10-Q 1 ten-q.txt 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the quarterly period ended September 30, 2001 ------------------ 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 33-95042 -------- PEGASUS MEDIA & COMMUNICATIONS, INC. ------------------------------------------------------ (Exact name of Registrant as specified in its charter) Delaware 23-2778525 -------- ---------- (State or other jurisdiction of (IRS Employer incorporation or organization) Identification Number) c/o Pegasus Communications Management Company; 225 City Line Avenue, Suite 200, Bala Cynwyd, PA 19004 ------------------------------------------------ ----- (Address of principal executive offices) (Zip code) Registrant's telephone number, including area code: (888) 438-7488 -------------- Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes_X_ No___ Number of shares of each class of the Registrant's common stock outstanding as of November 12, 2001: Class A, Common Stock, $0.01 par value 161,500 Class B, Common Stock, $0.01 par value 8,500 The Registrant meets the conditions set forth in General Instruction H(1)(a) and (b) of Form 10-Q and is therefore filing this Form with reduced disclosure format PEGASUS MEDIA & COMMUNICATIONS, INC. Form 10-Q Table of Contents For the Quarterly Period Ended September 30, 2001 Page ---- PART I. FINANCIAL INFORMATION Item 1 Financial Statements Condensed Consolidated Balance Sheets September 30, 2001 and December 31, 2000 4 Consolidated Statements of Operations and Comprehensive Loss Three months ended September 30, 2001 and 2000 5 Consolidated Statements of Operations and Comprehensive Loss Nine months ended September 30, 2001 and 2000 6 Condensed Consolidated Statements of Cash Flows Nine months ended September 30, 2001 and 2000 7 Notes to Consolidated Financial Statements 8 Item 2 Management's Narrative Analysis of the Results of Operations 18 PART II. OTHER INFORMATION Item 1 Legal Proceedings 22 Item 6 Exhibits and Reports on Form 8-K 22 Signature 23 2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS 3 Pegasus Media & Communications, Inc. Condensed Consolidated Balance Sheets (In thousands)

See accompanying notes to consolidated financial statements 4 Pegasus Media & Communications, Inc. Consolidated Statements of Operations and Comprehensive Loss (In thousands)

See accompanying notes to consolidated financial statements 5 Pegasus Media & Communications, Inc. Consolidated Statements of Operations and Comprehensive Loss (In thousands)

See accompanying notes to consolidated financial statements 6 Pegasus Media & Communications, Inc. Condensed Consolidated Statements of Cash Flows (In thousands)

See accompanying notes to consolidated financial statements 7 PEGASUS MEDIA & COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. The Company Pegasus Media & Communications, Inc. ("PM&C", and together with its subsidiaries, the "Company") is a direct subsidiary of Pegasus Satellite Communications, Inc. ("PSC"), which is a direct subsidiary of Pegasus Communications Corporation ("PCC"). In June 2001, PSC contributed all of the capital stock of Golden Sky Holdings, Inc. ("GSH") to a subsidiary of PM&C. Golden Sky Systems, Inc. ("GSS") and Golden Sky DBS, Inc. ("GSDBS") are subsidiaries of GSH. GSH was acquired by PSC in May 2000. GSH, through its subsidiaries, provides direct broadcast satellite services ("DBS"). At the date of contribution, Golden Sky had approximately 405,000 subscribers. Revenues for Golden Sky for 2001 through the date of contribution were $114.3 million, and $187.6 million for the year ended December 31, 2000. The amount of PSC's investment in GSH contributed to the Company at June 30, 2001 was $742.2 million. 2. Basis of Presentation The financial statements include the accounts of PM&C and all of its subsidiaries on a consolidated basis. All intercompany transactions and balances have been eliminated. The balance sheets and statements of cash flows are presented on a condensed basis. For financial reporting purposes, the financial statements of GSH have been combined with those of the Company on an "as if pooled" basis for all periods presented in this report from the date that GSH was acquired by PSC. As a result, prior year amounts have been adjusted from that previously reported and the current year's year to date amounts have been adjusted to include amounts of GSH. Through December 31, 2000, the Company's financial statements were presented on a combined basis with Pegasus Development Corporation ("PDC"). PDC, a subsidiary of PCC, had provided capital for various satellite initiatives that were integral to the Company's DBS operations for periods prior to those presented in this report. PDC's financial position, results of operations and cash flows no longer impact those of the Company and beginning in 2001 the financial statements of PDC were not combined with those of the Company. For comparative purposes, financial information contained in this report for periods prior to 2001 has been adjusted from that previously reported to exclude amounts associated with PDC. The accompanying unaudited consolidated financial statements are prepared in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The unaudited consolidated financial statements reflect all adjustments consisting of normal recurring items that, in the opinion of management, are necessary for a fair presentation, in all material respects, of the financial position of the Company and the results of its operations and comprehensive loss and its cash flows for the interim period. The interim results of operations contained herein may not necessarily be indicative of the results of operations for the full fiscal year. 3. Changes in Other Stockholder's Equity Changes in other stockholder's equity from December 31, 2000 to September 30, 2001 consist of: net loss of $(168.0) million; adjustments resulting from the exchange of GSS' and GSDBS' notes (see Note 4) of $320.4 million; net cash contributions from PSC of $25.5 million; net change in other comprehensive loss of $12.0 million (see Note 9); and other of $1.4 million. 