10-Q 1 pmc_f10q-2q03.txt PEGASUS MEDIA & COMMUNICATIONS FORM 10Q 2Q03 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 June 30, 2003 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from__________ to __________ Commission File Number 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: (800) 376-0022 -------------- Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /X/ No __ Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes__ No /X/ -- Number of shares of each class of the registrant's common stock outstanding as of August 6, 2003: 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 June 30, 2003 Page PART I. FINANCIAL INFORMATION Item 1. Financial Statements Condensed Consolidated Balance Sheets June 30, 2003 and December 31, 2002 4 Consolidated Statements of Operations and Comprehensive Loss Three months ended June 30, 2003 and 2002 5 Consolidated Statements of Operations and Comprehensive Loss Six months ended June 30, 2003 and 2002 6 Condensed Consolidated Statements of Cash Flows Six months ended June 30, 2003 and 2002 7 Notes to Consolidated Financial Statements 8 Item 2. Management's Narrative Analysis of the Results of Operations 25 Item 4. Controls and Procedures 32 PART II. OTHER INFORMATION Item 1. Legal Proceedings 33 Item 6. Exhibits and Reports on Form 8-K 33 Signatures 34 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. General All references to "we," "us," and "our" refer to Pegasus Media & Communications, Inc., together with its direct and indirect subsidiaries. "PM&C" refers to Pegasus Media & Communications, Inc. individually as a separate entity. "PSC" refers to Pegasus Satellite Communications, Inc., the parent company of PM&C. "PCC" refers to Pegasus Communications Corporation, the parent company of PSC. Other terms used are defined as needed where they first appear. Significant Risks and Uncertainties We have a history of losses principally due to the substantial amounts incurred for interest expense and depreciation and amortization. Net losses were $25.8 million, $201.2 million, and $131.1 million for 2002, 2001, and 2000, respectively. We hold the principal operations for PSC and PCC, and each relies on us as a source of cash in primarily meeting their respective debt and preferred stock obligations. Our ability to fund operations, planned capital expenditures, debt service, and other activities and to fund the debt service and preferred stock requirements of PCC and PSC depends on our ability to generate cash in the future. Our ability to generate cash depends on the success of our business strategy, prevailing economic conditions, regulatory risks, competitive activities by other parties, equipment strategies, technological developments, level of programming costs and subscriber acquisition costs ("SAC"), levels of interest rates, and financial, business, and other factors that are beyond our control. We cannot assure that our business will generate sufficient cash flow from operations or that alternative financing will be available to us in amounts sufficient to fund the needs previously specified. Our credit agreement and note indenture contain numerous covenants that, among other things, generally limit the ability to incur additional indebtedness and liens, issue other securities, make certain payments and investments, pay dividends, transfer cash, dispose of assets, and enter into other transactions. Failure to make debt payments or comply with covenants could result in an event of default that, if not cured or waived, could have a material adverse effect on us. Our principal business is the direct broadcast satellite business. For 2002, 2001, and 2000, revenues for this business were 96%, 96%, and 94%, respectively, of total consolidated revenues, and operating expenses for this business were 92%, 93%, and 93%, respectively, of total consolidated operating expenses. Total assets of the direct broadcast satellite business were 95% and 97% of total consolidated assets at December 31, 2002 and 2001, respectively. We are in litigation against DIRECTV, Inc. An outcome in this litigation that is unfavorable to us could adversely impact our direct broadcast satellite business. See Note 8 for further information. For the six months ended June 30, 2003 and 2002, the direct broadcast satellite business had income from operations of $26.5 million and $22.4 million, respectively. We attribute the improvement in the current year to our direct broadcast satellite business strategy. This strategy focuses on: increasing the quality of new subscribers and the composition of our existing subscriber base; enhancing the returns on investment in our subscribers; generating free cash flow; and preserving liquidity. The primary focus of our "Quality First" strategy is on improving the quality and creditworthiness of our subscriber base. Our goal is to acquire and retain high quality subscribers, to cause average subscribers to become high quality subscribers, and to reduce acquisition and retention investments in low quality subscribers. To achieve these goals, our subscriber acquisition, development, and retention efforts focus on subscribers who are less likely to churn and who are more likely to subscribe to more programming services, including local and network programming, and to use multiple receivers. "Churn" refers to subscribers whose service has terminated. Our strategy includes a significant emphasis on credit scoring of potential 8 PEGASUS MEDIA & COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued) subscribers, adding and upgrading subscribers in markets where DIRECTV offers local channels, and who subscribe to multiple receivers. It is our experience that these attributes are closely correlated with lower churn, increased cash flow, and higher returns on investment. Our strategy also includes the use of behavioral and predictive scores to group subscribers and to design retention campaigns, upgrade offers, and consumer offers consistent with our emphasis on acquiring and retaining high quality subscribers and reducing our investment in lower quality subscribers. Continued improvement in results from operations will in large part depend upon our obtaining a sufficient number of quality subscribers, retention of these subscribers for extended periods of time, and improving margins from them. While our direct broadcast satellite business strategy has resulted in an increase in income from operations, it has contributed to a certain extent to the decrease in the number of our direct broadcast satellite subscribers of 76 thousand and the decrease of $19.8 million in direct broadcast satellite net revenues for the six months ended June 30, 2003 compared to the six months ended June 30, 2002. In the near term, our direct broadcast satellite business strategy may result in further decreases in the number of our direct broadcast satellite subscribers and our direct broadcast satellite net revenues when compared to prior periods, but we believe that our results from operations for the direct broadcast satellite business will not be significantly impacted. We cannot make any assurances that this will be the case, however. If a disproportionate number of subscribers churn relative to the number of quality subscribers we enroll, we are not able to enroll a sufficient number of quality subscribers, and/or we are not able to maintain adequate margins from our subscribers, our results from operations may not improve or improved results that do occur may not be sustained. 