<PAGE> 1
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
FORM 10-K/A
(MARK ONE)
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1996
or
[ ]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________ TO ________
COMMISSION FILE NUMBER 0-23694
HEARTLAND WIRELESS COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<C> <C>
DELAWARE 73-1435149
(State or other jurisdiction of incorporation or (I.R.S. employer
organization) identification no.)
200 CHISHOLM PLACE, SUITE 200, 75075
PLANO, TEXAS (Zip code)
(Address of principal executive offices)
</TABLE>
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (972) 423-9494
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None.
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
(TITLE OF CLASS)
Common Stock, par value $.001 per share
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy statements incorporated by
reference in Part III of this Form 10-K/A or any amendment to this Form
10-K/A. [ ]
The aggregate market value of voting stock held by non-affiliates of the
registrant is $28,722,637, based on the closing price of the registrant's common
stock, $.001 par value per share (the "Common Stock"), on April 25, 1997, as
reported on the Nasdaq Stock Market's National Market.
The number of outstanding shares of Common Stock as of April 25, 1997, was
19,666,027.
DOCUMENTS INCORPORATED BY REFERENCE
None.
================================================================================
<PAGE> 2
HEARTLAND WIRELESS COMMUNICATIONS, INC.
FORM 10-K/A FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I
Item 1. Business.................................................... 3
Item 2. Properties.................................................. 19
Item 3. Legal Proceedings........................................... 19
Item 4. Submission of Matters to a Vote of Security Holders......... 19
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters....................................... 20
Item 6. Selected Financial Data..................................... 21
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 22
Item 8. Financial Statements and Supplementary Data................. 31
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................. 31
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 31
Item 11. Executive Compensation...................................... 34
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................ 38
Item 13. Certain Relationships and Related Transactions.............. 39
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K....................................................... 40
</TABLE>
INTRODUCTORY STATEMENT
The registrant hereby amends and restates its Annual Report on Form 10-K
for the year ended December 31, 1996 in its entirety for the purpose of
including the information required by Part III (Items 10, 11, 12 and 13) which
the registrant previously anticipated incorporating by reference from the
registrant's definitive proxy statement to be delivered to stockholders in
connection with its 1997 Annual Meeting of Stockholders. This Annual Report on
Form 10-K/A makes no other substantive changes to the Form 10-K previously filed
by the registrant.
2
<PAGE> 3
PART I
ITEM 1. BUSINESS
OVERVIEW
Heartland Wireless Communications, Inc. (the "Company") develops, owns and
operates wireless cable television systems, primarily in small to mid-size
markets located in the central United States. At December 31, 1996, the Company
had wireless cable channel rights in 95 markets representing approximately 10.3
million households, approximately 9.3 million of which the Company believes can
be served by line-of-sight ("LOS") transmissions (which generally require a
direct, unobstructed transmission path from the central transmitting antenna to
the antenna located on the subscriber's premises).
At December 31, 1996, pro forma for the acquisition of two operating
systems consummated in January 1997 and including one operating system managed
by the Company, the Company's 95 markets included 56 markets in which the
Company has systems in operation (the "Existing Systems") and 39 future launch
markets in which the Company has aggregated sufficient wireless cable channel
rights to commence construction of a system or the Company has leases with or
options from applicants for channel licenses that the Company expects to be
granted by the Federal Communications Commission (the "FCC"). At December 31,
1996, the Existing Systems were providing wireless cable service to
approximately 181,400 subscribers using the Company's new method for reporting
subscribers. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Changes in Method for Reporting Subscribers;
Write-Offs."
The Company generally targets small to mid-size markets with significant
numbers of LOS households that are unpassed by traditional hard-wire cable. Many
of these households, particularly in rural areas, have limited access to local
off-air VHF/UHF channels (such as ABC, NBC, CBS and Fox), and typically do not
have access to pay television service except via satellite receivers. As a
result, the Company believes that its wireless cable television service is an
attractive alternative to existing choices for such households. The Company
estimates that, within its 95 wireless cable markets, approximately 20%-40% of
the line of sight households are unpassed by traditional hard-wire cable
systems.
Wireless cable programming is transmitted through the air via microwave
frequencies from a transmission facility to a small receiving antenna at each
subscriber's location, which generally requires a direct, unobstructed
line-of-sight from the transmission facility to the subscriber's receiving
antenna, by utilizing up to 195 megahertz ("MHz") of radio spectrum allocated by
the FCC for ITFS and MDS service (each as defined herein), both of which
comprise the spectrum used for providing commercial wireless cable service. See
"Business -- Regulatory Environment." Traditional hard-wire cable systems also
transmit signals from a transmission facility, but deliver the signal to a
subscriber's location through an extensive network of coaxial cable and
amplifiers. Because wireless cable systems do not require such an extensive
cable network, wireless cable operators such as the Company can provide
subscribers with a high quality picture and a reliable signal resulting in fewer
transmission disruptions at a lower system capital cost per installed subscriber
than traditional hard-wire cable systems.
Like traditional hard-wire cable system operators, the Company can offer
its subscribers local off-air VHF/UHF channels from ABC, NBC, CBS and Fox
affiliates, as well as HBO, Showtime, Disney, ESPN, CNN, USA, WGN, WTBS,
Discovery, the Nashville Network, A&E and other programming services. The
channels that the Company offers in each market will vary depending upon the
channel rights secured in such market at the time of system launch. In addition,
the available channels in a market will typically change as the Company
continues to acquire channel rights.
The executive offices of the Company are located at 200 Chisholm Place,
Suite 200, Plano, Texas 75075, and the telephone number of the executive offices
is (972) 423-9494. The Company's operations and marketing headquarters are based
in Durant, Oklahoma. Unless the context otherwise requires, all references in
this Form 10-K to the Company refer collectively to Heartland Wireless
Communications, Inc., its predecessors and its majority-owned subsidiaries.
3
<PAGE> 4
CABLE INDUSTRY OVERVIEW
Cable Television Industry. The cable television industry began in the late
1940s and 1950s to serve the needs of residents in predominantly rural areas
with limited access to local off-air VHF/UHF broadcasts. The cable television
industry expanded to metropolitan areas due to, among other things, better
reception and more programming. Today, cable television systems offer various
types of programming, which generally include basic service, premium service
and, in some instances, pay-per-view service.
A traditional cable television customer generally pays an initial
connection charge and a fixed monthly fee for basic service. The amount of the
monthly basic service fee varies from one area to another and is a function, in
part, of the number of channels and services included in the basic service
package and the cost of such services to the television system operator. In most
instances, a separate monthly fee for each premium service and certain other
specific programming is charged to customers, with discounts generally available
to customers receiving multiple premium services. Monthly service fees for
basic, enhanced basic and premium services constitute the major source of
revenue for cable television systems. Converter rentals, remote control rentals,
installation charges and reconnect charges for customers who were previously
disconnected are also included in a cable television system's revenues, but
generally are not a major component of such revenues.
Wireless Cable Industry Background. Initially, most cable systems were
hard-wire systems, using coaxial cable and amplifiers to transmit television
signals. In 1983, the FCC allocated a portion of the radio spectrum from 2500 to
2700 MHz, which previously had been allocated entirely for educational use, to
commercial wireless cable operation. Simultaneously, the FCC also modified its
rules on the usage of the remaining portion of such spectrum allocated for
educational use to permit ITFS licensees to lease excess capacity to commercial
operators.
Like a traditional hard-wire cable system, wireless cable operates from a
transmission facility ("head-end"), consisting of satellite reception and other
equipment necessary to receive the desired programming. Programming is then
transmitted by microwave transmitters from an antenna located on a tower to a
small receiving antenna located on a subscriber's rooftop. At the subscriber's
location, the microwave signals are converted to frequencies that can pass
through conventional coaxial cable into an addressable descrambling converter
located on top of a television set. Wireless cable requires a clear
line-of-sight, because the microwave frequencies used will not pass through
large trees, hills, tall buildings or other obstructions. However, many signal
blockages can be overcome with the use of signal boosters which retransmit an
otherwise blocked signal over a limited area.
The Company believes that its coverage ultimately will be further enhanced
upon the implementation of digital technology. Currently, wireless cable
companies can offer up to 33 analog channels of programming. The ability to
offer substantially more programming utilizing existing wireless channel
capacity is dependent on effectively applying digital technology, which is a
technology whereby one analog channel is compressed such that the same 6 MHz of
spectrum can transmit six or more channels. FCC approval is required before the
Company's wireless cable systems can be converted to digital technology. The FCC
issued a Declaratory Ruling in July 1996 which effectively established interim
rules to govern the transition from analog to digital technology and authorized
wireless cable operators to file minor modifications to existing systems to
specify digital operation. The FCC has yet to commence a rulemaking proceeding
to adopt permanent rules. There can be no assurance as to what permanent rules
and policies the FCC will adopt to govern the use of digital technology, when
such rules and policies will be adopted, or the Company's ability to comply with
those rules and policies. It is expected that digital technology will be
commercially available sometime in 1997. It is also expected that the cost of
digital equipment will materially exceed the cost of analog equipment. There can
be no assurance, however, that digital converter boxes and other equipment
necessary to implement digital technology, including satellite delivery of
digital signals, will be available on this timetable or that digital technology
can be successfully deployed.
The Company believes that conversion to a fully digital system would
require a significant investment in capital and time. As a result, conversion
from current analog technology to a digital technology will not take place in
all markets simultaneously, if at all. Whether the Company elects to implement
digital technology, if
4
<PAGE> 5
and when available, will depend upon a number of factors including equipment
costs, required staffing levels, possibility of subscriber growth and numerous
competitive factors. Nonetheless, the Company does not believe
that it will be required to convert from analog to digital technology in most of
its markets in the near future because of the size of these markets and nature
of competitive pressures in such markets.
REGULATORY ENVIRONMENT
General. The wireless cable industry is subject to regulation by the FCC
pursuant to the Communications Act of 1934, as amended (the "Communications
Act"). The Communications Act empowers the FCC, among other things, to issue,
revoke, modify and renew licenses within the spectrum available to wireless
cable; to approve the assignment and/or transfer of control of such licenses; to
approve the location of wireless cable systems; to regulate the kind,
configuration and operation of equipment used by wireless cable systems; and to
impose certain equal employment opportunity and other reporting requirements on
wireless cable operators.
The FCC has determined that wireless cable systems are not "cable systems"
for purposes of the Communications Act. Accordingly, a wireless cable system
does not require a local franchise and is subject to fewer local regulations
than a hard-wire cable system. Moreover, all transmission and reception
equipment for a wireless cable system can be located on private property;
accordingly, there is no need to make use of utility poles or dedicated
easements or other public rights-of-way. Although wireless cable operators
typically have to lease the right to use wireless cable channels from the
holders of channel licenses, unlike hard-wire cable operators, they do not have
to pay local franchise fees. Recently, legislation has been introduced in some
states, including Illinois, Maryland, Pennsylvania and Virginia, to authorize
state and local authorities to impose on all video program distributors
(including wireless cable operators) a tax on the distributors' gross receipts
comparable to the franchise fees cable operators pay. Similar legislation might
be introduced in several other states. While the proposals vary among states,
the bills all would require, if passed, as much as 5.0% of gross receipts to be
paid by wireless distributors to local authorities. Efforts are underway by the
industry trade association to preempt such state taxes through federal
legislation. In addition, the industry is opposing the state bills as they are
introduced, and, in Virginia, it has succeeded in being exempted from the video
tax that was eventually enacted into law. However, it is not possible to predict
whether new state laws will be enacted which impose new taxes on wireless cable
operators. The imposition of a gross receipts tax on the Company could have a
material adverse effect on the Company's business.
In the nation's 50 largest metropolitan markets, 33 channels are available
for wireless cable (in addition to local off-air VHF/UHF broadcast channels that
are not retransmitted over the microwave channels). In the Company's markets, 32
channels are available for wireless cable (in addition to local off-air VHF/UHF
broadcast channels that are not retransmitted over the microwave channels), 12
of which can be licensed to for-profit entities such as the Company for
full-time usage without programming restrictions ("MDS" channels). Except in
limited circumstances, the other 20 wireless cable channels can generally only
be licensed to qualified non-profit educational organizations, and, in general,
each must be used a minimum of 20 hours per week per channel for educational
programming ("ITFS" channels). The remaining excess air time on an ITFS channel
may be leased to wireless cable operators for commercial use, without further
programming restrictions (other than the right of the ITFS license holder, at
its option, to recapture up to an additional 20 hours of air time per week for
educational programming). Certain programs (e.g., The Discovery Channel and A&E)
qualify as educational and thereby facilitate full-time usage of an ITFS channel
by commercial wireless cable operators. Additionally, a technique known as
"channel mapping" permits ITFS licensees to meet their minimum educational
programming requirements by transmitting educational programming over several
ITFS channels at different times, but the viewer sees the transmission as one
channel. In addition, lessees of ITFS excess air time, including the Company,
generally have the right to transmit to their subscribers the educational
programming provided by the lessor at no incremental cost. In 1994, the FCC
amended its rules to permit "channel loading." Channel loading permits ITFS
license holders to consolidate their educational programming on one or more of
their ITFS channels thereby providing wireless cable operators leasing such
channels, including the Company, with greater flexibility in their use of ITFS
channels. The remaining 12 wireless cable channels (commonly referred to as MDS
or commercial
5
<PAGE> 6
channels) available in most of the Company's markets are made available by the
FCC for full-time commercial usage without programming restrictions. The FCC's
allocation of frequencies to wireless cable is subject to change and in the
future the FCC might propose to alter the present wireless cable allocation to
provide a portion of the spectrum for other emerging technologies. The Company
believes that if any such action were taken to reallocate any of the current
wireless cable spectrum, the FCC would allocate substitute frequency rights to
the wireless cable industry or provide other concessions.
In 1985, the FCC established a lottery procedure for awarding MDS licenses.
In 1990, the FCC established a filing "window" system for new multichannel MDS
("MMDS") applications. The FCC's selection among more than one acceptable MMDS
application filed during the same filing window was determined by a lottery.
Generally, once an MMDS application was selected by the FCC and the applicant
resolved any deficiencies identified by the FCC, a conditional license was
issued, allowing construction of the station to commence. Construction generally
must be completed within one year of the date of grant of the conditional
license, in the case of MMDS channels, or 18 months, in the case of ITFS
channels. ITFS and MMDS licenses generally have terms of 10 years. Licenses must
be renewed and may be revoked for cause in a manner similar to other FCC
licenses. FCC rules prohibit the sale for profit of an MMDS conditional license
or of a controlling interest in the conditional license holder prior to
construction of the station or, in certain instances, prior to the completion of
one year of operation. The FCC, however, does permit the leasing of 100% of an
MMDS license holder's spectrum capacity to a third party and the granting of
options to purchase a controlling interest in a license once the required
license holding period has lapsed and certain other conditions are met. During
the lifetime of any such lease or option agreement, the licensee must remain in
control of its FCC license to avoid violating FCC transfer of control rules.
Where two or more ITFS applicants file applications for the same channels and
the proposed facilities could not be operated without impermissible
interference, the FCC employs a set of comparative criteria to select from among
the competing applicants.
The FCC has concluded its auction ("BTA Auction") of available commercial
wireless cable spectrum in 487 "Basic Trading Areas" ("BTAs") and six additional
BTA-like geographic areas around the country. The winner of a BTA has the right
to develop the available MDS frequencies throughout the BTA, consistent with
certain specified interference criteria that protect existing ITFS and MDS
channels. Existing ITFS and MDS channel rights holders also must protect the BTA
winner's spectrum from interference caused by power increases or tower
relocations. The Company was the winning bidder in 93 BTAs at a total cost of
approximately $19.8 million. Under the terms of the BTA Auction, the Company
remitted a $1.0 million deposit at the commencement of the BTA Auction and
subsequently has remitted 20% of the total committed amount (less the $1.0
million deposit), or approximately $3.0 million, as down payments. The remaining
80% of the committed amount, or approximately $15.8 million, bears interest at
9.5% and will be paid over a 10-year period that began in the fourth quarter of
1996 (the "BTA Obligation"). The Company will be required to make quarterly
interest-only payments for the first two years and quarterly payments of
principal and interest over the remaining eight years. CS Wireless Systems, Inc.
("CS Wireless"), of which the Company owns approximately 34% of the outstanding
common stock, will reimburse the Company for all amounts paid in the BTA Auction
relating to 12 BTAs at a total cost of approximately $5.3 million, of which $1.1
million had been reimbursed as of December 31, 1996. The Company had certain
post-auction filing obligations including, but not limited to, applications that
propose new transmission facilities, exhibits concerning its involvement in
bidding consortia, and its plans to build-out two-thirds of the market over a
five-year period. The Company has made its initial filing in each of the 93 BTAs
for which the Company was the winning bidder. As of March 27, 1997, the FCC had
not denied any of the Company's post-auction filings. Due to the unique nature
of the BTA Auction, there is no prior regulatory history regarding the scope and
nature of the information the FCC will require, or how the FCC will treat the
information.
Application for renewal of MDS and ITFS licenses must be filed within a
certain period prior to expiration of the license term, and petitions to deny
applications for renewal may be filed during certain periods following the
filing of such applications. Licenses are subject to revocation or cancellation
for violations of the Communications Act or the FCC's rules and policies.
Conviction of certain criminal offenses may also render a licensee or applicant
unqualified to hold a license. The Company's lease agreements with license
holders typically require the license holders, at the Company's expense, to use
their best efforts, in
6
<PAGE> 7
cooperation with the Company, to make various required filings with the FCC in
connection with the maintenance and renewal of licenses. The Company believes
this reduces the likelihood that a license will be revoked, canceled or not
renewed by the FCC.
The FCC also regulates transmitter locations and signal strength. The
operation of a wireless cable television system requires the co-location of a
commercially viable number of channels operating with common technical
characteristics. In order to commence operations in many of the Company's future
launch markets, the Company has filed or will be required to file applications
with the FCC to modify licenses for unbuilt stations. In applying for these
modifications, the Company must demonstrate that its proposed signal does not
violate interference standards in the FCC-protected area of another wireless
cable channel license holder. A wireless cable license holder generally is
protected from interference from another wireless cable operator within a
35-mile radius of the transmission site. An ITFS license holder is entitled to
protection to all of its receive sites, but is only entitled to be awarded a
35-mile protected service area during excess capacity use by a wireless cable
operator. In addition, modifications submitted after the BTA Auction are
required to protect auction winners from interference. If such changes would
cause the Company's signal to cause interference in the FCC-protected service
area of another wireless cable channel license holder, the Company would be
required to obtain the consent of such other license holder; however, there can
be no assurance that such consent would be received and the failure to receive
such consent could adversely affect the Company's ability to serve the affected
market.
On February 19, 1997 the FCC issued a Report and Order ("WCS Order") in
which the FCC reallocated the frequency ranges of 2310-2320 MHz and 2345-2360
MHz (2.3 GHz band) on a primary basis for "wireless communications service," or
"WCS," including wireless Internet services and local loop connections. These
frequency ranges fall between the MDS and ITFS frequencies used by wireless
cable operators. The FCC intends to auction the WCS spectrum in April 1997. The
Company believes that, because of the location of the reallocated WCS spectrum
and the unregulated signal power level currently authorized for WCS, the use of
WCS spectrum could cause interference with the Company's wireless cable channels
without appropriate modifications to or replacement of its downconverters to
eliminate such interference. The Wireless Cable Association ("WCA") filed a
Petition for Expedited Reconsideration of the WCS Order on March 10, 1997
requesting the FCC to reconsider its decision not to impose a power limitation
on WCS licensees. The Wireless Cable Association also filed an Emergency Motion
for Stay on March 10, 1997 requesting the FCC to temporarily stay the WCS
spectrum auction until the FCC considers fully the WCA's Petition for
Reconsideration of the WCS Order. In addition, the Company believes that the
majority of its rural markets will not be affected in the near future by WCS
interference; however, there can be no assurance that either the WCA's or other
challenges to the WCS Order will be successful or that certain of the Company's
markets will not experience significant interference from WCS operators.
In addition, wireless cable operators have experienced interference from
operators of personal communications systems, or PCS, because of proximity to
PCS substations and the orientation of individual receive sites. To date, the
Company has not experienced significant interference from PCS operators and
currently does not expect significant interference in the majority of its
markets. However, there can be no assurance that the Company will not experience
significant PCS interference in the future in certain markets.
The Cable Act. On October 5, 1992, Congress passed the Cable Television
Consumer Protection and Competition Act of 1992 (the "Cable Act"), which imposes
greater regulation on traditional hard-wire cable operators and permits
regulation of prices in areas in which there is no "effective competition."
Pursuant to the Cable Act, the FCC, among other things, adopted comprehensive
new federal standards for local regulation of certain rates charged by
traditional hard-wire cable operators. The Cable Act also provides for
deregulation of traditional hard-wire cable in a given market when other
multi-channel video providers serve, in the aggregate, at least 15% of the cable
franchise area. Rates charged by wireless cable operators, typically already
lower than traditional hard-wire cable rates, are not subject to regulation
under the Cable Act.
Under the retransmission consent provisions of the Cable Act and the FCC's
implementing regulations, all multi-channel video providers (including both
hard-wire and wireless cable) seeking to retransmit certain commercial broadcast
signals must first obtain the permission of the broadcast station. Hard-wire
cable
7
<PAGE> 8
systems, but not wireless cable systems, are required under the Cable Act and
the FCC's "must carry" rules to retransmit a specified number of local
commercial television or qualified low power television signals. Oral argument
was recently heard in the Supreme Court in a case challenging the "must carry"
provisions of the Cable Act. If the challenge is successful and "must carry" is
overturned, the retransmission consent requirement would remain in effect and
will be negotiated by all broadcasters.
The 1996 Telecommunications Act. In February 1996, the Telecommunications
Act of 1996 (the "1996 Telecommunications Act") was enacted. Pursuant to the
1996 Telecommunications Act, all cable programming service tier rate regulation
will be eliminated after three years. In addition, for "small systems" (as
defined in the 1996 Telecommunications Act) and under certain other
circumstances, including cases where a cable system faces "effective
competition," such rate regulation will be eliminated immediately. Until these
sunset provisions go into effect, hard-wire cable operators will continue to be
subject to rate regulations. The 1996 Telecommunications Act removes certain
barriers to investment by telephone companies in hard-wire cable companies. The
legislation lifts the current statutory cross-ownership ban contained in the
Communications Act, which prevents a telephonecompany from using hard-wire
facilities to provide cable television service to the same community where it
provides telephone service. The statutory ban was never applied to a telephone
company's investment in wireless cable. Telephone companies operating in the
markets serviced by the Company were legally permitted to build, lease or
purchase hard-wire cable systems and become competitors of the Company. Although
the 1996 Telecommunications Act offered specific benefits and relief to the
wireless cable industry including: (1) clarifying that wireless cable operators
are not "common carriers" and therefore not subject to a number of regulations
governing such licensees, and (2) directing the FCC to implement rules
preempting municipalities' or local governments' regulations restricting
wireless cable reception antennae, including restrictions of homeowners
associations, the Company is currently unable to predict what effect these
regulations may have on the Company. Direct broadcast satellite operators were
afforded relief under the legislation in the form of an exemption from local
taxes on their service. Wireless cable operators did not receive such an
exemption; however, the wireless cable industry has continued to lobby Congress
for a similar exemption.
While current FCC regulations are intended to promote the development of a
competitive multichannel video programming industry, the rules and regulations
affecting the wireless cable industry may change, and any future changes in FCC
rules, regulations, policies and procedures could have a material adverse effect
on the industry as a whole and on the Company in particular. In addition, a
number of legal challenges to the Cable Act and the regulations promulgated
thereunder have been filed, both in the courts and before the FCC. These
challenges, if successful, could substantially increase the Company's operating
costs, make some programming unavailable to the Company and otherwise have a
material adverse effect on the wireless cable industry as a whole or the Company
in particular. Other aspects of the Cable Act that have been challenged, the
outcome of which could adversely affect the Company and the wireless cable
industry in general, include the Cable Act's provisions governing rate
regulation. The Cable Act empowered the FCC to regulate the subscription rates
charged by traditional hard-wire cable operators. As described above, the FCC
issued rules requiring such cable operators, under certain circumstances, to
reduce the rates charged for basic services by 17%. The Cable Act also empowered
the FCC to establish certain minimum customer service standards to be maintained
by traditional hard-wire cable operators. These standards include prompt
responses to customer telephone inquiries, reliable and timely installations and
repairs and readily understandable billing practices. Should these provisions
withstand court and regulatory challenges, the extent to which wireless cable
operators may continue to maintain an advantage over traditional hard-wire cable
operators in price and customer service practices could be diminished.
Other Regulations. Because the vast complex of coaxial cable utilized by
traditional hard-wire cable operators requires a "right of way" to cross
municipal streets, such operators must acquire a municipal franchise and pay
municipal franchise fees. Because wireless cable uses FCC approved frequencies,
it does not require a municipal right of way. Accordingly, wireless cable
operators are not subject to those franchise fees. Traditional hard-wire cable
operators are also required to set aside public access channels for municipal
and local resident use. Wireless cable operators are not subject to these or
other franchise requirements.
8
<PAGE> 9
Wireless cable license holders are subject to regulation by the FAA with
respect to the construction, maintenance and lighting of transmission towers and
to certain local zoning regulations affecting construction of towers and other
facilities. There may also be restrictions imposed by local authorities. There
can be no assurance that the Company will not be required to incur additional
costs in complying with such regulations and restrictions.
AVAILABILITY OF PROGRAMMING
General. Once a wireless cable operator has obtained the right to transmit
programming over specified frequencies, the operator must then obtain the right
to use the programming to be transmitted. Currently, with the exception of the
retransmission of off-air VHF/UHF broadcast signals, programming is made
available in accordance with contracts with program suppliers under which the
system operator pays a royalty based on the number of subscribers receiving
service each month. Individual program pricing varies from supplier to supplier;
however, more favorable pricing for programming is generally afforded to
operators with larger subscriber bases. The Company, Wireless One, Inc.
