<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 September 30, 1999
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;
225 City Line Avenue, Suite 200, Bala Cynwyd, PA 19004
------------------------------------------------- -----
(Address of principal executive offices) (Zip code)
Registrants' telephone number, including area code: (888) 438-7488
--------------
Indicate by check mark whether each of the Registrants: (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___
Digital Television Services, Inc. and DTS Capital, Inc. each had 100
shares of common stock outstanding as of November 5, 1999.
The Registrants meet the conditions set forth in General Instruction H
(1)(a) and (b) of Form 10-Q and are therefore filing this Form with the reduced
disclosure format.
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DIGITAL TELEVISION SERVICES, INC.
Form 10-Q
Table of Contents
For the Quarterly Period Ended September 30, 1999
Page
Part I. Financial Information ----
Item 1 Consolidated Financial Statements
Consolidated Balance Sheets
December 31, 1998 and September 30, 1999 3
Consolidated Statements of Operations
Three months ended September 30, 1998 and 1999 4
Consolidated Statements of Operations
Nine months ended September 30, 1998 and 1999 5
Consolidated Statements of Cash Flows
Nine months ended September 30, 1998 and 1999 6
Notes to Consolidated Financial Statements 7
Item 2 Management's Discussion and Analysis of
Financial Condition and Results of Operations 10
Part II. Other Information
Item 5 Other Information 17
Item 6 Exhibits and Reports on Form 8-K 17
Signature 19
2
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Digital Television Services, Inc.
Consolidated Balance Sheets
<TABLE>
<CAPTION>
December 31, September 30,
1998 1999
------------ -------------
ASSETS (unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 6,255,370 $ 4,345,023
Restricted cash 18,879,305 -
Accounts receivable, less allowance for doubtful
accounts of $183,000 2,718,783 3,087,941
Inventory 732,898 512,670
Prepaid expenses and other 228,962 1,430,104
------------ ------------
Total current assets 28,815,318 9,375,738
Property and equipment, net 3,268,884 2,885,816
Intangible assets, net 343,986,107 312,689,518
Deferred taxes 2,109,901 1,957,579
Deposits and other - 119,464
------------ ------------
Total assets $378,180,210 $327,028,115
============ ============
LIABILITIES AND EQUITY
Current liabilities:
Current portion of long-term debt $ 4,061,677 $ 4,186,865
Accounts payable 1,369,324 218,220
Accrued interest 8,334,313 3,259,192
Accrued satellite programming, fees and commissions 9,622,479 12,407,438
Accrued expenses and other 1,491,411 4,418,184
------------ ------------
Total current liabilities 24,879,204 24,489,899
Long-term debt 204,804,632 216,721,923
Deferred taxes 66,941,018 62,107,175
------------ ------------
Total liabilities 296,624,854 303,318,997
------------ ------------
Commitments and contingent liabilities - -
Preferred Stock; $0.01 par value; 1,000 shares authorized - -
Common stockholder's equity:
Common stock; $0.01 par value; 1,000 shares
authorized; 100 shares issued and outstanding 1 1
Additional paid-in capital 124,264,836 124,525,314
Deficit (42,709,481) (100,816,197)
------------ ------------
Total stockholder's equity 81,555,356 23,709,118
------------ ------------
Total liabilities and stockholder's equity $378,180,210 $327,028,115
============ ============
</TABLE>
See accompanying notes to consolidated financial statements
3
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Digital Television Services, Inc.
Consolidated Statements of Operations
Three Months Ended September 30,
---------------------------------------
1998 1999
---------------- -------------------
(unaudited)
Net revenues:
Basic satellite service $ 16,239,298 $ 23,615,715
Premium services 2,411,461 3,704,208
Other 813,355 2,015,001
------------ ------------
Total net revenues 19,464,114 29,334,924
Operating expenses:
Programming 8,622,804 12,599,983
General and administrative 5,029,873 8,375,956
Marketing and selling 6,943,267 13,325,285
Incentive compensation 75,000 150,000
Corporate expenses - 422,129
Depreciation and amortization 9,652,185 9,768,743
------------ ------------
Loss from operations (10,859,015) (15,307,172)
Interest expense (6,236,453) (6,673,270)
Interest income 295,294 204,620
Other income (expense), net 19,417 (13,428)
------------ ------------
Loss before income taxes (16,780,757) (21,789,250)
Benefit for income taxes - (3,192,116)
------------ ------------
Net loss ($16,780,757) ($18,597,134)
============ ============
See accompanying notes to consolidated financial statements
4
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Digital Television Services, Inc.