2. Basis of Presentation The unaudited financial statements herein 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. These financial statements are prepared in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles in the United States of America for complete financial statements. The financial statements reflect all adjustments consisting of normal recurring items that, in our opinion, are necessary for a fair presentation, in all material respects, of our financial position and the results of our operations and comprehensive loss and our cash flows for the interim period. The interim results of operations contained herein may not necessarily be indicative of the results of operations for the full fiscal year. Prior year amounts have been reclassified where appropriate to conform to the current year classification for comparative purposes. 3. Changes in Other Stockholder's Equity The net change in other stockholder's equity from December 31, 2002 to June 30, 2003 of $(38.1) million consisted of net loss of $(3.6) million, cash contributions from PSC of $28.3 million and cash distributions to PSC of $(62.8) million. 4. Long Term Debt All principal amounts borrowed under our revolving credit facility were repaid during the six months ended June 30, 2003. Letters of credit outstanding under the revolving credit facility, which reduce the availability thereunder, were $61.4 million at June 30, 2003. After deducting the letters of credit outstanding, net availability under our revolving credit facility at June 30, 2003 was $79.2 million. 9 PEGASUS MEDIA & COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued) We repaid $688 thousand of principal outstanding under its term loan facility during the three months ended June 30, 2003 as scheduled, thereby reducing the total principal amount outstanding thereunder to $268.1 million. The weighted average variable rate of interest including applicable margins on principal amounts outstanding under the term loan facility was 4.6% and 5.3% at June 30, 2003 and December 31, 2002, respectively. We repaid $158 thousand of principal outstanding under its incremental term loan facility during the three months ended June 30, 2003 as scheduled, thereby reducing the total principal amount outstanding thereunder to $62.5 million. The weighted average variable rate of interest including applicable margins on principal amounts outstanding under the incremental term loan facility was 4.6% and 5.3% at June 30, 2003 and December 31, 2002, respectively. See below for actions we took after June 30, 2003 that impact all three of the preceding facilities. On July 31, 2003, a newly formed, wholly owned subsidiary of ours (the "LC subsidiary") entered into a letter of credit facility with a bank for a maximum amount of $59.0 million that terminates in July 2004. The bank issues letters of credit under the facility on behalf of the LC subsidiary. Letters of credit issued are in favor of amounts owed to the National Rural Telecommunications Cooperative ("NRTC") by our subsidiaries other than the LC subsidiary. The facility pays a quarterly fee of 1.75% of the amount of letters of credit outstanding at the beginning of each quarterly payment period. Outstanding letters of credit are secured with cash provided by the LC subsidiary in an amount equal to 105% of the letters of credit outstanding. The LC subsidiary is entitled to all earnings earned by the cash collateral. Cash collateral provided by the LC subsidiary will be reported as restricted cash on the consolidated balance sheets. On August 1, 2003, letters of credit were issued aggregating $59.0 million, and the LC subsidiary provided cash collateral of $61.9 million. PSC contributed $44.9 million to the LC subsidiary in funding the cash collateral. In July 2003, we amended our credit agreement and obtained certain consents from the lenders thereunder with respect to a term loan facility of PSC. The effective date of the amendment was August 1, 2003. On the effective date: 1) the commitment under the revolving credit facility was permanently reduced by $60.0 million to $80.6 million; 2) the permanent quarterly commitment reductions under the revolving credit facility were changed to $12.2 million on September 30, 2003 and $13.7 million every quarterly period ended thereafter until the facility's expiration date of October 31, 2004; 3) letters of credit in favor of amounts owed to the NRTC associated with the revolving credit facility prior to the amendment that had the effect of reducing the availability of the facility are not associated with the facility after the amendment; and 4) $1.9 million of term loan principal and $468 thousand of incremental term principal, along with associated accrued interest for each, were repaid. Aggregate costs incurred to amend the credit agreement and for consent fees amounted to $1.5 million. Also on August 1, 2003, $17.0 million was borrowed under the revolving credit facility to fund cash collateral under the letter of credit facility discussed above. In June 2003, PSC contributed to us $17.1 million maturity value of our 12-1/2% notes that it had acquired for its own account in 2002. We constructively retired the notes upon its receipt, and accounted for the contribution of the notes as an extinguishment of debt. We recognized a loss on the extinguishment of $288 thousand that is recorded in other nonoperating expenses on the statement of operations and comprehensive loss. On August 1, 2003, PSC contributed $69.3 million to us that was placed in trust to redeem in September 2003 all of the remaining outstanding principal of our 12-1/2% notes of $67.9 million and accrued interest on the notes to the date of their redemption of $1.4 million. These are our only publicly held securities. 10 PEGASUS MEDIA & COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued) 5. Supplemental Cash Flow Information The only significant noncash investing and financing activity was a net change in other comprehensive loss for the six months ended June 30, 2002 of $1.0 million. 6. Dispositions In March 2003, we completed the sale of our Mobile, Alabama broadcast television station to an unaffiliated party. Cash received from the sale was $11.0 million, and we recognized a gain on the sale of $7.6 million, net of costs related to the sale. The operations and sale of this station are classified as discontinued in the statement of operations and comprehensive loss for all periods presented. In April 2003, we entered into an agreement to sell our two broadcast television stations located in Mississippi to an unaffiliated party. In connection with and prior to the sale, we transferred a subsidiary holding the Federal Communications Commission ("FCC") licenses of these stations to PSC. We received $5.4 million cash from PSC, consisting of $2.8 million for the net assets of the subsidiary and $2.6 million as a capital contribution. We did not recognize any gain or loss on the transfer, for this was a transfer between entities under common control. On April 30, 2003, we closed on the sale of the tangible and intangible property (collectively the "nonFCC assets") of these stations, except for certain equipment associated with the FCC licenses (the "FCC assets") that we retained. We received $5.1 million on the sale, and recognized a loss of $2.4 million, net of costs related to the sale. At the close of the sale of the nonFCC assets, we received $192 thousand from the buyer as a nonrefundable prepayment on the FCC assets. The carrying amount of the FCC assets is $368 thousand. We will recognize the $192 thousand prepayment in revenue and recognize a loss of $182 thousand, net of costs related to the sale, on the sale of the FCC assets when it is completed. The sale of the FCC assets will be completed when the FCC approves the transfer of the FCC licenses from PSC to the buyer. We expect that the close of the sale of the FCC assets will occur by the end of 2003. The operations and sale of the Mississippi stations are classified as discontinued in the statement of operations and comprehensive loss for all periods presented. Aggregate assets and liabilities associated with the broadcast television stations above were not significant to our financial position to show separately as held for sale on the balance sheet, but such have been classified as other current and noncurrent assets and liabilities as appropriate. Aggregate revenues for and pretax income (loss) from discontinued operations were as follows (in thousands): Three Months Ended Six Months Ended June 30, June 30, 2003 2002 2003 2002 -------- --------- -------- -------- Revenues $ 380 $ 1,284 $ 1,533 $ 2,632 Pretax income (loss) (2,591) (628) 4,592 (1,326) In the pretax income (loss) from discontinued operations for the three and six months ended 2003 above was a net loss of $2.4 million and a net gain of $5.2 million, respectively, from the sale of the applicable assets. 