4. Long-Term Debt In the second quarter 2001, PSC issued identical notes in exchange for all of the outstanding $195.0 million principal amount of 12-3/8% senior subordinated notes due August 2006 of GSS and outstanding $193.1 million maturity value of 13-1/2% senior discount notes due March 2007 of GSDBS. The GSS and GSDBS notes, with a carrying amount of $329.9 million, were cancelled and the balance of unamortized deferred financing costs associated with the notes of $9.5 million was transferred to PSC and associated with the newly issued notes of PSC. Accordingly, PM&C's paid-in capital was increased by a net $320.4 million. Consent fees of $1.6 million incurred in the exchange offers to amend the GSS and GSDBS note indentures were recorded as deferred financing costs that were included in the amounts transferred to PSC. 8 PEGASUS MEDIA & COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) In June 2001, all principal amounts outstanding under the term loan and revolving credit facilities of the GSS credit agreement were repaid and the credit agreement was terminated. Unamortized deferred financing costs associated with the credit agreement were written off and were reported as an extraordinary loss from extinguishment of debt on the statement of operations and comprehensive loss in the amount of $986,000, net of an income tax benefit of $604,000. All of the letters of credit outstanding under GSS' revolving credit facility were cancelled and new letters of credit related to these cancelled letters of credit were subsequently issued pursuant to PM&C's revolving credit facility. During the three months ended September 30, 2001, PM&C repaid a net $35.0 million under its revolving credit facility. The total principal amount outstanding under the revolving credit facility was $72.0 million at September 30, 2001 and $35.0 million at December 31, 2000. Letters of credit outstanding under the revolving credit facility, which reduce the availability thereunder, were $49.2 million at September 30, 2001 and $40.4 million at December 31, 2000. At September 30, 2001, the commitment for the revolving credit facility was permanently reduced as scheduled under the terms of the credit agreement to approximately $208.1 million. Availability under the revolving credit facility at September 30, 2001 was $86.7 million. Beginning March 31, 2001, PM&C began making scheduled quarterly payments of $687,500 on its term loan facility that have reduced the amount outstanding thereunder to $272.9 million at September 30, 2001. The weighted average variable rates of interest including applicable margins on principal amounts outstanding under PM&C's credit agreement at September 30, 2001 and December 31, 2000 were 6.13% and 10.19%, respectively, for the term facility and 5.87% and 10.11%, respectively, for the revolving facility. 5. Industry Segments The Company's only reportable segment at September 30, 2001 was DBS. The broadcast segment had been a reportable segment in periods prior to the contribution of GSH in June 2001. However, with the contribution of GSH to the Company, the broadcast segment was no longer significant and the Company believes that it will not be significant in the future. Information on DBS' revenue and measure of profit/loss and how these contribute to the Company's consolidated loss from continuing operations before income taxes for each period reported is as presented on the consolidated statements of operations and comprehensive loss. DBS derived all of its revenues from external customers for each period presented. Identifiable total assets for DBS were approximately $2.0 billion at September 30, 2001, which did not change significantly from the total DBS assets at December 31, 2000, as consolidated with the assets of GSH at that date. 6. Supplemental Cash Flow Information Significant non-cash investing and financing activities were as follows (in thousands):

9 PEGASUS MEDIA & COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 7. Derivative Instruments Statement of Financial Accounting Standards No. 133 "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"), as amended by SFAS No. 138, became effective for the Company on January 1, 2001. SFAS 133 establishes accounting and reporting standards for derivative instruments and hedging activities. The statement requires that all derivatives are to be recognized as either assets or liabilities in the statement of financial position and the instruments are to be measured at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. The fair values of interest rate swaps and caps held by the Company are determined by the financial institutions that are party to the contracts. The fair values are determined by the amount that the Company or the other parties to the contracts would pay if the contracts were terminated at the measurement date. No cash is transferred in determining the termination values. The Company did not designate these instruments as hedges upon adopting SFAS 133. Accordingly, the changes in the fair values of these instruments are recognized in earnings in the period of change. On January 1, 2001, the Company's derivative instruments were two interest rate swap and two interest rate cap instruments. The net cumulative effect on January 1, 2001 of adopting SFAS 133 was the recording of a liability of $1.6 million and a charge to earnings of $1.0 million, net of tax of $600,000. 