("Wireless One"), CAI Wireless Systems, Inc. ("CAI") and CS Wireless recently
formed a cooperative organization to obtain volume-based programming contracts
at a discount from rates currently paid by each of the parties. There can be no
assurances that the cooperative will achieve such discounts. The likelihood that
program material will be unavailable to the Company has been significantly
mitigated by the Cable Act and various FCC regulations issued thereunder which,
among other things, impose limits on exclusive programming contracts and
prohibit cable programmers in which a cable operator has an attributable
interest from discriminating against cable competitors with respect to the
price, terms and conditions of programming. Only a few of the major cable
television programming services carried by the Company are not currently
directly owned by vertically integrated multiple cable system operators and the
Company historically has not had difficulty in arranging satisfactory contracts
for these services. The basic programming package offered in each of the
Existing Systems is comparable to that offered by the local traditional
hard-wire cable operators. However, several of such local traditional hard-wire
cable operators currently offer more premium, pay-per-view and public access
channels than the Company.
Copyright. Under the Federal copyright laws, permission from the copyright
holder generally must be secured before a video program may be retransmitted.
Under Section 111 of the Copyright Act of 1976 (the "Copyright Act"), certain
"cable systems" are entitled to engage in the secondary transmission of
programming without the prior permission of the holders of copyrights in the
programming. In order to do so, a cable system must secure a compulsory
copyright license. Such a license may be obtained upon the filing of certain
reports and the payment of certain fees set by copyright arbitration royalty
panels.
Wireless cable operators may rely on Section 111. In 1994, Congress enacted
legislation that clarified the ability of wireless cable operators to obtain the
benefit of the compulsory copyright license. Periodically, Congress has
considered proposals to phase out the compulsory license. Congress has requested
the U.S. Copyright Office to hold a public hearing on the issue of compulsory
license. That hearing currently is scheduled for May 1997. Because the Existing
Systems retransmit only a limited number of broadcast channels, the Company does
not believe that the termination of the compulsory copyright license would have
a material adverse effect on the Company.
Effective October 6, 1993, broadcasters (other than superstations) could
require that cable operators obtain their consent before retransmitting off-air
VHF/UHF broadcasts. The FCC has exempted wireless cable operators from the
retransmission consent rules if the receive-site antenna is either owned by the
subscriber or within the subscriber's control and available for purchase by the
subscriber upon the termination of service. In all other cases, wireless cable
operators must obtain consent to retransmit broadcast signals. The Company has
obtained such consents in each of its Existing Systems where the Company is
retransmitting broadcast signals on a wireless cable channel. Such consents will
be required in the Company's other markets. There can be no assurance that the
Company will be able to obtain such consents on terms satisfactory to the
Company, if at all.
9
<PAGE> 10
PAY TELEVISION INDUSTRY TRENDS
The Company's business will be affected by pay television industry trends
and, in order to maintain and increase its subscriber base in the years ahead,
the Company will need to adapt rapidly to industry trends and modify its
practices to remain competitive. Due to the limited number of physical
components of the wireless transmission system, the Company believes it will be
less expensive for it to adapt to coming industry trends than for traditional
hard-wire cable operators. The cost of such adaptation by the Company could
nonetheless be substantial.
Compression. Several decoder manufacturing companies are developing digital
compression technology, which would allow several programs to be carried in the
amount of bandwidth where only one program is carried now. Manufacturers have
projected varying compression ratios for future equipment, with estimates
ranging from 6-to-1 to 10-to-1. The Company believes compression technology,
allowing six to 10 channels within one 6-MHz bandwidth, will be commercially
available sometime in 1997. It is generally expected that the intended use for
this expanded channel capacity would be for pay-per-view video services.
Wireless cable companies will be able to use digital compression technology
through upgraded set-top converters. The Company believes traditional hard-wire
cable companies will be required to expend significant funds on upgrading
current systems in order to utilize digitally-compressed signals.
Advertising. Until recently, most advertising on cable has been sold by
program suppliers, who sell national advertising time as part of the signal they
deliver to cable operators. Recently, however, advertisers have begun placing
advertisements on channels dedicated exclusively to advertising, as well as in
local available time (typically, two minutes each hour) set aside by program
suppliers for local insertions in their programming of advertisements sold by
cable operators. Use of local available time requires automatic spot insertion
equipment, which is readily available today at a minimal capital cost.
Internet and the World Wide Web. Certain hard-wire cable operators have
announced their intentions to introduce cable modems that would connect to the
Internet and the World Wide Web at significantly higher bandwidths than
currently offered over conventional telephone lines. In addition, several
multimedia and Internet software and access providers plan to develop rich
multimedia content to be distributed over the Internet, such as digital audio
and video, interactive home shopping and video games, as high-bandwidth Internet
connections become widely available. Certain wireless cable operators have
successfully tested wireless cable modems that connect to the Internet at speeds
equal to or greater than hard-wire cable modems and T-1 telephone lines. The
Company has no immediate plans to introduce wireless Internet access products
and services in its markets; however, the Company believes that it will be able
to offer high-speed Internet access service as products and services and market
demand require high-bandwidth Internet access service.
COMPETITION
In addition to competition from established traditional hard-wire cable
systems, wireless cable operators face competition from a number of other
sources, including potential competition from emerging trends and technologies
in the pay television industry, some of which are described below.
Direct Broadcast Satellite ("DBS"). DBS involves the transmission of an
encoded signal direct from a satellite to the customer's home. Because the
signal is at a higher power level and frequency than most satellite-transmitted
signals, its reception can be accomplished with a relatively small (18-inch)
dish mounted on a rooftop or in the yard. DBS cannot, for technical and legal
reasons, provide local VHF/UHF broadcast channels as part of its service,
although many DBS subscribers receive such channels via standard over-air
receive antennae. Moreover, DBS may provide subscribers with access to broadcast
network distant signals only when such subscribers reside in areas unserved by
any broadcast station. The cost to a DBS subscriber for equipment and service is
generally substantially higher than the cost to wireless cable subscribers.
Several DBS services currently are available throughout the Company's markets,
and more are expected to be launched in 1997. DBS currently has approximately
4.5 million subscribers. The Company does not currently experience, and does not
anticipate in the near future that it will experience, significant competition
from DBS in the markets in which the Company operates due primarily to DBS'
higher cost and failure to provide local VHF/UHF broadcast channels. However, in
August 1996, the U.S. Copyright Office issued an advisory letter
10
<PAGE> 11
indicating that it "would not question" DBS companies that file copyright
statements that include the retransmission of local broadcast signals. There is
no assurance that the Company will continue to maintain a competitive advantage
over DBS services as a result of DBS' traditional inability to provide local
VHF/UHF broadcast channels.
Local Multi-Point Distribution Service ("LMDS"). In 1993, the FCC proposed
to redesignate the 28 gigahertz band to create a new video programming delivery
service referred to as local multipoint distribution service. In July 1996, the
FCC proposed to award LMDS licenses in each of 493 BTAs pursuant to auctions.
Sufficient spectrum for up to 49 analog channels has been designated for the
LMDS service. On March 12, 1997, the FCC adopted rules to govern these licenses.
The FCC will award two licenses in each BTA (one for 1150 MHz and one for 150
MHz). The FCC determined that telephone companies and traditional hard-wire
cable operators will not be permitted to bid on LMDS licenses in their
territory. Auctions are expected to be held sometime in 1997.
Satellite Receivers. Satellite receivers are generally six to 12 foot
dishes mounted in the yards of homes to receive television signals from orbiting
satellites. Until the implementation of encryption, these dishes enabled
reception of any and all signals without payment of fees. Having to purchase
decoders and pay for programming has reduced their popularity, although the
Company will to some degree compete with these systems in marketing its
services.
Satellite Master Antenna Television ("SMATV"). SMATV is a multi-channel
television service offered through a wired plant very similar to a traditional
hard-wire cable system, except that it operates without a franchise from a local
authority. SMATV operates under an agreement with a private landowner to service
one or more specific multiple-dwelling units, so long as no public right of way
is crossed between such units. The FCC has recently amended its rules to provide
point-to-point delivery of video programming by SMATV operators and other video
delivery systems in the 18 gigahertz band.
Telephone Companies. Before 1996, local exchange carriers ("LECs") were
prohibited from providing video programming directly to subscribers in their
respective telephone service areas. The FCC has ruled, however, that LECs may
acquire wireless cable channel operations. Moreover, certain U.S. District
Courts and Courts of Appeal have held that the "telco-cable cross-ownership ban"
abridges the First Amendment rights of LECs to free expression under the U.S.
Constitution. The 1996 Telecommunications Act lifts barriers to the provision of
cable television services by telephone companies including allowing telephone
companies to provide video service as "open video systems," which are similar to
traditional cable systems but are subject to different regulatory requirements.
While the competitive effect of the entry of telephone companies into the video
programming business is still uncertain, the Company believes that wireless
cable systems will continue to maintain a cost advantage over fiber optic
distribution technologies.
Off-Air VHF/UHF Broadcasts. Off-air VHF/UHF broadcasts (such as those
providing programming from ABC, NBC, CBS and Fox) provide a free programming
alternative to the public. Previously, wireless cable systems could retransmit
these broadcast signals without permission. However, effective October 6, 1993,
pursuant to the Cable Act, broadcasters may require that cable operators obtain
their consent before retransmitting off-air VHF/UHF broadcasts. The Company has
obtained such consents in the Existing Systems where the Company is
retransmitting on a wireless cable channel. The FCC also has recently permitted
broadcasters to acquire, subject to certain restrictions, ownership interests in
traditional hard-wire cable systems.
Low Power Television ("LPTV"). LPTV utilizes a limited portion of the
spectrum allocated by the FCC for local off-air VHF/UHF broadcasts, but LPTV
utilizes lower power transmission equipment than local off-air VHF/UHF
broadcasts and its signal may be encrypted. LPTV typically has only a 15 to 20
mile signal range. LPTV requires a separate transmitter for each channel and a
standard antenna at the receiving site. Moreover, current proposals for Advanced
Television or High Definition Television may have an adverse effect on certain
LPTV stations.
11
<PAGE> 12
BUSINESS STRATEGY
The Company's primary business objective is to develop, own and operate
wireless cable television systems in markets in which the Company believes it
can achieve positive system cash flow after system launch and then expand such
system while ultimately increasing such system's cash flow.
Rural Market Focus. The Company aggregates wireless cable channel rights
and locates operations in geographic clusters of small to mid-size markets that
have a substantial number of households not currently passed by traditional
hard-wire cable. The Company believes that this size market typically has a
stable economic base, less competition from alternative forms of entertainment
and other conditions conducive to wireless cable transmissions. Within the rural
areas of these small to mid-size markets, the Company's subscribers consist
primarily of single family households, as compared to the non-rural areas of
these markets that are typically passed by hard-wire cable and in which multiple
dwelling units ("MDUs") comprise a much larger percentage of the Company's
subscribers. The Company generally focuses its marketing primarily on rural,
unpassed single family households because they generate a higher revenue per
subscriber than MDU subscribers. However, in 1996, the Company's MDU subscribers
increased as a result of the substantial existing MDU penetration of several of
the markets acquired by the Company in 1996. As of December 31, 1996, the
Company's subscriber base consisted of approximately 94.3% single family units
and 5.7% MDUs, using the Company's revised method for calculating MDU
subscribers. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Changes in Method for Reporting Subscribers;
Write-Offs." The Company currently expects that the percentage of MDU
subscribers should decline as the Company maintains its focus on adding
subscribers in rural, unpassed areas.
Managed Subscriber Penetration. The Company attempts to manage system
launch and subscriber growth in order to contain system launch costs and to
achieve positive cash flow. Within a system, the Company initially directs its
marketing at unpassed households, which typically have limited access to local
off-air VHF/UHF broadcast channels. Once a system achieves positive System
EBITDA (defined in "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Overview"), the Company may expand the channel
offering and add subscribers.
Low Cost Structure. Wireless cable systems typically cost less to build and
operate than traditional hard-wire cable systems. While both traditional
hard-wire cable operators and wireless cable operators must construct a
transmission facility ("head-end"), traditional hard-wire cable operators must
also install an extensive network of coaxial cable and amplifiers in order to
transmit signals from the head-end to subscribers. Once the head-end is
constructed, the Company estimates that each additional single family household
subscriber currently requires an incremental capital expenditure by the Company
of approximately $465, consisting of, on average, $280 of material (depending
upon the type and sophistication of the equipment), $145 of installation labor
and overhead charges and $40 of direct commission. The Company has recently
launched systems utilizing a more sophisticated type of equipment that costs
approximately $65 less per installation and therefore it believes that the
average cost of materials will decline as more subscribers are added in systems
that utilize such equipment. Typically, an MDU subscriber requires an
incremental capital expenditure by the Company lower than that of a single
family household subscriber. Also, without an extensive cable network, wireless
cable operators typically incur lower system maintenance costs and depreciation
expense. Finally, by locating its operations in geographic clusters, the Company
can further contain costs by taking advantage of economies of scale in
management, sales and customer service.
Churn Rate. Because of recent subscriber write-offs and changes in the
Company's methodology for calculating certain MDU subscribers, the churn rate
for the quarter and year ended December 31, 1996 was 9.6% and 4.1%,
respectively. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Changes in Method for Reporting Subscribers;
Write-Offs." Excluding the subscriber write-offs and methodology change for
reporting MDU subscribers, and on a comparable basis with prior periods, the
Company's average monthly churn rate was 3% and 2.2% for the fourth quarter and
year ended December 31, 1996, respectively. For the two months ended February
28, 1997, the Company experienced a rate of subscriber turnover of an average of
approximately 2% per month. The Company expects its churn rate in the
foreseeable future to be lower than the industry standard because a majority of
its markets are
12
<PAGE> 13
characterized by (i) limited or no access to affordable pay television
alternatives, (ii) less competition from alternative forms of entertainment and
(iii) a stable population base. In addition, the Company has implemented
improved subscriber qualification and retention policies that include a
combination of credit checks, service deposits, advance payments and
installation fees for certain subscribers.
EXISTING SYSTEMS AND FUTURE LAUNCH MARKETS
The following tables provide information regarding the 95 markets in which
the Company has, or expects to acquire, wireless cable channel rights that it
intends to retain and develop as of December 31, 1996. In these markets, the
Company has acquired or is in the process of acquiring sufficient channel rights
to commence the launch of a system in the market. The Existing Systems are
listed in order of date of launch or, for acquired markets, date of acquisition.
The subscriber numbers set forth below have been calculated based upon the
Company's revised methodology for reporting subscribers in MDUs, effective
December 31, 1996, and reflect subscribers written off as of December 31, 1996.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Changes in Method for Reporting Subscribers; Write-Offs."
<TABLE>
<CAPTION>
NUMBER OF
ESTIMATED ESTIMATED SUBSCRIBERS
TOTAL LINE-OF-SIGHT AT
EXISTING SYSTEMS HOUSEHOLDS(1) HOUSEHOLDS(2) 12/31/96
---------------- ------------- ------------- -----------
<S> <C> <C> <C>
Ada, OK......................................... 23,348 21,013 4,483
Wichita Falls, TX............................... 102,928 97,783 4,744
Midland, TX..................................... 166,893 158,548 4,086
Abilene, TX..................................... 130,313 123,800 3,201
Lawton, OK...................................... 102,777 97,638 7,252
Laredo, TX...................................... 344,135 326,929 4,346
Enid, OK........................................ 85,059 80,807 4,788
Lindsay, OK..................................... 57,628 51,865 3,469
Ardmore, OK..................................... 68,069 61,263 3,704
Mt. Pleasant, TX................................ 35,268 31,742 2,879
Chanute, KS..................................... 56,109 50,810 4,856
Stillwater, OK.................................. 76,917 69,225 5,760
Texarkana, TX................................... 147,371 132,634 1,850
Lubbock, TX..................................... 139,626 125,663 4,980
McLeansboro, IL................................. 91,458 82,312 1,965
Vandalia, IL.................................... 127,329 114,596 2,217
Olney, IL....................................... 71,203 64,082 2,309
Taylorville, IL................................. 177,350 159,615 2,460
Peoria, IL...................................... 317,703 285,933 2,079
Bucyrus, OH..................................... 254,160 228,744 1,459
Paragould, AR................................... 109,927 98,934 2,870
Sikeston, MO.................................... 107,662 96,896 3,051
Manhattan, KS................................... 59,541 53,587 1,938
Olton, TX....................................... 36,669 34,836 1,399
O'Donnell, TX................................... 77,669 73,785 1,408
Monroe City/Lakenan, MO......................... 76,686 69,017 2,199
Sherman/Denison, TX............................. 105,576 95,019 8,663
Freeport, IL.................................... 200,291 150,218 1,884
Paris, TX....................................... 58,378 52,540 3,666
Strawn/Ranger, TX............................... 36,212 32,591 1,326
Corsicana/Athens, TX............................ 72,619 65,357 2,485
Champaign, IL................................... 211,583 190,425 3,695
Austin, TX...................................... 389,958 350,962 15,470
Waco, TX........................................ 113,234 101,911 6,071
Temple/Killeen, TX.............................. 120,216 108,194 9,872
</TABLE>
13
<PAGE> 14
<TABLE>
<CAPTION>
NUMBER OF
ESTIMATED ESTIMATED SUBSCRIBERS
TOTAL LINE-OF-SIGHT AT
EXISTING SYSTEMS HOUSEHOLDS(1) HOUSEHOLDS(2) 12/31/96
---------------- ------------- ------------- -----------
<S> <C> <C> <C>
Corpus Christi, TX.............................. 144,805 130,324 14,735
Hamilton, TX.................................... 44,291 39,862 3,283
Marion, KS...................................... 74,337 66,903 1,805
Sterling, Kansas................................ 81,484 73,336 1,539
Macomb/Walnut Grove, IL......................... 142,457 128,211 2,356
Tulsa, OK....................................... 353,392 318,053 7,789
George West, TX................................. 28,135 25,322 1,943
Kingsville/Falfurrias, TX....................... 39,396 35,457 1,251
Uvalde/Sabinal, TX.............................. 16,585 14,926 955
Medicine Lodge/Anthony, KS...................... 16,588 14,929 1,062
Gainesville, TX................................. 87,788 79,010 951
Jourdanton/Charlotte, TX........................ 34,410 30,969 941
Kerrville, TX................................... 27,547 24,792 339
Greenville, PA.................................. 352,903 317,613 361
Jacksonville, IL................................ 49,180 44,262 416
Radcilffe, IA(3)................................ 77,356 73,101 1,819
Weatherford, OK................................. 33,017 31,367 87
Montgomery City, MO............................. 67,656 67,656 264
Beloit, KS...................................... 40,599 36,539 142
Woodward, OK.................................... 24,771 22,294 270
Watonga, OK..................................... 26,122 23,510 181
--------- --------- -------
Total Existing Markets................ 6,114,684 5,537,710 181,373
========= ========= =======
</TABLE>
<TABLE>
<CAPTION>
ESTIMATED ESTIMATED
FUTURE LAUNCH TOTAL LINE-OF-SIGHT
MARKETS(4) HOUSEHOLDS(1) HOUSEHOLDS(2)
------------- ------------- -------------
<S> <C> <C>
Altus, OK................................................ 32,186 30,576
Amarillo, TX............................................. 190,779 181,241
Borger, TX............................................... 22,713 21,576
Bumet, TX................................................ 26,991 24,291
Casper, WY............................................... 50,882 45,794
Cheyenne, WY............................................. 42,053 37,847
Columbia, MO............................................. 175,834 158,251
Crow, TX................................................. 74,996 67,497
Des Moines, IA........................................... 347,158 312,442
El Dorado, AR............................................ 63,860 57,474
El Paso, TX.............................................. 237,811 214,030
Elk City, OK............................................. 27,698 24,928
Fischer, TX.............................................. 332,891 299,602
Flagstaff, AZ............................................ 31,819 28,638
Forrest City, AR......................................... 58,424 43,819
Great Bend, KS........................................... 29,126 26,213
Hays, KS................................................. 67,328 60,595
Henryetta, OK............................................ 35,093 31,584
Holdenville, OK.......................................... 53,169 47,852
Kalispell, MT (3)........................................ 33,263 29,937
Kossuth, TX.............................................. 55,118 49,606
Lenapah, OK.............................................. 55,284 49,755
Lufkin, TX............................................... 127,770 114,993
Mayfield, KY............................................. 189,337 170,403
</TABLE>
14
<PAGE> 15
<TABLE>
<CAPTION>
ESTIMATED ESTIMATED
FUTURE LAUNCH TOTAL LINE-OF-SIGHT
MARKETS(4) HOUSEHOLDS(1) HOUSEHOLDS(2)
------------- ------------- -------------
<S> <C> <C>
McAlester, OK(5)......................................... 39,058 35,152
Miami, OK................................................ 95,937 86,344
Muskogee, OK(6).......................................... 89,906 80,916
Ottawa/LaSalle, IL....................................... 259,678 233,710
Peaksville, MO........................................... 50,565 45,508
Ponca City, OK........................................... 45,257 40,731
Purdin, MO............................................... 29,173 26,256
Scottsbluff, NE (3)...................................... 24,995 22,496
Searcy, AR............................................... 75,909 68,318
Seminole, OK............................................. 44,314 39,833
Shreveport, LA........................................... 225,031 191,276
Springfield, MO.......................................... 241,182 217,064
Stromsberg, NE........................................... 36,554 31,071
Topeka, KS............................................... 257,509 231,759
Tyler, TX................................................ 259,470 233,523
---------- ---------
Total-Future Markets........................... 4,136,121 3,712,901
---------- ---------
Total-All Company Markets...................... 10,250,805 9,250,611
========== =========
</TABLE>
- ---------------
(1) Estimated Total Households represent the Company's estimate of the total
number of households that are within the Company's service area. The
Company's service area includes (i) areas that are presently served, (ii)
areas where systems are not presently in operation but where the Company
intends to commence operations and (iii) areas where service may be provided
by signal repeaters or, in some cases, pursuant to FCC applications.
(2) Estimated Line-of-Sight Households represents the Company's estimate of the
number of households that can receive an adequate signal from the Company in
its service area (determined by applying a discount to the Estimated Total
Households in order to account for those homes that the Company estimates
will be unable to receive service due to certain characteristics of the
particular market). The calculation of Estimated LOS Households assumes (i)
the grant of pending applications for new licenses or for modification of
existing licenses and (ii) the grant of applications for new licenses and
license modification applications which have not yet been filed with the
FCC.
(3) The Company is operating or maintaining these markets, as applicable, under
a Management Agreement.
(4) Such markets include markets with respect to which the Company has systems
under construction or aggregated or is aggregating additional wireless cable
channel rights. The Company expects a substantial number of such licenses to
be granted by the FCC.
(5) System launched in February 1997.
(6) System launched in January 1997.
Existing Systems. As of December 31, 1996, pro forma for the acquisition of
two operating systems consummated in January 1997 and including one operating
system managed by the Company, the Company had 56 Existing Systems. The Company
generally offers 16 to 24 basic wireless cable channels (including three to six
local off-air VHF/UHF broadcast channels that are retransmitted), one to three
premium channels (HBO, Showtime or Cinemax) and one pay-per-view channel.
Generally, the Company's Existing Systems lease all of their wireless cable
channels. The terms of such leases typically expire five to 10 years from the
license grant date, ranging from years 1998 to 2005, and such leases provide for
either a right of first refusal or two automatic five-year renewal periods or
one 10-year renewal period if such automatic renewals are then permitted by the
FCC. The Existing Systems transmit at 10 to 100 watts of power from a
transmission tower that generally has a signal pattern covering a radius of 35
to 50 miles.
15
<PAGE> 16
Future Launch Markets. In these markets, the Company has aggregated or is
aggregating additional wireless cable channel rights. Certain of the Company's
channel rights in the future launch markets are in the form of lease agreements
with educational entities that have pending applications for ITFS channels or
that have had applications returned without prejudice by the FCC which will be
refiled. These ITFS applications undergo review by the FCC's engineering and
legal staff. Because the FCC's application review process does not lend itself
to complete certainty, and given the considerable number of applications
involved, no assurance can be given as to the precise number of applications
that will be granted.
The Company currently does not expect to launch any new markets during the
next three to six months, during which period the Company's time and resources
will be focused on increasing cash flow and profitability in the Existing
Systems. Following such period, the Company will determine an appropriate
construction schedule for its future launch markets, based upon multiple
factors, including, but not limited to, the availability of capital resources,
the number of wireless cable channels for which FCC licenses have been obtained,
the expiration dates of leases and FCC construction permits, the number of
potential subscribers in each market and the proximity of a market to the
Existing Systems of other markets ready for construction. Construction will
involve the construction of a transmission building near a transmission tower
and the installation of transmission equipment and, in certain cases, the
construction of the transmission tower. The construction of the transmission
facility will enable the Company to launch wireless cable service in such
markets.
CUSTOMER SERVICE, VALUE AND QUALITY
The Company believes that the key factors that determine the attractiveness
of its service offerings are the following: (i) customer service; (ii)
programming, (iii) price, and (iv) picture quality and reliability.
Customer Service. The Company has established a goal of maintaining high
levels of customer satisfaction. In furtherance of that goal, the Company
emphasizes employee training, responsiveness and convenient installation
scheduling. The Company has established customer retention programs in an effort
to obtain and retain new subscribers. In an effort to further improve customer
service, the Company is currently re-evaluating its customer retention programs.
Programming. In the Existing Systems, the Company believes that it has
assembled sufficient channel rights and programming agreements to provide a
programming package competitive with those offered by traditional hard-wire
cable and DBS operators. Additionally, the Company has the capacity to offer
pay-per-view programming and impulse addressability not currently widely offered
by traditional hard-wire cable operators. The Company's typical channel offering
includes between 16 and 24 basic cable channels (including three to six local
off-air VHF/UHF broadcast channels that are retransmitted), one to three premium
channels (HBO, Showtime or Cinemax) and one pay-per-view channel on an
event-by-event basis. Specific programming packages vary according to particular
market demand.
