UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED:
MARCH 31, 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: 0-32617
HORIZON TELCOM, INC.
(Exact name of registrant as specified in its charter)
OHIO 31-1449037
(State or other jurisdiction of incorporation (I.R.S. Employer Identification No.)
or organization)
68 EAST MAIN STREET, CHILLICOTHE, OH 45601-0480
(Address of principal executive offices) (Zip Code)
(740) 772-8200
(Registrant's telephone number, including area code)
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 [ ]
Indicated by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No[X]
As of May 11, 2003, there were 90,552 shares of class A common stock and 271,926
shares of class B common stock outstanding.
HORIZON TELCOM, INC.
FORM 10-Q
FIRST QUARTER REPORT
TABLE OF CONTENTS
PAGE NO.
-------
PART I FINANCIAL INFORMATION
Item 1. Financial Statements....................................................3
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations..............................................20
Item 3. Quantitative and Qualitative Disclosures About Market Risk.............35
Item 4. Controls and Procedures................................................36
PART II OTHER INFORMATION
Item 1. Legal Proceedings......................................................37
Item 2. Changes in Securities and Use of Proceeds..............................37
Item 3. Defaults Upon Senior Securities........................................37
Item 4. Submission of Matters to a Vote of Security Holders....................37
Item 5. Other Information......................................................37
Item 6. Exhibits and Reports on Form 8-K.......................................54
As used herein and except as the context may otherwise require, "the
Company," "we," "us," "our" or "Horizon Telcom" means, collectively, Horizon
Telcom, Inc., and its subsidiaries: Horizon PCS, Inc., The Chillicothe Telephone
Company, Horizon Technology, Inc., and Horizon Services, Inc. References to
"Horizon PCS" refer to Horizon PCS, Inc., and its subsidiaries: Horizon Personal
Communications, Inc. ("HPC"), and Bright Personal Communications Services, LLC
("Bright PCS").
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HORIZON TELCOM, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
As of March 31, 2003 and December 31, 2002
- --------------------------------------------------------------------------------
March 31, December 31,
2003 2002
--------------- ---------------
ASSETS (unaudited)
- ------
CURRENT ASSETS:
Cash and cash equivalents (includes $11,000,000 and $55,000,000 on deposit at
March 31, 2003 and December 31, 2002, respectively, in accordance with
covenant amendment in 2002).............................................. $ 79,344,733 $ 94,948,351
Restricted cash............................................................ 24,063,259 24,063,259
Accounts receivable - subscriber, less allowance for doubtful accounts of
approximately $2,208,000 and $2,654,000 at March 31, 2003 and December 31,
2002, respectively....................................................... 21,883,207 20,560,658
Accounts receivable - interexchange carriers, access charge pools and other,
less allowance for doubtful accounts of approximately $93,000 as of March
31, 2003 and $71,000 as of December 31, 2002............................. 6,867,598 5,045,930
Inventories................................................................ 5,059,053 6,336,877
Investments, available-for-sale, at fair value............................. 812,820 745,860
Prepaid expenses and other current assets.................................. 7,135,742 5,926,816
--------------- ---------------
Total current assets................................................. 145,166,412 157,627,751
--------------- ---------------
OTHER ASSETS:
Intangible assets - Sprint PCS licenses, net of amortization............... 39,766,368 40,381,201
Debt issuance costs, net................................................... 19,617,085 20,365,415
Deferred Personal Communications Services ("PCS") activation expense....... 5,350,674 6,092,645
Prepaid pension costs and other............................................ 5,545,805 5,361,994
--------------- ---------------
Total other assets................................................... 70,279,932 72,201,255
--------------- ---------------
PROPERTY, PLANT AND EQUIPMENT, NET ........................................... 307,212,552 315,921,107
--------------- ---------------
Total assets.................................................... $ 522,658,896 $ 545,750,113
=============== ===============
(Continued on next page)
3
HORIZON TELCOM, INC. AND SUBSIDIARIES
Consolidated Balance Sheets (Continued)
As of March 31, 2003 and December 31, 2002
- --------------------------------------------------------------------------------
March 31, December 31,
2003 2002
--------------- ---------------
(unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Accounts payable........................................................... $ 22,703,807 $ 24,827,065
Payable to Sprint.......................................................... 13,601,094 9,910,262
Deferred PCS revenue....................................................... 5,970,738 5,308,457
Accrued real estate and other taxes........................................ 6,212,832 6,514,707
Accrued interest, payroll and other accrued liabilities.................... 16,868,977 10,237,300
Lines of credit............................................................ 500,000 --
--------------- ---------------
Total current liabilities............................................ 65,857,448 56,797,791
--------------- ---------------
LONG-TERM DEBT AND OTHER LIABILITIES:
Long-term debt............................................................. 565,559,698 558,284,349
Deferred income taxes, net................................................. 15,257,176 15,234,409
Postretirement benefit obligation.......................................... 6,838,690 6,526,991
Deferred PCS activation revenue............................................ 5,350,674 6,092,645
Other long-term liabilities................................................ 10,889,749 11,075,183
--------------- ---------------
Total long-term debt and other liabilities........................... 603,895,987 597,213,577
--------------- ---------------
Total liabilities.................................................. 669,753,435 654,011,368
--------------- ---------------
CONVERTIBLE PREFERRED STOCK OF SUBSIDIARY..................................... 160,174,311 157,105,236
COMMITMENTS AND CONTINGENCIES (Note 10)
STOCKHOLDERS' EQUITY (DEFICIT):
Common stock - class A, no par value, 200,000 shares authorized, 99,726
shares issued and 90,552 shares outstanding, stated at $4.25 per share... 423,836 423,836
Common stock - class B, no par value, 500,000 shares authorized, 299,450
shares issued and 271,926 shares outstanding, stated at $4.25 per share.. 1,272,662 1,272,662
Treasury stock - 36,698 shares, at cost.................................... (5,504,700) (5,504,700)
Accumulated other comprehensive income (loss), net......................... 310,793 (67,307)
Additional paid-in capital................................................. 72,197,212 72,197,212
Deferred stock compensation................................................ (570,112) (666,721)
Retained deficit........................................................... (375,398,541) (333,021,473)
--------------- ---------------
Total stockholders' equity (deficit)............................... (307,268,850) (265,366,491)
--------------- ---------------
Total liabilities and stockholders' equity (deficit)............ $ 522,658,896 $ 545,750,113
=============== ===============
The accompanying notes are an integral part of these
consolidated financial statements.
4
HORIZON TELCOM, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
For the Three Months Ended March 31, 2003 and 2002 (unaudited)
- --------------------------------------------------------------------------------
For the Three Months Ended
March 31,
2003 2002
---------------- ----------------
OPERATING REVENUES:
Wireless PCS revenue............................................... $ 57,371,647 $ 45,733,388
PCS equipment sales................................................ 1,818,096 2,375,288
Basic local, long-distance and other landline...................... 4,377,509 4,597,831
Network access..................................................... 5,426,833 4,595,470
Equipment systems sales, information services, Internet access and
other ........................................................... 2,244,824 2,105,749
---------------- ----------------
Total operating revenues....................................... 71,238,909 59,407,726
---------------- ----------------
OPERATING EXPENSES:
Cost of PCS and other equipment sales.............................. 5,910,547 5,092,010
Cost of services (exclusive of items shown separately below)....... 48,059,427 39,492,143
Selling and marketing.............................................. 12,856,959 15,085,457
General and administrative (exclusive of items shown separately
below)........................................................... 12,863,889 12,798,088
Non-cash compensation expense...................................... 96,609 101,867
Loss on disposal of property and equipment......................... 257,376 285,739
Depreciation and amortization...................................... 13,209,276 10,120,011
---------------- ----------------
Total operating expenses....................................... 93,254,083 82,975,315
---------------- ----------------
OPERATING LOSS........................................................ (22,015,174) (23,567,589)
---------------- ----------------
NONOPERATING INCOME (EXPENSE):
Interest expense, net of amounts capitalized....................... (16,974,705) (13,203,579)
Subsidiary preferred stock dividends............................... (3,069,109) (2,856,369)
Interest income and other, net..................................... 316,391 742,175
---------------- ----------------
Total nonoperating income (expense)............................ (19,727,423) (15,317,773)
---------------- ----------------
LOSS BEFORE INCOME TAX (EXPENSE) BENEFIT
AND MINORITY INTEREST............................................... (41,742,597) (38,885,362)
INCOME TAX (EXPENSE) BENEFIT.......................................... (163,274) (207,634)
MINORITY INTEREST IN LOSS............................................. 24 --
---------------- ----------------
NET LOSS.............................................................. $ (41,905,847) $ (39,092,996)
=============== ================
Basic and diluted net loss per share.................................. $ (115.61) $ (107.89)
=============== ================
Weighted-average common shares outstanding ........................... 362,478 362,336
================ ================
The accompanying notes are an integral part of these
consolidated financial statements.