11 PEGASUS MEDIA & COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued) 7. Industry Segments Our only reportable segment at June 30, 2003 was our direct broadcast satellite business. Information on the direct broadcast satellite business' revenue and how it contributed to our consolidated loss from continuing operations before income taxes for each period reported is as presented on the statements of operations and comprehensive loss. The direct broadcast satellite business derived all of its revenues from external customers for each period presented. Identifiable total assets for the direct broadcast satellite business were approximately $1.7 billion at June 30, 2003, which were not significantly different from those at December 31, 2002. We evaluate the direct broadcast satellite business segment based on its EBITDA, which we define as the direct broadcast satellite business' net operating revenue less its operating expenses (excluding depreciation and amortization), as derived from the statements of operations and comprehensive loss, excluding $4.5 million for a contract termination fee reversal in 2003 included in other subscriber related costs in the statement of operations and comprehensive loss. 8. Commitments and Contingent Liabilities Legal Matters DIRECTV Litigation: National Rural Telecommunications Cooperative Our subsidiaries, Pegasus Satellite Television ("PST") and Golden Sky Systems ("GSS"), are affiliates of the NRTC that participate through agreements in the NRTC's direct broadcast satellite program. "DIRECTV" refers to the programming services provided by DIRECTV, Inc. On June 3, 1999, the NRTC filed a lawsuit in United States District Court, Central District of California against DIRECTV, Inc. seeking a court order to enforce the NRTC's contractual rights to obtain from DIRECTV, Inc. certain premium programming formerly distributed by United States Satellite Broadcasting Company, Inc. for exclusive distribution by the NRTC's members and affiliates in their rural markets. On July 22, 1999, DIRECTV, Inc. filed a counterclaim seeking judicial clarification of certain provisions of DIRECTV, Inc.'s contract with the NRTC. On August 26, 1999, the NRTC filed a separate lawsuit in United States District Court, Central District of California against DIRECTV, Inc. claiming that DIRECTV, Inc. had failed to provide to the NRTC its share of launch fees and other benefits that DIRECTV, Inc. and its affiliates have received relating to programming and other services. The NRTC and DIRECTV, Inc. have also filed indemnity claims against one another that pertain to the alleged obligation, if any, of the NRTC to indemnify DIRECTV, Inc. for costs incurred in various lawsuits described herein. These claims have been severed from the other claims in the case and will be tried separately. DIRECTV, Inc. is seeking as part of its counterclaim a declaratory judgment that the term of the NRTC's agreement with DIRECTV, Inc. is measured only by the life of DBS-1, the first DIRECTV satellite launched, and not the orbital lives of the other DIRECTV satellites at the 101(degree) W orbital location. If DIRECTV, Inc. were to prevail on its counterclaim, any failure of DBS-1 could adversely impact our DIRECTV rights. On May 22, 2003, the Court issued an order denying DIRECTV, Inc.'s motion for summary judgment relating to the term of the agreement. While the NRTC has a right of first refusal to receive certain services after the term of NRTC's agreement with DIRECTV, Inc., the scope and terms of this right of first refusal are also being disputed as part of DIRECTV, Inc.'s counterclaim. On December 29, 1999, DIRECTV, Inc. filed a motion for partial summary judgment seeking an order 12 PEGASUS MEDIA & COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued) that the right of first refusal does not include programming services and is limited to 20 program channels of transponder capacity. On January 31, 2001, the Court issued an order denying DIRECTV Inc.'s motion for partial summary judgment relating to the right of first refusal. On July 3, 2002, the Court granted a motion for partial summary judgment filed by DIRECTV, Inc., holding that the NRTC is liable to indemnify DIRECTV, Inc. for the costs of defense and liabilities that DIRECTV, Inc. incurs in a patent case filed by Pegasus Development Corporation ("PDC"), a subsidiary of PCC, and Personalized Media Communications, L.L.C. ("Personalized Media") in December 2000 in the United States District Court, District of Delaware against DIRECTV, Inc., Hughes Electronics Corporation, Thomson Consumer Electronics, and Philips Electronics North America Corporation. Personalized Media is a company with which PDC has a licensing arrangement. In February 2003, the United States District Court, District of Delaware granted PDC's and Personalized Media's motion for leave to amend the complaint to exclude relief for the delivery nationwide, using specified satellite capacity, of services carried for the NRTC, plus any other services delivered through the NRTC to subscribers in the NRTC's territories. The NRTC filed a motion with the United States District Court, Central District of California to reconsider its July 3, 2002 decision that the NRTC indemnify DIRECTV, Inc. for DIRECTV, Inc.'s costs of defense and liabilities from the patent litigation. The motion was heard by the Court on June 2, 2003. On June 10, 2003, the Court granted the NRTC's motion for reconsideration, reversed the partial summary judgment previously granted to DIRECTV, Inc., and granted partial summary judgment in favor of the NRTC. The Court's ruling provides that the NRTC has no obligation to indemnify DIRECTV, Inc. for the costs of defense or liabilities that DIRECTV, Inc. incurs in the patent litigation, based on the allegations of the amended complaint. PDC and Personalized Media are seeking injunctive relief and monetary damages for the defendants' alleged patent infringement and unauthorized manufacture, use, sale, offer to sell, and importation of products, services, and systems that fall within the scope of Personalized Media's portfolio of patented media and communications technologies, of which PDC is an exclusive licensee within a field of use. The technologies covered by PDC's exclusive license include services distributed to consumers using certain Ku band BSS frequencies and Ka band frequencies, including frequencies licensed to affiliates of Hughes Electronics and used by DIRECTV, Inc. to provide services to its subscribers. We are unable to predict the possible effects of this litigation on our relationship with DIRECTV, Inc. 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, Inc. 