain measures of operating profitability. Under the terms of
the Credit Facility, capital expenditures and business acquisitions in excess of
certain agreed upon levels will require lender consent.
The Company's operating results in any period may be affected by the
incurrence of advertising and promotion expenses that do not necessarily produce
commensurate revenues in the short-term until the impact of such advertising and
promotion is realized in future periods.
The Company believes that inflation has not been a material factor
affecting the Company's business. In general, the Company's revenues and
expenses are impacted to the same extent by inflation. Substantially all of the
Company's indebtedness bears interest at a fixed rate.
The Company has adopted the provisions of Statement of Financial
Accounting Standards ("SFAS") No. 128, "Earnings Per Share" ("SFAS No. 128").
The Company has reviewed the provisions of SFAS No. 130, "Reporting
Comprehensive Income" and SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information", and the implementation of the above
standards is not expected to have any significant impact on its consolidated
financial statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable.
18
<PAGE>
PART II
ITEM 5. OTHER INFORMATION
On April 27, 1998, Pegasus DTS Merger Sub, Inc., a subsidiary of
Pegasus Communications Corporation ("Pegasus"), was merged into DTS pursuant to
the terms of the Agreement and Plan of Merger dated January 8, 1998 (the "Merger
Agreement") among Pegasus, DTS, Pegasus DTS Merger Sub, Inc., certain
stockholders of Pegasus and certain stockholders of DTS. As a result of the
Merger, DTS and DTS Capital became wholly-owned subsidiaries of Pegasus.
Pursuant to the terms of the Merger Agreement, 5,471,296 shares in the
aggregate of Pegasus' Class A Common Stock were issued to the former DTS
stockholders, holders of DTS options received options to purchase an aggregate
of 67,042 shares of Pegasus' Class A Common Stock, and holders of DTS warrants
received warrants to purchase an aggregate of 156,996 shares of Pegasus' Class A
Common Stock.
Upon consummation of the Merger, (i) all of DTS' and DTS Capital's
directors either resigned or were removed, (ii) Marshall W. Pagon, the
President, Chief Executive Officer and Chairman of the Board of Pegasus, Howard
E. Verlin, a Vice President of Pegasus, and Nicholas A. Pagon were elected to
DTS' Board of Directors, and (iii) Marshall W. Pagon was elected the sole
director of DTS Capital.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits required to be filed by Item 601 of Regulation S-K:
27.1 Financial Data Schedule.
(b) Reports on Form 8-K
There were no Current Reports on Form 8-K filed during the quarter
ended March 31, 1998.
19
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Digital Television Services, Inc. has duly caused this
Report to be signed on its behalf by the undersigned, thereto duly authorized.
Digital Television Services, Inc.
May 14, 1998 By: /s/ Robert N. Verdecchio
- ----------------------------- ----------------------------
Date Robert N. Verdecchio
Senior Vice President,
Chief Financial Officer and
Assistant Secretary
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, DTS Capital, Inc. has duly caused this Report to be signed
on its behalf by the undersigned, thereto duly authorized.
DTS Capital, Inc.
May 14, 1998 By: /s/ Robert N. Verdecchio
- ----------------------------- ----------------------------
Date Robert N. Verdecchio
Senior Vice President,
Chief Financial Officer and
Assistant Secretary
20
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS FINANCIAL DATA SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED
FROM THE CONDENSED CONSOLIDATED BALANCE SHEETS OF DIGITAL TELEVISION SERVICES,
INC. AND SUBSIDIARIES AS OF MARCH 31, 1998 (UNAUDITED) AND DECEMBER 31, 1997 AND
THE RELATED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS
ENDED MARCH 31, 1998 (UNAUDITED) AND MARCH 31, 1997 (UNAUDITED). THIS
INFORMATION IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<CURRENCY> U.S.DOLLARS
<MULTIPLIER> 1
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 3-MOS
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1997
<PERIOD-START> JAN-01-1998 JAN-01-1997
<PERIOD-END> MAR-31-1998 MAR-31-1997
<EXCHANGE-RATE> 1 1
<CASH> 4,478,512 39,113,152
<SECURITIES> 0 0
<RECEIVABLES> 6,044,009 5,364,666
<ALLOWANCES> 200,548 190,647
<INVENTORY> 1,487,370 2,229,918
<CURRENT-ASSETS> 30,511,827 65,616,080
<PP&E> 3,815,851 3,474,754
<DEPRECIATION> 776,106 554,537
<TOTAL-ASSETS> 219,182,155 257,662,066
<CURRENT-LIABILITIES> 26,933,874 63,336,431
<BONDS> 186,749,451 177,641,876
0 0
14,041 14,041
<COMMON> 21,370 21,370
<OTHER-SE> 5,452,184 16,637,113
<TOTAL-LIABILITY-AND-EQUITY> 219,182,155 257,662,066
<SALES> 19,963,243 7,435,179
<TOTAL-REVENUES> 19,963,243 7,435,179
<CGS> 13,598,105 4,508,007
<TOTAL-COSTS> 13,598,105 4,508,007
<OTHER-EXPENSES> 10,956,521 5,072,062
<LOSS-PROVISION> 231,901 101,053
<INTEREST-EXPENSE> 6,196,148 1,686,800
<INCOME-PRETAX> (11,184,929) (3,898,858)
<INCOME-TAX> 0 0
<INCOME-CONTINUING> (11,184,929) (3,898,858)
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