5
HORIZON TELCOM, INC. AND SUBSIDIARIES
Consolidated Statements of Other Comprehensive Income (Loss)
For the Three Months Ended March 31, 2003 and 2002 (unaudited)
- --------------------------------------------------------------------------------
For the Three Months Ended
March 31,
------------------------------------
2003 2002
--------------- ---------------
NET LOSS............................................................... $ (41,905,847) $ (39,092,996)
OTHER COMPREHENSIVE INCOME (LOSS):
Net unrealized gain on hedging activities............................ 333,907 389,943
Net unrealized gain (loss) on securities available-for-sale, as of
March 31, 2003 and 2002, net of taxes of $22,767 and $349,085,
respectively....................................................... 44,193 (677,635)
--------------- ---------------
COMPREHENSIVE INCOME (LOSS)............................................ $ (41,527,747) $ (39,380,688)
=============== ===============
The accompanying notes are an integral part of these
consolidated financial statements.
6
HORIZON TELCOM, INC. AND SUBSIDIARIES
Consolidated Statements to Cash Flows
For the Three Months Ended March 31, 2003 and 2002 (unaudited)
- --------------------------------------------------------------------------------
Three Months Ended March 31,
2003 2002
--------------- ---------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss............................................................... $ (41,905,847) $ (39,092,996)
--------------- ---------------
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Depreciation and amortization....................................... 13,209,276 10,120,011
Deferred federal income taxes....................................... -- 349,085
Non-cash compensation expense....................................... 96,609 101,867
Non-cash interest expense........................................... 7,811,830 6,118,481
Loss on disposal of property, plant and equipment................... 257,376 285,739
Non-cash preferred stock dividend of subsidiary..................... 3,069,109 2,856,369
Minority interest in subsidiary..................................... (24) --
Provision for bad debt expense...................................... 1,566,264 3,295,989
Loss on hedging activities.......................................... -- 34,103
Decrease (Increase) in certain assets:
Accounts receivable............................................... (4,710,481) (6,707,025)
Inventories....................................................... 1,277,824 1,969,055
Prepaid expenses and other........................................ (1,145,625) (3,042,787)
Increase (Decrease) in certain liabilities:
Accounts payable.................................................. (2,123,258) 2,609,234
Payable to Sprint................................................. 3,690,832 6,648,003
Accrued liabilities and deferred PCS service revenue.............. 5,961,797 4,046,987
Other accrued liabilities......................................... 1,030,285 2,054,261
Postretirement benefit obligation................................. 311,699 185,745
Change in other assets and liabilities, net......................... 43,640 (182,102)
--------------- ---------------
Total adjustments............................................... 30,347,153 30,743,015
--------------- ---------------
Net cash used in operating activities......................... (11,558,694) (8,349,981)
--------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures, net........................................... (4,073,727) (26,333,246)
Proceeds from sale of property and equipment........................ -- 1,253,182
--------------- ---------------
Net cash used in investing activities.................................. (4,073,727) (25,080,064)
--------------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings on line of credit........................................ 500,000 --
Borrowings on long-term debt........................................ -- 105,400,000
Repayments on long-term debt........................................ -- (1,167,338)
Exercise of subsidiary stock options................................ 24 --
Dividends paid...................................................... (471,221) (452,911)
--------------- ---------------
Net cash provided by financing activities..................... 28,803 103,779,751
--------------- ---------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS................... (15,603,618) 70,349,706
CASH AND CASH EQUIVALENTS, beginning of period......................... 94,948,351 127,154,227
--------------- ---------------
CASH AND CASH EQUIVALENTS, end of period............................... $ 79,344,733 $ 197,503,933
=============== ===============
The accompanying notes are an integral part of these
consolidated financial statements.
7
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
As of March 31, 2003 and December 31, 2002
And for the Three Months Ended March 31, 2003 and 2002 (unaudited)
- --------------------------------------------------------------------------------
NOTE 1 - GENERAL
The results of operations for the periods shown are not necessarily
indicative of the results to be expected for the fiscal year. In the opinion of
management, the information contained herein reflects all adjustments necessary
to make a fair statement of the periods presented. All such adjustments are of a
normal recurring nature. The financial information presented herein should be
read in conjunction with the Company's Form 10-K for the year ended December 31,
2002, which includes information and disclosures not presented herein.
NOTE 2 - LIQUIDITY
As of March 31, 2003, Horizon PCS, Inc. ("Horizon PCS"), a subsidiary of
Horizon Telcom and a registrant that files separate statements with the
Securities and Exchange Commission, was in compliance with its covenants with
regard to all outstanding debt (approximately $523.6 million at March 31, 2003).
However, the Company believes that it is probable that Horizon PCS will violate
one or more of its covenants under the secured credit facility in 2003. Horizon
PCS, represents approximately 83% of total consolidated revenues for the quarter
ended March 31, 2003 and 80% of the total consolidated assets at March 31, 2003.
The failure to comply with a covenant would be an event of default under the
secured credit facility, and would give the lenders the right to pursue remedies
against Horizon PCS. These remedies could include acceleration of amounts due
under the facility. If the lenders elected to accelerate the amounts due under
the facility, this would also represent a default under the indentures for the
senior notes and discount notes. As noted in our 10-K filing dated March 31,
2003, at December 31, 2002, Horizon PCS' independent auditors' report states
these matters raise substantial doubt about Horizon PCS' ability to continue as
a going concern. The consolidated financial statements do not include any
adjustments that might result from the outcome of this uncertainty. Please refer
to Horizon PCS' 2002 10-K filing for more details.
Horizon PCS is currently in the process of negotiating various terms with
its creditors. Horizon Telcom, Chillicothe Telephone, Horizon Technology, and
Horizon Services are not obligated in any form to assist Horizon PCS in their
negotiations nor are they obligated to compensate any of Horizon PCS' creditors
should Horizon PCS default on any debt agreements. Defaults of covenants on debt
agreements of Horizon PCS will not result in defaults in any debt agreements or
other contractual obligation of Horizon Telcom or any of its subsidiaries.
Should Horizon PCS be unsuccessful in their discussions, the Company could
potentially revise the ownership structure in Horizon PCS. Should ownership of
our voting rights fall below 50% or otherwise lose control of Horizon PCS,
Horizon PCS may not be included in the consolidated results of Horizon Telcom.
This would have a significant impact on the presentation of operations of
Horizon Telcom.
NOTE 3 - ORGANIZATION AND BUSINESS OPERATIONS
The Company is a facilities-based telecommunications carrier that provides
a variety of voice and data services to commercial, residential/small business
and local market segments. The Company provides landline telephone service,
very-high digital subscriber line ("VDSL") television service and Internet
access services to the southern Ohio region, principally in and surrounding
Chillicothe, Ohio. The Company also provides PCS operations to a twelve-state
region in the Midwest, including Ohio, Indiana, Pennsylvania, Virginia and West
Virginia, as an affiliate of Sprint PCS.