Consolidated Statements of Operations
Nine Months Ended September 30,
---------------------------------------
1998 1999
---------------- -------------------
(unaudited)
Net revenues:
Basic satellite service $ 44,556,030 | $ 64,316,489
Premium services 7,328,230 | 10,022,406
Other 2,799,301 | 4,979,513
------------ | ------------
Total net revenues 54,683,561 | 79,318,408
|
Operating expenses: |
Programming 24,483,144 | 34,779,349
General and administrative 13,888,456 | 20,663,216
Marketing and selling 16,023,958 | 34,074,500
Incentive compensation 173,919 | 345,000
Corporate expenses - | 1,115,728
Depreciation and amortization 22,837,276 | 31,716,036
------------ | ------------
Loss from operations (22,723,192) | (43,375,421)
|
Interest expense (18,693,648) | (19,701,489)
Interest income 1,136,990 | 554,198
Other expense, net (278,855) | (26,120)
------------ | ------------
Loss before income taxes (40,558,705) | (62,548,832)
Benefit for income taxes - | (4,442,116)
------------ | ------------
|
Net loss ($40,558,705) | ($58,106,716)
============ | ============
See accompanying notes to consolidated financial statements
5
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Digital Television Services, Inc.
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Nine Months Ended September 30,
---------------------------------------
1998 1999
----------------- -----------------
(unaudited)
<S> <C> <C>
Cash flows from operating activities:
Net loss ($40,558,705) | ($58,106,716)
Adjustments to reconcile net loss |
to net cash used for operating activities: |
Depreciation and amortization 22,837,276 | 31,716,036
Accretion on discount of bonds and seller notes 1,094,092 | 814,466
Stock incentive compensation 173,919 | 345,000
Gain on disposal of assets - | (35,343)
Bad debt expense 985,319 | 2,002,019
Change in assets and liabilities: |
Accounts receivable (2,182,896) | (2,373,065)
Inventory 1,816,754 | 220,228
Prepaid expenses and other (464,153) | (1,201,142)
Accounts payable and accrued expenses 6,270,094 | (205,415)
Accrued interest (4,936,704) | (5,075,121)
Deposits and other - | (119,464)
------------- | ------------
Net cash used for operating activities (14,965,004) | (32,018,517)
------------- | ------------
Cash flows from investing activities: |
Acquisitions (37,172,504) | -
Capital expenditures (1,232,829) | (433,307)
Purchase of intangible assets (5,588,721) | (74,829)
Proceeds from sale of assets - | 508,988
------------- | ------------
Net cash provided (used) by investing activities (43,994,054) | 852
------------- | ------------
|
Cash flows from financing activities: |
Repayments of long-term debt and capital leases (9,727,157) | (4,071,987)
Borrowings on bank credit facilities 14,000,000 | 15,900,000
Repayments of bank credit facilities (200,000) | (600,000)
Restricted cash 18,389,853 | 18,879,305
Contributions by Parent 2,146,087 | -
------------- | ------------
Net cash provided by financing activities 24,608,783 | 30,107,318
------------- | ------------
|
Net decrease in cash and cash equivalents (34,350,275) | (1,910,347)
Cash and cash equivalents, beginning of year 39,113,152 | 6,255,370
------------ | ------------
Cash and cash equivalents, end of period $ 4,762,877 | $ 4,345,023
============ | ============
</TABLE>
See accompanying notes to consolidated financial statements
6
<PAGE>
DIGITAL TELEVISION SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. The Company:
Digital Television Services, Inc. ("DTS" or together with its
subsidiaries, the "Company") is a holding company which operates primarily
through its wholly owned subsidiaries and is a successor to Digital Television
Services, LLC and DBS Holdings, L.P. The Company provides direct broadcast
satellite television ("DBS") services to customers in certain rural areas of
eleven states.
Until April 27, 1998, the sole member and manager of the operating
subsidiaries was DTS Management, LLC ("DTS Management"), which is a subsidiary
of DTS. The Company's other direct subsidiary, DTS Capital, Inc. ("DTS
Capital"), was formed in 1997 and has nominal assets and does not conduct any
operations. DTS Capital was formed to facilitate the issuance of $155.0 million
of 12.5% Series A Senior Subordinated Notes due 2007 (the "Series A Notes") in
July 1997.
On April 27, 1998, the Company merged (the "Merger") with Pegasus DTS
Merger Sub, Inc., a wholly owned subsidiary of Pegasus Communications
Corporation ("Pegasus" or the "Parent") in a transaction accounted for as a
purchase. In connection with the Merger, the stockholders of the Company
exchanged all of their outstanding capital stock for approximately 5.5 million
shares of Pegasus' Class A Common Stock and, as a consequence, the Company
became a wholly owned subsidiary of Pegasus. Pegasus did not assume, guarantee
or otherwise have any liability for DTS' outstanding indebtedness 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 Pegasus' subsidiaries.
Total consideration for the Merger was approximately $363.9 million,
which consisted of approximately 5.5 million shares of Pegasus' Class A Common
Stock (amounting to $118.8 million at a price of $21.71 per share, the average
closing price per share five days prior and subsequent to the acquisition
announcement), options and warrants to purchase a total of 224,038 shares of
Pegasus' Class A Common Stock (amounting to $3.3 million at the time of
issuance), approximately $158.9 million in assumed net liabilities and
approximately $82.9 million of a deferred tax liability, primarily as a result
of non-deductible amortization.