8. Income Taxes The Company's effective federal income tax rate for continuing operations for the nine months ended September 30, 2001 was 37.1%, compared to the effective federal income tax rate for continuing operations for the year ended December 31, 2000 of 33.6%, after inclusion of GSH's income tax benefits for 2000. The Company's effective federal income tax rate varies with the changes in the Company's net deferred income tax position. The prior year's rate was lessened by valuation allowances on deferred income tax assets during a portion of the year. 9. Loss on Impairment of Marketable Securities At September 30, 2001, the Company determined that its investment in the marketable securities it held had incurred an other than temporary decline in fair market value. Accordingly, the Company wrote down its cost basis in the marketable securities to their fair market value at September 30, 2001 and charged operations in the amount of $34.2 million for the impairment loss realized. The income tax benefit recorded in income taxes for continuing operations associated with this charge was $13.0 million. In connection with this write down, the Company made a reclassification adjustment to other comprehensive income (loss) for the three and nine months ended September 30, 2001 and other stockholder's equity at September 30, 2001 of $21.2 million, net of income tax benefit of $13.0 million, to remove all of the net unrealized losses on the marketable securities accumulated at that date that were realized and recorded in earnings. 10. Commitments and Contingent Liabilities Legal Matters DIRECTV Litigation: National Rural Telecommunications Cooperative Pegasus Satellite Television, Inc. ("PST"), a subsidiary of PM&C, is an affiliate of the National Rural Telecommunications Cooperative ("NRTC"), which participates through agreements in the NRTC's direct broadcast satellite program. On May 5, 2000, PSC acquired GSS, another affiliate of the NRTC. On June 29, 2001, GSS became a direct subsidiary of PST. 10 PEGASUS MEDIA & COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) On June 3, 1999, the NRTC filed a lawsuit in federal court against DIRECTV, Inc. ("DIRECTV") seeking a court order to enforce the NRTC's contractual rights to obtain from DIRECTV certain premium programming formerly distributed by United States Satellite Broadcasting Company, Inc. for exclusive distribution by the NRTC's members and affiliates in their rural markets. The NRTC also sought a temporary restraining order preventing DIRECTV from marketing the premium programming in such markets and requiring DIRECTV to provide the NRTC with the premium programming for exclusive distribution in those areas. The court, in an order dated June 17, 1999, denied the NRTC a preliminary injunction on such matters, without deciding the underlying claims. On July 22, 1999, DIRECTV responded to the NRTC's continuing lawsuit by rejecting the NRTC's claims to exclusive distribution rights and by filing a counterclaim seeking judicial clarification of certain provisions of DIRECTV's contract with the NRTC. As part of the counterclaim, DIRECTV is seeking a declaratory judgment that the term of the NRTC's agreement with DIRECTV is measured only by the orbital life of DBS-1, the first DIRECTV satellite launched, and not by the orbital lives of the other DIRECTV satellites at the 101(degree)W orbital location. According to DIRECTV, DBS-1 suffered a failure of its primary control processor in July 1998 and since that time has been operating normally using a spare control processor. While the NRTC has a right of first refusal to receive certain services from any successor DIRECTV satellite, the scope and terms of this right of first refusal are also being disputed in the litigation, as discussed below. This right is not expressly provided for in the Company's agreements with the NRTC. On September 9, 1999, the NRTC filed a response to DIRECTV's counterclaim contesting DIRECTV's interpretations of the end of term and right of first refusal provisions. On December 29, 1999, DIRECTV filed a motion for partial summary judgment. The motion sought a court order that the NRTC's right of first refusal, effective at the termination of DIRECTV's contract with the NRTC, does not include programming services and is limited to 20 program channels of transponder capacity. On January 31, 2001, the court issued an order denying DIRECTV's motion in its entirety for partial summary judgment relating to the right of first refusal. If DIRECTV were to prevail on its counterclaim, any failure of DBS-1 could have a material adverse effect on the Company's DIRECTV rights. On August 26, 1999, the NRTC filed a separate lawsuit in federal court against DIRECTV claiming that DIRECTV had failed to provide to the NRTC its share of launch fees and other benefits that DIRECTV and its affiliates have received relating to programming and other services. On November 15, 1999, the court granted a motion by DIRECTV and dismissed the portion of this lawsuit asserting tort claims, but left in place the remaining claims asserted by the NRTC. NRTC and DIRECTV have also filed indemnity claims against one another, which pertain to NRTC's alleged obligation to indemnify DIRECTV for costs incurred in the various lawsuits described herein. The litigation described herein has been consolidated for