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, Inc.'s failure to provide the NRTC with certain premium programming, and on DIRECTV, Inc.'s position with respect to launch fees and other benefits, term, and 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, and withdrew the class action allegations to allow a new class action to be filed on behalf of the members and affiliates of the NRTC. The amended complaint also added claims regarding DIRECTV Inc.'s failure to allow distribution through the NRTC of various advanced services, including Tivo. The new class action was filed on February 29, 2000. The Court certified the plaintiff's class on December 28, 2000. On March 9, 2001, DIRECTV, Inc. filed a counterclaim against PST and GSS, as well as the class members, seeking two claims for relief: 1) a declaratory judgment whether DIRECTV, Inc. is under a contractual obligation to provide PST and GSS with services after the expiration of the term of their agreements with the NRTC and 2) an order that DBS-1 is the satellite (and 13 PEGASUS MEDIA & COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued) the only satellite) that measures the term of PST's and GSS' agreements with the NRTC. On October 29, 2001, the Court denied DIRECTV Inc.'s motion for partial summary judgment on its term counterclaim. On June 20, 2001, PST and GSS filed a second amended complaint, updating the claims asserted in the earlier complaints. On June 22, 2001, DIRECTV, Inc. 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, Inc. and PST and GSS. On July 13, 2001, PST and GSS terminated the seamless marketing agreement. The seamless marketing agreement provided seamless marketing and sales for DIRECTV retailers and distributors. On July 16, 2001, PST and GSS filed a cross complaint against DIRECTV, Inc. alleging, among other things, that 1) DIRECTV, Inc. breached the seamless marketing agreement and 2) DIRECTV, Inc. engaged in unlawful and/or unfair business practices, as defined in Section 17200, et seq. of the California Business and Professions Code. This suit has since been removed to the United States District Court, Central District of California. On September 16, 2002, PST and GSS filed first amended counterclaims against DIRECTV, Inc. Among other things, the first amended counterclaims added claims for 1) rescission of the seamless marketing agreement on the ground of fraudulent inducement, 2) specific performance of audit rights, and 3) punitive damages on the breach of the implied covenant of good faith claim. In addition, the first amended counterclaims deleted the business and professions code claim and the claims for tortious interference that were alleged in the initial cross complaint. On November 5, 2002 the Court granted DIRECTV, Inc.'s motion to dismiss 1) the specific performance claim and 2) the punitive damages allegations on the breach of the implied covenant of good faith claim. The Court denied DIRECTV, Inc.'s motion to dismiss the implied covenant of good faith claim in its entirety. DIRECTV, Inc. filed four summary judgment motions on September 11, 2002 against the NRTC, the class members, and PST and GSS on a variety of issues in the case. The motions cover a broad range of claims in the case, including 1) the term of the agreement between the NRTC and DIRECTV, Inc., 2) the right of first refusal as it relates to PST and GSS, 3) the right to distribute the premiums, and 4) damages relating to the premiums, launch fees, and advanced services claims. These motions were argued on May 5, 2003 and decided on May 22, 2003, and were then the subject of a motion for reconsideration argued on June 2, 2003 and decided on June 5, 2003. As a result of these and earlier rulings, the term of the agreement, the content of the right of first refusal, and plaintiffs rights to launch fees and advanced services and to distribute premiums will all be determined at trial. The Court dismissed PST's tort and punitive damage claims and the restitution aspects of PST's unfair business practices claim other than with respect to launch fees. The Court did not dismiss the injunctive relief portions of the unfair business practices claim. The Court also ruled that DIRECTV, Inc. has no obligation to provide PST with services after the Member Agreements between PST and the NRTC expire, except that the ruling does not affect: (1) obligations the NRTC has or may have to PST under the Member Agreements or otherwise; (2) obligations DIRECTV, Inc. has or may have in the event it steps into the shoes of the NRTC as the provider of services to PST; or (3) fiduciary or cooperative obligations to deliver services owed PST by DIRECT, Inc. through the NRTC. On July 25, 2003, the Court ruled on motions in limine filed by all parties. While the rulings narrowed certain issues to be presented to the Court, it did not materially alter any of the parties' causes of action. The Court also denied DIRECTV Inc.'s motion to dismiss PST and GSS, among others, on jurisdictional grounds. The lawsuits described above, including both lawsuits brought by the NRTC, the class action and PST's and GSS' lawsuit (but excluding the indemnity and seamless marketing lawsuits) were set to be 14 PEGASUS MEDIA & COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued) tried in phases before the same judge beginning August 14, 2003. The first phase of the trial was to include issues relating to term and the right of first refusal. However, the Court was informed of a conditional settlement reached among DIRECTV, Inc., the NRTC and the class relating to all of their claims; and, on August 12, 2003, the Court vacated the trial date and set a status conference for September 4, 2003. The Court also ordered further settlement proceedings between DIRECTV, Inc. and PST. The announced settlement among DIRECTV, Inc., the NRTC and the class is conditioned on a satisfactory "fairness hearing" conducted by the Court relating to the class claims, the date of which has not been set but is anticipated to be held in approximately 75 to 90 days. We do not believe that the proposed settlement will resolve the pending claims between DIRECTV, Inc. and PST and GSS. PST and GSS are in the process of evaluating the settlement. We have filed copies of the proposed settlement with a Form 8-K dated August 11, 2003. Other Legal Matters: In addition to the matters discussed above, from time to time we are involved with claims that arise in the normal course of our business. We believe that the ultimate liability, if any, with respect to these claims will not have a material effect on our consolidated operations, cash flows, or financial position. Commitments Customer Relationship Management Services: In the second quarter 2002, we recorded a termination fee liability of $4.5 million and associated expense to the direct broadcast satellite business' other subscriber related expense with respect to an agreement for customer relationship management services that we intended to terminate early. The termination fee was to be paid and the termination was to be effective in July 2003. During the second quarter 2003, we amended this agreement and the termination fee was no longer payable. Accordingly, during the second quarter 2003 we reversed the termination fee liability and reduced direct broadcast satellite's other subscriber related expenses by $4.5 million. The amended agreement does not require any minimum annual services amount, whereas the agreement prior to the amendment required a prorated minimum annual services amount of $10.9 million for 2003. 