NOTE 4 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Note 2 in the Notes to Consolidated Financial Statements in the Company's
Annual Report on Form 10-K for the year ended December 31, 2002, describes the
Company's significant accounting policies in greater detail than presented
herein.
8
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
As of March 31, 2003 and December 31, 2002
And for the Three Months Ended March 31, 2003 and 2002 (unaudited)
- --------------------------------------------------------------------------------
NOTE 4 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
BASIS OF PRESENTATION
The accompanying consolidated financial statements reflect the operations of
Horizon Telcom, and its subsidiaries, the Chillicothe Telephone Company
("Chillicothe Telephone"), Horizon PCS, Inc. ("Horizon PCS"), Horizon Services,
Inc. ("Horizon Services"), and Horizon Technology, Inc ("Horizon Technology,"
formerly United Communications, Inc.) and have been prepared in accordance with
the rules and regulations of the Securities and Exchange Commission ("SEC").
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
in the United States have been condensed or omitted pursuant to such rules and
regulations. All material intercompany transactions and balances have been
eliminated in consolidation.
INVENTORIES
Inventories consist of equipment held for resale, materials and supplies
and installation-related work in progress held by Chillicothe Telephone and
Horizon PCS. Chillicothe Telephone inventories include the cost (determined by
the first-in, first-out method) of equipment to be used in the installation of
telephone systems, as well as costs related to direct sales orders in process.
Horizon PCS' inventories consist of handsets and related accessories which are
carried at the lower of cost (determined by the weighted-average method) or
market (replacement cost).
Inventories consist of the following at March 31, 2003 and at December 31,
2002:
March 31, December 31,
2003 2002
--------------- ---------------
Equipment held for resale....................... $ 2,772,257 $ 4,204,296
Materials, supplies and work in progress........ 2,286,796 2,132,581
--------------- ---------------
Total inventories.......................... $ 5,059,053 $ 6,336,877
=============== ===============
ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ materially
from those estimates.
ACCOUNTING FOR RATE REGULATION
Chillicothe Telephone is subject to rate regulation. Statement of Financial
Accounting Standards ("SFAS"). 71 "Accounting for the Effects of Certain Types
of Rate Regulation" provides that rate-regulated public utilities account for
revenues and expenses and report assets and liabilities consistent with the
economic effect of the way in which regulators establish rates. Chillicothe
Telephone follows the accounting and reporting requirements of SFAS No. 71. As
of March 31, 2003, the Company has recorded regulatory liabilities of
approximately $1,992,000. As of December 31, 2002, regulatory assets and
liabilities were approximately $63,000 and $480,000, respectively.
RESTRICTED CASH
In connection with Horizon PCS' December 2001 offering of $175,000,000 of
senior notes due in 2011 (Note 9), approximately $48,660,000 of the offering's
proceeds were placed in an escrow account to be used toward the first four
semi-annual interest payments due under the terms of the notes. During 2002, the
Company paid approximately $24,596,000, representing the first two installments.
The remaining two payments have been classified as short-term and are scheduled
to be paid in June and December of 2003.
9
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
As of March 31, 2003 and December 31, 2002
And for the Three Months Ended March 31, 2003 and 2002 (unaudited)
- --------------------------------------------------------------------------------
NOTE 4 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment, including improvements that extend useful
lives, are stated at cost (Note 7), while maintenance and repairs are charged to
operations as incurred. Construction work in progress includes expenditures for
the purchase of capital equipment, construction and items such as direct payroll
and related benefits and interest capitalized during construction.
The Company capitalizes interest pursuant to SFAS No. 34 "Capitalization of
Interest Cost." The Company capitalized interest of approximately $473,000 and
$2,118,000 for the three months ended March 31, 2003 and 2002, respectively. In
addition, the Company capitalized labor costs of approximately $535,000 and
$1,881,000 for the three months ended March 31, 2003 and 2002, respectively.
DERIVATIVE FINANCIAL INSTRUMENTS
The Company's policies do not permit the use of derivative financial
instruments for speculative purposes. The Company uses interest rate swaps to
manage interest rate risk. The net amount paid or received on interest rate
swaps is recognized as an adjustment to interest income and other.
The Company has adopted SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," as amended by SFAS No. 138, "Accounting for
Derivative Instruments and Certain Hedging Activities." These statements require
an entity to recognize all derivative and hedging activities as an asset or
liability measured at fair value. Depending on the intended use of the
derivative, changes in its fair value will be reported in the period of change
as either a component of earnings or a component of other comprehensive income.
The Company uses interest rate swaps, designated as cash flow hedges, to manage
interest rate risk. The net amount paid or received on interest rate swaps is
recognized as an adjustment to interest income and other. Changes in the fair
value of a derivative that is highly effective and that is designated and
qualifies as a cash-flow hedge are recorded in other comprehensive income to the
extent that the derivative is effective as a hedge, until earnings are affected
by the variability in cash flows of the designated hedged item. The ineffective
portion of the change in fair value of a derivative instrument that qualifies as
either a fair-value hedge or a cash-flow hedge is reported in earnings. Changes
in the fair value of derivative trading instruments are reported in current
period earnings. Outstanding temporary gains and losses are netted together and
shown as either a component of other assets or accrued liabilities.
REVENUE RECOGNITION
Horizon PCS records equipment revenue from the sale of handsets and
accessories to subscribers in its retail stores and to local distributors in its
territories upon delivery. Horizon PCS does not record equipment revenue on
handsets and accessories sold by national third-party retailers or directly by
Sprint to subscribers in its territory. After the handset has been purchased,
the subscriber purchases a service package, revenue from which is recognized
monthly as service is provided and is included in subscriber revenue, net of
credits related to the billed revenue. Horizon PCS believes the equipment
revenue and related cost of equipment associated with the sale of wireless
handsets and accessories is a separate earnings process from the sale of
wireless services to subscribers. For industry competitive reasons, Horizon PCS
sells wireless handsets at a loss. Because such arrangements do not require a
customer to subscribe to Horizon PCS' wireless services and because Horizon PCS
sells wireless handsets to existing customers at a loss, Horizon PCS accounts
for these transactions separately from agreements to provide customers wireless
service.
10
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
As of March 31, 2003 and December 31, 2002
And for the Three Months Ended March 31, 2003 and 2002 (unaudited)
- --------------------------------------------------------------------------------
NOTE 4 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Horizon PCS recognizes revenues when persuasive evidence of an arrangement
exists, services have been rendered or products have been delivered, the price
to the buyer is fixed and determinable, and collectibility is reasonably
assured. Horizon PCS' revenue recognition policy is consistent with the current
interpretations of SEC Staff Accounting Bulletin ("SAB") No. 101, "Revenue
Recognition in Financial Statements." Accordingly, activation fee revenue and
direct customer activation expense is deferred and will be recorded over the
average contract life for those customers (currently estimated to be 24 months)
that are assessed an activation fee.
A management fee of 8% of collected PCS revenues from Sprint PCS
subscribers based in Horizon PCS' territory, is accrued as services are provided
and remitted to Sprint and recorded as general and administrative expense.
Revenues generated from the sale of handsets and accessories, inbound and
outbound Sprint PCS roaming fees, and roaming services provided to Sprint PCS
customers who are not based in Horizon PCS' territory are not subject to the 8%
management fee.
The landline telephone services operating segment consists of basic local
and long-distance toll, network access services and other telephone service
revenue. All revenue is recognized monthly as service is provided.
MINORITY INTEREST
As part of the acquisition of Bright Personal Communication Services, LLC
("Bright PCS"), the former members of Bright PCS have approximately an 8%
ownership in Horizon PCS. The Company accounts for this ownership by recording
the portion of net income (loss) attributable to the minority shareholders as
minority interest in earnings (loss) in the accompanying consolidated statements
of operations. The minority interest's share in the Company's losses during 2001
reduced the minority interest's accounting basis to zero.