discovery and pre-trial purposes. A trial date of August 13, 2002 has been set, although at this stage it is not clear which of the lawsuits will be tried on that date. Pegasus Satellite Television and Golden Sky Systems On January 10, 2000, PST and GSS filed a class action lawsuit in federal court in Los Angeles against DIRECTV as representatives of a proposed class that would include all members and affiliates of the NRTC that are distributors of DIRECTV. The complaint contained causes of action for various torts, common counts and declaratory relief based on DIRECTV's failure to provide the NRTC with certain premium programming, and on DIRECTV's position with respect to launch fees and other benefits, term and right of first refusal. The complaint sought monetary damages and a court order regarding the rights of the NRTC and its members and affiliates. On February 10, 2000, PST and GSS filed an amended complaint which added new tort claims against DIRECTV for interference with PST's and GSS' relationships with manufacturers, distributors and dealers of direct broadcast satellite equipment. The class action allegations PST and GSS previously filed were withdrawn to allow a new class action to be filed on behalf of the members and affiliates of the NRTC. The new class action was filed on February 29, 2000. 11 PEGASUS MEDIA & COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) On December 10, 2000, the court rejected in its entirety DIRECTV's motion to dismiss certain of the claims asserted by PST, GSS and the putative class. On January 31, 2001, the court denied in its entirety a motion for summary judgment filed by DIRECTV relating to the right of first refusal. The court also certified the plaintiff's class on December 28, 2000. On March 9, 2001, DIRECTV filed a counterclaim against PST and GSS, as well as the class members. In the counterclaim, DIRECTV seeks two claims for relief: (i) a declaratory judgement that PST and GSS have no right of first refusal in their agreements with the NRTC to have DIRECTV provide any services after the expiration of the term of these agreements, and (ii) an order that DBS-1 is the satellite (and the only satellite) that measures the term of PST's and GSS' agreements with the NRTC. PST's and GSS' motion to dismiss the counterclaims were denied on May 8, 2001, and on June 4, 2001, PST, GSS and the class filed a response denying DIRECTV's counterclaims. On July 2, 2001, DIRECTV filed under seal a summary judgment motion on its term claim, which motion was heard on October 22, 2001. On October 31, 2001, the court issued a final ruling denying DIRECTV's motion. On May 21, 2001, PST, GSS and the class members moved to amend their complaints to add certain additional claims against DIRECTV relating to, among other things, DIRECTV's provision of advanced services. The court granted this motion on June 19, 2001. DIRECTV filed its answer to the second amended complaint on July 20, 2001. On June 22, 2001, DIRECTV brought suit against PST and GSS in Los Angeles County Superior Court for breach of contract and common counts. The lawsuit pertains to the seamless marketing agreement dated August 9, 2000, as amended, between DIRECTV and PST and GSS. Pursuant to the terms of that agreement, the parties agreed upon arrangements relating to the marketing activities of DIRECTV retailers and distributors in PST's and GSS' territories. DIRECTV alleges that PST and GSS have not made certain payments due under the agreement. Prior to the filing of DIRECTV's complaint, PST and GSS asserted in correspondence to DIRECTV that DIRECTV was in breach of the agreement in numerous respects. PST and GSS advised DIRECTV that unless the breaches were cured, PST and GSS would exercise their termination rights under the agreement. On July 13, 2001, PST and GSS terminated the seamless marketing agreement. On July 16, 2001, PST and GSS filed a cross-complaint against DIRECTV alleging, among other things, that (i) DIRECTV has breached the seamless marketing agreement, and (ii) DIRECTV has engaged in unlawful and/or unfair business practices, as defined in Section 17200, et seq. of California Business and Professions Code. On July 19, 2001, PST and GSS removed the case from state to federal court. DIRECTV moved to remand the case back to state court but, on September 19, 2001, the court denied DIRECTV's motion All five lawsuits discussed above, including both lawsuits brought by the NRTC, the class action and PST's and GSS' lawsuit, are pending before the same judge. The court has set a trial date of August 13, 2002, although, as noted above, it is not clear whether all the lawsuits will be tried together. Other Matters: In addition to the matters discussed above, from time to time the Company is involved with claims that arise in the normal course of the Company's business. In the Company's opinion, the ultimate liability with respect to these claims will not have a material adverse effect on the Company's consolidated operations, cash flows or financial position. 