Price. The Company offers its subscribers a programming package consisting
of basic service and premium programs. The Company can offer a price to its
subscribers for basic service that is competitive with traditional hard-wire
cable and DBS operators. The Company believes it will continue to be price
competitive with traditional hard-wire cable and DBS operators with respect to
comparable programming. The Company's typical single family unit pricing
structure is $22.95 to $24.95 for basic service and $5.95 to $9.95 for one
premium service channel or $15.95 for a combination premium service. Depending
on market demand and competition, the Company offers a combination package
consisting of basic service, rental of the receive-site equipment and two
premium channels for $29.95 to $34.95 per month for existing subscribers.
Picture Quality and Reliability. The Company believes that it is
positioning itself as a reliable alternative to traditional hard-wire cable by
delivering a high quality signal throughout the entire signal area of the
Existing Systems. Wireless cable subscribers enjoy substantially outage-free,
highly reliable picture quality because there is no coaxial cable, amplifiers or
processing and filtering equipment between the head-end and the subscriber's
household, as in the case of traditional hard-wire cable. Within the signal
range of the Existing Systems, the picture quality of the Company's service is
at least as good as that typically received by
16
<PAGE> 17
traditional hard-wire cable subscribers because, absent any line-of-sight
obstruction, there is less opportunity for signal degradation between the
Company's head-end and the subscriber.
EMPLOYEES
As of March 21, 1997, the Company had approximately 1,390 employees. None
of the Company's employees are subject to a collective bargaining agreement. The
Company has experienced no work stoppages and believes that it generally has
good relations with its employees. The Company also presently utilizes the
services of independent contractors to install certain of its wireless cable
systems and market its services.
ACQUISITIONS, DIVESTITURES AND RECENT TRANSACTIONS
February 1996 Transactions. Effective February 23, 1996, the Company,
directly or through one or more subsidiaries, acquired all the assets and
liabilities and succeeded to the businesses of American Wireless Systems, Inc.
and CableMaxx, Inc., and acquired substantially all of the assets and certain
liabilities and succeeded to all the businesses of Fort Worth Wireless Cable
T.V. Associates, Wireless Cable TV Associates #38 and Three Sixty Corp.,
successor to Technivision, Inc. (collectively referred to herein as the
"Transactions"). The Company issued approximately 6.76 million shares of Common
Stock representing approximately 34.9% of its then outstanding Common Stock in
connection with the Transactions. Following the CS Transaction (described below)
and the subsequent distribution of other wireless cable assets acquired in the
Transactions, the Company retained wireless cable channel rights in the
following markets acquired in the Transactions: Amarillo, Corsicana/Athens,
Austin, Corpus Christi, El Paso, Lubbock, Sherman/Denison, Temple/Killeen, and
Waco, Texas. In addition to the consideration received upon the transfer of
markets acquired in the Transactions to CS Wireless, the Company has received
approximately $13.6 million in cash from other sales of markets acquired in the
Transactions.
The CS Wireless Transaction. Effective February 23, 1996, immediately
following the closing of the Transactions, the Company, CAI and CS Wireless
consummated a Participation Agreement pursuant to which the Company (or certain
of its subsidiaries) contributed or sold a substantial portion of the assets
received in the Transactions and certain other assets to CS Wireless (the "CS
Wireless Transaction"). Simultaneously with the contribution and sale of such
assets by the Company to CS Wireless, CAI (or certain of its subsidiaries) also
contributed to CS Wireless (directly or by contribution of stock of
subsidiaries) certain wireless cable television assets which, collectively with
the Company's contributed assets, created a company with approximately 5.7
million line-of-sight households and approximately 58,500 subscribers as of
February 23, 1996.
In connection with the CS Wireless Transaction, the Company (or its
subsidiaries) received (i) shares of CS Wireless common stock constituting
approximately 35% of the outstanding shares of CS Wireless common stock, (ii)
approximately $28.3 million in cash paid at the closing, (iii) a promissory note
in the principal sum of $25 million (which note has been prepaid by its terms)
and (iv) a promissory note in the sum of $15 million payable 10 years from
closing and prepayable from asset sales and certain other events. CS Wireless,
CAI and the Company are in the process of completing certain post-closing
adjustments. Components of such adjustments include the relative accounts
payable, accounts receivable and related working capital assets of the
contributed systems, the number of granted channels represented and actually
contributed to CS Wireless for each market, the amount of any increase or
decrease in the number of subscribers in each contributed system from the number
of subscribers previously disclosed and related factors. The Company has
received $5.0 million in cash in partial payment of such adjustments. Following
the completion of these adjustments, additional payments of cash and/or shares
of CS Wireless common stock are expected to be made to the Company by CS
Wireless and/or CAI.
Also, in connection with the closing of the CS Wireless Transaction, CAI,
the Company and CS Wireless entered into a stockholders agreement (the "CS
Wireless Stockholders Agreement"). The CS Wireless Stockholders Agreement
provides, among other things, that the Company and CAI will agree to vote their
shares of CS Wireless Common Stock in favor of a Board of Directors of CS
Wireless having nine members consisting of (i) up to four members designated by
CAI (provided that at least one of whom may not be an
17
<PAGE> 18
affiliate of either CAI or the Company); (ii) up to three members designated by
the Company (provided that at least one of whom may not be an affiliate of
either CAI or the Company); (iii) the Chief Executive Officer of CS Wireless;
and (iv) the Chief Operating Officer of CS Wireless. The Stockholders' Agreement
and CS Wireless' bylaws further provide that certain major transactions will
require the affirmative approval of at least 70% (seven of nine) of the
Directors of CS Wireless.
Telinor Investment. In July 1996, the Company acquired 49% of the
outstanding capital stock of Television Interactiva del Norte, SA de C.V., a
Mexican corporation ("Telinor"), for approximately $0.5 million. The Company
anticipates that Telinor will seek to aggregate wireless cable channel rights
throughout Mexico.
$15 Million Note Offering. On March 25, 1996, the Company consummated a
private placement of $15 million principal amount of 13% Senior Notes (the
"Series C Notes"). On January 22, 1997, the Company consummated an exchange
offer pursuant to which $15 million principal amount of 13% Senior Series D
Notes ("Series D Notes") were issued in exchange for an equal principal amount
of Series C Notes, all of which were cancelled. The terms of the Series C Notes
and the Series D Notes are identical in all material respects except that the
Series D Notes have been registered under the Securities Act and therefore do
not have legends restricting their transfer.
$25 Million Revolving Credit Facility. On November 27, 1996, a wholly owned
subsidiary of the Company entered into a senior secured revolving credit
facility, permitting borrowings in an aggregate principal amount outstanding at
any time of up to $25.0 million (the "Bank Facility"). Approximately $6.7
million in borrowings under the Bank Facility were repaid from the proceeds of
the private placement of the 14% Notes (defined below) and the Bank Facility has
been terminated.
$125 Million Note Offering. On December 20, 1996, the Company consummated a
private placement of $125 million principal amount of 14% Senior Notes (the "Old
Notes"). On February 10, 1997, the Company filed a Registration Statement on
Form S-4 (No. 333-12577) with the SEC to register the offering of $125 million
principal amount of 14% Series B Senior Notes (the "Exchange Notes" and
collectively with the Old Notes the "14% Notes") in exchange for the Old Notes
(the "Exchange Offer"). The terms of the Exchange Notes and the 14% Notes are
identical in all material respects. The Exchange Offer will expire April 10,
1997, unless extended by the Company. Upon the consummation of the Exchange
Offer, the Exchange Notes will be registered under the Securities Act and
therefore will not have legends restricting their transfer.
Programming Cooperative. In February 1997, the Company, CS Wireless,
Wireless One and CAI formed a cooperative organization to negotiate and obtain
volume-based programming contracts at a discount from rates currently paid by
each of the parties. The organization may expand its purposes upon approval of
each party to include mutually advantageous endeavors such as volume-based
purchases of equipment and other services. There can be no assurance that any
such benefits will be realized.
Other Divestitures. On May 6, 1996, the Company consummated the sale of
wireless cable markets in Memphis and Flippin, Tennessee to TruVision Wireless,
Inc. ("TruVision") for approximately $5.4 million in cash. On June 21, 1996, the
Company sold wireless cable channel rights in Los Angeles, California for $8.2
million in cash plus a reimbursement of $1.5 million of expenses. On July 17,
1996, a subsidiary of the Company consummated the sale of wireless cable channel
rights in Adairsville, Powers Crossroads and Rutledge, Georgia to CS Wireless
for $7.2 million in cash.
Pending Acquisitions and Divestitures. The Company has entered into a
nonbinding letter of intent to acquire one wireless cable operating system in
Iowa and wireless cable assets in one market in each of Nebraska and Montana
from CS Wireless. In addition, a subsidiary of the Company has agreed to sell to
CAI certain wireless cable assets in Portsmouth, New Hampshire. The Company will
receive approximately 267,000 shares of common stock of CS Wireless as its
portion of the consideration for such assets. Also, the Company has entered into
an agreement with American Telecasting, Inc. in which the parties agreed to
exchange certain wireless cable channel rights and related assets in South
Dakota, Florida, Michigan and Illinois. Each of the above agreements is subject
to customary closing conditions. The Company anticipates
18
<PAGE> 19
that these agreements will be consummated on or before June 30, 1997, although
there can be no assurance that any of these transactions will be consummated.
RECENT EVENTS
On March 29, 1997, John A. Fanning resigned as a director of the Company.
Mr. Fanning remained as Interim President and Chief Executive Officer of the
Company until April 24, 1997, when he was replaced by Carroll D. McHenry. On
March 29, 1997, the remaining directors ratified and authorized a Search
Committee comprised of Alvin H. Lane, Jr., Dennis M. O'Rourke and John A.
Sprague to conduct a search for and hire a permanent Chief Executive Officer
without further action from the Board of Directors. In connection therewith,
Jupiter Partners, L.P., the holder of $40,150,000 gross proceeds of 9%
convertible subordinated discount notes issued by the Company ("Convertible
Notes"), and Hunt Capital Group, L.L.C. and L. Allen Wheeler, principal
stockholders of the Company, stated their intention as security holders of the
Company to nominate (or to request their respective designees to the Board of
Directors of the Company to nominate), upon the selection of a permanent Chief
Executive Officer, a slate of directors comprised of a representative of each of
them, together with the permanent Chief Executive Officer and three (3)
independent directors.
ITEM 2. PROPERTIES
The Company leases approximately 24,000 square feet of office space, of
which approximately 10,000 square feet is subleased to CS Wireless, for its
executive offices in Plano, Texas under a lease that expires April 10, 2003. The
Company pays approximately $385,000 per annum rent for such space, of which
$192,500 (50%) is reimbursed to the Company by CS Wireless. The Company leases
from affiliates of L. Allen Wheeler, a director of the Company, and David E.
Webb, a former executive officer and director of the Company, approximately
16,350 square feet in several locations for its operating, executive,
telemarketing and collections offices in Durant, Oklahoma under leases that
expire between March 1, 2000 and May 31, 2000. The Company pays a total of
$108,000 per annum rent for such space. The Company leases approximately an
additional 30,000 square feet of tower and warehouse space in Durant, Oklahoma
from an affiliate of Messrs. Webb and Wheeler under two leases that expire on
March 1, 2000 and August 1, 2000. The Company pays $35,000 per annum rent for
such space. The Company leases from an affiliate of Messrs. Webb, Wheeler and
Robert R. Story, a former executive officer of the Company, an additional 12,430
square feet of office space in Durant, Oklahoma under a lease that expires March
1, 2000. The Company pays $62,000 per annum rent for such space. The Company
believes that these facilities are adequate for the foreseeable future.
The principal physical assets of a wireless cable system consist of
satellite signal reception equipment, radio transmitters and transmission
antennae, as well as office space and transmission tower space. The Company
leases office space for the Existing Systems and will, in the future, purchase
or lease additional office space in other locations where it launches other
wireless cable systems. The Company also owns transmission towers or leases
space on transmission towers located in its markets. The current capacity range
of the Company's transmission facilities is from 10 to 100 watts, capable of
generating a signal over a 35 to 50 mile range. The Company believes that office
space and space on transmission towers currently is readily available on
acceptable terms in the markets where the Company intends to operate wireless
cable systems.
ITEM 3. LEGAL PROCEEDINGS
The Company is a party, from time to time, to routine litigation incident
to its business. It is the opinion of management that no pending litigation
matter will have a material adverse effect on the Company's consolidated
financial position or operating results.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Between October 29, 1996 and December 9, 1996, the Company engaged in the
solicitation of consents ("Consent Solicitation") of the holders of its 13%
Series B Senior Notes due 2003 ("Series B Notes") and holders of its Series C
Notes (together with the Series B Notes, the "Notes", and collectively all of
the Company's 13% Senior Notes are referred to as the 13% Notes") to amend
certain (i) provisions of the indentures (the "13% Note Indentures") of the
Notes to permit the Company to, among other things, issue the 14% Notes and (ii)
definitions and covenants in the 13% Note Indentures, which impose restrictions
on
19
<PAGE> 20
the Company's ability to pursue certain additional financing and investment
opportunities that the Company believes were necessary to enhance the value of
the Company (collectively, the "Amendments").
Pursuant to the terms of the 13% Note Indentures, the Amendments required
the approval of at least a majority in aggregate principal amount of the Notes
that were outstanding on or before December 5, 1996, the expiration date of the
Consent Solicitation. The Amendments received approval of 100% in aggregate
principal amount of the Notes and, accordingly, became effective as of December
9, 1996, upon the execution of supplemental indentures embodying such
Amendments. Promptly upon the effectiveness of the supplemental indentures
including the Amendments, the Company paid to each holder of the Notes who
delivered a properly completed and executed consent form $60 in cash for each
$1,000 principal amount of Notes for which such consent form was delivered by
such holder. The Company paid an aggregate of $6.9 million to the holders of the
Notes in this regard.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Common Stock began trading on the Nasdaq National Market on April 22,
1994. The following table sets forth, on a per share basis for the periods
shown, the high and low closing sale prices of the Common Stock as reported on
the Nasdaq National Market. Such quotations reflect inter-dealer prices, without
retail mark-up, mark-down or commission and may not necessarily represent actual
transactions.
<TABLE>
<CAPTION>
CLOSING SALE PRICE
------------------
HIGH LOW
------- -------
<S> <C> <C>
Fiscal Year Ended December 31, 1995:
First Quarter............................................. $17.25 $11.75
Second Quarter............................................ $24.25 $15.50
Third Quarter............................................. $25.75 $19.50
Fourth Quarter............................................ $31.50 $27.00
Fiscal Year Ended December 31, 1996:
First Quarter............................................. $29.75 $23.00
Second Quarter............................................ $28.63 $22.88
Third Quarter............................................. $25.25 $19.56
Fourth Quarter............................................ $25.25 $11.75
Fiscal Year Ending December 31, 1997:
First Quarter............................................. $12.38 $ 2.13
Second Quarter (through April 25, 1997)................... $ 3.06 $ 1.88
</TABLE>
On April 25, 1997, the last reported sale price for the Common Stock as
reported on the Nasdaq National Market was $2.13 per share. As of April 25,
1997, there were approximately 701 holders of record of the Common Stock.
The Company has never declared or paid any cash dividends on the Common
Stock and does not presently intend to pay cash dividends on the Common Stock in
the foreseeable future. The Company intends to retain future earnings for
reinvestment in its business. The Company's ability to declare or pay cash
dividends is affected by the ability of the Company's present and future
subsidiaries to declare and pay dividends or otherwise transfer funds to the
Company since the Company conducts its operations through majority-owned
subsidiaries. The terms governing the preferred stock issued by one of the
Company's majority-owned subsidiaries include a preference as to dividend
payments over the Company, as a holder of common stock of such subsidiary.
Certain covenants in a Note Purchase Agreement among the Company, Jupiter
Partners L.P. and Thomas R. Haack prohibit the Company from declaring or paying
cash dividends.
20
<PAGE> 21
Future loan facilities, if any, obtained by the Company or any of its
subsidiaries also may prohibit or restrict the payment of dividends or other
distributions. Subject to the waiver of such prohibitions and compliance with
such limitations, the payment of cash dividends on shares of Common Stock will
be within the discretion of the Company's Board of Directors and will depend
upon the earnings of the Company, the Company's capital requirements, applicable
requirements of the Delaware General Corporation Law and other factors that are
considered relevant by the Company's Board of Directors.
ITEM 6. SELECTED FINANCIAL DATA
The selected historical financial data presented below as of December 31,
1996 and 1995 and for the years ended December 31, 1996, 1995 and 1994 were
derived from the consolidated financial statements of the Company, which were
audited by KPMG Peat Marwick LLP, independent certified public accountants, and
which are included elsewhere in this Form 10-K. The selected historical
financial data presented below as of December 31, 1994, 1993 and 1992 and for
the years ended December 31, 1993 and 1992 were derived from consolidated
financial statements of the Company, which were audited by KPMG Peat Marwick
LLP, but which are not included in this Form 10-K. This selected consolidated
financial data should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the Company's
consolidated financial statements (including the notes thereto) included
elsewhere in this Form 10-K.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------------
1996 1995 1994 1993 1992
-------- -------- ------- ------ ------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Statement of operations data:
Revenues................................ $ 56,017 $ 15,300 $ 2,229 $ 869 $ 205
Operating expenses:
Systems operations................... 21,255 4,893 762 321 36
Selling, general and
administrative..................... 42,435 11,887 4,183 647 148
Depreciation and amortization........ 39,323 6,234 1,098 138 35
-------- -------- ------- ------ ------
Total operating expenses........ 103,013 23,014 6,043 1,106 219
-------- -------- ------- ------ ------
Operating loss.......................... (46,996) (7,714) (3,814) (237) (14)
Interest expense, net................... (18,166) (10,857) (210) (73) --
Equity in losses of affiliates.......... (18,612) (1,369) (387) -- --
Other income (expense).................. 4,981 (247) (227) (96) (37)
Income tax benefit...................... 28,156 4,285 1,595 -- --
-------- -------- ------- ------ ------
Loss before extraordinary item.......... $(50,637) $(15,902) $(3,043) $ (406) $ (51)
Extraordinary item, net of tax
benefit.............................. (10,424) -- -- -- --
-------- -------- ------- ------ ------
Net loss................................ $(61,061) $(15,902) $(3,043) $ (406) $ (51)
======== ======== ======= ====== ======
Loss before extraordinary item per
common share......................... $ (2.74) $ (1.34) $ (0.30) $(0.05) $(0.01)
Extraordinary item per common share..... (0.57) -- -- -- --
-------- -------- ------- ------ ------
Net loss per common share............... $ (3.31) $ (1.34) $ (0.30) $(0.05) $(0.01)
======== ======== ======= ====== ======
Weighted average number of common shares
outstanding.......................... 18,473 11,866 10,011 8,000 8,000
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------------------
1996 1995 1994 1993 1992
-------- -------- ------- ------ ------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Balance sheet data:
Cash and cash equivalents............... $ 79,596 $ 23,143 $11,986 $ 815 $ 165
Total assets............................ 515,364 205,405 77,921 8,665 2,268
Long-term debt, including current
portion.............................. 303,538 141,652 40,506 1,593 --
Total stockholders' equity.............. 180,847 51,688 30,081 4,493 1,004
</TABLE>
21
<PAGE> 22
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company develops, owns and operates wireless cable television systems.
The Company has wireless cable channel rights in small to mid-size markets in
the central United States. The Company targets small to mid-size markets with
significant numbers of households that are unpassed by traditional hard-wire
cable. The Company offers its subscribers local off-air VHF/UHF channels, as
well as HBO, Showtime, Disney, ESPN, CNN, USA, WGN, WTBS, Discovery, the
Nashville Network, A&E and other popular cable television networks. At December
31, 1996 the Company had wireless cable channel rights in 95 markets,
representing approximately 10.3 million households, approximately 9.3 million of
which can be served by line-of-sight transmissions. Furthermore, the Company
estimates that within these markets, approximately 20%-40% of line-of-sight
households are currently unpassed by traditional hard-wire cable systems. At
December 31, 1996, pro forma for the acquisition of two operating systems
consummated in January 1997 and including one operating system managed by the
Company, the Company had 56 markets with systems in operation, providing
wireless cable service to an aggregate of 181,373 subscribers. In addition, the
Company owns an approximate 20% equity interest in Wireless One and an
approximate 34% equity interest in CS Wireless.
The Company has experienced significant subscriber growth since its
inception, both internally and through acquisitions. Although the Company has
recorded net losses of $80.6 million since inception, 31 systems achieved
positive System EBITDA for the year ended December 31, 1996. The Company's 25
remaining systems did not achieve positive System EBITDA for the year ended
December 31, 1996, primarily as a result of their early stages of development
and number of subscribers, and the write-off of subscribers and related account
balances at December 31, 1996. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Changes in Method for Reporting
Subscribers; Write-Offs."
"System EBITDA" means net income (loss) plus interest expense, income tax
expense, depreciation and amortization expense and all other non-cash charges,
less any non-cash items which have the effect of increasing net income or
decreasing net loss, for a system and includes all selling, general and
administrative expenses attributable to employees employed in that system. For
the periods presented, there are no such non-cash items. EBITDA is presented
because it is a widely accepted financial indicator of a company's ability to
service and/or incur indebtedness. However, EBITDA is not a financial measure
determined under generally accepted accounting principles and should not be
considered as an alternative to net income as a measure of operating results or
to cash flows as a measure of funds available for discretionary or other
liquidity purposes.
Effective December 31, 1996, the Company (i) revised its methodology for
reporting MDU subscribers and (ii) wrote off approximately 33,000 subscribers
with delinquent balances. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Changes in Method for Reporting
Subscribers; Write-Offs." As a result of the methodology changes and write offs,
the Company's reported subscriber base decreased, while the average monthly
revenue per subscriber and the average monthly churn rate increased. The changes
resulted in (a) a total reduction of the Company's reported subscriber base at
December 31, 1996 of approximately 59,300 subscribers, of which approximately
26,300 relates to the change in methodology for reporting MDU subscribers and
33,000 relating to the write-off of subscribers with delinquent balances, (b) an
increase in reported average monthly revenue per subscriber during the fourth
quarter of 1996 from $27.14 (excluding the methodology changes and subscriber
write-offs) to $28.70 (including the methodology changes and subscriber
write-offs), and (c) an increase in the reported average monthly churn rate
during the fourth quarter from 3.0% (excluding the methodology changes and
subscriber write-offs) to 9.6% (including the methodology changes and subscriber
write-offs). For the year ended December 31, 1996 and in future periods, the
Company will report its subscriber base, average revenue per subscriber and
churn rate based upon the new methodology (the "new method"). However, the
Company is unable to retroactively apply the new methodology to the prior
periods. Therefore, the information set forth below will contain information
with subscriber data calculated using the old methodology (the "old method")
solely for the purposes of comparison with prior periods.
22
<PAGE> 23
In addition to the matters noted above, certain other statements made in
this report are forward looking. Such statements are based on an assessment of a
variety of factors, contingencies and uncertainties deemed relevant by
management, including (i) business conditions and subscriber growth in the
Company's existing markets, (ii) the successful launch of systems in new and
existing markets, (iii) the Company's existing indebtedness and the need for
additional financing to fund subscriber growth and system development, (iv) the
successful integration of new systems processes (including subscriber
qualification and retention efforts) and management personnel, (v) regulatory
and interference issues, including the grant of pending applications for new
licenses or for modification of existing licenses and the grant of applications
for new licenses and license modification applications that have not yet been
filed with the FCC, and (vi) competitive products and services, as well as those
matters discussed specifically elsewhere herein. As a result, the actual results
realized by the Company could differ materially from the statements made herein.
Investors are cautioned not to place undue reliance on the forward looking
statements made in this report.
RESULTS OF OPERATIONS FOR THE THREE YEARS ENDED DECEMBER 31, 1996
Revenues. The Company's revenues consist of monthly fees paid by
subscribers for basic programming, premium programming, program guides,
equipment rental and other miscellaneous fees. The Company's revenues were $56.0
million in 1996, $15.3 million in 1995 and $2.2 million in 1994, representing
increases of 266% from 1995 to 1996 and 595% from 1994 to 1995. As discussed
more fully in Note 1 of the notes to the consolidated financial statements, the
Company changed, effective January 1, 1995, its method of accounting for the
direct cost and installation fees related to subscriber installations. The
revenue increases from 1994 to 1996 were primarily due to average subscribers,
calculated under the old method, increasing to 168,566 in 1996 from 43,360 in
1995 and 5,966 in 1994. Under the old method, average monthly revenue per
subscriber was $27.93 during 1996, $29.41 for 1995 and $27.35 for 1994. The
decrease in average monthly revenue per subscriber in 1996 as compared to 1995
was primarily due to an increase in MDU subscribers, which typically generate
lower per subscriber revenue than single-family units, and an increase in the
number of "soft disconnect" subscribers. Soft disconnect subscribers are
subscribers who are past due on their bills and not receiving service; however,
their equipment has not been recovered. The increase in average monthly revenue
per subscriber in 1995 as compared to 1994 was primarily due to increased
premium channel penetration. At December 31, 1996, proforma for the acquisition
of two operating systems consummated in January 1997 and including one operating
system managed by the Company, the Company had 240,700 subscribers under the old
method (181,373 subscribers under the new method) versus 85,160 subscribers at
December 31, 1995 and 19,840 subscribers at December 31, 1994. Under the old
method, approximately 55% of the subscriber increase from 1995 to 1996 was
attributable to same-system growth (net subscriber additions in the Company's
systems in operation at December 31, 1995), 19% was attributable to 16 new
systems launched during 1996 and 26% was attributable to seven operating systems
acquired, net of three operating systems divested, during 1996. During 1996, the
Company reclassified the Lufkin, Texas market from an operating system to a
future market. Approximately 43% of the subscriber increase from 1994 to 1995
was attributable to same-system growth, 41% was attributable to 17 new systems
launched during 1995 and 16% was attributable to six operating systems acquired,
net of two operating systems divested, during 1995. Proforma for the acquisition
of two operating systems consummated during January 1997 and including one
operating system managed by the Company, the Company had 56 systems in operation
at December 31, 1996, compared to 34 systems in operation at December 31, 1995
and 13 systems at December 31, 1994.