9. New Accounting Pronouncements On April 30, 2003, the Financial Accounting Standards Board ("FASB") issued Statement No. 149 "Amendment of Statement 133 on Derivative Instruments and Hedging Activities" ("FAS 149"). FAS 149 amends and clarifies various items and issues related to derivative instruments. There was no material impact to us upon the adoption of this statement. The FASB issued Statement No. 150 "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity" ("FAS 150") in May 2003. FAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument within its scope as a liability (or an asset in some circumstances). We continue to study the provisions of the statement to determine what, if any, further impact there may be to us. 15 PEGASUS MEDIA & COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued) 10. Subsidiary Guarantees Our 12-1/2% 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, with the exception of certain subsidiaries described in the following sentence. Pegasus Satellite Development Corporation and South Plains DBS L.P., both of which are direct or indirect subsidiaries of ours, are not guarantors of the notes ("Nonguarantor Subsidiaries"). We believe separate financial statements and other disclosures concerning the Guarantor Subsidiaries are not significant to an understanding of their financial position, results of operations, and cash flows. In lieu of separate financial statements, we are providing the following condensed consolidating financial statements to present the financial position, results of operations, and cash flows of the guarantor and nonguarantor entities comprising the consolidated reporting group. 16 PEGASUS MEDIA & COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued) 10. Subsidiary Guarantees (continued) Condensed Consolidating Balance Sheets (In thousands)

17 PEGASUS MEDIA & COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued) 10. Subsidiary Guarantees (continued) Condensed Consolidating Balance Sheets (In thousands)

18 PEGASUS MEDIA & COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued) 10. Subsidiary Guarantees (continued) Condensed Consolidating Statements of Operations (In thousands)

19 PEGASUS MEDIA & COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued) 10. Subsidiary Guarantees (continued) Condensed Consolidating Statements of Operations (In thousands)

20 PEGASUS MEDIA & COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued) 10. Subsidiary Guarantees (continued) Condensed Consolidating Statements of Operations (In thousands)

21 PEGASUS MEDIA & COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued) 10. Subsidiary Guarantees (continued) Condensed Consolidating Statements of Operations (In thousands)

22 PEGASUS MEDIA & COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued) 10. Subsidiary Guarantees (continued) Condensed Consolidating Statements of Cash Flows (In thousands)

23 PEGASUS MEDIA & COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued) 10. Subsidiary Guarantees (continued) Condensed Consolidating Statements of Cash Flows (In thousands)

24 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," "hope," "intend," "expect," and similar expressions are intended to identify forward looking statements, although not all forward looking statements contain these identifying words. Such statements reflect our current views with respect to future events and are subject to unknown risks, uncertainties, and other factors that may cause actual results to differ materially from those contemplated in such forward looking statements. Such factors include the risks described elsewhere in this report and, among others, the following: general economic and business conditions, both nationally, internationally, and in the regions in which we operate; catastrophic events, including acts of terrorism; relationships with and events affecting third parties like DIRECTV, Inc. and the National Rural Telecommunications Cooperative; litigation with DIRECTV, Inc.; the potential sale of DIRECTV, Inc.; demographic changes; existing government regulations, and changes in, or the failure to comply with, government regulations; competition, including our ability to offer local programming in our direct broadcast satellite markets; the loss of any significant numbers of subscribers or viewers; changes in business strategy or development plans; the cost of pursuing new business initiatives; an expansion of land based communications systems; technological developments and difficulties; the ability to attract and retain qualified personnel; our significant indebtedness; the availability and terms of capital to fund the expansion of our businesses; and other factors referenced in this report and in other reports filed from time to time with the Securities and Exchange Commission, including our Annual Report on Form 10-K for the fiscal year ended December 31, 2002. Readers are cautioned not to place undue reliance on these forward looking statements, which speak only as of the date hereof. We do not undertake any obligation to publicly release any revisions to these forward looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. The following discussion of our results of operations should be read in conjunction with the consolidated financial statements and related notes herein. General All references to "we," "us," and "our" refer to Pegasus Media & Communications, Inc., together with its direct and indirect subsidiaries. "PM&C" refers to Pegasus Media & Communications, Inc. individually as a separate entity. "PSC" refers to Pegasus Satellite Communications, Inc., the parent company of PM&C. "PCC" refers to Pegasus Communications Corporation, the parent company of PSC. Other terms used are defined as needed where they first appear. We have a history of losses principally due to the substantial amounts incurred for interest expense and depreciation and amortization. Net losses were $25.8 million, $201.2 million, and $131.1 million for 2002, 2001, and 2000, respectively. Our principal business is the direct broadcast satellite business. For 2002, 2001, and 2000, revenues for this business were 96%, 96%, and 94%, respectively, of total consolidated revenues, and 25 PEGASUS MEDIA & COMMUNICATIONS, INC. operating expenses for this business were 92%, 93%, and 93%, respectively, of total consolidated operating expenses. Total assets of the direct broadcast satellite business were 95% and 97% of total consolidated assets at December 31, 2002 and 2001, respectively. The following sections focus on our direct broadcast satellite business, as this is our only significant business segment. Significant Risks and Uncertainties We hold the principal operations for PSC and PCC, and each primarily relies on us as a source of cash in primarily meeting their respective debt and preferred stock obligations. Our ability to fund operations, planned capital expenditures, debt service, and other activities and to fund the debt service and preferred stock requirements of PCC and PSC depends on our ability to generate cash in the future. Our ability to generate cash depends on the success of our business strategy, prevailing economic conditions, regulatory risks, competitive activities by other parties, equipment strategies, technological developments, level of programming costs and subscriber acquisition costs ("SAC"), levels of interest rates, and financial, business, and other factors that are beyond our control. We cannot assure that our business will generate sufficient cash flow from operations or that alternative financing will be available to us in amounts sufficient to fund the needs previously specified. Our credit agreement and note indenture contain numerous covenants that, among other things, generally limit the ability to incur additional indebtedness and liens, issue other securities, make certain payments and investments, pay dividends, transfer cash, dispose of assets, and enter into other transactions. Failure to make debt payments or comply with covenants could result in an event of default that, if not cured or