12 PEGASUS MEDIA & COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 11. New Accounting Pronouncements The Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141 "Business Combinations." This statement addresses financial accounting and reporting for business combinations. All business combinations in the scope of this statement are to be accounted for using only the purchase method. The provisions of this statement apply to all business combinations initiated after June 30, 2001 and those accounted for using the purchase method for which the date of acquisition is July 1, 2001 or later. The Company has not made any acquisitions since the effective date of this statement. The Company will apply the provisions of this statement when, if any, future business combinations are transacted. The FASB issued SFAS No. 142 "Goodwill and Other Intangible Assets." This statement addresses financial accounting and reporting for acquired goodwill and other intangible assets. It addresses how intangible assets that are acquired individually or with a group of other assets, but not those acquired in a business combination, should be accounted for in financial statements upon their acquisition. This statement also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. The provisions of this statement are to be applied starting with fiscal years beginning after December 15, 2001. Goodwill and intangible assets acquired after June 30, 2001 will be subject immediately to the nonamortization and amortization provisions of this statement. The Company has not acquired any goodwill or intangible assets since the effective date of this statement. The Company is still studying the provisions of this statement and has not determined the impacts that this statement may have on it. The FASB issued SFAS No. 143 "Accounting for Asset Retirement Obligations." This statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. This statement is effective for financial statements issued for fiscal years beginning after June 15, 2002. The Company is studying the provisions of this statement and has not determined the impacts that this statement may have on it. The FASB issued SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets." This statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets. The provisions of this statement are effective for financial statements issued for fiscal years beginning after December 15, 2001. The Company is studying the provisions of this statement and has not determined the impacts that this statement may have on it. 12. Subsidiary Guarantees PM&C's 12-1/2% Series B senior subordinated notes due 2005 are guaranteed on a full, unconditional, senior subordinated basis, jointly and severally by each of its 100% owned direct and indirect subsidiaries, including GSH and its subsidiaries, with the exception of certain subsidiaries described in the following sentence. Pegasus Satellite Finance Corporation 2000, Pegasus Satellite Finance Corporation, Pegasus Satellite Development Corporation and South Plains DBS L.P., all of which are direct or indirect subsidiaries of PM&C, are not guarantors of the notes ("Non-guarantor Subsidiaries"). PM&C believes separate financial statements and other disclosures concerning the Guarantor Subsidiaries are not deemed significant. In lieu of separate financial statements, PM&C is providing the following condensed consolidating financial statements to present the financial position, results of operations and cash flows of the various guarantor and nonguarantor entities comprising the consolidated reporting group. 13 PEGASUS MEDIA & COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 12. Subsidiary Guarantees (continued)

14 PEGASUS MEDIA & COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 12. Subsidiary Guarantees (continued) Condensed Consolidating Statements of Operations and Comprehensive Income (Loss) (In thousands)

15 PEGASUS MEDIA & COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 12. Subsidiary Guarantees (continued) Condensed Consolidating Statements of Operations and Comprehensive Income (Loss) (In thousands)

16 PEGASUS MEDIA & COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 12. Subsidiary Guarantees (continued) Condensed Consolidating Statements of Cash Flows (in thousands)

17 PEGASUS MEDIA & COMMUNICATIONS, INC. ITEM 2. MANAGEMENT'S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS In reliance upon General Instruction (H)(2)(a) of Form 10-Q, we are providing the limited disclosure set forth below. Such disclosure requires us only to provide a narrative analysis of the results of operations which explains the reasons for material changes in the amount of revenue and expense items between the most recent fiscal year-to-date period presented and the corresponding year-to-date period in the preceding fiscal year. This report contains certain forward-looking statements (as such term is defined in the Private Securities Litigation Reform Act of 1995) and information relating to us that are based on our beliefs, as well as assumptions made by and information currently available to us. When used in this report, the words "estimate," "project," "believe," "anticipate," "intend," "expect" and similar expressions are intended to identify forward-looking statements. Such statements reflect our current views with respect to future events and are subject to unknown risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated in such forward-looking statements. Such factors include, among other things, the following: general economic and business conditions, both nationally, internationally and in the regions in which we operate; catastrophic events, including acts of terrorism; relationships with and events affecting third parties like DIRECTV, Inc.; litigation with DIRECTV; the proposed merger of Hughes Electronics Corporation with EchoStar Communications Corporation; demographic changes; existing government regulations and changes in, or the failure to comply with, government regulations; competition; the loss of any significant numbers of subscribers or viewers; changes in business strategy or development plans; the cost of pursuing new business initiatives; expansion of land-based communications; technological developments and difficulties; the ability to attract and retain qualified personnel; our significant indebtedness; the availability and terms of capital to fund the expansion of our businesses; and other factors referenced in this report and in reports and registration statements filed from time to time with the Securities and Exchange Commission. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. We do not undertake any obligation to publicly release any revisions to these forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. The following discussion of our results of operations should be read in conjunction with the consolidated financial statements and related notes herein. General Approximately 96% of our revenues and 83% of our operations for the nine months ended September 30, 2001, and approximately 96% of our assets at September 30, 2001, are associated with providing multichannel DBS services as an independent DIRECTV provider. DIRECTV is a service of DIRECTV, Inc. We may be adversely affected by any material adverse changes in the assets, financial condition, programming, technological capabilities or services of DIRECTV, Inc. Separately, we are involved in litigation with DIRECTV. An outcome in this litigation that is unfavorable to us could have a material adverse effect on our DBS business. See Note 10 of the Notes to Consolidated Financial Statements for information on the litigation. In June 2001, our parent Pegasus Satellite Communications contributed all of the capital stock of Golden Sky Holdings to one of our subsidiaries. Golden Sky was acquired by Pegasus Satellite in May 2000. For financial reporting purposes, we have combined the financial statements of Golden Sky with ours on an "as if pooled" basis for all periods presented in this report from the date that Golden Sky was acquired by Pegasus Satellite. As a result, prior year amounts have been adjusted from that previously reported and the current year's year to date amounts have been adjusted to include amounts of Golden Sky. At the date of contribution, Golden Sky had approximately 405,000 subscribers. Revenues for Golden Sky for 2001 through the date of contribution were $114.3 million, and $187.6 million for the year ended December 31, 2000. Through December 31, 2000, our financial statements were presented on a combined basis with Pegasus Development Corporation. The prior relationship we had with Pegasus Development no longer impacts our financial position, results of operations, or cash flows, and beginning in 2001 we no longer combine Pegasus Development's financial statements with ours. For comparative purposes, financial information contained in this report for periods prior to 2001 has been adjusted from that previously reported to exclude amounts associated with Pegasus Development. 18 PEGASUS MEDIA & COMMUNICATIONS, INC. Results of Operations In this section, amounts and changes specified are for the nine months ended September 30, 2001 compared to the nine months ended September 30, 2000, unless indicated otherwise. The discussion that follows includes the effects of Golden Sky in the current and prior year period and excludes the effects of Pegasus Development from the prior year period. Comparison of Nine Months Ended September 30, 2001 and 2000 DBS Business Revenues increased $228.8 million to $618.6 million. This increase was due to a larger extent to an increase in the number of subscribers and to a lesser extent higher average revenue per subscriber. The current year period fully includes revenues resulting from PSC's acquisition of Golden Sky Holdings that took place in May 2000, whereas the prior year period includes only the incremental effects from the acquisition date. Number of subscribers were 1,496,000 at September 30, 2001 compared to 1,312,000 at September 30, 2000. This increase was substantially due to internal growth. At September 30, 2001, we had exclusive DIRECTV distribution rights to approximately 7.5 million households. Our sales and marketing efforts have increased our penetration within our territories to approximately 20.0% at September 30, 2001 from 17.8% at September 30, 2000. Average revenue per subscriber was $47.61 for the current year period compared to $43.33 for the prior year period. The increase in the current year's average revenue per subscriber amount was primarily due to the incremental impact of the seamless consumer agreement that became effective in the fourth quarter 2000. This arrangement enables us to directly provide certain premium programming from DIRECTV to our subscribers and earn the associated revenues. Because of the number of households available to us within our territories that are not yet our subscribers, we believe that the prospects for continued subscriber growth are favorable. We continue to believe that conditions exist for further subscriber growth through acquisitions. However, we cannot make any assurances that internal growth or growth through acquisitions will occur and when or as to the rate of that growth. Programming, technical, general and administrative expenses increased $170.7 million to $443.6 million. This increase was primarily due to the incremental costs incurred in providing service to an increased subscriber base. Our margins on revenue over programming, technical, general and administrative expenses were 28.3% for the current year period compared to 30.0% for the prior year period. The decrease in the current year's margin was primarily caused by margins associated with the seamless consumer program being lower than the margins on our other programs and the