During the first quarter of 2003, two Horizon PCS executives exercised 200
options for class A common stock. These transactions created a less than 1%
ownership in the equity of Horizon PCS. Horizon Telcom accounts for this
ownership by recording the portion of net loss attributable to the minority
shareholders as minority interest in loss in the accompanying condensed
consolidated statements of operations. There will be no further allocations to
minority interest until such time as Horizon PCS becomes profitable and any
unallocated losses to minority interest are offset with income in future
periods.
STOCK-BASED COMPENSATION
The Company applies the intrinsic value-based method of accounting
prescribed by Accounting Principles Board ("APB") Opinion No. 25, "Accounting
for Stock Issued to Employees," and related interpretations including Financial
Accounting Standards Board ("FASB") Interpretation No. 44, "Accounting for
Certain Transactions involving Stock Compensation an interpretation of APB
Opinion No. 25" issued in March 2000, to account for its fixed plan stock
options. Under this method, compensation expense is recorded on the date of
grant only if the current market price of the underlying stock exceeded the
exercise price. SFAS No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure - an amendment of FASB Statement No. 123" established
accounting and disclosure requirements using a fair value-based method of
accounting for stock-based employee compensation plans. As allowed by SFAS No.
148, the Company has elected to continue to apply the intrinsic value-based
method of accounting described above, and has adopted the disclosure
requirements of SFAS No. 148.
11
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
As of March 31, 2003 and December 31, 2002
And for the Three Months Ended March 31, 2003 and 2002 (unaudited)
- --------------------------------------------------------------------------------
NOTE 4 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The following table illustrates the effect on net loss if the
fair-value-based method had been applied to all outstanding and unvested awards
in each of the three month periods ending March 31:
2003 2002
---------------- ----------------
Net Loss
As reported..................................... $ (41,905,847) $ (39,092,996)
Add: Stock-based employee compensation expense
included in reported net loss................... 96,609 101,867
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards.................................. (214,511) (292,428)
---------------- ----------------
Pro forma net loss.............................. $ (42,023,749) $ (39,283,557)
================ ================
Basic and diluted loss per share
As reported..................................... $ (115.61) $ (107.89)
Pro forma....................................... $ (115.93) $ (108.42)
================ ================
The Company accounts for equity instruments issued to non-employees in
accordance with the provisions of SFAS No. 148 and Emerging Issues Task Force
("EITF") Issue No. 96-18, "Accounting for Equity Instruments That Are Issued to
Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or
Services." All transactions in which goods or services are the consideration
received for the issuance of equity instruments are accounted for based on the
fair value of the consideration received or the fair value of the equity
instrument issued, whichever is more reliably measurable. The measurement date
of the fair value of the equity instrument issued is the earlier of the date on
which the counter-party's performance is complete or the date on which it is
probable that performance will occur.
NET LOSS PER SHARE
The Company computes net loss per common share in accordance with SFAS No.
128, "Earnings per Share." Basic and diluted loss per share before extraordinary
item is computed by dividing loss before extraordinary item, for each period, by
the weighted-average outstanding common shares. Basic and diluted net loss per
share is computed by dividing net loss, for each period, by the weighted-average
outstanding common shares. No conversion of common stock equivalents (options,
warrants or convertible securities) has been assumed in the calculations since
the effect would be antidilutive. As a result, the number of weighted-average
outstanding common shares as well as the amount of net loss per share are the
same for basic and diluted net loss per share calculations for all periods
presented. There are three items that could potentially dilute basic earnings
per share in the future. These items include the common stock options, the stock
purchase warrants and the convertible preferred stock. These items will be
included in the diluted earnings per share calculation when dilutive.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure - an amendment of FASB Statement No.
123." This Statement provides alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, this Statement requires prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. The Company adopted the disclosure requirements of SFAS No. 148 as of
December 31, 2002, but continues to account for stock compensation costs in
accordance with APB Opinion No. 25.
12
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
As of March 31, 2003 and December 31, 2002
And for the Three Months Ended March 31, 2003 and 2002 (unaudited)
- --------------------------------------------------------------------------------
NOTE 4 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." This Statement addresses financial
accounting and reporting for costs associated with exit or disposal activities
by requiring that expenses related to the exit of an activity or disposal of
long-lived assets be recorded when they are incurred and measurable. Prior to
SFAS No. 146, these charges were accrued at the time of commitment to exit or
dispose of an activity. The Company adopted SFAS 146 on January 1, 2003, and it
did not have a material effect on the Company's financial position, results of
operations or cash flows.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." SFAS No. 145 addresses the accounting for gains and losses from
the extinguishment of debt, economic effects and accounting practices of
sale-leaseback transactions and makes technical corrections to existing
pronouncements. The Company adopted SFAS No. 145 on January 1, 2003, and it did
not have a material effect on the Company's financial position, results of
operations or cash flows.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." This statement addresses financial accounting and
reporting for obligations associated with the retirements of tangible long-lived
assets and the associated asset retirement costs. It applies to legal
obligations associated with the retirement of long-lived assets that result from
the acquisition, construction, development and the normal operation of a
long-lived asset. The Company adopted this statement effective January 1, 2003
(see Note 7).
In 2002, the FASB's EITF, reached a consensus on Issue 00-21, "Revenue
Arrangements with Multiple Deliverables." Issue 00-21 provides guidance on how a
vendor should account for arrangements under which it will perform multiple
revenue-generating activities. The guidance in this Issue is effective for
revenue agreements entered into in fiscal periods beginning after June 15, 2003.
The Company is still evaluating the impact this guidance might have on its
financial position, results of operations and cash flows. The Company will adopt
the guidance in Issue 00-21 as of July 1, 2003.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform with the 2003
presentation.
NOTE 5 - SEGMENT INFORMATION
The Company is organized around the differences in products and services it
offers. Under this organizational structure, the Company operates in two
reportable business segments as defined by SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information." These segments are wireless
personal communications services and landline telephone services. The wireless
personal communications services segment includes three major revenue streams:
PCS subscriber revenues, PCS roaming revenues and PCS equipment sales. The
landline telephone services segment includes four major revenue streams: basic
local service, long-distance service, network access and other related telephone
service.
13
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
As of March 31, 2003 and December 31, 2002
And for the Three Months Ended March 31, 2003 and 2002 (unaudited)
- --------------------------------------------------------------------------------
NOTE 5 - SEGMENT INFORMATION (CONTINUED)
Other business activities of the Company include Internet access services,
equipment systems sales, and other miscellaneous revenues, which do not meet the
definition of a reportable segment under SFAS No. 131. Amounts related to these
business activities are included below under the heading "All other."
Unallocated administrative expenses represent general and administrative
expenses incurred at a corporate level. All other assets represent common assets
not identified to an operating segment.
The Company evaluates the performance of the segments based on operating
earnings before the allocation of administrative expenses. Information about
interest income and expense and income taxes is not provided on a segment level.
The accounting policies of the segments are the same as described in the summary
of significant accounting policies.