2. Basis of Presentation:
The accompanying unaudited consolidated financial statements have been
prepared in accordance with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. The financial statements include the accounts of DTS and
all of its subsidiaries. All intercompany transactions and balances have been
eliminated. Certain amounts for 1998 have been reclassified for comparative
purposes.
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. For further information, refer to the consolidated financial
statements and footnotes thereto for the year ended December 31, 1998 included
in the Company's Annual Report on Form 10-K for the year then ended.
As a result of the Merger and Pegasus' use of the purchase method of
accounting to record the acquisition of the Company, the "push down" effect of
the purchase price increased the Company's intangible assets by approximately
$205.0 million. As a consequence, results prior to the Merger are not comparable
with those subsequent to the Merger.
3. Equity:
On April 27, 1998, in connection with the Merger, the stockholders of
the Company exchanged all of their outstanding capital stock for shares of
Pegasus' Class A Common Stock, options and warrants to purchase Pegasus' Class A
Common Stock and, as a result, the Company became a wholly owned subsidiary of
Pegasus.
As of December 31, 1998 and September 30, 1999, the Company had one
class of Common Stock. The Company's ability to pay dividends on its Common
Stock is subject to certain restrictions.
7
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4. Long-Term Debt:
<TABLE>
<CAPTION>
Long-term debt consists of the following : December 31, September 30,
1998 1999
---- ----
<S> <C> <C>
Series B Notes payable by DTS, due 2007, interest at 12.5%,
payable semi-annually in arrears on February 1 and
August 1, net of unamortized discount of $1,784,844 and
$1,582,585 as of December 31, 1998 and September 30,
1999, respectively........................................ $153,215,156 $153,417,415
Senior six-year $70.0 million revolving credit facility,
payable by DTS, interest at the Company's option at
either the bank's base rate plus an applicable margin or
the Eurodollar Rate plus an applicable margin............. 26,800,000 42,700,000
Senior six-year $20.0 million term loan facility, payable by
DTS, interest at the Company's option at either the
bank's base rate plus an applicable margin or the
Eurodollar Rate plus an applicable margin................. 19,600,000 19,000,000
Sellers' notes, due 1999 to 2001, interest at 3% to 4%, net
of unamortized discount of $1,576,895 and $964,688 as of
December 31, 1998 and September 30, 1999, respectively.... 9,161,681 5,742,440
Capital leases and other...................................... 89,472 48,933
------------ ------------
208,866,309 220,908,788
Less current maturities....................................... 4,061,677 4,186,865
------------ ------------
Long-term debt................................................ $204,804,632 $216,721,923
============ ============
</TABLE>
The Company maintains a $70.0 million senior revolving credit facility
and a $20.0 million senior term credit facility (collectively, the "DTS Credit
Facility") which expires in 2003 and is collateralized by substantially all of
the assets of DTS and its subsidiaries. The DTS Credit Facility is subject to
certain financial covenants as defined in the loan agreement, including a debt
to adjusted cash flow covenant. As of September 30, 1999, $14.4 million of
stand-by letters of credit were issued pursuant to the DTS Credit Facility,
including $6.7 million collateralizing certain of the Company's outstanding
sellers' notes.
The Company's 12.5% Series B Notes due 2007 (the "12.5% Series B
Notes") may be redeemed, at the option of the Company, in whole or in part, at
various points in time after August 1, 2002 at the redemption prices specified
in the indenture governing the 12.5% Series B Notes, plus accrued and unpaid
interest thereon.
The Company's indebtedness contain certain financial and operating
covenants, including restrictions on the Company to incur additional
indebtedness, create liens and to pay dividends.
5. Supplemental Cash Flow Information:
Significant noncash investing and financing activities are as follows:
<TABLE>
<CAPTION>
Nine Months Ended September 30,
-------------------------------
1998 1999
---- ----
<S> <C> <C>
Capital contribution and related acquisition of intangibles..................... 120,094,028 -
Deferred taxes, net and related intangibles..................................... 82,934,179 -
</TABLE>
For the nine months ended September 30, 1998 and 1999, the Company paid
cash for interest in the amount of $23.6 million and $24.8 million,
respectively. The Company paid no federal income taxes for the nine months ended
September 30, 1998 and 1999.
8
<PAGE>
6. Commitments and Contingent Liabilities:
Legal Matters:
The Company has been sued in Indiana for allegedly charging DBS
subscribers excessive fees for late payments. The plaintiffs, who purport to
represent a class consisting of residential DIRECTV(R) ("DIRECTV") customers in
Indiana, seek unspecified damages for the purported class and modification of
the Company's late-fee policy. The Company is advised that similar suits have
been brought against DIRECTV and various cable operators in other parts of the
United States.