greater weight this program has had in our subscribers' programming mix in the current year's period. Marketing and selling expenses, which are also known as subscriber acquisition costs, increased $19.0 million to $130.6 million. The increase was primarily due to an overall increase in gross subscriber additions and commission and equipment subsidy costs incurred under the seamless marketing agreement for the amount of time in effect within the current and prior year periods. This increase was offset in part by rental equipment costs capitalized in association with increased gross rental additions. The successful promotion of our rental programs has resulted in increasing popularity of this alternative with our subscribers. Since we own the equipment used by rental subscribers, we capitalize the equipment and applicable related costs that we depreciate over three years into depreciation expense, and exclude from marketing and selling expenses. Similar subscriber acquisition costs associated with equipment for nonrental subscribers are immediately expensed as marketing and selling expenses because we do not own the related equipment. The seamless marketing agreement came into effect in August 2000, and was terminated in mid-July 2001. Termination of the seamless marketing agreement significantly reduced the amount of commissions and subsidy costs that we had previously incurred while the agreement was in effect. We have adopted some additional commission and equipment subsidy programs with the termination of the seamless marketing agreement to promote activations in our exclusive DBS territories, but the costs are far less than those under the agreement. Our subscriber acquisition costs per gross subscriber added through internal growth and expensed were $421 for the current year period compared to $379 for the prior year period. Subscriber acquisition costs including amounts capitalized per gross subscriber added through internal growth were $480 for the current year period and $414 for the prior year period. 19 PEGASUS MEDIA & COMMUNICATIONS, INC. Depreciation and amortization increased $65.3 million to $189.7 million principally due to the amortization of DBS rights assets obtained in acquisitions in 2000 that are fully included in the current year period but only incrementally from the date of acquisition in the prior year period. Over half of the increase is associated with DBS rights assets of approximately $1.3 billion for Golden Sky that PSC acquired in May 2000. Broadcast Business The net operations of the broadcast business declined by $1.9 million to $(3.7) million. The continuing general downturn in the United States' economy has caused a sliding reduction in television advertising dollars available to us and broadcasters throughout the industry in 2001. Indications are that the softness in advertising revenues will continue as long as the economy continues to slump. We cannot predict the further course of the economy and its impact on advertising revenues generally and specifically to us. Other Statement of Operations and Comprehensive Loss Items Other expense, net within operating expenses increased $13.5 million to $15.8 million. These expenses primarily consist of costs associated with the ongoing DIRECTV litigation. Interest expense increased only $728,000 to $55.4 million for the current year period due to higher average amounts of principal outstanding for term loans and revolving credit facilities in the current year period compared to the prior year period. Also, the current year period fully includes the impacts of fixed rate debt outstanding for subsidiaries of Golden Sky that PSC acquired in May 2000 but only incrementally from the acquisition date in the prior year period. Interest expense in the current year period was negated in part by lower variable interest rates on term loans and revolving credit facilities in the current year period than in the prior year period. The aggregate weighted average principal outstanding for term loans and revolving credit facilities in the current year period was $402.1 million with a weighted average variable interest rate of 7.93%, compared to $301.3 million in the prior year period with a weighted average variable interest rate of 9.97%. At September 30, 2001, we determined that our investment in the marketable securities we held had incurred an other than temporary decline in fair market value. Accordingly, we charged operations in the amount of $34.2 million for the impairment loss realized. The income tax benefit recorded in income taxes for continuing operations associated with this charge was $13.0 million. In connection with this write down, we made a reclassification adjustment to other comprehensive income (loss) in the current year period of $21.2 million, net of income tax benefit of $13.0 million, to remove all of the net unrealized losses on the marketable securities accumulated at that date that were realized and recorded in earnings. Other non-operating expense, net increased by $5.1 million to $5.5 million. These expenses primarily consist of net losses for the charge recorded upon the adoption at January 1, 2001 of new accounting standards concerning derivative instruments and subsequent reduction in the fair values of these instruments. The income tax benefit on the loss from continuing operations increased by $34.4 million to $100.8 million primarily due to a greater amount of pretax loss in the current year period. We recognized an extraordinary loss on the extinguishment of debt of $986,000, net of income tax benefit of $604,000, in the current year period for the write off of unamortized deferred financing costs associated with the termination of Golden Sky Systems' credit agreement in June 2001. 