Systems Operations. Systems operations expenses include programming costs,
channel lease payments, costs of service calls and churn, transmitter site and
tower rentals, cost of program guides and certain repairs and maintenance
expenditures. Programming costs (with the exception of minimum payments), cost
of program guides and channel lease payments (with the exception of certain
fixed payments) are variable expenses which increase as the number of
subscribers increases. Systems operations expenses were $21.3 million in 1996,
$4.9 million in 1995 and $0.76 million in 1994. As a percentage of revenues,
systems operations expenses were 38% in 1996, 32% in 1995 and 34% in 1994. As a
percentage of revenue, systems operations expense increased from 1995 to 1996,
primarily due to increased programming costs as a percentage of revenue. The
Company experienced higher programming costs during 1996 due to the acquisition
of markets with a larger number of channels and the promotion of a special
programming package which carried lower
23
<PAGE> 24
margins than the Company's basic programming package. The Company expects
programming expense as a percentage of revenue to slightly increase over the
short-term; however, the Company is currently evaluating all of its programming
packages as to their impact on cash flow and profitability, which may result in
an increase or a decrease in the Company's future programming expenses as a
percentage of revenue. In addition, the Company experienced increased service
call expense, due to installation corrections at certain subscriber households.
The Company expects to continue to experience increased service call expense as
its subscriber base increases. The decrease in systems operations expense as a
percentage of revenue from 1994 to 1995 was due to revenue increases (as
previously discussed) and the semi-fixed nature of the Company's systems
operations expense.
Selling, General and Administrative ("SG&A"). The Company has experienced
increasing SG&A since its inception as a result of its increasing wireless cable
activities and associated administrative costs, including costs related to
opening and maintaining additional offices, additional accounting and support
costs and additional compensation expense. SG&A was $42.4 million in 1996, $11.9
million in 1995 and $4.2 million in 1994. As a percentage of revenues, SG&A was
76% in 1996, 78% in 1995 and 191% in 1994. As discussed more fully in Note 1 of
the notes to the consolidated financial statements, the Company changed,
effective January 1, 1995, its method of accounting for the direct costs and
installation fees related to subscriber installations. In addition to the
aforementioned reasons, the increase in SG&A from 1995 to 1996 was due to
increased bad debt and advertising expense. Bad debt expense as a percentage of
revenue increased from 5% in 1995 to 13% in 1996. The significant increase in
bad debt expense was due to the Company's prior subscriber qualification and
retention efforts and resulted in the write-off of approximately 33,000
subscribers and associated accounts receivable as of December 31, 1996. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Changes in Method for Reporting Subscribers; Write-Offs." The
Company believes that it has implemented improved subscriber qualification and
retention policies which include a combination of credit checks, service
deposits, advance payments and installation fees for certain subscribers.
Advertising expense as a percentage of revenue increased from 7% in 1995 to 10%
in 1996. During the fourth quarter of 1996, the Company changed its advertising
mix from direct sales to telemarketing. Direct sales commissions are capitalized
by the Company, while advertising expenses such as telemarketing activities are
expensed as incurred. In addition, the Company conducted a number of special
advertising campaigns during the year. The Company is currently reviewing its
sales and marketing strategies in order to improve their cost effectiveness. The
outcome of such review may significantly affect the Company's future advertising
expenses. Other increase in SG&A from 1994 to 1995 is principally due to an
increase in the Company's corporate and executive staff to support the Company's
overall growth, increased advertising costs to support the Company's subscriber
growth, and, to a lesser extent, increased costs associated with property and
casualty insurance, group health insurance and property taxes.
Depreciation and Amortization. Depreciation and amortization expense
includes depreciation of systems and equipment and amortization of license and
leased license investment and the excess of cost over fair value of net assets
acquired. Depreciation and amortization expense was $39.3 million in 1996, $6.2
million in 1995 and $1.1 million in 1994. As discussed more fully in Note 1 of
the notes to the consolidated financial statements, the Company changed,
effective January 1, 1995, its method of accounting for the direct costs and
installation fees related to subscriber installations. The increases in
depreciation expenses from 1994 to 1996 were due to additional systems and
equipment in connection with the launch of 16 systems during 1996, 17 systems
during 1995 and six systems during 1994 and increased amortization expense on
license and leased license investment of systems in operation and excess of cost
over fair value of net assets acquired related to the acquisition of wireless
cable channel rights, operating wireless cable systems and the acquisition of
minority interests in certain subsidiaries of the Company. In addition, during
1996, the Company incurred increased depreciation expense related to (i) the
increased write off of the unamortized balance of capitalized labor and
overhead, sales commissions and non-recoverable equipment associated with
subsidiaries which have disconnected (including the write-off of approximately
33,000 subscribers) (see "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Changes in Method for Reporting
Subscribers; Write-Offs"), (ii) the write-off of license and leased license
investment in certain markets where the Company was unsuccessful in obtaining
wireless cable channel rights, and (iii) changes in estimates of useful lives.
In the fourth quarter of 1996, the Company reduced its estimates of the useful
lives
24
<PAGE> 25
of the non-recoverable portion of subscriber installation costs and license and
leased license investment and excess of cost over fair value of assets acquired.
Its amortization period related to the nonrecoverable portion of subscriber
installation costs was reduced from six years (approximately 1.5% churn per
month) to four years (approximately 2.0% churn per month) to correspond to the
Company's estimate of its average subscription term. The estimated useful life
of license and leased license investment and excess of cost over fair market
value of net assets acquired was reduced from 20 years to 15 years.
Operating Loss. The Company generated operating losses of $47.0 million
during 1996, $7.7 million during 1995 and $3.8 million during 1994. EBITDA was
negative $7.7 million for 1996, negative $1.5 million for 1995 and negative $2.7
million for 1994. As previously discussed, the increases in the Company's
operating loss and negative EBITDA from 1994 to 1996 was primarily due to
increased systems operations and SG&A expense, partially offset by increases in
revenue. Increased depreciation and amortization expenses from 1994 to 1996 also
contributed to the increases in the Company's operating losses during these
periods.
Interest Income. Interest income was $3.8 million in 1996, $2.9 million in
1995 and $0.4 million in 1994. The increase in interest income from 1995 to 1996
was due to higher average cash equivalents subsequent to the receipt of
approximately $53.3 million in cash related to the formation of CS Wireless and
cash received from asset sales. The increased interest income from 1994 to 1995
was due to higher average cash equivalents subsequent to the Company's placement
of $100 million of 13% Notes.
Interest Expense. The Company incurred interest expense of $22.0 million in
1996, $13.7 million in 1995 and $.6 million in 1994. The increase in interest
expense over the periods presented is due to increases in borrowed funds.
Interest expense during 1996 primarily consisted of (i) non-cash interest of
$4.2 million related to interest on the Convertible Notes, (ii) interest on the
Company's 13% Notes, (iii) interest related to the Company's Bank Facility, (iv)
interest on debt incurred in conjunction with the BTA auction, and (v) interest
on the Company's 14% Notes from December 20, 1996. Interest expense during 1995
included (i) non-cash interest of $3.8 million related to interest on the
Convertible Notes and (ii) interest on the Company's 13% Notes since April 26,
1995. Interest expense during 1994 included (i) non-cash interest of $0.3
million related to one month's interest on the Convertible Notes, (ii) interest
on bridge financing provided by Internationale Nederlanden (U.S.) Capital
Corporation and (iii) interest expense on short-term borrowings that were repaid
in connection with the Company's initial public offering in April 1994.
Equity in Losses of Affiliates. The Company had equity in losses of
affiliates of $18.6 million in 1996, $1.4 million in 1995 and $.4 million in
1994. Equity in losses of affiliates during 1996 represents losses from CS
Wireless in which the Company has an approximate 34% interest and losses in
Wireless One in which the Company has an approximate 20% interest. The Company
acquired its interest in CS Wireless on February 23, 1996. Equity in losses of
affiliates during 1995 primarily represents losses from Wireless One. The
Company acquired its interest in Wireless One in October 1995. Equity in losses
of affiliates during 1994 represents losses from RuralVision Joint Venture in
which the Company had a 50% interest. The Company ceased to be a joint venturer
in RuralVision Joint Venture during May 1995.
Other Income (Expenses). Other income (expenses) is comprised of gain on
the sale of assets and other non-operating income, offset by minority interests
in the net earnings of subsidiaries, dividends on preferred stock of certain
subsidiaries and other non-operating expenses. In 1996, the Company had other
income of $5.3 million related to a gain on the sale of the Flippin, Tennessee
market and the sale of channel rights in three Georgia markets. Offsetting this
income, the Company incurred $.4 million of other expenses, of which $.2 million
related to non-operational settlement charges. In 1995, the Company incurred $.3
million of other expenses, of which $.2 million relates to non-operational
settlement charges between the Company and an unaffiliated third party and
$21,000 relates to dividends on preferred stock of certain subsidiaries. During
1994, the Company incurred $.2 million of other expenses, primarily consisting
of a recapitalization charge relating to costs incurred in connection with a
rescinded offering of securities and $21,000 relates to minority interest
owners' share of net earnings in subsidiaries and dividends on preferred stock
of certain subsidiaries.
Income Tax Benefit. As discussed more fully in Note 6 of the notes to the
consolidated financial statements, the Company recognized income tax benefits
related to the Company's losses before income taxes and extraordinary items of
$28.2 million for 1996, $4.3 million for 1995 and $1.6 million for 1994. The
25
<PAGE> 26
Company recognized income tax benefits to the extent of future reversals of
existing taxable temporary differences.
Extraordinary Item. In December 1996, the Company recognized an
extraordinary loss of $11.5 million, net of tax of $1.1 million. This
extraordinary loss resulted from a substantive modification of the terms of the
13% Notes due to the amount of consent fees paid ($6.9 million). For financial
reporting purposes, the 13% Notes have been treated as having been extinguished
and reissued upon the consummation of the 14% Notes, and recorded at their
estimated fair value as of such date. The extraordinary loss consists of the
associated write-off of debt issuance costs related to the 13% Notes of $5.3
million, the consent payments of $6.9 million, the decrease in the 13% Notes of
$1.1 million to reflect their estimated fair value and other costs of $.4
million.
Net Loss. The Company has recorded net losses since inception. The Company
incurred net losses of $61.1 million or $3.31 per share during 1996, $15.9
million or $1.34 per share during 1995 and $3.0 million or $0.30 per share
during 1994. As previously discussed, although the Company's total revenue
increased 266% from 1995 to 1996 and 586% from 1994 to 1995, due to initial
operating losses associated with the launch of 16 markets during 1996, 17
markets during 1995 and six markets during 1994, increased systems operations,
SG&A, depreciation and amortization and interest expense, and the extraordinary
item in 1996, the Company's net losses have increased from 1994 to 1996. The
Company expects to continue to incur net losses throughout 1997 and beyond.
LIQUIDITY AND CAPITAL RESOURCES
The wireless cable television business is a capital intensive business.
Since inception, the Company has expended funds to lease or otherwise acquire
channel rights in various markets and systems in operation, to construct
operating systems and to finance initial system operating losses. To date, the
primary sources of capital of the Company have been from the sale of the
Company's common stock, debt financing and the sale of wireless cable channel
rights that are not part of the Company's strategic plan.
The Company estimates that a launch of a wireless cable system in a typical
market will involve the initial expenditure of approximately $0.5 million to
$0.9 million for wireless cable system transmission equipment and tower
construction, depending upon the type and sophistication of the equipment and
whether the Company is required to construct a transmission tower, and
incremental installation costs of approximately $465 per single family household
subscriber for equipment, labor, overhead charges and direct commission. The
Company has recently launched systems utilizing a more sophisticated type of
equipment that will cost approximately $65 less per installation and therefore
it believes that the average cost of materials will continue to decrease as
subscribers are added in systems that utilize such equipment. The Company is
currently reviewing its installation cost structure in an effort to improve
operational efficiency. As a result, the Company's incremental installation
costs may vary from those presented above. Other launch costs include the cost
of securing adequate space for marketing and warehouse facilities, as well as
costs related to employees. As a result of these costs, operating losses are
likely to be incurred by a system during the start-up period.
Cash used in operations was $22.8 million in 1996 and $6.5 million in 1995,
versus cash provided by operations of $0.7 million in 1994. The increase in cash
consumed by operations during 1996 was primarily due to increased systems
operations, SG&A and interest expense, partially offset by a 266% increase in
revenues from 1995 to 1996 and a decrease in working capital. The increase in
cash used in operations during 1995 as compared to 1994 was primarily due to
increases in systems operations, SG&A and interest expense, as well as initial
operating losses associated with the launch of 17 systems during 1995, versus
six systems in 1994.
Cash used in investing activities was $34.2 million in 1996, $96.7 million
in 1995 and $46.5 million in 1994. Cash used in investing activities principally
relates to the construction of additional operating systems, the acquisition and
installation of subscriber receive-site equipment, the upgrade of transmission
equipment in certain markets and the acquisition of wireless cable channel
rights and operating systems, partially offset by the sale of wireless cable
channel rights that are not a part of the Company's strategic plan. In addition,
as
26
<PAGE> 27
discussed more fully in Note 3 of the notes to the consolidated financial
statements, cash provided by/used in investing activities includes purchases and
sales of debt securities, representing proceeds from the sale of the Company's
13% Notes and 14% Notes placed in escrow for the semi-annual payment of
interest. The Company's purchases of systems and equipment have increased over
the periods presented due to (i) the launch of 16 systems during 1996, 17
systems during 1995 and six systems during 1994 and (ii) the purchase of
subscriber receive-site equipment due to the Company's subscriber base, as
calculated under the old method, increasing from 2,735 subscribers at December
31, 1993 to 240,700 subscribers at December 31, 1996.
As discussed more fully in Notes 3 and 8 of the notes to the consolidated
financial statements, cash used in investing activities during 1996 also
included the Company's acquisition of the Champaign, Illinois and Gainesville,
Texas operating systems, payments related to the BTA Auction and out-of-pocket
expenses related to the acquisition of the businesses of CableMaxx, Inc. and
American Wireless Systems, Inc., assets of Fort Worth Wireless Cable T.V.
Associates, Wireless Cable T.V. Associates #38 and certain of the wireless cable
television assets of Three Sixty Corp., formerly Technivision, Inc.
(Collectively the "CableMaxx, AWS and Technivision Acquisitions"). These uses of
cash were partially offset by the receipt of approximately $58.3 million in cash
from CS Wireless in connection with the Company's contribution of wireless cable
assets to CS Wireless, and sale of wireless cable channel rights in Memphis and
Flippin, Tennessee; Los Angeles, California; Anahauc, Texas; Tilden, Illinois;
and Adairsville, Powers Crossroads and Rutledge, Georgia for total proceeds of
approximately $23.8 million. As discussed more fully in Note 8 of the notes to
the consolidated financial statements, cash used in investing activities during
1995 included the Company's investment in RuralVision Joint Venture, the
acquisition of certain wireless cable assets from RuralVision Joint Venture and
Cross Country Wireless, Inc., the acquisition of the Lubbock, Texas and Tulsa,
Oklahoma markets and payments made in connection with the CableMaxx, AWS and
Technivision Acquisitions. These uses of cash were partially offset by the sale
of wireless cable channel rights in five markets and the repayment of a $10.0
million note from Wireless One. Cash used in investing activities during 1994
included the Company's investment in RuralVision Joint Venture and the
acquisition of certain wireless cable assets from RuralVision Joint Venture.
Net cash provided by financing activities was $113.4 million in 1996,
$114.3 million in 1995 and $57.0 million in 1994. As discussed more fully in
Notes 3 and 8 of the notes to the consolidated financial statements, cash
provided by financing activities during 1996 includes the net proceeds from the
sale of $125 million of 14% Notes and $15 million of 13% Notes, partially offset
by payments on long-term debt assumed in the CableMaxx, AWS and Technivision
Acquisitions and the repayment of the Bank Facility. As discussed more fully in
Note 3 of the notes to the consolidated financial statements, cash provided by
financing activities during 1995 primarily represents the sale of $100 million
of 13% Notes. Cash provided by financing activities during 1994 includes the net
proceeds from the Company's initial public offering and the sale of the
Convertible Notes.
At March 20, 1997, the Company had approximately $55.0 million of
cash-on-hand and subscriber equipment in inventory and to be retrieved from
disconnected subscribers to add approximately 70,000 new subscribers. In
addition, the Company holds a $15.0 million note from CS Wireless, of which the
Company expects to receive approximately $7.3 million during 1997, upon the
consummation of certain asset sales by CS Wireless.
In an effort to conserve capital resources, the Company has suspended new
system launches for the next three to six months. Following such period, the
Company will determine an appropriate launch schedule based upon multiple
factors, including, but not limited to, the availability of capital resources
and the number of wireless cable channels for which the Company has obtained FCC
licenses in such markets. In addition, the Company is currently in the process
of evaluating its Existing Systems in order to identify 15 to 20 Existing
Systems for aggressive subscriber growth. The remaining Existing Systems will be
operated to maximize cash flow, and the Company expects that subscriber
additions in these systems will be sufficient to replace churn. Offsetting these
cash savings are increased service calls anticipated by the Company during the
first half of 1997 in order to continue to improve picture quality, correct
installation deficiencies and add decoders at certain subscriber households. In
addition, during the first half of 1997, the Company anticipates increased
27
<PAGE> 28
expenses related to the retrieval of subscriber equipment due to subscriber
write-offs as of December 31, 1996. See "Management's Discussion and Analysis of
Financial Condition and Result of Operations -- Changes in Method for Reporting
Subscribers; Write-Offs." Furthermore, the Company may be required to modify or
replace its downconverters in certain markets due to potential interference from
"wireless communications services" or "WCS" anticipated to be auctioned by the
FCC in April 1997. The Company believes that the location of WCS spectrum and
the unregulated signal power level currently authorized for WCS could cause
interference to certain of the Company's wireless cable channels. The Company is
unable to quantify the cost of such modifications, if any. As a result of the
aforementioned factors, the Company estimates that its cash-on-hand will be
sufficient to fund its operations and debt service requirements through the
first quarter of 1998.
As a result of the offering of 13% Notes and 14% Notes and the possible
incurrence of additional indebtedness, the Company will be required to satisfy
certain debt service requirements. Following the disbursements in April 1997 and
April 1998 of all of the funds in the escrow accounts established in connection
with the 13% Note Indentures and the Indenture governing the 14% Notes (the "14%
Note Indenture"), respectively, a substantial portion of the Company's cash flow
will be devoted to debt service on the 13% Notes and 14% Notes, respectively.
The ability of the Company to make payments of principal and interest will be
largely dependent upon its future performance. Many factors, some of which will
be beyond the Company's control (such as prevailing economic conditions), may
affect its performance. There can be no assurance that the Company will be able
to generate sufficient cash flow to cover required interest and principal
payments when due on the 13% Notes, the 14% Notes or any other indebtedness of
the Company, including indebtedness incurred to the FCC in connection with the
BTA Auction. If the Company is unable to make interest and principal payments in
the future, it may, depending upon the circumstances which then exist, seek
additional equity or debt financing, attempt to refinance its existing
indebtedness or sell all or part of its business or assets to raise funds to
repay its indebtedness.
Despite the Company's efforts to conserve capital resources and to maximize
cash flow, the Company does not expect that sufficient cash flow will be
generated to fund subscriber growth and new system development after the first
quarter of 1998 and beyond. As a result, in order to continue growing the
Company's subscriber base and to launch future operating systems, the Company
will be required to seek external sources of funding to satisfy its capital
needs. Such sources of funding may be financed in whole or in part directly by
the Company and/or by its existing or future subsidiaries, through debt or
equity financings, joint ventures or other arrangements. As in the past, the
Company may also seek capital through the sale of its existing portfolio
wireless cable channel rights. There can be no assurance that the sale of the
Company's existing portfolio of wireless cable channel rights or sufficient debt
or equity financing will be available on satisfactory terms and conditions, if
at all. Failure to obtain such additional funds could adversely affect the
growth and cash flow of the Company and would require the Company to suspend its
subscriber growth and new system development plans.
CHANGES IN METHOD FOR REPORTING SUBSCRIBERS; WRITE-OFFS.
Effective December 31, 1996, the Company changed its methodology for
reporting subscribers in multiple dwelling units ("MDUs"). MDU subscribers who
receive bills directly from the Company, who previously had been reported using
an equivalent basic unit ("EBU") rate of $9.05, have been reclassified as
individually-billed units, similar to single family units ("SFU") subscribers.
In addition, under the new methodology, MDU subscribers who are billed in bulk
to the MDU owner have been converted to SFU subscribers using an EBU rate of
$17.95, as opposed to $9.05 under the old methodology. These methodology changes
resulted in a reduction to the Company's reported subscriber base at December
31, 1996 of approximately 26,300 subscribers. As adjusted, during the fourth
quarter of 1996, the Company's direct-billed MDU subscriber base generated
average monthly revenue per subscriber of $27.31 and the Company's bulk-billed
MDU subscribers generated average monthly revenue per subscriber of $17.95,
versus $9.05 during the third quarter of 1996 for both direct and bulk-billed
MDU subscribers. MDU and EBU subscriber reporting conventions are subjective,
and any changes in methodology that decrease subscriber count result in a
corresponding increase in average revenue per subscriber. The Company believes
that using the revised EBU
28
<PAGE> 29
rate of $17.95 and reclassifying individually billed units more accurately
reflects the revenue derived from these subscribers, and will minimize the
impact on monthly revenue per subscriber resulting from future changes in the
number of MDU subscribers relative to SFU subscribers.
Separately, the Company has identified approximately 33,000 subscribers
with delinquent balances to whom it does not expect to provide service in the
future. Of these subscribers, approximately 20,700 were "soft disconnect"
subscribers who, as of December 31, 1996, had past due account balances. Soft
disconnect subscribers are subscribers who are past due on their bills and are
not receiving service whose equipment has not been recovered. The remaining
approximate 12,300 subscribers were active subscribers at December 31, 1996 that
the Company has disconnected or intends to disconnect during the first quarter
of 1997. The Company has written off all 33,000 subscribers and the accounts
receivable related to such subscribers as of December 31, 1996. In addition, the
Company has written off as a charge to depreciation expense, the unamortized
balance of capitalized labor, sales commissions and non-recoverable equipment
related to such subscribers.
Generally, the Company defines an "active subscriber" as a subscriber
receiving programming service with an outstanding receivable balance of less
than 60 days past due or a subscriber that has a pay-out plan with the Company.
In no event will a subscriber with an outstanding balance greater than 90 days
past due be counted in the Company's subscriber base.
Including the year-end subscriber write-off and the change in methodology
for reporting MDU subscribers, the Company's monthly churn rate was 9.6% and
4.1% for the fourth quarter and year ended December 31, 1996, versus 2.0% for
the third quarter ended September 30, 1996. Excluding the subscriber write-offs
and methodology changes for reporting MDU subscribers, and on a comparable basis
with prior periods, the Company's average monthly churn rate was 3.0% and 2.2%
for the fourth quarter and year ended December 31, 1996, versus 1.7% for the
third quarter ended September 30, 1996.
INCOME TAX MATTERS
The Company and certain of its subsidiaries will file a consolidated
Federal income tax return. Subsidiaries in which the Company owns less than 80%
of the voting stock will file separate Federal income tax returns. The Company
has had no material state or Federal income tax expense since inception. As of
December 31, 1996, the Company had approximately $68.1 million in net operating
losses for U.S. Federal for tax purposes, expiring in years 2008 through 2011.
The Company estimates that approximately $38 million of the above losses relate
to various acquisitions and as such are subject to certain limitations. In
addition, the Internal Revenue Code of 1986, as amended (the "Code"), limits the
amount of loss carryforwards that a company can use to offset future income upon
the occurrence of certain changes in ownership. As a result of the investment in
the Company by Hunt Capital Group, L.L.C., the Company's initial public offering
of its common stock in April 1994 and other transactions discussed more fully in
Note 6 of the notes to the consolidated financial statements, the Company has
undergone more than a 50% change in ownership. Management does not anticipate
any significant limitation on the use of the Company's net operating losses as a
result of such change in ownership.
INFLATION
Management does not believe that inflation has had or is likely to have any
significant impact on the Company's operations. Management believes that the
Company will be able to increase subscriber rates, if necessary, to keep pace
with inflationary increases in costs.
FUTURE OPERATING RESULTS
The Company's future revenues and profitability are difficult to predict
due to a variety of risks and uncertainties, including (i) business conditions
and growth in the Company's existing markets, (ii) the successful launch of
systems in new markets, (iii) the Company's existing indebtedness and the need
for additional financing to fund subscriber growth and system development, (iv)
government regulation, including FCC regulations, (v) the Company's dependence
on channel leases, (vi) the successful integration of future
29
<PAGE> 30
acquisitions and (vii) numerous competitive factors, including alternative
methods of distributing and receiving television transmissions.
The Company is currently in the process of reviewing and evaluating all of
its business operations, processes and systems and the Company has engaged
Arthur Andersen L.L.P. and others to assist the Company in this effort. In
addition, the Company is currently in the process of identifying 15 to 20
Existing Systems to target for aggressive marketing and subscriber growth. While
the Company plans to increase its subscriber base during 1997, the rate of
increase cannot be estimated with precision or certainty. In addition, the
Company cannot quantify the potential impact on its 1997 financial performance
resulting from the implementation of expense reductions, new business processes
and management information systems. Furthermore, successful selection, marketing
and operating of the 15 to 20 Existing Systems targeted for aggressive growth
will have a significant impact on the Company's 1997 operating and financial
performance.