The following table includes revenue, intercompany revenues, operating
earnings (loss), depreciation and amortization expense and capital expenditures
for the quarters ended March 31, 2003 and 2002, and assets as of March 31, 2003
and December 31, 2002, for each segment and reconciling items necessary to total
to amounts reported in the financial statements:
Net Revenues
------------------------------------
Three Months Ended March 31,
2003 2002
---------------- ----------------
Wireless personal communications services................. $ 59,189,743 $ 48,108,676
Landline telephone services............................... 9,804,342 9,193,301
All other................................................. 2,244,824 2,105,749
---------------- ----------------
Total net revenue....................................... $ 71,238,909 $ 59,407,726
================ ================
Intercompany Revenues
------------------------------------
Three Months Ended March 31,
2003 2002
---------------- ----------------
Wireless personal communications services................. $ 5,178 $ 101,106
Landline telephone services............................... 314,575 401,914
All other................................................. 131,644 107,317
---------------- ----------------
Total intercompany revenue.............................. $ 451,397 $ 610,337
================ ================
Operating Earnings (Loss)
------------------------------------
Three Months Ended March 31,
2003 2002
---------------- ----------------
Wireless personal communications services................. $ (21,570,642) $ (23,075,544)
Landline telephone services............................... 3,506,622 3,548,542
All other................................................. (1,027,253) (973,055)
Unallocated administrative expenses....................... (2,923,901) (3,067,532)
---------------- ----------------
Total operating loss.................................... $ (22,015,174) $ (23,567,589)
================ ================
14
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
As of March 31, 2003 and December 31, 2002
And for the Three Months Ended March 31, 2003 and 2002 (unaudited)
- --------------------------------------------------------------------------------
NOTE 5 - SEGMENT INFORMATION (CONTINUED)
Depreciation and Amortization
------------------------------------
Three Months Ended March 31,
2003 2002
---------------- ----------------
Wireless personal communications services................. $ 10,860,686 $ 7,949,631
Landline telephone services............................... 1,738,314 1,679,674
All other................................................. 610,276 490,706
---------------- ----------------
Total depreciation and amortization..................... $ 13,209,276 $ 10,120,011
================ ================
Capital Expenditures
------------------------------------
Three Months Ended March 31,
2003 2002
---------------- ----------------
Wireless personal communications services................. $ 2,209,313 $ 23,438,012
Landline telephone services............................... 1,501,196 2,002,531
All other................................................. 363,218 892,703
---------------- ----------------
Total capital expenditures, net......................... $ 4,073,727 $ 26,333,246
================ ================
Assets
------------------------------------
March 31 December 31
2003 2002
---------------- ----------------
Wireless personal communications services................. $ 417,961,434 $ 443,116,762
Landline telephone services............................... 85,500,902 83,258,131
All other................................................. 19,196,560 19,375,220
---------------- ----------------
Total assets............................................... $ 522,658,896 $ 545,750,113
================ ================
Net operating revenues by product and services were as follows for the
quarters ended March 31:
Three Months Ended March 31,
2003 2002
--------------- ---------------
Wireless personal communications services:
PCS subscriber revenues................................. $ 43,573,774 $ 34,914,100
PCS roaming revenues.................................... 13,797,873 10,819,288
PCS equipment sales..................................... 1,818,096 2,375,288
--------------- ---------------
Total wireless personal communications services....... 59,189,743 48,108,676
--------------- ---------------
Landline telephone services:
---------------------------
Basic local service..................................... 3,388,136 3,605,256
Long-distance toll...................................... 248,545 309,392
Network access services................................. 5,426,833 4,595,470
Other related telephone services........................ 740,828 683,183
--------------- ---------------
Total landline telephone services...................... 9,804,342 9,193,301
--------------- ---------------
Other:
-----
Internet access services................................ 703,741 806,828
Equipment systems sales................................. 279,328 380,336
Other miscellaneous revenues............................ 1,261,755 918,585
--------------- ---------------
Total other............................................ 2,244,824 2,105,749
--------------- ---------------
Total operating revenues.......................... $ 71,238,909 $ 59,407,726
=============== ===============
15
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
As of March 31, 2003 and December 31, 2002
And for the Three Months Ended March 31, 2003 and 2002 (unaudited)
- --------------------------------------------------------------------------------
NOTE 6 - INVESTMENTS
The following summarizes unrealized gains and losses on investments at March
31, 2003, and December 31, 2002:
2003: Unrealized Unrealized Fair
- ---- Cost Gain Loss Value
----------- ---------- ----------- ----------
Equity securities available-for-sale.... $ 250,000 $ 562,820 $ -- $ 812,820
=========== ========== =========== ==========
2002:
- ---- Unrealized Unrealized Fair
Cost Gain Loss Value
----------- ---------- ----------- ----------
Equity securities available-for-sale.... $ 250,000 $ 495,860 $ -- $ 745,860
=========== ========== =========== ==========
NOTE 7 - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following:
March 31, December 31,
2002 2002
--------------- ---------------
Network assets..................................................... $ 307,415,370 $ 293,825,031
Switching equipment................................................ 62,584,893 63,294,413
Land and buildings................................................. 15,856,491 15,856,491
Computer and telecommunications equipment.......................... 13,610,068 13,369,767
Furniture, vehicles and office equipment........................... 12,714,731 12,518,760
--------------- ---------------
Property, plant and equipment in-service, at cost................ 412,181,553 398,864,462
Accumulated depreciation........................................... (109,268,084) (99,376,895)
--------------- ---------------
Property, plant and equipment in-service, net................. 302,913,469 299,487,567
Construction work in progress...................................... 4,299,083 16,433,540
--------------- ---------------
Total property, plant and equipment, net................. $ 307,212,552 $ 315,921,107
=============== ===============
During the three months ended March 31, 2003, the Company incurred a loss
of approximately $257,000 related to closing of two of our PCS retail stores and
a planned PCS store that never opened. During the three months ended March 31,
2002, the Company retired certain wireless network assets and replaced them with
equipment to upgrade the network. resulting in a loss of approximately $286,000.
During the three months ended March 31, 2003, Horizon PCS recorded a
liability of $22,600 and a cumulative change in accounting principle of $9,570
related to the adoption SFAS No. 143 of $22,600 for potential costs associated
with certain asset retirement obligations. The cumulative change in accounting
principle is included in "interest income and other, net" on the accompanying
statement of operations.
NOTE 8 - LINES OF CREDIT
On December 15, 2002, Chillicothe Telephone entered into an agreement with
Huntington National Bank for a line of credit that provides maximum borrowings
of $15,000,000, payable on demand. Interest accrues on the outstanding balance
at a fluctuating rate tied to the London Interbank Offered Rate ("LIBOR") and is
due and payable monthly. At March 31, 2003, the interest rate on the line of
credit was 2.92%. As of March 31, 2003, Chillicothe Telephone had drawn $500,000
under this line of credit. The line of credit contains several covenants
requiring minimum tangible net worth, a fixed charge coverage ratio, a funded
debt to consolidated total capitalization ratio and an interest coverage ratio.
As of March 31, 2003, Chillicothe Telephone was in compliance with these
covenants.
16
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
As of March 31, 2003 and December 31, 2002
And for the Three Months Ended March 31, 2003 and 2002 (unaudited)
- --------------------------------------------------------------------------------
NOTE 9 - LONG-TERM DEBT
The components of long-term debt outstanding are as follows:
Interest Rate at
March 31, March 31, December 31,
2003 2003 2002
---------------------- --------------- ----------
Horizon PCS:
Discount notes.......................... 14.00% $ 295,000,000 $ 295,000,000
Senior notes............................ 13.75% 175,000,000 175,000,000
Secured credit facility-term loan A..... 5.40% 105,000,000 105,000,000
Secured credit facility-term loan B..... 5.86% 50,000,000 50,000,000
Chillicothe Telephone:
2002 Senior Notes....................... 6.64% 30,000,000 30,000,000
1998 Senior Notes....................... 6.72% 12,000,000 12,000,000
--------------- ---------------
Long-term debt, par value............ 667,000,000 667,000,000
Less: Unaccreted interest portion of
Horizon PCS discount notes............ (101,440,302) (108,715,651)
--------------- ---------------
Total long-term debt............... $ 565,559,698 $ 558,284,349
--------------- ---------------
Horizon PCS' secured credit facility includes financial covenants including
restrictions on the Company's ability to draw on the $95.0 million line of
credit and deposit requirements on the $105.0 million term loan A. These amounts
are summarized below:
The following table details the maximum amount available to be borrowed on
Horizon PCS' line of credit for the period then ended (subject to other
restrictions in the secured credit facility):
Maximum amount
available to be
borrowed
----------------
March 31, 2003...................................