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 and matters will not have a material adverse effect on the
consolidated operations, liquidity, cash flows or financial position of the
Company.
9
<PAGE>
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 the beliefs of our management, as
well as assumptions made by and information currently available to our
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 our current
views with respect to future events and are subject to unknown risks,
uncertainties and other factors that may cause actual results to differ
materially from those contemplated in such forward-looking statements. Such
factors include, among other things, the following: general economic and
business conditions, both nationally, internationally and in the regions in
which we operate; relationships with and events affecting third parties like
DIRECTV, Inc.; demographic changes; existing government regulations and changes
in, or the failure to comply with government regulations; competition; the loss
of any significant numbers of subscribers; changes in business strategy or
development plans; technological developments and difficulties (including any
associated with the year 2000); the ability to attract and retain qualified
personnel; our significant indebtedness; the availability and terms of capital
to fund the expansion of our business; and other factors referenced in this
Report and in reports and registration statements filed by Digital Television
Services and its parent company, Pegasus Communications Corporation, from time
to time with the Securities and Exchange Commission. Readers are cautioned not
to place undue reliance on these forward-looking statements, which speak only as
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.
In reliance upon General Instruction (H)(2)(a) of Form 10-Q, Digital
Television Services is providing the limited disclosure set forth below. Such
disclosure requires us only to provide narrative analysis of the results of
operations which explains the reasons for material changes in the amount of
revenue and expense items between the most recent fiscal year-to-date period
presented and the corresponding year-to-date period in the preceding fiscal
year. The following discussion of the financial condition and results of
operations of Digital Television Services should be read in conjunction with the
consolidated financial statements and related notes which are included on pages
3-9 herein.
General
Digital Television Services, Inc. is:
o A wholly owned subsidiary of Pegasus Communications Corporation.
o An independent provider of DIRECTV with 246,000 subscribers at
October 31, 1999. We have the exclusive right to distribute DIRECTV
digital broadcast satellite services to approximately 1.8 million
rural households in 11 states. We distribute DIRECTV through the
Pegasus retail network, a network in excess of 2,000 independent
retailers.
We were originally formed on January 30, 1996, to acquire, own and
manage rights to distribute DIRECTV services to residential households and
commercial establishments in certain rural areas of the United States. On April
27, 1998, we became a wholly owned subsidiary of Pegasus Communications
Corporation, the largest independent provider of DIRECTV, through a merger with
a subsidiary of Pegasus.
In connection with the merger, the stockholders of Digital Television
Services exchanged all of their capital stock for approximately 5.5 million
shares of Pegasus' Class A Common Stock and, as a consequence, we became a
wholly owned subsidiary of Pegasus Communications Corporation.
10
<PAGE>
Total consideration for the merger was approximately $363.9 million,
which consisted of:
o approximately 5.5 million shares of Pegasus' Class A Common Stock
(amounting to $118.8 million),
o options and warrants to purchase a total of 224,038 shares of
Pegasus' Class A Common Stock (amounting to $3.3 million),
o approximately $158.9 million in assumed net liabilities, and
o approximately $82.9 million of a deferred tax liability, primarily as
a result of non-deductible amortization.
Pegasus has accounted for the acquisition as a purchase and applied
"push down" accounting, thereby adjusting our accounting basis. The effect of
the change in accounting basis has been a $205.0 million increase in our
intangible assets. Results prior to and subsequent to the acquisition of Digital
Television Services by Pegasus are not comparable.
Revenues are principally derived from monthly customer subscriptions
and pay-per-view services.
In this section we use the terms pre-marketing operating expenses,
pre-marketing cash flow and location cash flow. Pre-marketing operating expenses
consist of:
o programming expenses, including amounts paid to program suppliers,
digital satellite system authorization charges and satellite control
fees, each of which is paid on a per subscriber basis, and DIRECTV
royalties which are equal to 5% of DBS program service revenues, and
o general and administrative expenses, including administrative costs
associated with our sales and customer service operations.
Pre-marketing cash flow is calculated by taking our earnings and adding
back the following expenses:
o interest,
o income taxes,
o depreciation and amortization,
o non-cash charges, such as incentive compensation under Pegasus'
restricted stock plan and 401(k) plans,
o corporate overhead, and
o subscriber acquisition costs, which are sales and marketing expenses
incurred to acquire new subscribers.
Location cash flow is pre-marketing cash flow less subscriber
acquisition costs.
Pre-marketing cash flow and location cash flow are not, and should not
be considered, an alternative to net income from operations, net income, net
cash provided by operating activities or any other measure for determining our
operating performance or liquidity, as determined under generally accepted
accounting principles. Pre-marketing cash flow and location cash flow also do
not necessarily indicate whether our cash flow will be sufficient to fund
working capital, capital expenditures, or to react to changes in Digital
Television Services' industry or the economy generally. We believe that
pre-marketing cash flow and location cash flow are important, however, for the
following reasons:
11
<PAGE>
o those who follow our industry frequently use them as measures of
performance and ability to pay debt service, and
o they are measures that our lenders, investors and we use to monitor
our financial performance and debt leverage.