Because of the foregoing uncertainties affecting the Company's future
operating results, past performance should not be considered to be a reliable
indicator of future performance, and investors should not use historical trends
to anticipate results or trends in future periods. In addition, the Company's
participation in a highly dynamic industry often results in significant
volatility in the price of the Company's Common Stock.
30
<PAGE> 31
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report................................ F-1
Consolidated Balance Sheets as of December 31, 1996 and
1995...................................................... F-2
Consolidated Statements of Operations for the Three Years
Ended December 31, 1996................................... F-3
Consolidated Statements of Stockholders' Equity for the
Three Years Ended December 31, 1996....................... F-4
Consolidated Statements of Cash Flow for the Three Years
Ended December 31, 1996................................... F-5
Notes to Consolidated Financial Statements.................. F-7
</TABLE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
IDENTIFICATION OF DIRECTORS
The following paragraphs set forth certain information concerning the
Company's directors at April 25, 1997, including any positions or offices held
with the Company, directorships in other companies, their ages and the date each
became a director:
Carroll D. McHenry, 54, joined the Company as Chairman of the Board,
President, Chief Executive Officer and Acting Chief Financial Officer in April
1997. For the past five years, Mr. McHenry was a senior executive at Alltel,
Inc., a national communications holding company, most recently serving as
President of Alltel's Communications Services Group, and serving as President of
Alltel Mobile Communications, Inc. from 1992 to 1995. From 1991 to 1992, Mr.
McHenry was Vice President of Cellular Business Development at Qualcomm, Inc.
From 1989 to 1991, Mr. McHenry was President, Chief Executive Officer and
Chairman of the Board of Celluland, Inc., a franchisor of cellular telephone
stores. From 1980 to 1989, Mr. McHenry served in various capacities with Mobile
Communications Corporation of America ("MCCA") and as President and Chief
Executive Officer of American Cellular Communications, a joint venture between
MCCA and BellSouth.
J. R. Holland, Jr., 53, began advising the Company as a consultant in
October 1992 and was Chairman of the Board of Directors from October 1993 until
March 1997. Mr. Holland is a member of the Compensation Committee of the Board
of Directors. Mr. Holland has been employed as President and Chief Executive
Officer of Unity Hunt, Inc. since September 1991. Unity Hunt, Inc. is a large
international, private holding company with interests in entertainment, cable
television, retail, investments, real estate, natural resources and energy
businesses. Mr. Holland is also the President and Chief Executive Officer of
Hunt Capital Group, L.L.C. ("Hunt Capital"), the Company's largest single
stockholder. See "Security Ownership of Certain Beneficial Owners and
Management." From November 1988 to September 1991, Mr. Holland was Chairman of
the Board and Chief Executive Officer of Nedinco, Inc., a large diversified,
international holding company. Prior to that, Mr. Holland was President and a
director of KSA Industries, Inc., a private, diversified company involved in
entertainment, retail, transportation and energy businesses, and President and a
director of Western Services International, Inc., a company involved in energy
services, equipment and chemicals. Mr. Holland began his career with Booz-Allen
& Hamilton, Inc., a major management consulting firm. In
31
<PAGE> 32
addition, Mr. Holland is currently a director of Placid Refining Company,
Optical Securities Group, Inc., TNP Enterprises, Inc., Wireless One, Inc. and CS
Wireless Systems, Inc.
Alvin H. Lane, Jr., 54, became a director of the Company in January 1994.
Mr. Lane is a member of the Audit Committee of the Board of Directors. In 1983,
Mr. Lane founded, and since then has been the President of, Lane and Associates,
a management consulting firm. Since October 1993, Mr. Lane has been the
President of AHL Finance Company, L.L.C. From 1972 to 1983, Mr. Lane was the
Chief Financial Officer and Secretary of the Dr Pepper Company. Mr. Lane is also
Chairman of the Board of Love Bottling Company, a soft drink bottling franchise.
Dennis M. O'Rourke, 54, became a director of the Company in January 1994.
Mr. O'Rourke is a member of the Compensation Committee of the Board of
Directors. In 1985, Mr. O'Rourke founded, and since then has been the Chairman
of the Board and Chief Executive Officer of, O'Rourke Companies Inc., a human
resources consulting firm. Prior to that, Mr. O'Rourke was employed in various
capacities by Boise Cascade Corporation, American Hospital Supply Corporation
and General Motors Corporation.
John A. Sprague, 44, became a director of the Company in January 1995. Mr.
Sprague is a member of the Compensation Committee of the Board of Directors.
Since March 1994, Mr. Sprague has been the managing partner of Jupiter Partners
L.P., an investment firm. See "Security Ownership of Certain Beneficial Owners,
Directors and Management." From January 1993 until February 1994, Mr. Sprague
was an independent investor. Prior to that, Mr. Sprague served as a General
Partner of Forstmann Little & Co., an investment firm.
L. Allen Wheeler, 64, a founder of the Company, has served as a director of
the Company since its formation in September 1990 and was Vice Chairman of the
Board of Directors from February 1996 until February 1997. From January 1997
until February 1997 Mr. Wheeler served as the acting President and Chief
Executive Officer of the Company. Mr. Wheeler is a member of the Audit Committee
of the Board of Directors. Mr. Wheeler has owned and managed diversified
investments through Allen Wheeler Management, Inc., a personal holding company,
for over 20 years. Mr. Wheeler's investments have emphasized the
media/communications industries. Mr. Wheeler has been a shareholder, director
and officer of several media/communications companies involved in network and
independent television stations, AM and FM radio stations, paging and telephony.
On March 29, 1997, the directors of the Company ratified and authorized the
CEO Search Committee comprised of Alvin H. Lane, Jr., Dennis M. O'Rourke and
John A. Sprague. It is currently contemplated that the slate of directors to be
proposed by management at the 1997 Annual Meeting of Stockholders will consist
of a representative of each of Jupiter Partners, L.P. ("Jupiter"), Hunt Capital
and L. Allen Wheeler, together with Carroll D. McHenry and three (3) independent
directors. See Item 1. "Business -- Recent Events."
IDENTIFICATION OF EXECUTIVE OFFICERS
The following table sets forth the executive officers of the Company as of
April 25, 1997. See "Identification of Directors" for a description of the
business experience of Mr. McHenry.
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Carroll D. McHenry...................... 54 Chairman of the Board, President, Chief Executive
Officer and Acting Chief Financial Officer
Randall C. May.......................... 35 Vice President -- Operations
Wayne M. Taylor......................... 51 Vice President -- Administration
Christopher P. Dailledouze.............. 38 Vice President -- Technical Services
David D. Hagey.......................... 36 Vice President, Controller and Assistant Secretary
J. Curtis Henderson..................... 34 Vice President, General Counsel and Secretary
</TABLE>
32
<PAGE> 33
Randall C. May joined the Company in October 1994 as a Regional Manager.
Mr. May was appointed Director of System Development in March 1995 and
Vice-President -- Operations in February 1996. From 1988 to 1994 Mr. May worked
for Post-Newsweek Cable, most recently serving as General Manager of certain
cable television and radio properties. From 1983 to 1988, Mr. May served as Vice
President -- Area Manager for Sooner Cable Television Inc., an independent cable
television company.
Wayne M. Taylor joined the Company in February 1996 as Director of
Administration and was appointed Vice President -- Administration in February
1996. From May 1989 to February 1996, Mr. Taylor was a Group Controller at
Borden, Inc. From 1972 to 1989 Mr. Taylor was employed by Frito Lay, most
recently as a Group Manager -- Finance.
Christopher P. Dailledouze joined the Company in March 1996 as Director of
Engineering and was appointed Vice President -- Technical Services in April
1997. From March 1992 to March 1996, Mr. Dailledouze was Director of Engineering
for American Wireless Systems, Inc. From April 1988 to March 1992, Mr.
Dailledouze was Chief Engineer for Galaxy Cablevision, Inc.
David D. Hagey joined the Company in June 1994 as Vice President,
Controller and Assistant Secretary. Prior to joining the Company, Mr. Hagey was
employed by KPMG Peat Marwick LLP for 11 years, most recently as Senior Manager.
J. Curtis Henderson joined the Company in May 1996 as Vice President,
General Counsel and Secretary. From July 1994 to April 1996, Mr. Henderson was
Senior Vice President, General Counsel and Secretary of ZuZu, Inc., a restaurant
and franchising company in Dallas, Texas. Prior to his employment at ZuZu, Mr.
Henderson was an associate with the Dallas law firm of Locke Purnell Rain
Harrell.
Executive officers of the Company are appointed by the Board of Directors
and serve at the discretion of the Board. Except as described in Item 11.
"Executive Compensation," the Company has no employment agreements with any
Named Executive Officer (as defined in Item 11. "Executive Compensation"). There
are no family relationships between members of the Board of Directors or any
executive officers of the Company.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act") requires the Company's officers and directors, and persons who
are beneficial owners of ten percent or more of the Company's Common Stock, to
file reports of ownership and changes in ownership of the Company's securities
with the SEC. Officers, directors and greater than ten percent beneficial owners
are required by applicable regulations to furnish the Company with copies of all
forms they file pursuant to Section 16(a).
Based solely upon a review of the copies of the forms furnished to the
Company, and written representations from certain reporting persons that no Form
5's were required, the Company believes that during the fiscal year ended
December 31, 1996, all filing requirements applicable to its officers, directors
and ten percent beneficial owners were complied with except for the following:
the late filing by Mr. Story of a Form 4, Statement of Changes in Beneficial
Ownership of Securities, with respect to his purchase of 2,000 shares of Common
Stock occurring in March 1996.
33
<PAGE> 34
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth a summary of the compensation of the
Company's Chief Executive Officer and the Company's four most highly compensated
executive officers who were serving as executive officers at the end of the
Company's last completed fiscal year (collectively, the "Named Executive
Officers") for services rendered in all capacities to the Company during the
Company's fiscal years ended December 31, 1996, 1995 and 1994.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
AWARDS
ANNUAL COMPENSATION ------------
------------------------------------ SECURITIES
OTHER ANNUAL UNDERLYING ALL OTHER
BONUS COMPENSATION OPTIONS/SARS COMPENSATION
NAME AND PRINCIPAL POSITION YEAR SALARY ($) ($)(1) ($)(2) (#) ($)
--------------------------- ---- ---------- ------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
David E. Webb(3)........................ 1996 $120,000 $80,000 $11,304 -- $4,600(4)
President and Chief Executive 1995 120,000 -- 6,088 -- --
Officer 1994 120,000 -- 7,306 -- --
L. Allen Wheeler(5)..................... 1996 120,000 -- 8,400 -- --
Vice Chairman of the Board 1995 -- -- -- -- --
1994 -- -- -- -- --
John R. Bailey(6)....................... 1996 110,000 45,000 9,899 100,000 6,000(4)
Senior Vice President -- Finance, 1995 90,000 45,000 7,800 60,000 --
Chief Financial Officer, 1994 90,000 -- 4,200 100,000 --
Treasurer and Secretary
Randy R. Hendrix(7)..................... 1996 100,000 45,000 6,512 46,000 3,300(4)
Senior Vice President -- 1995 90,000 45,000 5,568 24,000 --
Marketing 1994 90,000 -- 6,668 130,000 --
Robert R. Story(7)...................... 1996 100,000 45,000 8,400 85,000 800(4)
Senior Vice President -- 1995 60,000(8) -- -- 65,000 --
Operations
</TABLE>
- ---------------
(1) Bonuses paid relate to prior fiscal year.
(2) Other annual compensation is comprised of car allowances.
(3) Mr. Webb resigned as the President and Chief Executive Officer of the
Company in January 1997 and from the Board of Directors of the Company in
March 1997.
(4) Represents Company 401(k) Retirement Plan contributions.
(5) Mr. Wheeler became an employee of the Company in March 1996. Mr. Wheeler did
not receive any compensation from the Company, other than certain rental
income paid by the Company to an affiliate for its operating and marketing
offices and warehouse space, during the years ended December 31, 1995 and
1994. See "Certain Transactions and Relationships." Mr. Wheeler resigned
from his position as Vice Chairman of the Board in February 1997, having
received approximately $95,000 in salary to such date.
(6) Mr. Bailey resigned as the Senior Vice President -- Finance, Chief Financial
Officer, Treasurer and Secretary of the Company in March 1997.
(7) Messrs. Hendrix and Story resigned from their respective positions with the
Company in March 1997.
(8) Includes $37,500 paid by the Company in the form of consulting fees.
34
<PAGE> 35
The following table sets forth, for the fiscal year ended December 31,
1996, the number of individual grants of stock options made during such fiscal
year to each of the Named Executive Officers. All options granted during the
last fiscal year were granted pursuant to the Company's 1994 Employee Stock
Option Plan, as amended (the "Employee Option Plan") at an exercise price equal
to the fair market value on the date of grant.
OPTION/SAR GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE VALUE
AT ASSUMED ANNUAL RATES OF
STOCK PRICE APPRECIATION FOR
INDIVIDUAL GRANTS OPTION TERM(1)
------------------------------------------------- -----------------------------
NUMBER OF
SECURITIES PERCENT OF
UNDERLYING TOTAL
OPTIONS/ OPTIONS/SARS EXERCISE
SARS GRANTED TO OR BASE
GRANTED EMPLOYEES IN PRICE EXPIRATION
NAME (#) FISCAL YEAR ($/SH) DATE 5% ($) 10% ($)
- ---------------------------------------- ---------- ------------ -------- ---------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
David E. Webb(2)........................ -- -- -- -- -- --
L. Allen Wheeler........................ -- -- -- -- -- --
John R. Bailey.......................... 100,000(3) 19.8% $25.50 2/26/2003 $1,038,102 $2,419,228
Randy R. Hendrix........................ 46,000(3) 9.1% $25.50 2/26/2003 $ 477,527 $1,112,845
Robert R. Story......................... 85,000(3) 16.8% $25.50 2/26/2003 $ 882,387 $2,056,344
</TABLE>
- ---------------
(1) Potential realizable value is based on the assumption that the price of the
Company's Common Stock appreciates at the annual rate shown, compounded
annually, from the date of grant until the end of the seven-year option
term. The values are calculated in accordance with rules promulgated by the
SEC and do not reflect the Company's estimate of future stock price
appreciation.
(2) Pursuant to the terms of the Employee Option Plan, Mr. Webb was not eligible
to receive stock option grants thereunder.
(3) Non-qualified options granted at an exercise price equal to fair market
value on the date of grant vest at a rate of 20% per year, subject to
acceleration upon the death of the optionee or termination of the optionee
following a Change of Control (as defined in the option agreements), and
have a term of seven years.
The following table sets forth information with respect to each exercise of
stock options during the fiscal year ended December 31, 1996 by each of the
Named Executive Officers and the number of options held at fiscal year end and
the aggregate value of in-the-money options held at fiscal year end.
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND
FY-END OPTION/SAR VALUES
<TABLE>
<CAPTION>
SHARES
ACQUIRED NUMBER OF SECURITIES VALUE OF UNEXERCISED IN-
ON VALUE UNDERLYING OPTIONS/SARS THE-MONEY OPTIONS/SARS
EXERCISE REALIZED AT FISCAL YEAR-END (#) AT FISCAL YEAR-END ($)
NAME (#) ($) EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
---- -------- -------- -------------------------- --------------------------
<S> <C> <C> <C> <C>
David E. Webb.................. -- -- -- --
L. Allen Wheeler............... -- -- -- --
John R. Bailey................. -- -- 76,000/144,000 $105,000/$52,500
Randy R. Hendrix............... -- -- 118,400/81,600 $273,000/$68,250
Robert R. Story................ -- -- 13,000/137,000 $0/$0
</TABLE>
Non-employee directors receive an annual fee of $5,000 and a meeting fee of
$500 per meeting attended, plus reimbursement of out-of-pocket expenses, for
their services as directors of the Company. In addition, each non-employee
director of the Company is entitled to receive stock options under the Company's
Stock Option Plan for Non-Employee Directors (the "Non-Employee Directors Plan")
for his services as a director. See Item 11. "Executive Compensation -- Stock
Option Plans -- Stock Option Plan for Non-Employee
35
<PAGE> 36
Directors." Directors who are also employees do not receive any additional
compensation for their services as directors.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Compensation Committee of the Board of Directors is comprised on
Messrs. Holland, O' Rourke and Sprague. Mr. Holland is a director of the Company
and an affiliate of Hunt Capital, a principal stockholder of the Company. Mr.
Sprague is indirectly a controlling general partner of Jupiter, the holder of
$40.0 million gross proceeds of the Company's Convertible Notes.
Unity Hunt, Inc., an affiliate of Hunt Capital of which Mr. Holland is
President, received management fees during 1996 totaling $120,000 for services
provided to the Company by Mr. Holland.
Mr. Holland, a director of the Company during 1996, serves on the Board of
Directors of Wireless One and CS Wireless. Mr. Holland also serves on the
Compensation Committee of the Board of Directors of Wireless One and CS
Wireless. Mr. Webb, formerly a director and executive officer of the Company,
served on the Board of Directors of Wireless One during 1996 and continues to
serve on the Board of Directors of CS Wireless.
STOCK OPTION PLANS
Employee Stock Option Plan. The Company adopted, effective upon
consummation of the Company's initial public offering, the Employee Option Plan,
which provides for the grant to officers and employees of both "incentive stock
options" within the meaning of Section 422 of the Code and stock options that
are non-qualified for Federal income tax purposes. As of April 25, 1997, there
were six executive officers and approximately 1,350 employees eligible to
receive options under the Employee Option Plan. The total number of shares of
Common Stock for which options may currently be granted pursuant to the Employee
Option Plan is 1,950,000. The Employee Option Plan will terminate on April 21,
2004. An Equity Subcommittee of the Compensation Committee (comprised of Messrs.
O'Rourke and Sprague) determines which of the Company's officers and employees
receive options, the time when options are granted, whether the options are
incentive stock options or non-qualified stock options, the terms of such
options, the exercise date of any options and the number of shares subject to
options. Members of the Equity Subcommittee are not eligible to receive options
under the Employee Option Plan. Directors who are also employees are eligible to
receive options under the Employee Option Plan. Non-employee directors are not
eligible to receive options under the Employee Option Plan.
The exercise price of incentive stock options granted under the Employee
Option Plan may not be less than 100% of the fair market value of the Common
Stock at the time of grant and the term of any option may not exceed 10 years.
With respect to any employee who owns stock representing more than 10% of the
voting power of the outstanding capital stock of the Company, the exercise price
of any incentive stock option may not be less than 110% of the fair market value
of such shares at the time of grant and the term of such option may not exceed
five years.
The exercise price of a non-qualified stock option is determined by the
Equity Subcommittee on the date the option is granted. However, the exercise
price of a non-qualified stock option may not be less than 100% of the fair
market value of the Common Stock at the time of grant.
Options granted under the Employee Option Plan are nontransferable and,
with certain exceptions in the event of the death or disability of an optionee,
may be exercised by the optionee only during employment. Options granted under
the Employee Option Plan typically vest over a five-year period, although
certain options granted to certain employees (including Messrs. Bailey and
Hendrix) were 40% vested upon grant and vested an additional 20% per year over a
three-year period. Upon the death of an optionee or the termination of the
optionee following a Change of Control (as defined in the option agreements),
the vesting of an option accelerates. Options granted under the Employee Option
Plan expire after seven years, unless terminated earlier.
In April 1997, the Company entered into Separation Agreements with former
executive officers John Bailey, Randy Hendrix and Robert Story. As a part of
such Separation Agreements, the Company agreed
36
<PAGE> 37
(i) that all options previously granted to such individuals would vest pursuant
to the vesting schedules in such individuals' original option agreements through
April 21, 1997, and (ii) to extend the termination period of such vested options
in the event of termination of employment, death and disability until December
31, 1999.
As of April 25, 1997 options to purchase an aggregate of 1,428,367 shares
of Common Stock were outstanding under the Employee Option Plan to 45 current
and former employees, at a weighted average exercise price per share equal to
$9.68.
Stock Option Plan for Non-Employee Directors. The Company adopted, also
effective upon consummation of the Company's initial public offering, the
Heartland Wireless Communications, Inc. 1994 Stock Option Plan for Non-Employee
Directors, Non-Employee Directors ("Non-Employee Directors Plan"). The purpose
of the Non-Employee Directors Plan is to attract and retain the services of
experienced and knowledgeable independent directors of the Company for the
benefit of the Company and its stockholders and to provide additional incentive
for such directors to continue to work for the best interests of the Company and
its stockholders through continuing ownership of Common Stock. A total of 50,000
shares of Common Stock may be issued through the exercise of options granted
pursuant to the Non-Employee Directors Plan. No option may be granted under the
Non-Employee Directors Plan after April 21, 2004.
The Non-Employee Directors Plan is administered by the Board of Directors.
Subject to the terms of the Non-Employee Directors Plan, the Board of Directors
has the sole authority to determine questions arising under, and to adopt rules
for the administration of, the Non-Employee Directors Plan. The Non-Employee
Directors Plan may be terminated at any time by the Board of Directors, but such
action will not affect options previously granted pursuant thereto.
Directors of the Company who are not, and who have not been during the
immediately preceding 12-month period, employees of the Company or any
subsidiary of the Company (each, a "Non-Employee Director") are automatically
participants in the Non-Employee Directors Plan. There are currently three
directors, Messrs. Lane, O'Rourke, and Sprague, who are eligible to receive
options under the Non-Employee Directors Plan. More than one option may be
granted to any one person and be outstanding at any time.
Each non-employee director who was in office on the consummation of the
initial public offering (including Messrs. Lane and O'Rourke) was, upon such
consummation, automatically granted an option to acquire 4,000 shares of Common
Stock at an exercise price per share equal to $10.50 Each Non-Employee Director
who is in office on November 15 of any year will, on the immediately succeeding
January 1, automatically be granted an option to acquire 2,000 shares of Common
Stock. The price of shares that may be purchased upon exercise of an option is
the fair market value of the Common Stock on the date of grant, as evidenced by
the average of the high and low sales prices of Common Stock on such date as
reported on the Nasdaq National Market. Options granted pursuant to the
Non-Employee Directors Plan, except as discussed below, are exercisable in
installments of 25% upon each anniversary of the date of grant. The term of each
option, except as discussed below, is for a period not exceeding seven years
from the date of grant. Options may not be assigned or transferred except by
will or by operation of the laws of descent and distribution.
In the event of a Change in Control of the Company (as defined in the
Non-Employee Directors Plan), an option granted to a Non-Employee Director will
become fully exercisable if, within one year of such Change in Control, such
Non-Employee Director ceases for any reason to be a member of the Board of
Directors. Any exercise of an option permitted in the event of a Change of
Control must be made within 180 days of the relevant Non-Employee Director's
termination as a director of the Company.
37
<PAGE> 38
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding the ownership
of Common Stock with respect to (i) each person known by the Company to own
beneficially more than 5% of the outstanding shares of Common Stock, (ii) each
of the Company's directors, (iii) the Named Executive Officers as such term is
defined in Item 11. "Executive Compensation" and (iv) all directors and
executive officers as a group, in each case, as of April 25, 1997. Except as
otherwise indicated, each of the stockholders has sole voting and investment
power with respect to the shares beneficially owned. Unless otherwise indicated,
the address for each stockholder is c/o the Company, 200 Chisholm Place, Suite
200, Plano, Texas 75075.
<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP
-----------------------
SHARES PERCENT(1)
--------- ----------
<S> <C> <C>
Hunt Capital Group, L.L.C.(2)............................... 4,000,000 20.3%
L. Allen Wheeler............................................ 2,071,228 10.5
David E. Webb............................................... 1,401,235 7.1
Jupiter Partners, L.P.(3)................................... 3,214,864 14.1
Putnam Investments, Inc.(4)................................. 1,344,460 6.8
FMR Corp.(5)................................................ 1,168,067 5.9
Carroll D. McHenry.......................................... 75,000 *
J. R. Holland, Jr.(6)....................................... -- --
Alvin H. Lane, Jr.(7)....................................... 2,500 *
Dennis M. O'Rourke(8)....................................... 1,500 *
John A. Sprague(9).......................................... 500 *
John R. Bailey(10).......................................... 111,200 *
Randy R. Hendrix(11)........................................ 118,400 *
Robert R. Story(12)......................................... 25,500 *
All officers and directors as a group (11 persons)(13)...... 2,176,992 11.1
</TABLE>
- ---------------
* Less than 1%.
(1) Based on 19,666,027 shares of the Common Stock outstanding on April 25,
1997.
(2) Address is 4000 Thanksgiving Tower, 1601 Elm Street, Dallas, Texas 75201.
(3) Address is 30 Rockefeller Plaza, Suite 4525, New York, N.Y. 10112. Jupiter
is the holder of $40.0 million gross proceeds of the Convertible Notes.
Each Convertible Note is convertible into the number of shares of Common
Stock computed by dividing (i) the principal amount of the Convertible Note
(after taking into account accretions in value) by (ii) the Conversion
Price then in effect. The current Conversion Price is $15.34 per share.
(4) Putnam Investments, Inc. has reported on Schedule 13G dated January 27,
1997 that it was the beneficial owner of such shares and has stated that
(i) it has no voting power, except for 27,700 shares for which it has
shared voting power, and (ii) it has shared dispositive power with respect
to all of such shares. Putnam Investments, Inc. has indicated that it
shares with Putnam Investment Management, Inc. dispositive power as to
1,295,960 shares and with Putnam Advisory Company, Inc. voting power as to
27,700 shares and dispositive power as to 48,500 shares. Therefore, Putnam
Investments Management, Inc. and Putnam Advisory Company, Inc. have been
reported on such Schedule 13G as beneficially owning 1,295,960 (6.6%) and
48,500 (less than one percent) shares. Putnam Investment Management, Inc.
and Putnam Advisory Company, Inc. are each reported to be registered
investment advisors and wholly-owned subsidiaries of Putnam Investments,
Inc. Putnam Investments, Inc. is reported to be an investment company and a
wholly-owned subsidiary of Marsh & McLennan Companies, Inc. Marsh &
McLennan Companies, Inc. has disclaimed any beneficial ownership of such
shares. The address of each of Putnam Investments, Inc., Putnam Investments
Management, Inc. and Putnam Advisory Company, Inc. is One Post Office
Square, Boston, MA 02109. The Company is unaware of any subsequent changes
in beneficial ownership.