June 30, 2003.................................... $ 16,000,000
September 30, 2003............................... 26,000,000
December 31, 2003................................ 33,000,000
March 31, 2004................................... 52,000,000
April 1, 2004.................................... 95,000,000
The following table details the minimum balance requirements placed on
Horizon PCS' cash and cash equivalents under the amended terms of the secured
credit facility:
Deposit balance
requirement
-------------------
February 16, 2003, through March 31, 2003............. $ 11,000,000
April 1, 2003, through May 15, 2003................... 5,500,000
As of March 31, 2003, Horizon PCS was in compliance with its covenants
under the agreements for the senior credit facility, therefore, Horizon PCS'
indebtedness under the facility was classified as long-term. However as
described in Note 2, we believe it is probable that Horizon PCS will violate one
or more of its covenants during 2003. If Horizon PCS violates a covenant, is
declared to be in default of the credit agreement, then this indebtedness will
be reclassified to current liabilities. In addition, if the lenders accelerate
the indebtedness under the senior credit facility, this would cause a default
under Horizon PCS's other notes, in which case the balance of the notes would be
reclassified as short-term.
17
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
As of March 31, 2003 and December 31, 2002
And for the Three Months Ended March 31, 2003 and 2002 (unaudited)
- --------------------------------------------------------------------------------
NOTE 10 - COMMITMENTS AND CONTINGENCIES
SPRINT 3G DEVELOPMENT FEES
Recently, Sprint increased service fees in connection with its development
of 3G-related back-office systems and platforms. Horizon PCS, along with other
PCS affiliates of Sprint, is currently disputing the validity of Sprint's right
to pass through this fee to the affiliates. If this dispute is resolved
unfavorably to Horizon PCS, then Horizon PCS will incur additional expenses. As
of March 31, 2003, Horizon PCS has not recorded or paid amounts billed by Sprint
for 3G development costs of approximately $813,000.
OPERATING LEASES
The Company leases office space and various equipment under several
operating leases. In addition, Horizon PCS has tower lease agreements with third
parties whereby it leases towers for substantially all of its cell sites. The
tower leases are operating leases with a term of five to ten years with three
consecutive five-year renewal option periods. In addition, Horizon PCS receives
a site development fee from a tower lessor for certain tower sites which the
lessor constructs on behalf of the Company.
Horizon PCS also leases space for its retail stores. At March 31, 2003,
Horizon PCS leased 43 retail stores operating throughout its territories.
LEGAL MATTERS
The Company is party to legal claims arising in the normal course of
business. Although the ultimate outcome of the claims cannot be ascertained at
this time, it is the opinion of management that none of these matters, when
resolved, will have a material adverse impact on the Company's results of
operations or financial condition.
HORIZON PCS STORE CLOSINGS
During the first quarter of 2003 the Company closed two retail stores. In
conjunction with these closing, we recorded a liability and corresponding lease
expense of approximately $97,000 representing the net present value of the
remaining lease obligations, net of the anticipated sublease revenues.
NTELOS NETWORK AGREEMENT
In August 1999, Horizon PCS entered into a wholesale network services
agreement with the West Virginia PCS Alliance and the Virginia PCS Alliance (the
"Alliances"), two related, independent PCS providers whose network is managed by
NTELOS. Under the network services agreement, the Alliances provide Horizon PCS
with the use of and access to key components of their network in most of HPCS'
markets in Virginia and West Virginia. The initial term was through June 8,
2008, with four automatic ten-year renewals.
This agreement was amended in the third quarter of 2001 to provide for a
minimum monthly fee to be paid by Horizon PCS through December 31, 2003. The
minimum monthly fee includes a fixed number of minutes to be used by Horizon
PCS' subscribers. Horizon PCS incurs additional per minute charges for minutes
used in excess of the fixed number of minutes allotted each month. The aggregate
amount of future minimum payments for the full year ended December 31, 2003 is
$38,600,000. Total costs recorded, for both fixed and variable charges incurred
by the NTELOS agreement, were approximately $9.7 million and $6.7 million for
the three months ended March 31, 2003 and 2002, respectively, and approximately
$33,036,000, for the year ended December 31, 2002.
18
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
As of March 31, 2003 and December 31, 2002
And for the Three Months Ended March 31, 2003 and 2002 (unaudited)
- --------------------------------------------------------------------------------
NOTE 10 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
On March 4, 2003, NTELOS and certain of its subsidiaries filed voluntarily
petitions for reorganization under Chapter 11 of the U.S. Bankruptcy Code in the
U.S. Bankruptcy Court for the Eastern District of Virginia. The results of
NTELOS' restructuring could have a material adverse impact on our operations.
Pursuant to bankruptcy law, the Alliances have the right to assume or reject the
network services agreement. If the Alliances reject the network services
agreement, we will lose the ability to provide service to our subscribers in
Virginia and West Virginia and will be in breach of our management agreements
with Sprint.
ASSET RETIREMENT OBLIGATION
Horizon PCS owns three of the towers within its wireless network. Under the
provisions of SFAS No. 143, which the Company adopted on January 1, 2003, a
liability and a corresponding asset in the amount of approximately $23,000 were
recorded on January 1, 2003 for the legal obligation the Company has to remove
these towers and make necessary improvements to bring the site to its original
condition at the end of the land lease term. A one-time charge of approximately
$10,000 for the cumulative change in accounting policy is included in "Interest
income and other, net" for the period ended March 31, 2003. The balance of the
asset will be depreciated over the remaining lives of the land leases associated
with the towers.
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
As used herein and except as the context may otherwise require, "the
Company," "we," "us," "our" or "Horizon Telcom" means, collectively, Horizon
Telcom, Inc. and its subsidiaries: Horizon PCS, Inc., The Chillicothe Telephone
Company, Horizon Technology, Inc. and Horizon Services, Inc. References to
"Horizon PCS" refer to Horizon PCS, Inc., and its subsidiaries Horizon Personal
Communications, Inc. ("HPC" or "Horizon Personal Communications") and Bright
Personal Communications Services, LLC ("Bright PCS").
FORWARD-LOOKING STATEMENTS
This quarterly report on Form 10-Q includes forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended (the
Securities Act), and Section 21E of the Securities Exchange Act of 1934, as
amended (the Exchange Act), which can be identified by the use of
forward-looking terminology such as: "may", "might", "could", "would",
"believe", "expect", "intend", "plan", "seek", "anticipate", "estimate",
"project" or "continue" or the negative thereof or other variations thereon or
comparable terminology. All statements other than statements of historical fact
included in this quarterly report on Form 10-Q, including without limitation,
the statements under "ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "ITEM 5. Other Information" and located
elsewhere herein regarding our financial position and liquidity are
forward-looking statements. These forward-looking statements also include, but
are not limited to:
O changes in industry conditions created by the Federal
Telecommunications Act of 1996 and related state and federal
legislation and regulations;
O recovery of the substantial costs which will result from the
implementation and expansion of our new businesses;
O retention of our existing customer base and our ability to attract new
customers;
O rapid changes in technology;
O our future compliance with debt covenants;
O actions of our competitors;
O estimates of current and future population for our markets;
O forecasts of growth in the number of consumers and businesses using
personal communication services ("PCS");
O estimates for churn and ARPU (defined below);
O statements regarding Horizon PCS' plans for and costs of the build-out
of its PCS network;
O statements regarding our anticipated revenues, expense levels,
liquidity and capital resources and projections of when we will
achieve break-even or positive operating cash flow; and
O the anticipated impact of recent accounting pronouncements.