Results of Operations
Three months ended September 30, 1999 compared to three months ended September
30, 1998
At September 30, 1998 and 1999, Digital Television Services had
exclusive DIRECTV distribution rights to approximately 1.8 million households.
At September 30, 1999, Digital Television Services had 239,000 subscribers as
compared to 163,000 subscribers at September 30, 1998. Subscriber penetration
increased from 9.1% at September 30, 1998 to 13.3% at September 30, 1999.
Total net revenues were $29.3 million for the three months ended
September 30, 1999, an increase of $9.9 million, or 51%, compared to total net
revenues of $19.5 million for the same period in 1998. The increase is primarily
due to an increase in the average number of subscribers in the third quarter of
1999 compared to the third quarter of 1998. The average monthly revenue per
subscriber was $44.57 for the three months ended September 30, 1999 compared to
$41.08 for the same period in 1998.
Pre-marketing operating expenses were $21.0 million for the three
months ended September 30, 1999, an increase of $7.3 million, or 54%, compared
to $13.7 million for the same period in 1998. The increase is attributable to
significant growth in subscribers over the last twelve months. As a percentage
of revenue, pre-marketing operating expenses were 71.5% for the three months
ended September 30, 1999 compared to 70.1% for the same period in 1998.
Subscriber acquisition costs were $13.3 million for the three months
ended September 30, 1999, an increase of $6.4 million compared to $6.9 million
for the same period in 1998. Gross subscriber additions were 39,500 for the
three months ended September 30, 1999 compared to 20,100 for the same period in
1998. The total subscriber acquisition costs per gross subscriber addition were
$337 for the three months ended September 30, 1999 compared to $345 for the same
period in 1998. The decrease in subscriber acquisition costs per gross
subscriber addition is due to a decrease in promotional programming.
Incentive compensation, through a plan that became applicable to us on
April 27, 1998 when Pegasus acquired Digital Television Services, is calculated
from increases in pro forma location cash flow. Incentive compensation was
$150,000 for the three months ended September 30, 1999, an increase of $75,000,
or 100%, compared to $75,000 for the same period in 1998.
Corporate expenses were $422,000 for the three months ended September
30, 1999. Corporate expenses represent an allocated portion of Pegasus'
corporate overhead, which Digital Television Services began incurring in 1999.
Depreciation and amortization was $9.8 million for the three months
ended September 30, 1999, an increase of $117,000, or 1%, compared to $9.7
million for the same period in 1998.
Interest expense was $6.7 million for the three months ended September
30, 1999, an increase of $437,000, or 7%, compared to interest expense of $6.2
million for the same period in 1998. The increase in interest expense is
primarily due to an increase in bank borrowings, partially offset by a reduction
in seller debt. Interest income was $205,000 for the three months ended
September 30, 1999, a decrease of $91,000, or 31%, compared to interest income
of $295,000 for the same period in 1998. The decrease in interest income is due
to lower average cash balances, including restricted cash, in the third quarter
of 1999 as compared to the third quarter of 1998.
12
<PAGE>
Other expenses were $13,000 for the three months ended September 30,
1999, an increase of $33,000 compared to other income of $19,000 for the same
period in 1998. The increase is primarily due to a nonrecurring gain on the
disposal of certain DBS assets of $37,000 in the third quarter of 1998.
The benefit for income taxes was $3.2 million for the three months
ended September 30, 1999. The benefit for income taxes is primarily a result of
the amortization of the deferred tax liability that originated from the
acquisition of Digital Television Services by Pegasus. There was no income tax
provision for the three months ended September 30, 1998 as a result of Digital
Television Services' status as a nontaxable entity for federal and state income
tax purposes prior to its conversion to a corporation in October 1997 and the
incurrence of net operating losses subsequent to that event.
Nine months ended September 30, 1999 compared to nine months ended September 30,
1998
Total net revenues were $79.3 million for the nine months ended
September 30, 1999, an increase of $24.6 million, or 45%, compared to total net
revenues of $54.7 million for the same period in 1998. The increase is primarily
due to an increase in the average number of subscribers in the first three
quarters of 1999 compared to the first three quarters of 1998. The average
monthly revenue per subscriber was $43.21 for the nine months ended September
30, 1999 compared to $41.47 for the same period in 1998.
Pre-marketing operating expenses were $55.4 million for the nine months
ended September 30, 1999, an increase of $17.1 million, or 44%, compared to
$38.4 million for the same period in 1998. The increase is attributable to
significant growth in subscribers over the last twelve months. As a percentage
of revenue, pre-marketing operating expenses were 69.9% for the nine months
ended September 30, 1999 compared to 70.2 % for the same period in 1998.