38
<PAGE> 39
(5) FMR Corp. ("FMR") has reported on Schedule 13G dated March 10, 1997 that it
was the beneficial owner of such shares and has stated that (i) it has sole
power to vote 108,500 shares and (ii) sole power to dispose of all of such
shares. FMR has indicated that Fidelity Management & Research Company, a
wholly owned subsidiary of FMR ("Fidelity") is the beneficial owner of
1,046,867 shares (5.36%) of the outstanding common stock as a result of
acting as investment adviser to various investment companies. Additionally,
FMR has reported that Edward C. Johnson 3d, Chairman of the Board of FMR,
FMR and the funds each has sole power to dispose of the 1,046,867 shares
owned by the funds. The 13G also indicates that Edward C. Johnson 3d and
Abigail P. Johnson may be deemed to form a controlling group with respect
to FMR. The address of each of FMR, Fidelity, Edward C. Johnson 3d and
Abigail P. Johnson is 82 Devonshire Street, Boston, Massachusetts 02109.
(6) Mr. Holland is the sole Manager and President of Hunt Capital. Hunt Capital
is owned by trusts, of which Mr. Holland serves as a trustee. Mr. Holland
disclaims beneficial ownership of the shares of Common Stock owned by Hunt
Capital.
(7) Includes 2,500 shares that Mr. Lane has the right to acquire upon the
exercise of stock options exercisable within 60 days.
(8) Includes 1,500 shares that Mr. O'Rourke has the right to acquire upon the
exercise of stock options exercisable within 60 days.
(9) Mr. Sprague is indirectly a controlling general partner of Jupiter.
Accordingly, Mr. Sprague may be deemed to be a beneficial owner of the
shares issuable to Jupiter on conversion of the Convertible Notes. Mr.
Sprague shares voting and investment power as to shares issuable to Jupiter
on conversion of the Convertible Notes with Terry J. Blumer. Mr. Sprague
disclaims beneficial ownership of such shares. Includes 500 shares that Mr.
Sprague has the right to acquire upon the exercise of stock options
exercisable within 60 days.
(10) Includes 108,000 shares that Mr. Bailey has the right to acquire upon the
exercise of stock options exercisable within 60 days.
(11) Includes 149,200 shares that Mr. Hendrix has the right to acquire upon the
exercise of stock options exercisable within 60 days.
(12) Includes 13,000 shares that Mr. Story has the right to acquire upon the
exercise of stock options exercisable within 60 days.
(13) Includes 27,500 shares that six directors and executive officers have the
right to acquire beneficial ownership of upon the exercise of stock options
and other rights exercisable within 60 days.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
During the year ended December 31, 1996, the Company paid $97,065 to an
accounting firm controlled by Mr. Webb for subscriber and payroll services
rendered to the Company.
The Company leases an aggregate of approximately 51,345 square feet for its
operating and marketing offices and warehouse space in Durant and Lindsay,
Oklahoma from affiliates of Messrs. Webb and Wheeler. The per annum rent for
such space is $139,452. The Company leases approximately 12,430 square feet for
its installation and operating offices in Durant, Oklahoma from an affiliate of
Messrs. Story, Webb and Wheeler. The per annum rent for such space is $62,150.
In October 1996 the Company purchased a paging franchise and paging assets
from an affiliate of Messrs. Webb and Wheeler for $123,250 for multiple-site
paging for Company employees.
39
<PAGE> 40
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents Filed as Part of the Report
1. Financial Statements
The following financial statements are filed as part of this Form
10-K:
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report................................ F-1
Consolidated Balance Sheets as of December 31, 1996 and
1995...................................................... F-2
Consolidated Statements of Operations for the three years
ended December 31, 1996................................... F-3
Consolidated Statements of Stockholders' Equity for the
three years ended December 31, 1996....................... F-4
Consolidated Statements of Cash Flows for the three years
ended December 31, 1996................................... F-5
Notes to Consolidated Financial Statements.................. F-7
</TABLE>
2. Financial Statement Schedules
The following financial statement schedules are filed as part of
this Form 10-K:
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report................................ S-1
Schedule II -- Valuation and Qualifying Accounts............ S-2
</TABLE>
Schedules other than the above have been omitted because they are either
not applicable or the required information has been disclosed in the financial
statements or notes thereto.
3. EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
2.1 -- Letter Agreement regarding formation of the Registrant
(filed as Exhibit 2.1 as the Registrant's Registration
Statement on Form S-1, File No. 33-74244 (the "Form
S-1"), and incorporated herein by reference)
2.2 -- Supplement to Letter Agreement regarding formation of the
Registrant (filed as Exhibit 2.2 to the Form S-1 and
incorporated herein by reference)
3.1 -- Restated Certificate of Incorporation of the Registrant
(filed as Exhibit 3.1 to the Form S-1 and incorporated
herein by reference)
3.2 -- Restated By-laws of the Registrant (filed as Exhibit 3.2
to the Form S-1 and incorporated herein by reference)
4.1 -- 1994 Employee Stock Option Plan of the Registrant (filed
as Exhibit 4.1 to the Registrant's Registration Statement
on Form S-8 (File No. 333-04263) and incorporated herein
by reference
4.2 -- Revised Form of Nontransferable Incentive Stock Option
Agreement under the 1994 Employee Stock Option Plan of
the Registrant (filed as Exhibit 4.2 to the Registrant's
Registration Statement on Form S-4, File No. 33-91930
(the "February 1996 Form S-4")and incorporated herein by
reference)
</TABLE>
40
<PAGE> 41
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
4.3 -- Revised Form of Nontransferable Non-Qualified Stock
Option Agreement under the 1994 Employee Stock Option
Plan of the Registrant (filed as Exhibit 4.3 to the
February 1996 Form S-4 and incorporated herein by
reference)
4.4 -- 1994 Stock Option Plan for Non-Employee Directors of the
Registrant (filed as Exhibit 4.4 to the Form S-1 and
incorporated herein by reference)
4.5 -- Form of Stock Option Agreement under the 1994 Stock
Option Plan for Non-Employee Directors of the Registrant
(filed as Exhibit 4.5 to the Form S-1 and incorporated
herein by reference)
4.6 -- Indenture between the Registrant and First Trust of New
York, National Association , as Trustee (the "Trustee")
(filed as Exhibit 4.20 to the Registrant's Registration
Statement on Form S-4, File No. 333-12577 (the "December
1996 Form S-4") and incorporated herein by reference)
4.7 -- Supplemental Indenture dated as of December 9, 1996,
between the Registrant and the Trustee (filed as Exhibit
4.21 to the December 1996 Form S-4 and incorporated
herein by reference)
4.8 -- Heartland Wireless Communications, Inc. 401(k) Plan
(filed as Exhibit 4.3 to the Registrant's Registration
Statement on Form S-8 (File No. 333-05943) and
incorporated herein by reference)
*10.1 -- Standard Form of MMDS License Agreement
*10.2 -- Standard Form of ITFS License Agreement
10.3 -- Form of Indemnity Agreement between the Registrant and
each of its directors (filed as Exhibit 10.3 to the Form
S-1 and incorporated herein by reference)
10.4 -- Noncompetition Agreement between the Registrant and J.R.
Holland, Jr. (filed as Exhibit 10.4 to the Form S-1 and
incorporated herein by reference)
10.5 -- Noncompetition Agreement between the Registrant and David
E. Webb (filed as Exhibit 10.5 to the Form S-1 and
incorporated herein by reference)
10.6 -- Noncompetition Agreement between the Registrant and John
R. Bailey (filed as Exhibit 10.6 to the Form S-1 and
incorporated herein by reference)
10.7 -- Noncompetition Agreement between the Registrant and Randy
R. Hendrix (filed as Exhibit 10.7 to the Form S-1 and
incorporated herein by reference)
10.8 -- Noncompetition Agreement between the Registrant and L.
Allen Wheeler (filed as Exhibit 10.9 to the Form S-1 and
incorporated herein by reference)
10.9 -- Building Lease Agreement dated June 1, 1990, between
Wireless Communications, Inc. and The Federal Building,
Inc. (filed as Exhibit 10.13 to the 1994 Form 10-K and
incorporated herein by reference)
10.10 -- Building Lease Agreement dated January 2, 1995, between
the Registrant and W&W Commercial Group, L.L.C. (filed as
Exhibit 10.14 to the 1994 Form 10-K and incorporated
herein by reference)
10.11 -- Building Lease Agreement dated May 1, 1994, between
Wireless Communications, Inc. and The Federal Building,
Inc.
10.12 -- Purchase Agreement among the Registrant, BT Securities
and Lazard (filed as Exhibit 10.17 to the February 1995
Form S-4 and incorporated herein by reference)
10.13 -- Building Lease Agreement dated November 20, 1995, between
the registrant and the Federal Building, Inc. (filed as
Exhibit 10.18 to the February 1996 Form S-4 and
incorporated herein by reference)
</TABLE>
41
<PAGE> 42
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
10.14 -- Office Lease dated April 10, 1996 between Merit Office
Portfolio Limited Partnership and the Registrant for the
Registrant's Plano, Texas office (filed as Exhibit 10.1
to the Form 10-Q Quarterly Report for the quarter ended
June 30, 1996 ("June 1996 Form 10-Q") and incorporated
herein by reference)
10.15 -- Sublease Agreement dated June 14, 1996 between the
Registrant and CS Wireless (filed as Exhibit 10.2 to the
June 1996 Form 10-Q and incorporated herein by reference)
*10.16 -- Building Lease Agreement dated February 1, 1996, as
amended June 1, 1996, between Registrant and National
Horizon Development, L.C.
*21 -- List of Subsidiaries
**23 -- Consent of KPMG Peat Marwick LLP
*27 -- Financial Data Schedule
</TABLE>
- ---------------
* Previously filed.
** Filed herewith.
(b) Reports on Form 8-K
During the fourth quarter of the year ended December 31, 1996, the Company
filed the following reports on Form 8-K:
(i) Current Report on Form 8-K dated December 20, 1996 with respect
to the sale of $125 million of its 14% Senior Notes.
(ii) Current Report on Form 8-K dated November 22, 1996 regarding
third quarter financial results.
42
<PAGE> 43
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Heartland Wireless Communications, Inc.:
We have audited the accompanying consolidated balance sheets of Heartland
Wireless Communications, Inc. and subsidiaries as of December 31, 1996 and 1995,
and the related consolidated statements of operations, stockholders' equity and
cash flows for each of the years in the three-year period ended December 31,
1996. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Heartland
Wireless Communications, Inc. and subsidiaries as of December 31, 1996 and 1995,
and the results of their operations and their cash flows for each of the years
in the three-year period ended December 31, 1996, in conformity with generally
accepted accounting principles.
As discussed in note 1(d) to the consolidated financial statements, the
Company changed its method of accounting for the direct costs and installation
fees related to subscriber installations in 1995.
KPMG Peat Marwick LLP
Dallas, Texas
March 24, 1997
F-1
<PAGE> 44
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND 1995
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
1996 1995
-------- --------
<S> <C> <C>
Current assets:
Cash and cash equivalents................................. $ 79,596 $ 23,143
Restricted assets -- investment in debt securities (note
3)..................................................... 21,215 12,324
Subscriber receivables, net of allowance for doubtful
accounts of $5,468 in 1996 and $961 in 1995............ 5,382 2,544
Prepaid expenses and other................................ 1,586 1,583
Assets held for sale (note 8)............................. -- 2,200
-------- --------
Total current assets.............................. 107,779 41,794
-------- --------
Investments in affiliates, at equity (notes 8 and 9)........ 68,095 14,077
Systems and equipment, net (notes 2, 3 and 8)............... 145,797 60,649
License and leased license investment, net of accumulated
amortization of $7,127 in 1996 and $1,095 in 1995 (note
8)........................................................ 129,725 60,421
Excess of cost over fair value of net assets acquired, net
of accumulated amortization of $1,691 in 1996 and $283 in
1995 (notes 4 and 8)...................................... 28,220 4,411
Restricted assets -- investment in debt securities (note
3)........................................................ 8,792 6,415
Note receivable from affiliate (note 8)..................... 16,275 --
Other assets, net........................................... 10,681 17,638
-------- --------
$515,364 $205,405
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 9,804 $ 6,863
Accrued expenses and other liabilities.................... 20,936 3,345
Current portion of long-term debt (note 3)................ 1,188 765
-------- --------
Total current liabilities......................... 31,928 10,973
-------- --------
Long-term debt, less current portion (note 3)............... 302,350 140,887
Deferred income taxes (note 6).............................. -- 1,628
Minority interests in subsidiaries (note 4)................. 239 229
Stockholders' equity (note 5):
Common stock, $.001 par value; authorized 50,000,000
shares, issued 19,584,229 shares in 1996 and 12,611,131
shares in 1995......................................... 20 13
Additional paid-in capital................................ 261,652 71,165
Accumulated deficit....................................... (80,551) (19,490)
Treasury stock at cost, 10,252 shares in 1996............. (274) --
-------- --------
Total stockholders' equity........................ 180,847 51,688
Commitments and contingencies (notes 7 and 11)..............
-------- --------
$515,364 $205,405
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-2
<PAGE> 45
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
THREE YEARS ENDED DECEMBER 31, 1996
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
1996 1995 1994
-------- -------- -------
<S> <C> <C> <C>
Revenues.................................................... $ 56,017 $ 15,300 $ 2,229
-------- -------- -------
Operating expenses:
Systems operations........................................ 21,255 4,893 762
Selling, general and administrative....................... 42,435 11,887 4,183
Depreciation and amortization............................. 39,323 6,234 1,098
-------- -------- -------
Total operating expenses.......................... 103,013 23,014 6,043
-------- -------- -------
Operating loss.................................... (46,996) (7,714) (3,814)
Other income (expense):
Interest income........................................... 3,811 2,860 380
Interest expense.......................................... (21,977) (13,717) (590)
Equity in losses of affiliates (notes 8 and 9)............ (18,612) (1,369) (387)
Other income (expense), net (note 8)...................... 4,981 (247) (227)
-------- -------- -------
Total other income (expense)...................... (31,797) (12,473) (824)
-------- -------- -------
Loss before income taxes and extraordinary item........... (78,793) (20,187) (4,638)
Income tax benefit (note 6)................................. 28,156 4,285 1,595
-------- -------- -------
Loss before extraordinary item............................ (50,637) (15,902) (3,043)
Extraordinary item -- loss on extinguishment of debt, net of
tax (note 3).............................................. (10,424) -- --
-------- -------- -------
Net loss.......................................... $(61,061) $(15,902) $(3,043)
======== ======== =======
Loss per common share:
Loss before extraordinary item............................ $ (2.74) $ (1.34) $ (.30)
Extraordinary item........................................ (.57) -- --
-------- -------- -------
Net loss.......................................... $ (3.31) $ (1.34) $ (.30)
======== ======== =======
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE> 46
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
THREE YEARS ENDED DECEMBER 31, 1996
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL
------------------ PAID-IN ACCUMULATED TREASURY
SHARES AMOUNT CAPITAL DEFICIT STOCK TOTAL
---------- ------ ---------- ----------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1993......... 8,000,000 $ 8 $ 5,030 $ (545) $ -- $ 4,493
Issuance of common stock pursuant
to initial public offering (note
5)............................... 2,415,000 2 22,350 -- -- 22,352
Issuance of common stock for
acquisitions (note 4)............ 694,280 1 6,278 -- -- 6,279
Net loss........................... -- -- -- (3,043) -- (3,043)
---------- --- -------- -------- ----- --------
Balance, December 31, 1994......... 11,109,280 11 33,658 (3,588) -- 30,081
Issuance of common stock for
minority interest acquisitions
(note 4)......................... 338,121 1 5,263 -- -- 5,264
Issuance of common stock for
acquisitions (note 8)............ 1,122,730 1 21,999 -- -- 22,000
Issuance of warrants (note 3)...... -- -- 4,200 -- -- 4,200
Exercise of stock options.......... 41,000 -- 396 -- -- 396
Gain on equity investment, net of
taxes of $3,318 (note 8)......... -- -- 5,649 -- -- 5,649
Net loss........................... -- -- -- (15,902) -- (15,902)
---------- --- -------- -------- ----- --------
Balance, December 31, 1995......... 12,611,131 13 71,165 (19,490) -- 51,688
Issuance of common stock for
acquisitions (note 8)............ 6,923,788 7 184,840 -- (274) 184,573
Exercise of stock options warrants
and other, including tax
benefit.......................... 49,310 -- 658 -- -- 658
Gain on equity investment, net of
taxes of $2,931 (note 8)......... -- -- 4,989 -- -- 4,989
Net loss........................... -- -- -- (61,061) -- (61,061)
---------- --- -------- -------- ----- --------
Balance, December 31, 1996......... 19,584,229 $20 $261,652 $(80,551) $(274) $180,847
========== === ======== ======== ===== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE> 47
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE YEARS ENDED DECEMBER 31, 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss.................................................. $(61,061) $(15,902) $ (3,043)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Depreciation and amortization.......................... 39,323 6,234 1,098
Deferred income tax benefit............................ (29,240) (4,285) (1,595)
Debt accretion and debt issuance cost amortization..... 4,331 4,467 301
Equity in losses of affiliates......................... 18,612 1,369 387
Gain on sale of assets................................. (5,279) (43) (16)
Extraordinary item -- debt extinguishment.............. 4,253 -- --
Changes in assets and liabilities, net of acquisitions:
Subscriber receivables............................... (2,568) (2,109) (57)
Prepaid expenses and other........................... (414) (955) (656)
Accounts payable, accrued expenses and other
liabilities....................................... 9,289 4,750 4,292
-------- -------- --------
Net cash provided by (used in) operating
activities...................................... (22,754) (6,474) 711
-------- -------- --------
Cash flows from investing activities:
Investment in affiliate................................... (3,050) (5,426) (12,431)
Distribution from affiliate............................... 58,340 10,000 --
Proceeds from assets held for sale........................ 24,139 3,423 --
Purchases of systems and equipment........................ (93,298) (43,151) (12,415)
Expenditures for licenses and leased licenses............. (2,382) (2,883) (3,354)
Purchases of debt securities.............................. (24,550) (24,120) --
Proceeds from maturities of debt securities............... 14,250 5,380 --
Acquisitions, net of cash acquired........................ (7,618) (38,723) (16,300)
Other..................................................... -- (953) --
-------- -------- --------
Net cash used in investing activities............. (34,169) (96,703) (46,500)
-------- -------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock and warrants....... $ -- 24,596 22,352
Proceeds from long-term debt.............................. 141,350 95,800 40,150
Payment of debt issuance costs and consent fees........... (12,973) (5,948) (2,395)
Payments on long-term debt................................ (13,017) -- --
Proceeds from short-term borrowings and notes payable..... 6,700 3,070 10,409
Payments on short-term borrowings and notes payable....... (9,233) (3,243) (11,947)
Other..................................................... 549 59 (1,609)
-------- -------- --------
Net cash provided by financing activities......... 113,376 114,334 56,960
-------- -------- --------
Net increase in cash and cash equivalents................... 56,453 11,157 11,171
Cash and cash equivalents at beginning of year.............. 23,143 11,986 815
-------- -------- --------
Cash and cash equivalents at end of year.................... $ 79,596 $ 23,143 $ 11,986
======== ======== ========
Cash paid for interest...................................... $ 14,434 $ 6,362 $ 297
======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE> 48
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1996
(TABLES IN THOUSANDS, EXCEPT PER SHARE DATA)
(1) GENERAL AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Description of Business
Heartland Wireless Communications, Inc. (the "Company") develops, owns and
operates wireless cable television systems, primarily in small to mid-size
markets located in the central United States. The Company currently has systems
in operation in 56 markets.
Wireless cable television is a new industry within the highly competitive
pay television industry. The Company's cable television systems face or may face
competition from several sources, such as traditional hard-wire cable companies,
satellite master antenna television systems, direct broadcast satellite and
other alternate methods of distributing and receiving television transmissions.
As the telecommunications industry continues to evolve, the Company may face
additional competition from new providers of entertainment and data services.
There can be no assurance that the Company will compete successfully with
existing or potential competitors in the pay television industry.
The growth of the Company's business requires substantial investment on a
continuing basis to finance capital expenditures related to subscriber growth
and system development. The Company believes that its cash and cash equivalents
and cash generated from operations will be sufficient to fund the Company's
operations and expansion at least through the first quarter of 1998. Additional
funds will be necessary to complete the launch, build-out and expansion of all
of the Company's wireless cable systems and to bring such systems to a mature
state. Such sources of funding may be financed in whole or in part directly by
the Company through debt or equity financings, joint ventures, the sale and/or
exchange of existing wireless cable channel rights, or other arrangements. There
can be no assurance that the Company will achieve positive cash flow from
operations, that the Company will consummate the sale of any wireless cable
channel rights or that sufficient debt or equity financing will be available to
the Company. In addition, subject to restrictions under its outstanding debt,
the Company may pursue other opportunities to acquire additional wireless cable
channel rights and businesses that may utilize the capital currently expected to
be available for its current markets. The amount and timing of the Company's
future capital requirements will depend upon a number of factors, including
programming costs, equipment costs, marketing costs, staffing levels, subscriber
growth and competitive conditions, many of which are beyond the control of the
Company. Failure to obtain any required additional financing could materially
affect the growth, cash flow or earnings/loss of the Company.
(b) Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its majority-owned subsidiaries. Significant intercompany balances and
transactions between the entities have been eliminated in consolidation.
(c) Investments in Debt Securities
Investments in debt securities at December 31, 1996 consist of U.S.
Treasury Notes which mature periodically through April 15, 1998. The Company has
the ability and intent to hold these investments until maturity and,
accordingly, has classified these investments as held-to-maturity investments.
Held-to-maturity investments are recorded at amortized cost, adjusted for
amortization of premiums or discounts. Premiums and discounts are amortized over
the life of the related held-to-maturity investment as an adjustment to yield
using the effective interest method. A decline in market value of the Company's
investments below cost that is deemed other than temporary results in a
reduction in carrying amount to fair value. The impairment is charged to
earnings and a new cost basis for the investment is established. As of December
31, 1996 and 1995, gross unrealized gains and losses related to the Company's
investments in debt securities were not material.
F-6
<PAGE> 49
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(d) Systems and Equipment
Systems and equipment are stated at cost and include the cost of
transmission equipment as well as subscriber installations. In the third quarter
of 1995, the Company changed, effective January 1, 1995, its method of
accounting for the direct costs and installation fees related to subscriber
installations to achieve a better matching of its revenues and expenses.
Pursuant to the change, the Company's policy is to capitalize the excess of
direct costs of subscriber installations over installation fees. These direct
costs include reception materials and equipment on subscriber premises,
installation labor and overhead charges, and direct commissions. Such
capitalized costs are amortized on a subscriber-by-subscriber basis over the
useful life of the asset for the recoverable portion of such costs and the
estimated average subscription term (presently four years) for the
nonrecoverable portion of such costs. Any unamortized balance of the
non-recoverable portion of the cost of a subscriber installation is fully
depreciated upon subscriber disconnect and the related cost and accumulated
depreciation are removed from the balance sheet.
Prior to the accounting change, the Company's policy was to expense all
direct commissions associated with subscriber installations and to recognize as
revenue all installation fees to the extent of selling costs (including direct
commissions) incurred to obtain subscribers. Historically, such selling costs
have exceeded installation fees. In addition, upon subscriber disconnect, the
Company continued to depreciate the full capitalized installation cost
subsequent to the disconnection. The Company has not presented the cumulative
effect of the change in accounting because the effect of this change on periods
prior to January 1, 1995 was not material. In addition, the results of
operations for any prior annual period would not differ materially from results
under the new method of accounting. The effect of this change on the results of
operations for the year ended December 31, 1995 was to decrease net loss by
approximately $1.1 million ($.09 per common share).
Depreciation and amortization of systems and equipment are recorded on a
straight-line basis for financial reporting purposes over useful lives ranging
from 4 to 10 years. Repair and maintenance costs are charged to expense when
incurred; renewals and betterments are capitalized.
Equipment awaiting installation consists primarily of accessories, parts
and supplies for subscriber installations and is stated at the lower of average
cost or market.
(e) License and Leased License Investment
License and leased license investment includes costs incurred to acquire
and/or develop wireless cable channel rights. Costs incurred to acquire channel
rights issued by the Federal Communications Commission ("FCC") are deferred and
amortized ratably over an estimated useful life of 15 years beginning with
inception of service in each respective market. As of December 31, 1996,
approximately $39.5 million of the license and leased license investment was not
yet subject to amortization.
(f) Excess of Cost over Fair Value of Net Assets Acquired
The excess of cost over fair value of net assets acquired is amortized on a
straight-line basis over the expected periods to be benefited, generally 15
years. The Company assesses the recoverability of this intangible asset by
determining whether the amortization of the balance over its remaining life can
be recovered through undiscounted future operating cash flows of the acquired
operation. The amount of impairment, if any, is measured based on projected
discounted future operating cash flows using a discount rate reflecting the
Company's average cost of funds. The assessment of the recoverability of excess
of cost over fair value of net assets acquired will be impacted if estimated
future operating cash flows are not achieved.
(g) Long-Lived Assets
The Company adopted the provisions of SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, on
January 1, 1996. This Statement requires that long-
F-7
<PAGE> 50
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
lived assets and certain identifiable intangibles be reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. Recoverability of assets to be held and used is
measured by a comparison of the carrying amount of an asset to future net cash
flows expected to be generated by the asset. If such assets are considered to be
impaired, the impairment to be recognized is measured by the amount by which the
carrying amount of the assets exceeds the fair value of the assets. Assets to be
disposed of are reported at the lower of the carrying amount or fair value less
costs to sell. The adoption of this Statement did not have a material impact on
the Company's financial position, results of operations, or liquidity.