20 PEGASUS MEDIA & COMMUNICATIONS, INC. Cash Flow Information Cash used by operating activities for the nine months ended September 30, 2001 was $48.7 million compared to $47.9 million for the corresponding prior year period. DBS pre-marketing cash flow was $175.0 million for the current year period compared to $116.9 million for the prior year period. DBS EBITDA (earnings before interest, taxes and depreciation and amortization) was $44.4 million for the current year period compared to $5.3 million for the prior year period. Adjusted operating cash flow for the 12 months ended September 30, 2001 was $233.8 million. Pre-marketing cash flow of the DBS business is calculated by taking the DBS revenues and deducting from them their related programming, technical, general and administrative expenses. EBITDA of the DBS business is its pre-marketing cash flow less its marketing and selling expenses. Operating cash flow is income or loss from operations adjusted for depreciation, amortization and other noncash items therein, and excludes subscriber acquisition costs and corporate expenses. Marketing and selling expenses incurred by DBS are known as subscriber acquisition costs. Adjusted operating cash flow is DBS operating cash flow for the current quarter times four, plus operating cash flow from other operating divisions for the last four quarters. Pre-marketing cash flow, EBITDA and adjusted operating cash flow are not, and should not be considered, alternatives to income from operations, net income, net cash provided by operating activities or any other measure for determining our operating performance or liquidity, as determined under generally accepted accounting principles. Pre-marketing cash flow, EBITDA and adjusted operating cash flow also do not necessarily indicate whether our cash flow will be sufficient to fund working capital, capital expenditures or to react to changes in our industry or the economy generally. We believe that pre-marketing cash flow, EBITDA and adjusted operating cash flow are important for the following reasons: o people who follow our industry and us frequently use them as measures of financial performance and ability to pay debt service; and/or o they are measures that we, our lenders and investors use to monitor our financial performance and debt leverage. 21 PEGASUS MEDIA & COMMUNICATIONS, INC. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS For information relating to litigation with DIRECTV, Inc., we incorporate by reference herein the disclosure relating to this matter which is reported under Note 10 to the Notes to Consolidated Financial Statements. The Notes to Consolidated Financial Statements can be found under Part I, Item 1 of this Quarterly Report on Form 10-Q. We have previously filed reports during the fiscal year disclosing some or all of the legal proceedings referenced above. In particular, we have reported on such proceedings in our Annual Report on Form 10-K for the year ended December 31, 2000, in our Quarterly Reports on Form 10-Q for the quarter ended March 31, 2001 and June 30, 2001, and in our Current Reports on Form 8-K filed on June 25, 2001, July 18, 2001, October 17, 2001 and October 23, 2001. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (b) Reports on Form 8-K On July 11, 2001, we filed a Current Report on Form 8-K dated June 29, 2001 reporting under Item 2 the contribution of all of the capital stock of Golden Sky Holdings, Inc. into our company by our parent company, Pegasus Satellite Communications, Inc. On July 18, 2001, we filed a Current Report on Form 8-K dated June 19, 2001 reporting under Item 5 certain developments in the litigation involving Pegasus Satellite Communications, Golden Sky Systems, DIRECTV and Hughes Communications Galaxy, Inc., as well as certain developments in the litigation relating to the Seamless Marketing Agreement. On September 13, 2001, we filed an amendment to the Current Report on Form 8-K dated June 29, 2001 reporting under Item 2 the contribution of all of the capital stock of Golden Sky Holdings, Inc. into our company by our parent company, Pegasus Satellite Communications, Inc. This amendment provided financial information associated with the contribution. On October 17, 2001, we filed a Current Report on Form 8-K dated October 12, 2001 reporting under Item 5 that Pegasus Satellite Television, Golden Sky Systems and DIRECTV had entered into a new agreement for a revised seamless consumer program. On October 23, 2001, we filed a Current Report on Form 8-K dated October 22, 2001 reporting under Item 5 that oral argument was held on DIRECTV's motion for summary judgement with respect to its claim that the length of the agreement between the Company, through its indirect subsidiaries, and the National Rural Telecommunications Cooperative is tied to the life of only one satellite, DBS-1, and that the court had issued a written tentative ruling denying DIRECTV's motion and took the motion under submission. 22 PEGASUS MEDIA & COMMUNICATIONS, INC. SIGNATURE Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Pegasus Media & Communications, Inc. has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized. Pegasus Media & Communications, Inc. November 14, 2001 By: /s/ Kasin Smith --------------------------- ------------------------- Date Kasin Smith Chief Financial Officer, Treasurer and Executive Vice President of Finance and Information Technology (Principal Financial and Accounting Officer) 23

PEGASUS MEDIA & COMMUNICATIONS INC 10-Q