Subscriber acquisition costs were $34.1 million for the nine months
ended September 30, 1999, an increase of $18.1 million, or 113%, compared to
$16.0 million for the same period in 1998. Gross subscriber additions were
91,500 for the nine months ended September 30, 1999 compared to 50,600 for the
same period in 1998. The total subscriber acquisition costs per gross subscriber
addition were $372 for the nine months ended September 30, 1999 compared to $317
for the same period in 1998. The increase in subscriber acquisition costs per
gross subscriber addition is due to an increase in commissions and an increase
in promotional programming during the first half of 1999.
Incentive compensation, through a plan that became applicable to us on
April 27, 1998 when Pegasus acquired Digital Television Services, is calculated
from increases in pro forma location cash flow. Incentive compensation was
$345,000 for the nine months ended September 30, 1999, an increase of $171,000,
or 98%, compared to $174,000 for the same period in 1998.
Corporate expenses were $1.1 million for the nine months ended
September 30, 1999. Corporate expenses represent an allocated portion of
Pegasus' corporate overhead, which Digital Television Services began incurring
in 1999.
Depreciation and amortization was $31.7 million for the nine months
ended September 30, 1999, an increase of $8.9 million, or 39%, compared to $22.8
million for the same period in 1998. The increase in depreciation and
amortization is primarily due to an increase in the fixed and intangible asset
base as a result of the change in accounting basis resulting from the
acquisition of Digital Television Services by Pegasus.
Interest expense was $19.7 million for the nine months ended September
30, 1999, an increase of $1.0 million, or 5%, compared to interest expense of
$18.7 million for the same period in 1998. The increase in interest expense is
primarily due to an increase in bank borrowings, partially offset by a reduction
in seller debt. Interest income was $554,000 for the nine months ended September
30, 1999, a decrease of $583,000, or 51%, compared to interest income of $1.1
million for the same period in 1998. The decrease in interest income is due to
lower average cash balances, including restricted cash, in the first three
quarters of 1999 as compared to the first three quarters of 1998.
13
<PAGE>
Other expenses were $26,000 for the nine months ended September 30,
1999, a decrease of $253,000, or 91%, compared to other expenses of $279,000 for
the same period in 1998. The decrease is primarily due to a decrease in bank
charges and other non-operating expenses.
The benefit for income taxes was $4.4 million for the nine months ended
September 30, 1999. The benefit for income taxes is primarily a result of the
amortization of the deferred tax liability that originated from the acquisition
of Digital Television Services by Pegasus. There was no income tax provision for
the nine months ended September 30, 1998 as a result of Digital Television
Services' status as a nontaxable entity for federal and state income tax
purposes prior to its conversion to a corporation in October 1997 and the
incurrence of net operating losses subsequent to that event.
Liquidity and Capital Resources
Digital Television Services has required significant capital since its
formation in order to fund acquisitions, implement the infrastructure to support
its operations, meet debt service obligations and fund subscriber acquisition
costs. Digital Television Services' primary sources of liquidity have been
credit available under its credit facilities, the issuance of seller notes and
proceeds from private offerings.
Pre-marketing cash flow was approximately $8.4 million for the three
months ended September 30, 1999, an increase of $2.5 million, or 44%, as
compared to $5.8 million for the same period in 1998. The increase is primarily
attributable to the increase in our subscriber base.
Pre-marketing cash flow was approximately $23.9 million for the nine
months ended September 30, 1999, an increase of $7.6 million, or 46%, as
compared to $16.3 million for the same period in 1998. The increase is primarily
attributable to the increase in our subscriber base.
During the nine months ended September 30, 1999, $6.3 million of cash
on hand, together with $1,000 of net cash provided by Digital Television
Services' investing activities and $30.1 million provided by financing
activities was used to fund operating activities of approximately $32.0 million.
Investing activities consisted of:
o proceeds from the sale of certain DBS assets of $509,000, and
o other capital expenditures and intangibles totaling approximately
$508,000.
Financing activities consisted of:
o net borrowings on bank credit facilities totaling $15.3 million,
o the repayment of approximately $4.1 million of long-term debt,
primarily sellers' notes and capital leases, and
o net restricted cash draws of approximately $18.9 million to pay
interest on our $155.0 million notes.
As of September 30, 1999, cash on hand amounted to $4.3 million.
Digital Television Services maintains a $70.0 million senior, reducing
revolving credit facility and a $20.0 million senior term credit facility.
Borrowings under the credit facilities are available to refinance certain
indebtedness and for acquisitions, subject to the approval of the lenders in
certain circumstances, working capital, capital expenditures and for general
corporate purposes. As of September 30, 1999, $61.7 million was outstanding and
stand-by letters of credit amounting to $14.4 million were issued under our
$90.0 million credit facilities. The credit facilities expire in July 2003.