The Company's estimates of future gross revenues and operating cash flows,
the remaining estimated lives of long-lived assets, or both could be reduced in
the future due to changes in, among other things, technology, government
regulation, available financing or competition. As a result, the carrying
amounts of long-lived assets, including excess of cost over fair value of net
assets acquired, could be reduced by amounts which would be material to the
financial statements.
In the fourth quarter of 1996, the Company reduced its estimates of the
useful lives of the nonrecoverable portion of subscriber installation costs,
license and leased license investment, and excess of cost over fair value of net
assets acquired. The amortization period related to the nonrecoverable portion
of subscriber installation costs was reduced from six years to four years to
correspond to the Company's current estimate of its average subscription term.
The estimated useful life of license and leased license investment and excess of
cost over fair value of net assets acquired was reduced from 20 years to 15
years. The effect of this change in estimate was to increase 1996 depreciation
and amortization expense by $3.4 million and increase 1996 net loss by $2.2
million and $.12 per share.
(h) Investments in Affiliates
The Company uses the equity method of accounting for investments in
affiliates where the ability to exercise significant influence over such
entities exists.
(i) Revenue Recognition
Revenues from subscribers are recognized in the period of service.
(j) Systems Operations
Systems operations expenses consist principally of programming fees,
channel lease costs, tower rental and other costs of providing services.
(k) Income Taxes
Deferred income taxes are recognized for the tax consequences in future
years of differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Deferred tax
assets and liabilities are measured using the enacted tax rates applicable to
the periods in which the differences are expected to affect taxable income.
Valuation allowances are established when necessary to reduce deferred tax
assets to the amount expected to be realized.
(l) Sales of Subsidiary and Affiliate Stock
Gains and losses from the sales of capital stock by the Company's
majority-owned subsidiaries and affiliates accounted for using the equity method
are recognized as equity transactions in consolidation.
F-8
<PAGE> 51
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(m) Net Loss Per Common Share
Net loss per common share is based on the net loss applicable to common
stock divided by the weighted average number of common shares outstanding of
18,473,000 for the year ended December 31, 1996, 11,866,000 for the year ended
December 31, 1995 and 10,041,000 for the year ended December 31, 1994.
Shares issuable upon exercise of stock options, warrants and convertible
debt are antidilutive and have been excluded from the calculation. Fully-diluted
loss per common share is not presented as it would not materially differ from
primary loss per common share.
(n) Statements of Cash Flows
The Company considers all highly liquid investments purchased with original
maturities of three months or less to be cash equivalents.
During the year ended December 31, 1995, the Company entered into capital
leases and noncompetition agreements of $872,000 and $315,000, respectively.
During the year ended December 31, 1996, the Company entered into capital leases
and a noncompetition agreement of $676,000 and $750,000, respectively.
(o) Stock Option Plans
Prior to January 1, 1996, the Company accounted for its stock option plans
in accordance with the provisions of Accounting Principles Board ("APB") Opinion
No. 25, Accounting for Stock Issued to Employees, and related interpretations.
As such, compensation expense would be recorded on the date of grant only if the
current market price of the underlying stock exceeded
the exercise price. On January 1, 1996, the Company adopted SFAS No. 123,
Accounting for Stock-Based Compensation, which permits entities to recognize as
expense over the vesting period the fair value of all stock-based awards on the
date of grant. Alternatively, SFAS No. 123 also allows entities to continue to
apply the provisions of APB Opinion No. 25 and provide pro forma net income and
pro forma earnings per share disclosures for employee stock option grants made
in 1995 and future years as if the fair-value based method defined in SFAS No.
123 had been applied. The Company has elected to continue to apply the
provisions of APB Opinion No. 25 and provide the pro forma disclosures of SFAS
No. 123.
(p) 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.
F-9
<PAGE> 52
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(2) SYSTEMS AND EQUIPMENT
Systems and equipment consists of the following at December 31, 1996 and
1995:
<TABLE>
<CAPTION>
1996 1995
-------- -------
<S> <C> <C>
Equipment awaiting installation............................. $ 14,114 $10,052
Subscriber premises equipment and installation costs........ 98,289 30,437
Transmission equipment and system construction costs........ 43,309 22,180
Office furniture and equipment.............................. 6,858 2,054
Buildings and leasehold improvements........................ 1,604 423
-------- -------
164,174 65,146
Accumulated depreciation and amortization................... 18,377 4,497
-------- -------
$145,797 $60,649
======== =======
</TABLE>
As of December 31, 1996, equipment awaiting installation and approximately
$225,000 of transmission equipment and system construction costs were not yet
subject to depreciation.
(3) LONG-TERM DEBT
Long-term debt at December 31, 1996 and 1995 consists of the following:
<TABLE>
<CAPTION>
1996 1995
-------- --------
<S> <C> <C>
Convertible Notes........................................... $ 48,239 $ 44,174
13% Senior Notes............................................ 111,565 96,010
14% Senior Notes............................................ 125,000
Other notes payable......................................... 18,734 1,468
-------- --------
303,538 141,652
Less current portion........................................ 1,188 765
-------- --------
$302,350 $140,887
======== ========
</TABLE>
On November 30, 1994, the Company consummated the private placement of
$40,150,000 in gross proceeds of 9% Convertible Subordinated Discount Notes (the
"Convertible Notes") pursuant to the terms of a Note Purchase Agreement. The
Convertible Notes accrete at a rate of 9% compounded semiannually, to an
aggregate principal amount of $62.4 million at November 30, 1999. Thereafter,
interest accrues at the rate of 9% per annum and is payable semiannually from
November 30, 1999 or earlier upon the occurrence of a Material Default (as
defined in the Note Purchase Agreement). The Convertible Notes mature on
November 1, 2004 and are subordinated as to all existing and future indebtedness
of the Company other than indebtedness that is expressly subordinated to the
Convertible Notes.
At the option of a holder, the Convertible Notes are convertible into
common stock of the Company at $15.34 per share (the "Conversion Price"). The
Convertible Notes are redeemable at the option of the Company at any time on or
after November 30, 1999 at 100% of the principal amount at maturity plus accrued
and unpaid interest. However, such redemption right is only available if the
market price of the Company's common stock exceeds 150% of the Conversion Price
for a specified trading period.
In April 1995, the Company consummated a private placement of 100,000 units
consisting of $100 million aggregate principal amount of 13% Senior Notes due
2003 (the "13% Senior Notes") and 600,000 warrants to purchase an equal number
of shares of common stock at an exercise price of $19.525 per share. The
warrants are exercisable beginning April 1996 and terminate in April 2000. For
financial reporting purposes, the warrants were valued at $4.2 million. In March
1996, the Company consummated a private placement of
F-10
<PAGE> 53
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
an additional $15 million aggregate principal amount of the 13% Senior Notes.
The 13% Senior Notes are redeemable, in whole or in part, at the option of the
Company at any time on or after April 15, 1999 at redemption prices ranging from
105.6% to 100% of par. Interest on the 13% Senior Notes is payable semiannually
on April 15 and October 15 of each year. The Company placed a portion of the net
proceeds realized from the sales of the 13% Senior Notes into an escrow account
for the payment of two years of interest on the 13% Senior Notes. The amounts
placed in the escrow account have been invested in U.S. Treasury Notes. As of
December 31, 1996, the escrow account amounted to $7.3 million and will be
utilized to fund the April 15, 1997 interest payment on the 13% Senior Notes.
In March 1996, the FCC concluded an auction for the award of initial
commercial wireless cable licenses for 487 basic trading areas ("BTAs") and six
additional BTA-like geographic areas around the country (the "BTA Auction"). The
Company was the winning bidder in 93 BTAs at a total cost of approximately $19.8
million. Under the terms of the BTA Auction, the Company remitted a $1.0 million
deposit at the commencement of the BTA Auction and, because the Company
qualified as a "small business" for purposes of the BTA Auction, subsequently
has been required to remit only 20% of the total committed amount (less the $1.0
million deposit), or approximately $3.0 million. The remaining 80% of the
committed amount, or approximately $15.8 million, bears interest at 9.5% and
will be paid over a 10-year period commencing in the fourth quarter of 1996. The
Company will be required to make quarterly interest payments for the first two
years and quarterly payments of principal and interest over the remaining eight
years.
Pursuant to the CS Wireless Transaction (as hereinafter defined), CS
Wireless Systems, Inc. ("CS Wireless") will reimburse the Company for all
amounts paid in the BTA Auction relating to 12 BTAs awarded to the Company at a
total cost of approximately $5.3 million. As of December 31, 1996, CS Wireless
had reimbursed the Company approximately $1.1 million. The remaining amount owed
to the Company of $4.4 million has been included in the investment in affiliates
at December 31, 1996.
In December 1996, the Company consummated a private placement of $125,000,000
aggregate principal amount of 14% Senior Notes due 2004 (the "14% Senior
Notes"). The 14% Senior Notes are redeemable, in whole or in part, at the option
of the Company at any time on or after October 15, 2002 at redemption prices
ranging from 102.333% to 100% of par. Interest on the 14% Senior Notes is
payable semiannually on April 15 and October 15 of each year. The Company placed
$22 million of the net proceeds realized from the sale of the 14% Senior Notes
into an escrow account for the payment of the first three interest payments on
the 14% Senior Notes. The amounts placed in the escrow account have been
invested in U.S. Treasury Notes. As of December 31, 1996, the escrow account
amounted to $22.3 million and will be utilized to fund the April 1997, October
1997 and April 1998 interest payments on the 14% Senior Notes.
The 13% Senior Notes, 14% Senior Notes and Convertible Notes contain
covenants that, among other things, prohibit or limit the ability of the Company
and its subsidiaries to pay dividends, to sell or lease channel rights, to make
certain acquisitions and incur certain indebtedness.
In September 1995, the Company engaged in the solicitation of consents from
the holders of the 13% Senior Notes to amend certain provisions of the indenture
to permit the Company to consummate the Wireless One Transaction, the CableMaxx,
AWS and Technivision Acquisitions and the CS Wireless Transaction (as
hereinafter defined) and additionally amend certain definitions and
covenants. The proposed amendments to the indenture became effective as of
October 2, 1995 upon the execution of a supplemental indenture. The Company paid
an aggregate of $955,000 to consenting holders in October 1995.
In October 1996, the Company engaged in the solicitation of consents from
the holders of its 13% Senior Notes to permit the Company to (1) issue the 14%
Senior Notes and (2) amend certain definitions and covenants in the 13% Senior
Note indentures related to, among other things, additional financing and
investment opportunities. As consideration for the consents, the Company paid
each holder who consented to the amendments $60 for each $1,000 principal amount
of 13% Senior Notes held by such holder. The
F-11
<PAGE> 54
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Company paid $5 of the consent payment upon the execution of a supplemental
indenture and $55 of the consent payment upon consummation of the offering
related to the 14% Senior Notes.
During December 1996, the Company consummated its private placement of the
14% Senior Notes and amended certain definitions and covenants in the 13% Senior
Note indentures. As a result of a substantive modification of the terms of the
debt due to the amount of consent fees paid, the transaction has been treated as
an extinguishment of the 13% Senior Notes. Accordingly, for financial reporting
purposes, the 13% Senior Notes have been treated as having been extinguished and
reissued upon the consummation of the offering of the 14% Senior Notes, and
recorded at their estimated fair value as of such date. The write-off of debt
issuance costs of $5.3 million related to the 13% Senior Notes, the consent
payments and certain other costs of $7.3 million, and the decrease in the 13%
Senior Notes of $1.1 million to reflect their estimated fair value have been
recorded as an extraordinary loss of $11.5 million, net of tax of $1.1 million.
The Company is currently highly leveraged, and it is expected to continue
to have a high level of debt for the foreseeable future. As a result of its
leverage and in order to repay existing indebtedness, the Company will be
required to generate substantial operating cash flow. The ability of the Company
to meet these requirements will depend on, among other things, prevailing
economic conditions and financial, business and other factors, some of which are
beyond the control of the Company.
Aggregate maturities of long-term debt as of December 31, 1996 for the five
years ending December 31, 2001 are as follows: 1997 -- $1.2 million;
1998 -- $1.4 million; 1999 -- $2.2 million; 2000 -- $1.6 million; and
2001 -- $1.7 million.
(4) MINORITY INTERESTS
In connection with the development of certain wireless cable television
markets, the Company sold stock in certain of its subsidiary companies
principally for cash. In addition to providing a portion of the cash necessary
for market development, the sales of subsidiary stock were intended to provide
for local community involvement and ownership in the related wireless cable
systems.
In April 1994, the Company acquired all of the outstanding minority
ownership interests held by the minority interest owner in six of the Company's
majority-owned subsidiaries in exchange for the issuance by the Company of
650,000 restricted shares of common stock. As a result of the acquisition, the
six subsidiaries became wholly-owned subsidiaries of the Company. Additionally,
at various dates during 1994, the Company acquired minority interests in certain
other subsidiaries for an aggregate of approximately $1.6 million in cash and
44,280 restricted shares of common stock. The acquisitions of the minority
ownership interests in 1994 were accounted for using the purchase method of
accounting. For financial reporting purposes, the total purchase price was
approximately $7,882,000 and assumed a value per share of $8.93 to $10.75 for
the restricted shares. A deferred tax liability of approximately $2.6 million
was recorded for differences between the assigned values and the tax bases of
assets and liabilities recognized in the acquisition of the minority interests.
A corresponding amount has been recorded as excess of cost over fair value of
net assets acquired.
In March 1995, the Company issued an aggregate of 304,038 registered shares
of common stock in exchange for minority interests in 21 subsidiaries (17 of
which are now wholly-owned). The acquisitions of the minority interests in 1995
were accounted for using the purchase method of accounting. For financial
reporting purposes, the total purchase price was approximately $5.1 million,
including out-of-pocket expenses of approximately $500,000. A deferred tax
liability of approximately $1.4 million was recorded for differences between the
assigned values and the tax bases of assets and liabilities recognized in the
acquisitions of the minority interests. A corresponding amount has been recorded
as excess of cost over fair value of net assets acquired.
F-12
<PAGE> 55
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(5) STOCKHOLDERS' EQUITY
(a) Public Offering
In April 1994, the Company completed an initial public offering of
2,100,000 shares of its common stock. In June 1994, the Company sold an
additional 315,000 shares of common stock upon exercise by the underwriters of
their over-allotment option. The aggregate net proceeds to the Company were
approximately $22.4 million.
(b) Stock Options
In April 1994, the Company adopted the 1994 Employee Stock Option Plan
which, as amended in May 1996, provides for the granting of options to purchase
a maximum of 1,950,000 shares of common stock. Options may be granted to key
employees at exercise prices of not less than 100% of the fair market value of
the common stock on the date of grant. Options typically vest over a five-year
period (although options granted to certain employees were 40% vested upon grant
and vest an additional 20% per year over a three-year period) and expire at the
end of option periods of not more than seven years.
During 1994, the Company also adopted the 1994 Stock Option Plan for
Non-Employee Directors which provides for the granting of options to purchase a
maximum of 50,000 shares of common stock. Generally, each non-employee director
will be granted on an annual basis an option to acquire 2,000 shares of common
stock at exercise prices equal to the fair market value of the common stock on
the date of grant. Options granted generally become exercisable in 25%
cumulative annual installments beginning one year from the date of grant and
expire at the end of option periods of not more than seven years.
At December 31, 1996, there were 717,500 additional shares available for
grant under the plans. The per-share weighted-average fair value of stock
options granted during 1996 and 1995 was $10.82 and $7.56 on the date of grant
using the Black-Scholes option-pricing model with the following weighted-average
assumptions used: expected dividend yield 0%, risk-free interest rate of 6.5% in
1996 and 6.75% in 1995, volatility of 36% and expected lives of five years.
The Company applies APB Opinion No. 25 in accounting for its plans and,
accordingly, no compensation cost has been recognized for its stock options in
the financial statements. Had the Company determined compensation cost based on
the fair value at the grant date for its stock options under SFAS No. 123, the
Company's net loss would have been increased to the pro forma amounts indicated
below:
<TABLE>
<CAPTION>
1996 1995
-------- --------
<S> <C> <C>
Net loss as reported........................................ $(61,061) $(15,902)
Net loss per share as reported.............................. (3.31) (1.34)
Net loss pro forma.......................................... $(66,622) $(18,707)
Net loss per share pro forma................................ (3.61) (1.58)
</TABLE>
Pro forma net loss reflects only options granted in 1996 and 1995.
Therefore, the full impact of calculating compensation cost for stock options
under SFAS No. 123 is not reflected in the pro forma net loss amounts presented
above because compensation cost is reflected over the options' vesting period of
three to five years and compensation cost for options granted prior to January
1, 1995 is not considered.
F-13
<PAGE> 56
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes the activity in stock options under these
plans:
<TABLE>
<CAPTION>
NUMBER WEIGHTED AVERAGE
OF OPTIONS EXERCISE PRICE
---------- ----------------
<S> <C> <C>
Granted.................................................. 543 $10.54
Cancelled................................................ (130) 10.50
------
Outstanding at December 31, 1994........................... 413 10.55
Granted.................................................. 371 16.73
Exercised................................................ (41) 10.50
------
Outstanding at December 31, 1995........................... 743 13.64
Granted.................................................. 514 25.09
Exercised................................................ (40) 10.50
Cancelled................................................ (16) 24.41
------
Outstanding at December 31, 1996........................... 1,201 18.50
======
</TABLE>
The following table summarizes information about stock options outstanding
at December 31, 1996:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
------------------------------------- OPTIONS EXERCISABLE
WEIGHTED- -----------------------
AVERAGE WEIGHTED- WEIGHTED-
NUMBER REMAINING AVERAGE NUMBER AVERAGE
RANGE OF OUTSTANDING CONTRACTUAL EXERCISE EXERCISABLE EXERCISE
EXERCISE PRICES AT 12/31/96 LIFE PRICE AT 12/31/96 PRICE
--------------- ----------- ----------- --------- ----------- ---------
<S> <C> <C> <C> <C> <C>
$10.50 to 15.75........................... 604,000 4.7 years $12.21 373,800 $11.93
15.76 to 23.64........................... 139,500 5.8 22.20 22,400 22.12
23.65 to 29.25........................... 458,000 6.2 33.19 -- --
10.50 to 29.25........................... 1,201,500 5.4 $18.50 396,200 $12.51
</TABLE>
At December 31, 1995, the number of options exercisable was 279,800 and the
weighted-average exercise price of those options was $11.71.
(6) INCOME TAXES
Income tax benefit related to continuing operations of $28.2 million, $4.3
million and $1.6 million for the years ended December 31, 1996, 1995 and 1994,
respectively, consists of a deferred tax benefit. In addition, deferred income
tax benefit of $1.1 million and $110,000 was allocated to the extraordinary item
and stockholders' equity, respectively, for the year ended December 31, 1996.
Income tax benefit for the years ended December 31, 1996, 1995 and 1994
differed from the amount computed by applying the U.S. federal income tax rate
of 35% to loss before income taxes as a result of the following:
<TABLE>
<CAPTION>
1996 1995 1994
-------- ------- -------
<S> <C> <C> <C>
Computed "expected" tax benefit...................... $(27,578) $(7,065) $(1,623)
Amortization of goodwill........................... 521 104 27
Loss for which no tax benefit was recognized....... -- 3,190 104
Other.............................................. (1,099) (514) (103)
-------- ------- -------
$(28,156) $(4,285) $(1,595)
======== ======= =======
</TABLE>
F-14
<PAGE> 57
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December 31,
1996 and 1995 are presented below:
<TABLE>
<CAPTION>
1996 1995
-------- -------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards.......................... $ 25,200 $ 6,988
Investments in affiliates................................. 263 841
Subscriber receivables.................................... 1,970 --
Debt restructuring........................................ 1,574 --
Other..................................................... 124 18
-------- -------
Total gross deferred tax assets................... 29,131 7,847
Less valuation allowance.................................. (20,011) (3,981)
-------- -------
Net deferred tax assets........................... 9,120 3,866
-------- -------
Deferred tax liabilities:
License and leased license investment..................... (8,308) (3,990)
Systems and equipment..................................... (812) (1,504)
-------- -------
Total gross deferred tax liabilities.............. (9,120) (5,494)
-------- -------
Net deferred tax liability........................ $ -- $(1,628)
======== =======
</TABLE>
The net changes in the total valuation allowance for the years ended
December 31, 1996 and 1995 were increases of $16.0 million and $3.2 million,
respectively. In assessing the realizability of deferred tax assets, the Company
considers whether it is more likely than not that some portion or all of the
deferred tax assets will not be realized. The ultimate realization of deferred
tax assets is dependent upon the generation of future taxable income during the
periods in which those temporary differences become deductible. The Company
considers the scheduled reversal of deferred tax liabilities, projected future
taxable income, and tax planning strategies in making this assessment. Based
upon these considerations, the Company has recognized deferred tax assets to the
extent such assets can be realized through future reversals of existing taxable
temporary differences.
As of December 31, 1996, the Company has approximately $68 million of
federal income tax loss carryforwards which expire in years 2008 through 2011.
The Company estimates that approximately $38 million of the above losses relate
to various acquisitions and are subject to certain limitations.
(7) LEASES AND FCC LICENSES
The Company is dependent on leases with third parties for most of its
wireless cable channel rights. Under FCC rules, the base term of each lease
cannot exceed the term of the underlying FCC license. FCC licenses for wireless
cable channels generally must be renewed every ten years, and there is no
automatic renewal of such licenses. The use of such channels by the lessors is
subject to regulation by the FCC and, therefore, the Company's ability to
continue to enjoy the benefits of these leases is dependent upon the lessors'
continuing compliance with applicable regulations. The remaining initial terms
of most of the Company's channel leases range from 5 to 10 years, although
certain of the Company's channel leases have initial terms expiring in the next
several years. Most of the Company's leases grant the Company a right of first
refusal to purchase the channels after the expiration of the lease if FCC rules
and regulations so permit, provide for automatic renewal of the lease term upon
FCC renewal of the license and/or require the parties to negotiate lease
renewals in good faith. Although the Company does not believe that the
termination of or failure to renew a single channel lease would adversely affect
the Company, several of such terminations or failures in one or more markets
that the Company actively serves could have a material adverse effect on the
Company. Channel rights lease agreements generally require payments based on the
greater of specified minimums or
F-15
<PAGE> 58
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
amounts based upon various subscriber levels. Additionally, FCC licenses also
specify construction deadlines, which, if not met, could result in the loss of
the license. Requests for additional time to construct may be filed and are
subject to review pursuant to FCC rules.
Payments under the channel rights lease agreements generally begin upon the
completion of construction of the transmission equipment and facilities and
approval for operation pursuant to the rules and regulations of the FCC.
However, for certain leases, the Company is obligated to begin payments upon
grant of the channel rights. Channel rights lease expense was $3.3 million, $2.1
million and $167,000 for the years ended December 31, 1996, 1995 and 1994,
respectively.
The Company also has certain operating leases for office space, equipment
and transmission tower space. Rent expense incurred in connection with other
operating leases was $3.5 million, $436,000 and $205,000 for the years ended
December 31, 1996, 1995 and 1994, respectively.
Future minimum lease payments due under channel rights leases and other
noncancellable operating leases at December 31, 1996 are as follows (in
thousands):
<TABLE>
<CAPTION>
CHANNEL OTHER
YEAR ENDING RIGHTS OPERATING
DECEMBER 31, LEASES LEASES
------------ ------- ---------
<S> <C> <C>
1997...................................................... $ 3,028 $ 4,558
1998...................................................... 3,043 4,099
1999...................................................... 3,046 3,593
2000...................................................... 3,046 1,173
2001...................................................... 2,855 478
------- -------
$15,018 $13,901
======= =======
</TABLE>
(8) ACQUISITIONS/DISPOSITIONS
(a) RuralVision Joint Venture
In August 1994, RuralVision Joint Venture ("RuralVision Joint Venture"), a
newly-formed general partnership in which each of the Company and Cross Country
Wireless, Inc. ("Cross Country") had a 50% interest, purchased certain assets
(the "Rural Vision Assets"), including five operating wireless cable systems and
channel rights in approximately 100 markets, from RuralVision Central, Inc. and
RuralVision South, Inc. (collectively, "RuralVision"). The aggregate purchase
price of approximately $50 million for the RuralVision Assets was comprised of a
$46 million note bearing interest at the rate of 8% per annum (the "RuralVision
Note") and approximately $4 million of acquisition-related costs paid primarily
by the Company and Cross Country.
In December 1994, the Company acquired an operating wireless cable system
and wireless cable channel rights in 37 other markets from RuralVision Joint
Venture for an aggregate purchase price of $14 million in cash. The Company
allocated the purchase price to the assets acquired and liabilities assumed
based on the estimated fair values of such assets and liabilities.
In January 1995, the Company, Cross Country and RuralVision Joint Venture
entered into the Venture Distribution Agreement, as a result of which the
Company (i) paid an additional $4.32 million in satisfaction of 50% of the
remaining balance of the RuralVision Note, (ii) paid $513,000 in satisfaction of
50% of the remaining balance of certain liabilities which RuralVision Joint
Venture had assumed, (iii) paid transaction costs of $592,000, and (iv) received
a distribution from RuralVision Joint Venture of an operating wireless cable
system and wireless cable channel rights in 36 other markets with a carrying
amount of approximately $17.4 million. As part of this transaction, the Company
granted to Cross Country the right to sell certain remaining RuralVision Joint
Venture assets to the Company for $3.25 million in May 1995. Cross Country
F-16
<PAGE> 59
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
subsequently exercised its right to sell these assets to the Company and, as a
consequence, the Company acquired such markets. In addition, in May 1995, the
Company ceased to be a joint venturer in RuralVision Joint Venture.