Although we believe the expectations reflected in such forward-looking
statements are reasonable, we can give no assurance such expectations will prove
to have been correct. Important factors with respect to any such forward-looking
statements, including certain risks and uncertainties that could cause actual
results to differ materially from our expectations (Cautionary Statements), are
disclosed in this quarterly report on Form 10-Q, including, without limitation,
in conjunction with the forward-looking statements included in this quarterly
report on Form 10-Q. Important factors that could cause actual results to differ
materially from those in the forward-looking statements included herein include,
but are not limited to:
20
O changes or advances in technology and the acceptance of new technology
in the marketplace;
O competition in the industry and markets in which we operate;
O changes in government regulation; and
O general political economic and business conditions.
And, in addition the following factors related to Horizon PCS:
O Horizon PCS' ability to continue as a going concern;
O Horizon PCS' significant level of indebtedness;
O the likelihood that Horizon PCS will fail to comply with debt
covenants in its senior secured credit facility;
O the nature and amount of the fees that Sprint charges Horizon PCS for
back office services;
O Horizon PCS' potential need for additional capital or the need for
refinancing existing indebtedness;
O Horizon PCS' dependence on its affiliation with Sprint and its
dependence on Sprint's back office services;
O the need to successfully complete the build-out of Horizon PCS'
portion of the Sprint PCS network on our anticipated schedule;
O the potential to continue to experience a high rate of customer
turnover;
O Horizon PCS' lack of operating history and anticipation of future
losses;
O potential fluctuations in Horizon PCS' operating results;
O Horizon PCS' ability to attract and retain skilled personnel; and
O the possibility that the nature and extent of Horizon Telcom's
ownership interest in Horizon PCS may be materially adversely affected
by the foregoing factors.
These forward-looking statements involve known and unknown risks,
uncertainties and other factors which may cause our actual results, performance
or achievements to be materially different from any future results, performance
or achievements expressed or implied by such forward-looking statements. All
subsequent written and oral forward-looking statements attributable to us or
persons acting on our behalf are expressly qualified in their entirety by the
Cautionary Statements. See "ITEM 5. Other Information" included herein for
further information regarding risks and uncertainties related to our businesses.
OVERVIEW
Horizon Telcom is a holding company, which, in addition to its common stock
ownership of Horizon PCS, owns 100% of 1) Chillicothe Telephone, a local
telephone company, 2) Horizon Services, which provides administrative services
to other Horizon Telcom affiliates, and 3) Horizon Technology, a long-distance
and Internet services business.
Horizon Telcom provides a variety of voice and data services to commercial,
residential/small business and local market segments. Horizon Telcom provides
landline telephone service, VDSL television service and Internet access services
21
to the southern Ohio region, principally in and surrounding Chillicothe, Ohio.
Horizon Telcom also provides PCS operations to a twelve-state region in the
Midwest, including Ohio, Indiana, Virginia and West Virginia, as an affiliate of
Sprint PCS.
At March 31, 2003, Chillicothe Telephone serviced approximately 38,200
access lines in Chillicothe, Ohio and the surrounding area. Horizon Technology
provided Internet service to approximately 11,700 customers through its
bright.net Internet service. At March 31, 2003, Horizon PCS had launched service
covering approximately 7.4 million residents, or approximately 71% of the total
population in its territory, and serving approximately 294,900 customers.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Allowance for Doubtful Accounts. With respect to Horizon PCS, estimates are
used in determining our allowance for doubtful accounts receivable, which are
based on a percentage of our accounts receivables by aging category. The
percentage is derived by considering our historical collections and write-off
experience, current aging of our accounts receivable and credit quality trends,
as well as Sprint's credit policy. The following table provides certain
statistics on Horizon PCS' allowance for doubtful accounts receivable of
wireless subscribers for the three months ended March 31:
2003 2002
------------ ---------
Provision as a percent of wireless subscriber
revenue............................................ 3% 10%
Write-offs, net of recoveries as a percent of
wireless subscriber revenue........................ 4% 10%
Allowance for doubtful accounts as a percent of
PCS accounts receivable............................ 8% 10%
During the second half of 2001 and first half of 2002, a significant number
of our wireless customer additions were under the No Deposit Account Spending
Limit ("NDASL") program. These lower credit quality customers activated under
the NDASL program led to higher churn rates and an increased amount of bad debt
during 2002 as a significant number of these customers were disconnected and
written-off. Sprint has discontinued the NDASL program and replaced it with
Clear Pay, which tightened credit restrictions, and Clear Pay II, which
re-instituted deposit requirements for most lower credit quality customers and
introduces additional controls on loss exposure. In addition, we've focused our
marketing efforts into recruiting higher quality customers. As a result, our
percentage of prime credit customers in our subscriber portfolio increased to
73% at March 31, 2003, up from its lowest percentage of 65% at March 31, 2002.
The improvement of our wireless subscriber base has reduced our exposure to
write-offs. In addition, during the first quarter of 2003, we received
approximately $900,000 for deposits Sprint had retained through August of 2002,
that should have been used to offset write-offs. We applied this refund as a
reduction to bad debt expense.
With respect to our landline segments, accounts receivable consists
primarily of amounts billed to interexchange carriers for allowing their
customers to access our network when their customers place a call. Accounts
receivable also includes charges for advertising in Chillicothe Telephone's
yellow pages directory and amounts billed to customers for monthly services. Our
collection history with interexchange carriers has been good. However, all
pre-petition accounts receivables from WorldCom and WorldCom's MCI division,
which declared bankruptcy on July 21, 2002, were written off at year-end 2002.
Revenue Recognition. Horizon PCS records equipment revenue from the sale of
handsets and accessories to subscribers in its retail stores and to local
distributors in its territories upon delivery. Horizon PCS does not record
equipment revenue on handsets and accessories purchased from national
third-party retailers or directly from Sprint by subscribers in our territory.
After the handset has been purchased, the subscriber purchases a service
package, revenue from which is recognized monthly as service is provided and is
included in subscriber revenue, net of credits related to the billed revenue.
Horizon PCS believes the equipment revenue and related cost of equipment
22
associated with the sale of wireless handsets and accessories is a separate
earnings process from the sale of wireless services to subscribers. For industry
competitive reasons, Horizon PCS sells wireless handsets at a loss. Because such
arrangements do not require a customer to subscribe to Horizon PCS' wireless
services and because Horizon PCS sells wireless handsets to existing customers
at a loss, it accounts for these transactions separately from agreements to
provide customers wireless service.
Horizon PCS recognizes revenues when persuasive evidence of an arrangement
exists, services have been rendered or products have been delivered, the price
to the buyer is fixed and determinable, and collectibility is reasonable
assured. Horizon PCS revenue recognition policy is consistent with the current
interpretations of SEC SAB No. 101, "Revenue Recognition in Financial
Statements." Accordingly, activation fee revenue and direct customer activation
expense is deferred and will be recorded over the average contract life for
those customers (currently estimated to be 24 months) that are assessed an
activation fee.
A management fee of 8% of collected PCS revenues from Sprint PCS
subscribers based in Horizon PCS' territory, is accrued as services are provided
and remitted to Sprint and recorded as general and administrative. Revenues
generated from the sale of handsets and accessories, inbound and outbound Sprint
PCS roaming fees, and roaming services provided to Sprint PCS customers who are
not based in Horizon PCS' territory are not subject to the 8% management fee.
The landline telephone services operating segment consists of basic local
and long-distance toll, network access services and other related telephone
service revenue. Intra-LATA, (Local Access and Transport Area) (i.e., the area
of southern Ohio, including Columbus originally covered by area code 614), basic
local exchange and long-distance service revenue consists of flat rate services
and measured services billed to customers utilizing Chillicothe Telephone's
landline telephone network. Long distance intraLATA/interstate revenue consists
of message services that terminate beyond the basic service area of the
originating wire center. Network access revenue consists of revenue derived by
our landline telephone services segment from the provision of exchange access
services to an interexchange carrier or to an end user beyond the exchange
carrier's network. Other related telephone service revenue includes directory
advertising related to a telephone directory published annually.