14
<PAGE>
Digital Television Services believes that it has adequate resources to
meet its working capital, maintenance capital expenditure and debt service
obligations for at least the next twelve months. However, our ability in the
future to repay our existing indebtedness will depend upon the success of our
business strategy, prevailing economic conditions, regulatory matters, levels of
interest rates and financial, business and other factors that are beyond our
control. We cannot assure you that we will be able to generate the substantial
increases in cash flow from operations that we will need to meet the obligations
under our indebtedness. Furthermore, our agreements with respect to our
indebtedness contain numerous covenants that, among other things, restrict our
ability to:
o pay dividends and make certain other payments and investments;
o borrow additional funds;
o create liens; and
o sell our assets.
Failure to make debt payments or comply with our covenants could result in an
event of default which, if not cured or waived, could have a material adverse
effect on us.
Digital Television Services closely monitors conditions in the capital
markets to identify opportunities for the effective use of financial leverage.
In financing its future expansion requirements, Digital Television Services
would expect to avail itself of such opportunities and thereby increase its
indebtedness. This could result in increased debt service requirements. We
cannot assure you that such debt financing can be completed on terms
satisfactory to Digital Television Services or at all. Digital Television
Services may also issue additional equity to fund its future expansion
requirements.
Year 2000
The year 2000 issue is a general term used to describe the various
problems that may result from the improper processing of dates and
date-sensitive calculations by computers and other equipment as the year 2000
approaches and is reached. These problems generally arise from the fact that
most computer hardware and software have historically used only two digits to
identify the year in a date, often resulting in the computer failing to
distinguish dates in the 2000s from dates in the 1900s. These problems may also
arise from additional sources, such as the use of special codes and conventions
in software utilizing the date field.
Digital Television Services has reviewed its critical systems as to the
year 2000 issue. Digital Television Services' primary focus has been on its own
internal systems. Digital Television Services has replaced its corporate
accounting system. However, if any other additional necessary changes are not
made or completed in a timely fashion or unanticipated problems arise, the year
2000 issue may take longer for Digital Television Services to address and may
have a material impact on Digital Television Services' financial condition and
its results of operations.
15
<PAGE>
Digital Television Services relies on outside vendors for the operation
of its DBS satellite control and billing systems, including DIRECTV, the
National Rural Telecommunications Cooperative and their respective vendors.
Digital Television Services has established a policy to ensure that these
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. In addition, Digital
Television Services has had initial communications with certain of its other
significant suppliers, distributors, financial institutions and parties with
which it conducts business to evaluate their year 2000 compliance plans and
state of readiness and to determine the extent to which Digital Television
Services' systems may be affected by the failure of others to remediate their
own year 2000 issues. To date, however, Digital Television Services has received
only preliminary feedback from such parties and has not independently confirmed
any information received from other parties with respect to the year 2000 issue.
As such, we cannot assure you that these other parties will complete their year
2000 conversion in a timely fashion or will not suffer a year 2000 business
disruption that may adversely affect Digital Television Services' financial
condition and its results of operations.
Because Digital Television Services' year 2000 conversion is expected
to be completed prior to any potential disruption to Digital Television
Services' business, Digital Television Services has not yet completed the
development of a year 2000-specific contingency plan. If Digital Television
Services determines that its business or a segment thereof is at material risk
of disruption due to the year 2000 issue or anticipates that its year 2000
conversion will not be completed in a timely fashion, it will work to enhance
its contingency plan. Costs to be incurred beyond September 30, 1999 relating to
the year 2000 issue are not expected to be significant.
Seasonality
Digital Television Services' 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.
Inflation
Digital Television Services believes that inflation has not been a
material factor affecting its business. In general, Digital Television Services'
revenues and expenses are impacted to the same extent by inflation. A majority
of Digital Television Services' indebtedness bears interest at a fixed rate.
New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS No. 133"). As a result of the
subsequent issuance of SFAS No. 137, SFAS No. 133 is now effective for fiscal
years beginning after June 15, 2000. SFAS No. 133 establishes accounting and
reporting standards for derivative instruments and for hedging activities. The
Company does not expect that the adoption of SFAS No. 133 will have a material
effect on our business, financial position or results of operations.