waived, could have a material adverse effect on us. We are in litigation against DIRECTV, Inc. An outcome in this litigation that is unfavorable to us could adversely impact our direct broadcast satellite business. Our litigation with DIRECTV, Inc. may have a bearing on our estimation of the useful lives of our direct broadcast satellite rights assets. See Note 8 of the Notes to Consolidated Financial Statements for information regarding this litigation. Because we are a distributor of DIRECTV, we may be adversely affected by any material adverse changes in the assets, financial condition, programming, technological capabilities, or services of DIRECTV, Inc. For the six months ended June 30, 2003 and 2002, the direct broadcast satellite business had income from operations of $26.5 million and $22.4 million, respectively. We attribute the improvement in the current year to our direct broadcast satellite business strategy. This strategy focuses on: increasing the quality of new subscribers and the composition of our existing subscriber base; enhancing the returns on investment in our subscribers; generating free cash flow; and preserving liquidity. The primary focus of our "Quality First" strategy is on improving the quality and creditworthiness of our subscriber base. Our goal is to acquire and retain high quality subscribers, to cause average subscribers to become high quality subscribers, and to reduce acquisition and retention investments in low quality subscribers. To achieve these goals, our subscriber acquisition, development, and retention efforts focus on subscribers who are less likely to churn and who are more likely to subscribe to more programming services, including local and network programming, and to use multiple receivers. "Churn" refers to subscribers whose service has terminated. Our strategy includes a significant emphasis on credit scoring of potential subscribers, adding and upgrading subscribers in markets where DIRECTV offers local channels, and who subscribe to multiple receivers. It is our experience that these attributes are closely correlated with lower churn, increased cash flow, and higher returns on investment. Our strategy also includes the use of behavioral and predictive scores to group subscribers and to design retention campaigns, upgrade offers, and consumer offers consistent with our emphasis on acquiring and retaining high quality subscribers and reducing our investment in lower quality subscribers. 26 PEGASUS MEDIA & COMMUNICATIONS, INC. Continued improvement in results from operations will in large part depend upon our obtaining a sufficient number of quality subscribers, retention of these subscribers for extended periods of time, and improving margins from them. While our direct broadcast satellite business strategy has resulted in an increase in income from operations, it has contributed to a certain extent to the decrease in the number of our direct broadcast satellite subscribers of 76 thousand and the decrease of $19.8 million in the direct broadcast satellite business' net revenues during the six months ended June 30, 2003 compared to the six months ended June 30, 2002. In the near term, our direct broadcast satellite business strategy may result in further decreases in the number of our direct broadcast satellite subscribers and our direct broadcast satellite business' net revenues when compared to prior periods, but we believe that our results from operations for the direct broadcast satellite business will not be significantly impacted. We cannot make any assurances that this will be the case, however. If a disproportionate number of subscribers churn relative to the number of quality subscribers we enroll, we are not able to enroll a sufficient number of quality subscribers, and/or we are not able to maintain adequate margins from our subscribers, our results from operations may not improve or improved results that do occur may not be sustained. Results of Operations In this section, amounts and changes specified are for the six months ended June 30, 2003 compared to the six months ended June 30, 2002, unless indicated otherwise. With respect to our results from operations, we focus on our direct broadcast satellite business, as this is our only significant business. Direct Broadcast Satellite Business Subscribers: We had 1,232,744 subscribers at June 30, 2003, a net decrease of 75,726 from the number of subscribers at December 31, 2002. The average number of subscribers outstanding was 1,273,926 and 1,377,063 during the six months ended June 30, 2003 and 2002, respectively. Gross subscriber additions were 70,567 and 114,811 for the six months ended June 30, 2003 and 2002, respectively. We believe that the primary reasons for the net decrease in the number of subscribers during the 2003 period were: a significant competitive disadvantage that we experienced in several of our territories in which a competing direct broadcast satellite provider provides local channels but DIRECTV does not; our continued focus in 2003 on enrolling more creditworthy subscribers; our unwillingness to aggressively invest retention amounts in low margin subscribers; competition from digital cable providers; competition from a competing direct broadcast satellite provider other than with respect to local channels; the effect of general economic conditions on our subscribers and potential subscribers; and a reduction in the number of new subscribers we obtain from national retail chains with which we do not have compensation arrangements. Revenues: Revenues decreased $19.8 million to $411.4 million for the six months 2003. This decrease was primarily due to a decrease in our recurring subscription revenue from our core, a la carte, and premium package offerings of $22.5 million and a decrease in pay per view revenues of $7.8 million. The revenue decrease was partially offset by $10.4 million for the six months 2003 in revenues from a royalty fee introduced in July 2002 that passes on to subscribers a portion of the royalty costs charged to us in providing DIRECTV service. The decrease from our core, a la carte, and premium package offerings was primarily due to the net reduction in total subscribers described above, offset in part by increased average monthly revenue generated per subscriber ("ARPU") in 2003 compared to the corresponding 27 PEGASUS MEDIA & COMMUNICATIONS, INC. 2002 period. ARPU is direct broadcast satellite revenues for the period divided by the average number of subscribers during the period, divided by the number of months in the period. Total ARPU increased from $52.18 in 2002 to $53.52 in 2003 for the six months ended. ARPU for core, a la carte, and premium programming increased from $44.41 in 2002 to $45.05 in 2003 for the six months ended. A rate increase to certain a la carte and premium programming in second quarter 2003, as well as our ability to keep subscribers in and upgrade subscribers into higher retail priced packages, contributed to the increase in ARPU. Revenues for the second quarter 2003 were flat compared to the first quarter 2003 primarily due to a decrease in subscribers in the second quarter offset by increased average monthly revenue generated per subscriber in the second quarter. Total ARPU increased from $52.97 in the first quarter 2003 to $54.69 in the second quarter 2003. ARPU for core, a la carte, and premium programming increased from $44.25 in the first quarter 2003 to $45.88 in the second quarter 2003. A rate increase to certain a la carte and premium programming in second quarter 2003, as well as our ability to keep subscribers in and upgrade subscribers into higher retail priced packages contributed to the increases in ARPU. Direct Operating Expenses: Programming expense decreased $6.6 