In connection with the Company's allocation of the purchase price of the
acquisition in December 1994, the Company identified wireless cable channel
rights in certain markets which management expected to sell and classified $12.5
million of such assets as assets held for sale. Based on management's analysis
of additional assets to be sold that were included in the assets distributed to
the Company as part of the January 27, 1995 Venture Distribution Agreement, the
assets held for sale increased to $21.5 million. During 1995, losses of $265,000
related to the assets held for sale (consisting primarily of rental expense
under channel rights lease agreements) were excluded from the statement of
operations and accounted for as an adjustment to the carrying amount of assets
held for sale. The Company received cash and notes of approximately $11 million
and $2.2 million during 1995 and 1996, respectively, related to the assets held
for sale. The remaining portion of assets originally classified as held for sale
has been allocated to the net assets of the respective markets based on
management's decision to retain such markets.
(b) Wireless One Transaction
In October 1995, the Company contributed certain assets and related
liabilities with respect to two operating wireless cable systems and certain
other wireless cable markets in Texas, Louisiana, Alabama, Georgia and Florida
to Wireless One, Inc. ("Wireless One") for consideration consisting of
approximately 35% of the outstanding common stock of Wireless One and
approximately $10 million of notes (the "Wireless One Transaction"). In October
1995, Wireless One completed an initial public offering of 3,000,000 shares of
its common stock and, concurrently therewith, consummated the sale of $150.0
million in gross proceeds of 13% Senior Notes due 2003. As a result and pursuant
to the merger agreement, Wireless One repaid the $10 million of notes from the
proceeds of the offerings. As a result of the initial public offering of
Wireless One, the Company's investment in Wireless One increased by $8,967,000
and its ownership interest decreased to approximately 26%. Such increase (net of
tax of $3,318,000) has been recorded by the Company as additional paid-in
capital in the accompanying 1995 consolidated statement of stockholders' equity.
During 1996, Wireless One completed additional equity transactions which
increased the Company's investment in Wireless One by $7.9 million and decreased
its ownership interest to approximately 20%. Such increase (net of tax of $2.9
million) has been recorded by the Company as additional paid-in capital in the
accompanying 1996 consolidated statement of stockholders' equity.
(c) CableMaxx, AWS and Technivision Acquisitions
Effective February 23, 1996, the Company acquired all the assets and
liabilities and succeeded to the businesses of American Wireless Systems, Inc.
and CableMaxx, Inc. and acquired substantially all of the assets and certain of
the liabilities and succeeded to all of the businesses of Fort Worth Wireless
Cable T.V. Associates, Wireless Cable TV Associates #38 and Three Sixty Corp.,
the successor to Technivision, Inc., for an aggregate of 6,757,000 shares of the
Company's common stock (the aforementioned five transactions are collectively
referred to herein as the "CableMaxx, AWS and Technivision Acquisitions").
The CableMaxx, AWS and Technivision Acquisitions were accounted for as a
purchase. The aggregate purchase price of approximately $190 million has been
allocated to the net assets acquired based on management's estimates of the fair
values of assets acquired and liabilities assumed. Excess purchase price over
the fair value of net assets acquired will be amortized on a straight-line basis
over 15 years.
(d) CS Wireless Transaction
Effective February 23, 1996, immediately following the closing of the
CableMaxx, AWS and Technivision Acquisitions, the Company, CAI Wireless Systems,
Inc. ("CAI") and CS Wireless consummated the
F-17
<PAGE> 60
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CS Wireless Participation Agreement pursuant to which the Company contributed a
substantial portion of the assets received in the CableMaxx, AWS and
Technivision Acquisitions and certain other assets to CS Wireless (the "CS
Wireless Transaction"). Simultaneously with the contribution of such assets by
the Company to CS Wireless, CAI also contributed to CS Wireless certain wireless
cable television assets.
In connection with the CS Wireless Transaction, the Company received (i)
shares of CS Wireless common stock constituting approximately 35% of the
outstanding shares of CS Wireless common stock, (ii) approximately $28.3 million
in cash paid at closing, (iii) a promissory note in the principal sum of $25.0
million payable on or before nine months from the closing and secured by
proceeds of a contemplated issuance by CS Wireless of senior discount notes
(which note has been prepaid) and (iv) a promissory note in the sum of $15.0
million (the "CS Wireless Note") payable ten years from closing and prepayable
from asset sales and certain other events. The interest rate on the CS Wireless
Note increases from 10% to 15% if such note is not repaid within one year of
issuance, with interest accruing and added to the balance annually. No cash
interest will be paid on the CS Wireless Note until the senior discount notes of
CS Wireless have been paid in full. CS Wireless, CAI and the Company are in the
process of completing certain post-closing net working capital calculations.
Components of such calculations include the relative accounts payable, accounts
receivable and related working capital assets of the contributed systems, the
number of granted channels represented and actually contributed to CS Wireless
for each market, the amount of any increase or decrease in the number of
subscribers in each contributed system from the number of subscribers stated in
the CS Wireless Participation Agreement and related factors. On November 8,
1996, CS Wireless made an initial payment of $5 million in cash to the Company
that will be applied to the final amount owed to the Company pursuant to the CS
Wireless Transaction. Following the completion of all calculations, additional
payments of cash and/or shares of CS Wireless common stock are expected to be
made to the Company by CS Wireless and/or CAI.
(e) Other Acquisitions/Dispositions
In December 1994, the Company acquired an operating wireless cable system
in the Lindsay, Oklahoma market for $2.3 million in cash. In May 1995, the
Company purchased an operating wireless cable system in the Lubbock, Texas
market for approximately $5.4 million in cash and wireless cable channel rights
in the Tulsa, Oklahoma market for approximately $2 million in cash and
forgiveness of a $2 million note receivable (see note 10).
In July 1995, the Company privately placed 1,029,707 shares of its common
stock to RuralVision Joint Venture in exchange for $20,000,000 in cash.
Immediately subsequent to the issuance of the shares to RuralVision Joint
Venture, the Company acquired substantially all of the remaining assets of
RuralVision Joint Venture, consisting primarily of wireless cable systems
located in Lykens, Ohio; Paragould, Arkansas; Sikeston, Missouri and channel
rights in additional markets located in five states for $20,000,000 in cash (the
"Cross Country Acquisition").
In January 1996, the Company acquired an operating wireless cable
television system in Champaign, Illinois for approximately $2.1 million in cash
and sold two nonoperating wireless cable markets for approximately $2.2 million
in cash. No gain or loss was recognized on the sale of the two nonoperating
markets.
In May 1996, the Company consummated the sale of the Memphis and Flippin,
Tennessee wireless cable markets for approximately $5.4 million in cash,
resulting in a gain of $.4 million related to the sale of the Flippin market. No
gain or loss was recognized on the sale of the Memphis market.
In June 1996, the Company sold the wireless cable channel rights in Los
Angeles, California for $8.95 million in cash at closing and $750,000 in notes
and deferred payments. The notes and deferred
F-18
<PAGE> 61
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
payments were paid subsequent to December 31, 1996. No gain or loss was
recognized on the sale of the Los Angeles wireless cable channel rights.
In June 1996, the Company acquired operating wireless cable systems in
George West and Kingsville, Texas for $350,000 in cash and 126,601 unregistered
shares of the Company's common stock.
In July 1996, the Company consummated the sale of wireless cable channel
rights in Adairsville, Powers Crossroads and Rutledge, Georgia to CS Wireless
for total consideration of approximately $7.2 million in cash, resulting in a
gain of $4.8 million.
In August 1996, the Company acquired an operating wireless cable system in
Gainesville/Rosston, Texas for approximately $1 million in cash and $1.4 million
in notes secured by the assets acquired.
All acquisitions have been accounted for as purchases, and operations of
the companies and businesses acquired have been included in the accompanying
consolidated financial statements from their respective dates of acquisition.
The Company allocated the purchase prices of the acquisitions consummated
in 1996, 1995 and 1994 discussed above to the assets acquired and liabilities
assumed based on estimated fair values of such assets and liabilities as
follows:
<TABLE>
<CAPTION>
1996 1995 1994
-------- ------- -------
<S> <C> <C> <C>
Working capital (deficit).............................. $(19,790) $ 858 $ 88
Assets held for sale................................... 11,819 -- 12,638
Systems and equipment.................................. 19,489 6,784 1,912
License and leased license investment and goodwill..... 88,292 43,856 1,662
Deferred income taxes.................................. (24,851) (1,404) --
-------- ------- -------
Total purchase price......................... $ 74,959 $50,094 $16,300
======== ======= =======
</TABLE>
(f) Pro Forma Information (Unaudited)
Summarized below is the unaudited pro forma information for the years ended
December 31, 1996 and 1995 as if the acquisitions/transactions discussed above
had been consummated as of the beginning of 1996 and 1995, after giving effect
to certain adjustments, including amortization of intangibles and selected
income tax effects. The pro forma information does not purport to represent what
the Company's results of operations actually would have been had such
transactions or events occurred on the dates specified, or to project the
Company's results of operations for any future period.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
----------------------
1996 1995
--------- ---------
<S> <C> <C>
Revenues.................................................... $ 58,353 $ 16,584
Net loss.................................................... (82,594) (17,546)
Net loss per common share................................... (4.17) (1.40)
</TABLE>
(g) Pending Acquisitions
The Company has entered into a nonbinding letter of intent to acquire one
wireless cable operating system in Iowa and wireless cable assets in one market
in each of Nebraska and Montana from CS Wireless. In addition, the Company has
agreed to sell to CAI certain wireless cable assets in Portsmouth, New
Hampshire. The Company will receive approximately 267,000 shares of common stock
of CS Wireless as its portion of the consideration for such assets. Also, the
Company has entered into an agreement with a third-party in which the parties
agreed to exchange certain wireless cable channel rights and related assets.
Each of the above agreements is subject to customary closing conditions. The
Company anticipates that these
F-19
<PAGE> 62
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
agreements will be consummated on or before June 30, 1997, although there can be
no assurance that any of these transactions will be consummated.
(9) INVESTMENTS IN AFFILIATES
Investments in affiliates consists of approximately 20% of the common stock of
Wireless One and approximately 34% of the common stock of CS Wireless. Wireless
One and CS Wireless develop, own and operate wireless cable television systems
primarily in the southeast and central United States, respectively. The
unamortized portion of the difference between the Company's investment in CS
Wireless and the Company's share of net assets of CS Wireless is $7.2 million at
December 31, 1996. Such amount is being amortized over 15 years based on CS
Wireless' estimated useful life of license and leased license investment. As of
December 31, 1996, the Company's investment in CS Wireless includes amounts due
to the Company from CS Wireless for certain BTAs (see note 3) and an additional
receivable, in the amount of $4.4 million and $.4 million, respectively.
Summary combined financial information for Wireless One and CS Wireless as
of and for the years ended December 31, 1996 and 1995 follows:
<TABLE>
<CAPTION>
1996 1995
--------- ---------
<S> <C> <C>
Current assets.............................................. $ 241,560 $ 129,363
Current liabilities......................................... 30,071 7,279
--------- ---------
Working capital............................................. 211,489 122,084
Systems and equipment....................................... 125,592 14,267
Other assets................................................ 439,855 70,170
Long-term debt.............................................. (570,386) (150,871)
--------- ---------
Stockholders' equity........................................ $ 193,428 $ 55,650
========= =========
Revenues $ 34,103 $ 1,410
========= =========
Net loss $ 68,197 $ 7,692
========= =========
</TABLE>
(10) RELATED PARTY TRANSACTIONS
The Company leases office space from entities owned by certain current and
former officers and directors of the Company for which the expense amounted to
approximately $187,000 in 1996, $66,000 in 1995 and $22,000 in 1994.
The Company paid $97,000 in 1996, $52,000 in 1995 and $51,000 in 1994 to an
affiliate of an officer and director of the Company for certain administrative
services. During 1995, an entity owned by a director of the Company was paid
$44,000 for certain marketing services. The Company paid $57,000 in 1995 to an
entity owned by a director for certain consulting services. The Company paid
$244,000 in 1994 to various affiliates for services performed in connection with
the development of wireless cable television systems or the acquisition of
wireless cable channel rights.
In 1996, in exchange for the delivery of certain equipment and receipt of a
promissory note in the principal amount of $400,000, the Company acquired a 10%
interest in a limited liability company formed to acquire and operate wireless
cable channel rights and operating systems in Chile. An affiliate of a former
employee of the Company holds a 22% interest in such limited liability company.
In 1996, the Company purchased a paging franchise and related equipment for
intra-Company use from an entity owned by certain current and former directors
and officers of the Company for $123,000.
F-20
<PAGE> 63
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In December 1994, the Company entered into an agreement with a stockholder
and its affiliate pursuant to which the Company loaned $2 million to the
stockholder secured by 300,000 shares of the Company's common stock owned by the
stockholder and all of the affiliate's assets in and to the Tulsa, Oklahoma
wireless cable market. The loan bore interest at 12% per annum with all accrued
interest and the outstanding principal balance being repaid in June 1995. In
addition, in December 1994, the affiliate granted to the Company an option for
the Company to acquire the Tulsa, Oklahoma wireless cable market. The purchase
price of $4 million paid upon the exercise of the option in May 1995 included
forgiveness of the note receivable (see note 8).
(11) COMMITMENTS AND CONTINGENCIES
The Company has entered into a series of noncancellable agreements to
purchase entertainment programming for retransmission which expire through 2000.
The agreements generally require monthly payments based upon the number of
subscribers to the Company's systems, subject to certain minimums.
The Company is a party to legal proceedings incidental to its business
which, in the opinion of management, are not expected to have a material adverse
effect on the Company's consolidated financial position, liquidity or operating
results.
(12) FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the carrying amounts and estimated fair values
of the Company's financial instruments at December 31, 1996 and 1995. The fair
value of a financial instrument is defined as the amount at which the instrument
could be exchanged in a current transaction between willing parties.
<TABLE>
<CAPTION>
1996 1995
---------------------- ----------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Restricted assets -- investments in
debt securities................... $ 30,007 $ 28,802 $ 18,739 $ 18,626
Note receivable from affiliate...... 16,275 16,275 -- --
Long-term debt...................... (303,538) (303,538) (141,652) (170,745)
</TABLE>
The following methods and assumptions were used to estimate the fair value
of each class of financial instrument:
Cash and cash equivalents, accounts receivable and accounts payable:
The carrying amounts of these assets and liabilities approximate fair value
because of the short maturity of these instruments.
Investments in debt securities: The fair values of debt securities are
based on quoted market prices at the reporting date for those investments.
Long-term debt: The fair values of the Company's 13% Senior Notes, 14%
Senior Notes and Convertible Notes are based on market quotes obtained from
dealers.
Note receivable from affiliates: The carrying amount of this asset
approximates fair value since the interest rates equate to market rate of
interest.
F-21
<PAGE> 64
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(13) QUARTERLY FINANCIAL DATA (UNAUDITED)
The following summarizes the Company's unaudited quarterly results of
operations for 1996:
<TABLE>
<CAPTION>
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
-------- -------- ------------ -----------
<S> <C> <C> <C> <C>
Year ended December 31, 1996:
Revenues............................ $ 9,512 $ 13,801 $15,651 $ 17,053
Operating loss...................... (3,410) (5,644) (7,176) (30,766)
Loss before extraordinary item...... (8,244) (10,404) (5,443) (26,546)
Net loss............................ (8,244) (10,404) (5,443) (36,970)
Loss per share before extraordinary
item............................. (.54) (.54) (.28) (1.36)
Net loss per share.................. (.54) (.54) (.28) (1.89)
</TABLE>
During the fourth quarter of 1996, the Company recorded bad debt expense
and associated depreciation of nonrecoverable costs of $5.2 million and $5.2
million, respectively, related to certain subscribers with past due balances
which the Company has disconnected or intends to disconnect during the first
quarter of 1997. In addition, during the fourth quarter of 1996, the Company
recorded additional expense of $2.5 million related to changes in estimated
programming costs, a write-down of certain subscriber equipment of $2.3 million
and a write-down of license and leased license investment of $1.6 million.
F-22
<PAGE> 65
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report on its behalf
by the undersigned, thereunto duly authorized, on the 28th day of April, 1997.
HEARTLAND WIRELESS COMMUNICATIONS,
INC.
By: /s/ C. D. MCHENRY
----------------------------------
Carroll D. McHenry
Chairman of the Board,
President, Chief Executive Officer
and
Acting Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed on the 28th day of April, 1997, by the following persons
in the capacities indicated:
<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<C> <S>
/s/ C. D. MCHENRY Chairman of the Board, President, Chief
- ----------------------------------------------------- Executive Officer and Acting Chief Financial
Carroll D. McHenry Officer (Principal Executive Officer and
Acting Principal Financial Officer)
/s/ DAVID D. HAGEY Vice President, Controller and Assistant
- ----------------------------------------------------- Secretary (Principal Accounting Officer)
David D. Hagey
/s/ J. R. HOLLAND, JR. Director
- -----------------------------------------------------
J. R. Holland, Jr.
/s/ ALVIN H. LANE, JR. Director
- -----------------------------------------------------
Alvin H. Lane, Jr.
/s/ DENNIS M. O'ROURKE Director
- -----------------------------------------------------
Dennis M. O'Rourke
/s/ JOHN A. SPRAGUE Director
- -----------------------------------------------------
John A. Sprague
/s/ L. ALLEN WHEELER Director
- -----------------------------------------------------
L. Allen Wheeler
</TABLE>
<PAGE> 66
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Heartland Wireless Communications, Inc.:
Under the date of March 24, 1997, we reported on the consolidated balance
sheets of Heartland Wireless Communications, Inc. and subsidiaries as of
December 31, 1996 and 1995 and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the years in the
three year period ended December 31, 1996, which are included in the Company's
annual report on Form 10 K. In connection with our audits of the aforementioned
consolidated financial statements, we also audited the related financial
statement schedule as listed in the accompanying index. This financial statement
schedule is the responsibility of the Company's management. Our responsibility
is to express an opinion on this financial statement schedule based on our
audits.
In our opinion, such schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, present fairly, in all
material respects, the information set forth therein.
KPMG Peat Marwick LLP
Dallas, Texas
March 24, 1997
S-1
<PAGE> 67
SCHEDULE II
HEARTLAND WIRELESS COMMUNICATIONS, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
<TABLE>
<CAPTION>
ADDITIONS
--------------------------------------
BALANCE AT CHARGED TO BALANCE AT
BEGINNING COSTS AND CHARGED TO END OF
DESCRIPTION OF PERIOD EXPENSES OTHER DEDUCTIONS PERIOD
----------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1996:
Allowance for doubtful accounts.... $ 961 $7,295 $ 169(a) $(2,957) $5,468
====== ====== ====== ======= ======
Valuation allowance for deferred
tax assets...................... $3,981 $ $5,319(b) $ $9,300
====== ====== ====== ======= ======
Year ended December 31, 1995:
Allowance for doubtful accounts.... $ 123 $ 838 $ $ $ 961
====== ====== ====== ======= ======
Valuation allowance for deferred
tax assets...................... $ 791 $ $3,190(b) $ $3,981
====== ====== ====== ======= ======
Year ended December 31, 1994:
Allowance for doubtful accounts.... $ 25 $ 72 $ 26(c) $ $ 123
====== ====== ====== ======= ======
Valuation allowance for deferred
tax assets...................... $ 183 $ $ 608(b) $ $ 791
====== ====== ====== ======= ======
</TABLE>
- ---------------
(a) Allocation of assets from the CableMaxx and Technivision acquisitions.
(b) Recognized as a component of federal income tax benefit.
(c) Allocation of assets from the purchase of certain assets from RuralVision.
S-2
<PAGE> 68
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
2.1 -- Letter Agreement regarding formation of the Registrant
(filed as Exhibit 2.1 as the Registrant's Registration
Statement on Form S-1, File No. 33-74244 (the "Form
S-1"), and incorporated herein by reference)
2.2 -- Supplement to Letter Agreement regarding formation of the
Registrant (filed as Exhibit 2.2 to the Form S-1 and
incorporated herein by reference)
3.1 -- Restated Certificate of Incorporation of the Registrant
(filed as Exhibit 3.1 to the Form S-1 and incorporated
herein by reference)
3.2 -- Restated By-laws of the Registrant (filed as Exhibit 3.2
to the Form S-1 and incorporated herein by reference)
4.1 -- 1994 Employee Stock Option Plan of the Registrant (filed
as Exhibit 4.1 to the Registrant's Registration Statement
on Form S-8 (File No. 333-04263) and incorporated herein
by reference
4.2 -- Revised Form of Nontransferable Incentive Stock Option
Agreement under the 1994 Employee Stock Option Plan of
the Registrant (filed as Exhibit 4.2 to the Registrant's
Registration Statement on Form S-4, File No. 33-91930
(the "February 1996 Form S-4")and incorporated herein by
reference)
4.3 -- Revised Form of Nontransferable Non-Qualified Stock
Option Agreement under the 1994 Employee Stock Option
Plan of the Registrant (filed as Exhibit 4.3 to the
February 1996 Form S-4 and incorporated herein by
reference)
4.4 -- 1994 Stock Option Plan for Non-Employee Directors of the
Registrant (filed as Exhibit 4.4 to the Form S-1 and
incorporated herein by reference)
4.5 -- Form of Stock Option Agreement under the 1994 Stock
Option Plan for Non-Employee Directors of the Registrant
(filed as Exhibit 4.5 to the Form S-1 and incorporated
herein by reference)
4.6 -- Indenture between the Registrant and First Trust of New
York, National Association , as Trustee (the "Trustee")
(filed as Exhibit 4.20 to the Registrant's Registration
Statement on Form S-4, File No. 333-12577 (the "December
1996 Form S-4") and incorporated herein by reference)
4.7 -- Supplemental Indenture dated as of December 9, 1996,
between the Registrant and the Trustee (filed as Exhibit
4.21 to the December 1996 Form S-4 and incorporated
herein by reference)
4.8 -- Heartland Wireless Communications, Inc. 401(k) Plan
(filed as Exhibit 4.3 to the Registrant's Registration
Statement on Form S-8 (File No. 333-05943) and
incorporated herein by reference)
*10.1 -- Standard Form of MMDS License Agreement
*10.2 -- Standard Form of ITFS License Agreement
10.3 -- Form of Indemnity Agreement between the Registrant and
each of its directors (filed as Exhibit 10.3 to the Form
S-1 and incorporated herein by reference)
10.4 -- Noncompetition Agreement between the Registrant and J.R.
Holland, Jr. (filed as Exhibit 10.4 to the Form S-1 and
incorporated herein by reference)
10.5 -- Noncompetition Agreement between the Registrant and David
E. Webb (filed as Exhibit 10.5 to the Form S-1 and
incorporated herein by reference)
10.6 -- Noncompetition Agreement between the Registrant and John
R. Bailey (filed as Exhibit 10.6 to the Form S-1 and
incorporated herein by reference)
</TABLE>
<PAGE> 69
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
10.7 -- Noncompetition Agreement between the Registrant and Randy
R. Hendrix (filed as Exhibit 10.7 to the Form S-1 and
incorporated herein by reference)
10.8 -- Noncompetition Agreement between the Registrant and L.
Allen Wheeler (filed as Exhibit 10.9 to the Form S-1 and
incorporated herein by reference)
10.9 -- Building Lease Agreement dated June 1, 1990, between
Wireless Communications, Inc. and The Federal Building,
Inc. (filed as Exhibit 10.13 to the 1994 Form 10-K and
incorporated herein by reference)
10.10 -- Building Lease Agreement dated January 2, 1995, between
the Registrant and W&W Commercial Group, L.L.C. (filed as
Exhibit 10.14 to the 1994 Form 10-K and incorporated
herein by reference)
10.11 -- Building Lease Agreement dated May 1, 1994, between
Wireless Communications, Inc. and The Federal Building,
Inc.
10.12 -- Purchase Agreement among the Registrant, BT Securities
and Lazard (filed as Exhibit 10.17 to the February 1995
Form S-4 and incorporated herein by reference)
10.13 -- Building Lease Agreement dated November 20, 1995, between
the registrant and the Federal Building, Inc. (filed as
Exhibit 10.18 to the February 1996 Form S-4 and
incorporated herein by reference)
10.14 -- Office Lease dated April 10, 1996 between Merit Office
Portfolio Limited Partnership and the Registrant for the
Registrant's Plano, Texas office (filed as Exhibit 10.1
to the Form 10-Q Quarterly Report for the quarter ended
June 30, 1996 ("June 1996 Form 10-Q") and incorporated
herein by reference)
10.15 -- Sublease Agreement dated June 14, 1996 between the
Registrant and CS Wireless (filed as Exhibit 10.2 to the
June 1996 Form 10-Q and incorporated herein by reference)
*10.16 -- Building Lease Agreement dated February 1, 1996, as
amended June 1, 1996, between Registrant and National
Horizon Development, L.C.
*21 -- List of Subsidiaries
**23 -- Consent of KPMG Peat Marwick LLP
*27 -- Financial Data Schedule
</TABLE>
- ---------------
* Previously filed.
** Filed herewith.
<PAGE> 1
Exhibit 23
INDEPENDENT AUDITORS' CONSENT
The Board of Directors
Heartland Wireless Communications, Inc.:
We consent to incorporation by reference in the Registration Statements No.
333-04263 and No. 333-05943 on Form S-8 and in the Registration Statements No.
333-14149 and No. 333-12577 on Form S-4 of Heartland Wireless Communications,
Inc. and subsidiaries of our reports dated March 24, 1997, relating to the
consolidated balance sheets of Heartland Wireless Communications, Inc. and
subsidiaries as of December 31, 1996 and 1995, and the related consolidated
statements of operations, stockholders' equity, and cash flows and related
schedule for each of the years in the three-year period ended December 31,
1996, which reports appear in the December 31, 1996 annual report on Form 10-K/A
of Heartland Wireless Communications, Inc. and subsidiaries.
As discussed in note 1(d) to the consolidated financial statements, the Company
changed its method of accounting for the direct costs and installation fees
related to subscriber installations in 1995.
KPMG Peat Marwick LLP
Dallas, Texas
April 25, 1997