16
<PAGE>
PART II. OTHER INFORMATION
ITEM 5. OTHER INFORMATION
On June 3, 1999, the National Rural Telecommunications Cooperative
filed a lawsuit in federal court against DIRECTV, Inc. seeking a court order to
enforce the National Rural Telecommunications Cooperative's contractual rights
to obtain from DIRECTV certain premium programming formerly distributed by
United States Satellite Broadcasting Company, Inc. for exclusive distribution by
the National Rural Telecommunications Cooperative's members and affiliates in
their rural markets. The National Rural Telecommunications Cooperative also
sought a temporary restraining order preventing DIRECTV from marketing the
premium programming in such markets and requiring DIRECTV to provide the
National Rural Telecommunications Cooperative with the premium programming for
exclusive distribution in those areas. The court, in an order dated June 17,
1999, denied the National Rural Telecommunications Cooperative a preliminary
injunction on such matters, without deciding the underlying claims. On July 22,
1999, DIRECTV responded to the National Rural Telecommunications Cooperative's
continuing lawsuit by rejecting the National Rural Telecommunications
Cooperative's claims to exclusive distribution rights and by filing a
counterclaim seeking judicial clarification of certain provisions of DIRECTV's
contract with the National Rural Telecommunications Cooperative. In particular,
DIRECTV contends in its counterclaim that the term of DIRECTV's contract with
the National Rural Telecommunications Cooperative is measured solely by the
orbital life of DBS-1, the first DIRECTV satellite launched into orbit at the
101(degree) W orbital location, without regard to the orbital lives of the other
DIRECTV satellites at the 101(degree) W orbital location. DIRECTV also alleges
in its counterclaim that the National Rural Telecommunications Cooperative's
right of first refusal, which is effective at the end of the term of DIRECTV's
contract with the National Rural Telecommunications Cooperative, does not
provide for certain programming and other rights comparable to those now
provided under the contract. On September 8, 1999, the court denied a motion by
DIRECTV to dismiss certain of the National Rural Telecommunications
Cooperative's claims, leaving all of the causes of action asserted by the
National Rural Telecommunications Cooperative at issue.
On September 9, 1999, the National Rural Telecommunications Cooperative
filed a response to DIRECTV's counterclaim contesting DIRECTV's interpretations
of the end of term and right of first refusal provisions. On August 26, 1999,
the National Rural Telecommunications Cooperative filed a separate lawsuit in
federal court against DIRECTV claiming that DIRECTV had failed to provide to the
National Rural Telecommunications Cooperative its share of launch fees and other
benefits that DIRECTV and its affiliates have received relating to programming
and other services. While we are not a party to the pending litigation between
the National Rural Telecommunications Cooperative and DIRECTV, the outcome of
the litigation could have a material adverse effect on our direct broadcast
satellite business because we are an associate of the National Rural
Telecommunications Cooperative with contract rights that are affected by the
contractual relationship between the National Rural Telecommunications
Cooperative and DIRECTV.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 10.1 Agreement, effective as of September 13, 1999,
by and among ADS Alliance Data Systems, Inc., Pegasus
Satellite Television, Inc. and Digital Television
Services, Inc. (which is incorporated by reference to
Exhibit 10.1 to Pegasus Communications Corporations'
Form 10-Q for the quarterly period ended September
30, 1999). (Portions of this document were redacted
and filed separately with the Securities and Exchange
Commission pursuant to a request for confidential
treatment pursuant to Rule 24b-2 under the Securities
Exchange Act of 1934, as amended).
Exhibit 27.1 Financial Data Schedule of Digital Television
Services, Inc.
Exhibit 27.2 Financial Data Schedule of DTS Capital, Inc.
17
<PAGE>
(b) Reports on Form 8-K
There were no Current Reports on Form 8-K filed during the quarter
ended September 30, 1999.
18
<PAGE>
SIGNATURE
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.
November 12, 1999 By: /s/ M. Kasin Smith
- --------------------------- -----------------------
Date M. Kasin Smith
Vice President and Acting Chief
Financial Officer
(Principal Financial and Accounting Officer)
SIGNATURE
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.
November 12, 1999 By: /s/ M. Kasin Smith
- --------------------------- -----------------------
Date M. Kasin Smith
Vice President and Acting Chief
Financial Officer
(Principal Financial and Accounting Officer)
19
<PAGE>
EXHIBIT INDEX
Exhibit 10.1 Agreement, effective as of September 13, 1999, by and among
ADS Alliance Data Systems, Inc., Pegasus Satellite Television,
Inc. and Digital Television Services, Inc. (which is
incorporated by reference to Exhibit 10.1 to Pegasus
Communications Corporations' Form 10-Q for the quarterly
period ended September 30, 1999). (Portions of this document
were redacted and filed separately with the Securities and
Exchange Commission pursuant to a request for confidential
treatment pursuant to Rule 24b-2 under the Securities Exchange
Act of 1934, as amended).
Exhibit 27.1 Financial Data Schedule of Digital Television Services, Inc.
Exhibit 27.2 Financial Data Schedule of DTS Capital, Inc.
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This schedule contains summary financial information extracted from the
consolidated balance sheet of Digital Television Services, Inc. as September 30,
1999 (unaudited) and the related consolidated statements of operations and cash
flows for the three and nine months ended September 30, 1999 (unaudited). This
information is qualified in its entirety by reference to such financial
statements.
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This schedule contains summary financial information extracted from the
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information is qualified in its entirety by reference to such financial
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