million to $185.7 million for the six months 2003. This decrease was primarily due to: a decrease in the cost of our recurring core, a la carte, and premium package subscription offerings of $6.3 million; and a decrease in the cost of our pay per view programming of $3.3 million. The decrease in the cost of our core, a la carte, and premium package offerings was primarily due to the net reduction in total subscribers, offset by a 7% increase, effective January 2003, in certain per subscriber programming costs charged to us by the National Rural Telecommunications Cooperative ("NRTC"). We also experienced a 10% increase, effective January 2003, in certain pay per view programming costs charged to us by the NRTC. The net decrease to programming expense were also partially offset by our estimate of patronage to be received from the NRTC being $6.4 million less for the six months 2003 compared to the corresponding 2002 period. The NRTC patronage is a reduction to programming expense. Other subscriber related expenses decreased $15.6 million to $85.2 million for the six months 2003. In 2003 there was a reduction of expenses of $4.5 million for the reversal in the second quarter 2003 of a contract termination fee recorded in 2002 and scheduled to be paid in July 2003 for a contract intended to be terminated in July 2003. However, in the second quarter 2003 the associated agreement was amended and continued. The remaining decreases were primarily due to decreases in bad debt expense of $9.8 million mainly due to our continued focus on improving the quality of our subscriber base that we obtain and retain and improved account collection efforts. Other Operating Expenses: Promotion and incentives and advertising and selling expenses on our statement of operations and comprehensive loss constitute expensed SAC. Expensed SAC is the gross amount of SAC we incur less amounts of SAC deferred and/or capitalized. Commissions, subsidies, and promotional programming are costs included in SAC that are incurred only when new subscribers are enrolled. Commissions and subsidies are the substantial cost elements within our SAC. Amounts associated with SAC are contained in the following table: 28 PEGASUS MEDIA & COMMUNICATIONS, INC. Six Months Ended SAC (in thousands): June 30, Expensed: 2003 2002 --------- --------- Promotions and incentives $ 6,473 $ 3,770 Advertising and selling 12,298 16,121 --------- --------- Total expensed 18,771 19,891 Deferred 10,569 17,326 Capitalized 10,114 13,497 --------- --------- Gross SAC incurred $ 39,454 $ 50,714 ========= ========= Gross SAC decreased in 2003 primarily due to a lesser amount of gross subscriber additions in 2003 compared to the corresponding 2002 period. Promotions and incentives expense increased in 2003 period because in 2002 a greater percentage of the related costs were eligible for either deferral or capitalization. In accordance with our policy whereby we expense SAC in excess of amounts eligible to be deferred, we incurred more of these excess promotions and incentive costs in 2003 than in the corresponding 2002 period. Based on gross subscriber additions for the 2003 and 2002 periods noted above, total SAC per gross subscriber added was $559 and $458 for 2003 and 2002, respectively. The increase in 2003 compared to the corresponding 2002 period was primarily due to: the disproportionate impact our sales administration costs and other indirect SAC expenses have on the SAC per gross subscriber addition metric when divided by a substantially lesser number of gross subscriber additions; a greater percentage of our gross subscriber additions taking more than one receiver that adds incrementally to the per subscriber cost; a lesser percentage in 2003 compared to 2002 of our gross subscriber additions coming from national retailers with which we do not have compensation arrangements; and the higher per subscriber costs associated with enrolling more creditworthy subscribers and the proportionately greater number of such subscribers enrolled in 2003 than in 2002. Depreciation of capitalized SAC was $8.8 million and $6.0 million for the six months 2003 and 2002, respectively. Amortization of deferred SAC was $14.1 million and $13.5 million for the six months 2003 and 2002, respectively. Depreciation of capitalized SAC and amortization of deferred SAC are included in depreciation and amortization. General and administrative expenses decreased $2.5 million to $12.3 million for the six months 2003 primarily due to reduced expenditures for communication services resulting from a renegotiation at the end of March 2002 of the related contract for such services and continuing cost reduction efforts in the 2003 periods that realized incremental cost reductions over the corresponding 2002 periods. Depreciation and amortization increased $1.9 million to $82.8 million for the six months 2003. The increase in depreciation and amortization was primarily due to a greater amount of deferred SAC eligible to be amortized in 2003. Other Statement of Operations and Comprehensive Loss Items The loss on impairment of marketable securities for the three and six months 2002 was due to the write off of an investment in the common stock of another entity we owned at the time to the stock's then fair market value. The income tax benefit on the loss from continuing operations decreased $2.8 million to $4.4 million due to a reduced amount of pretax losses in the current year compared to the corresponding prior year period. 29 PEGASUS MEDIA & COMMUNICATIONS, INC. Discontinued operations for 2003 and 2002 consisted of a broadcast television station located in Mobile, Alabama and two stations located in Mississippi. In March 2003, we completed the sale of our Alabama station, and recognized a gain on the sale of $7.6 million, net of costs related to the sale. On April 30, 2003, we closed on the sale of tangible and intangible property (collectively the "nonFCC assets") of the Mississippi stations, and recognized a loss of $2.4 million, net of costs related to the sale. The operations and sale of all of the above stations are classified as discontinued in the statement of operations and comprehensive loss for all periods presented. Aggregate revenues for and pretax income (loss) from discontinued operations were as follows (in thousands): Three Months Ended Six Months Ended June 30, June 30, 2003 2002 2003 2002 --------- --------- -------- ---------- Revenues $ 380 $ 1,284 $ 1,533 $ 2,632 Pretax income (loss) (2,591) (628) 4,592 (1,326) In the pretax income (loss) from discontinued operations for the three and six months ended 2003 above was a net loss of $2.4 million and a net gain of $5.2 million, respectively, from the sale of the applicable assets. DBS EBITDA EBITDA for our direct broadcast satellite business ("DBS EBITDA") was $52.2 million and $54.6 million for three months ended June 30, 2003 and 2002, respectively, and $104.8 million and $103.3 million for the six months ended June 30, 2003 and 2002, respectively. We present DBS EBITDA because the direct broadcast satellite business is our only significant business and this business forms the principal portion of our results of operations. The calculation of DBS EBITDA and a reconciliation of DBS EBITDA to its most comparable GAAP financial measure of net loss follows (in thousands). All amounts are as contained on our consolidated statement of operations and comprehensive loss. For the Six Months Ended June 30, 2003 2002 ----------- ----------- Direct broadcast satellite net revenues $ 411,369 $ 431,171 Direct broadcast satellite operating expenses, excluding depreciation and amortization and contract termination fee reversal (306,521) (327,834) ----------- ----------- DBS EBITDA 104,848 103,337 Direct broadcast satellite depreciation and amortization (82,829) (80,937) Contract termination fee reversal 4,500 - Broadcast, net 291 (809) Corporate expenses (6,093) (7,619) Other operating expenses, net (14,112) (13,424) ----------- ----------- Income from operations 6,605 548 Interest expense (18,463) (18,165) Interest income 68 153 30 PEGASUS MEDIA & COMMUNICATIONS, INC. For the Six Months Ended June 30, table continued from previous page 2003 2002 ----------- ----------- Loss on impairment of marketable securities - (3,063) Other nonoperating income (expenses), net 1,000 1,239 Net benefit for income taxes 4,357 7,152 Discontinued operations, net 2,847 (822) ----------- ----------- Net loss $ (3,586) $ (12,958) =========== =========== We use DBS EBITDA as a measurement of earnings generated by the direct broadcast satellite business that are available to reinvest in the business via investments in deferred SAC and capital expenditures, to fund our debt service, to potentially fund equity dividends, and to potentially fund other development projects. We also use DBS EBITDA as a percentage of revenue as a measurement of operating efficiency, especially as benchmarked against competitors in the industry. Further, we use DBS EBITDA as the denominator in measuring a modified value to earnings multiple, to assess our enterprise value, and growth thereof over time, especially as benchmarked against comparables in the industry. Finally, we use DBS EBITDA as the denominator in measuring our leverage at various points throughout our capital structure, and improvements made thereto over time, especially as benchmarked against comparables in the industry. We believe that investors, analysts, lenders, and other interested parties who follow our industry use DBS EBITDA for the same reasons that we do. Investors, analysts, lenders, and other interested parties who follow our industry rely on the DBS EBITDA measure to make informed decisions, especially by benchmarking against comparables in the industry. Our ability and desire to reinvest in the DBS business, to fund debt service of the enterprise, to potentially fund equity dividends, and to potentially fund other development projects is largely dependent upon our ability to generate DBS EBITDA. We believe that the limitation associated with the use of DBS EBITDA, as compared to net income, is the number of items included or not included in DBS EBITDA that are included in net income. However, we believe this limitation is not significant and mitigated by the fact that, generally, all reconciling items are contained on the face of our statement of operations and comprehensive loss. DBS EBITDA is not, and should not be considered, an alternative to income from operations, net income, or any other measure for determining our operating performance, as determined under generally accepted accounting principles. Although EBITDA is a common measure used by other companies, our calculation of DBS EBITDA may not be comparable with that of others. New Accounting Pronouncements On April 30, 2003, the Financial Accounting Standards Board ("FASB") issued Statement No. 149 "Amendment of Statement 133 on Derivative Instruments and Hedging Activities" ("FAS 149"). FAS 149 amends and clarifies various items and issues related to derivative instruments. There was no material impact to us upon the adoption of this statement. The FASB issued Statement No. 150 "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity" ("FAS 150") in May 2003. FAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument within its scope as a liability (or an asset in some circumstances). We continue to study the provisions of the statement to determine what, if any, further impact there may be to us. 31 PEGASUS MEDIA & COMMUNICATIONS, INC. ITEM 4. CONTROLS AND PROCEDURES Within the 90 days prior to the filing date of this report on Form 10-Q, we carried out an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Senior Vice President of Finance (the principal financial officer), to determine the effectiveness of our disclosure controls and procedures. Based on this evaluation, the Chief Executive Officer and the Senior Vice President of Finance concluded that these controls and procedures are effective in their design to ensure that information required to be disclosed by the registrant in reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and that such information has been accumulated and communicated to the management of the registrant, including the above indicated officers, as appropriate to allow timely decisions regarding the required disclosures. There have not been any significant changes in the registrant's internal controls or in other factors that could significantly affect these controls subsequent to the date of this evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. 32 PEGASUS MEDIA & COMMUNICATIONS, INC. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS For information relating to litigation with DIRECTV, Inc. and others, we incorporate by reference herein the disclosure reported under Note 8 to the Notes to Consolidated Financial Statements. The Notes to Consolidated Financial Statements can be found under Part I, Item 1 of this Quarterly Report on Form 10-Q. We have previously filed reports during the fiscal year disclosing some or all of the legal proceedings referenced above. In particular, we have reported on such proceedings in our Annual Report on Form 10-K for the year ended December 31, 2002, our Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2003, and our Current Report on Form 8-K dated June 10, 2003. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a) Exhibits Exhibit Number 31.1* Certification Pursuant to Section 302 of the Sarbanes-Oxley Act. 31.2* Certification Pursuant to Section 302 of the Sarbanes-Oxley Act. 32.1* Certification Pursuant to Section 906 of the Sarbanes-Oxley Act. 32.2* Certification Pursuant to Section 906 of the Sarbanes-Oxley Act. ----------------- * Filed herewith. b) Reports on Form 8-K On April 3, 2003, we filed a Current Report on Form 8-K dated April 2, 2003 reporting under Item 5 that a newly formed subsidiary of our parent company Pegasus Satellite Communications, Inc. received a commitment for up to $100.0 million in term loan financing from a group of institutional lenders. We included exhibits to the Form the loan documents governing the commitment and the text of the press release describing the terms of the financing. On June 18, 2003, we filed a Current Report on Form 8-K dated June 10, 2003 reporting under Item 5 an update of our litigation with DIRECTV, Inc. with respect to decisions rendered on certain summary judgment motions filed by DIRECTV, Inc. We also disclosed the date set by the Court for the first phase of the trial. We also provided an updated description of (i) the DIRECTV, Inc. litigation and (ii) the patent infringement lawsuit filed by our subsidiary Pegasus Development Corporation and Personalized Media Communications, L.L.C. 33 PEGASUS MEDIA & COMMUNICATIONS, INC. SIGNATURES 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. August 14, 2003 By: /s/ Joseph W. Pooler, Jr. ------------------------------------ ------------------------------ Date Joseph W. Pooler, Jr. Senior Vice President of Finance (Chief financial and accounting officer) 34 PEGASUS MEDIA & COMMUNICATIONS, INC. Exhibit Index Exhibit Number 31.1* Certification Pursuant to Section 302 of the Sarbanes-Oxley Act. 31.2* Certification Pursuant to Section 302 of the Sarbanes-Oxley Act. 32.1* Certification Pursuant to Section 906 of the Sarbanes-Oxley Act. 32.2* Certification Pursuant to Section 906 of the Sarbanes-Oxley Act. ----------------- * Filed herewith. 35

PEGASUS MEDIA & COMMUNICATIONS INC 10-Q