Other revenues include Internet access services, equipment systems sales
and information services. Internet access revenues for our bright.net services
are monthly service fees and other charges billed to our bright.net customers.
Service fees primarily consist of monthly recurring charges billed to customers.
Equipment system sales and other revenues consist of sales made by Chillicothe
Telephone to various businesses or other residential customers for equipment
used on the telephone system.
Chillicothe Telephone is an independent local exchange carrier that
provides local telephone service within ten local exchanges. Chillicothe
Telephone follows an access charge system as ordered by the Federal
Communications Commission ("FCC") and the PUCO in 1984. The access charge
methodology provides a means whereby local exchange carriers, including
Chillicothe Telephone, provide their customers access to the facilities of the
long-distance carriers and charge long-distance carriers for interconnection to
local facilities.
The PUCO issued an Opinion and Order effective January 1, 1988, for
reporting intra-LATA (Local Access and Transport Area) toll revenues. This
methodology is defined as the Originating Responsibility Plan with a Secondary
Carrier Option (ORP-SCO). This plan calls for one or more primary carriers in
each LATA with other local exchange carriers acting as secondary carriers. The
secondary carriers provide the primary carrier with access to local facilities
and are compensated based upon applicable intra-LATA access charge tariffs.
Chillicothe Telephone is a primary carrier. Intra-LATA toll revenue is reflected
in basic and long-distance service revenue on the accompanying consolidated
statements of operations, and is recognized as such services are provided.
Estimated unbilled amounts are accrued at the end of each month.
Chillicothe Telephone recognizes revenue for billing and collection
services performed on behalf of certain interexchange carriers. Chillicothe
Telephone is reimbursed for this service based on the number of messages billed
on behalf of the interexchange carrier. The revenues from this service are
recognized in the same period the services are provided. Chillicothe Telephone
also recognizes advertising revenues from its telephone directory. Telephone
directory customers sign an annual contract which is billed in twelve equal
installments. The revenue derived from directory advertising is recognized
equally over the twelve-month period of the directory, consistent with the
ratemaking treatment. These items are recorded in other revenues on the
accompanying consolidated statements of operations.
23
Chillicothe Telephone recognizes revenues on the completed contract basis
for the installation of telecommunication and other related equipment. These
revenues are reported as equipment system sales on the accompanying consolidated
statements of operations. Maintenance revenues are recognized over the life of
the contract, and recorded as other revenues on the accompanying consolidated
statements of operations.
Horizon Technology is an FCC-licensed radio common carrier that primarily
provides Internet access services and resells long-distance service. Revenues on
equipment sales were recognized at the time of sale. Revenues for the Internet
and long distance services are recognized monthly as service is rendered.
24
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2003 COMPARED TO THE
THREE MONTHS ENDED MARCH 31, 2002
This discussion and analysis is presented on an operating segment basis.
The following unaudited table details the consolidated statements of income by
operating segment for the three months ended March 31, 2003 and 2002:
For the Three Months Ended, March 31,
Wireless Personal
Communications Services Landline Telephone Corporate and Other Services
-------------------------- ------------------------ ----------------------------
(Dollars in thousands)
OPERATING REVENUES: 2003 2002 2003 2002 2003 2002
------------ ------------ ----------- ----------- ----------- ------------
PCS subscriber and roaming..... $ 57,372 $ 45,733 $ -- $ -- $ -- $ --
PCS equipment.................. 1,818 2,375 -- -- -- --
Basic local and long-distance
and other landline........... -- -- 4,377 4,598 -- --
Network access................. -- -- 5,427 4,596 -- --
Equipment systems sales,
information services,
Internet access and other.... -- -- -- -- 2,245 2,106
----------- ----------- ----------- ------------ ------------- -----------
Total operating revenues.... 59,190 48,108 9,804 9,194 2,245 2,106
----------- ------------ ----------- ----------- ----------- ------------
OPERATING EXPENSES:
Cost of PCS and other
equipment sale.............. 5,755 4,920 -- -- 156 172
Cost of services.............. 43,797 35,650 2,490 2,285 1,772 1,557
Selling and marketing......... 12,441 14,707 183 113 233 265
General and administrative.... 7,557 7,565 1,885 1,566 3,422 3,667
Non-cash compensation......... 93 106 1 1 3 (5)
Loss on disposal of assets.... 257 286 -- -- -- --
Depreciation and amortization. 10,861 7,950 1,738 1,680 610 490
----------- ------------ ----------- ----------- ----------- ------------
Total operating expenses.... 80,761 71,184 6,297 5,645 6,196 6,146
----------- ------------ ----------- ----------- ----------- ------------
OPERATING INCOME (LOSS).......... (21,571) (23,076) 3,507 3,549 (3,951) (4,040)
----------- ------------ ----------- ----------- ----------- ------------
NONOPERATING INCOME (EXPENSE):
Interest expense, net......... (16,273) (12,738) (702) (465) -- (1)
Subsidiary preferred stock
dividends................... (3,069) (2,856) -- -- -- --
Interest income and other, net 300 744 12 (13) 4 11
----------- ------------ ----------- ----------- ----------- ------------
Total nonoperating expense.... (19,042) (14,850) (690) (478) 4 10
----------- ------------ ----------- ----------- ----------- ------------
LOSS BEFORE INCOME TAX EXPENSE
AND MINORITY INTEREST......... (40,613) (37,926) 2,817 3,071 (3,947) (4,030)
INCOME TAX (EXPENSE) BENEFIT..... -- -- (341) (440) 178 232
MINORITY INTEREST IN LOSS........ -- -- -- -- -- --
----------- ------------ ----------- ----------- ----------- ------------
NET INCOME (LOSS)................ $ (40,613) $ (37,926) $ 2,476 $ 2,631 $ (3,769) $ (3,798)
=========== ============ =========== ============ ============= ===========
OTHER COMPREHENSIVE INCOME (LOSS)
Net realized gain on hedging
activities..................... 334 390 -- -- -- --
Net unrealized gain (loss) on
securities available-for-sale,
net of taxes................... -- -- 44 (678) -- --
----------- ------------ ----------- ----------- ----------- ------------
COMPREHENSIVE INCOME (LOSS)...... $ (40,279) $ (37,536) $ 2,520 $ 1,953 $ (3,769) $ (3,798)
=========== ============ =========== ============ ============= ===========
25
WIRELESS PERSONAL COMMUNICATIONS SERVICES SEGMENT
The following discussion details key operating metrics and focuses on the
details of the financial performance of our wireless personal communications
segment over the three months ended March 31, 2003 compared to three months
ended March 31, 2002. Our wireless personal communications segment consists
entirely of the operations of Horizon PCS.
KEY METRICS - HORIZON PCS
Horizon PCS provides certain financial measures that are calculated in
accordance with accounting principles generally accepted in the Unites State
("GAAP") and adjustments to GAAP ("non-GAAP") to assess its financial
performance. In addition, Horizon PCS uses certain non-financial terms, such as
churn, which are metrics used in the wireless communications industry and are
not measures of financial performance under GAAP. The non-GAAP financial
measures reflect standard measures of liquidity, profitability or performance
and the non-financial metrics reflect industry conventions, both of which are
commonly used by the investment community for comparability purposes. The
non-GAAP financial measures should be considered in addition to, not as
substitutes for, the information prepared in accordance with GAAP. Please refer
to Horizon PCS' Form 10-Q dated March 31, 2003 for a discussion of its key
metrics.
RESULTS OF OPERATIONS
Subscriber revenues. Subscriber revenues for the three months ended March
31, 2003, were approximately $43.6 million, compared to approximately $34.9
million for the three months ended March 31, 2002, an increase of approximately
$8.7 million. The growth in subscriber revenues is primarily the result of the
growth in our customer base. We managed approximately 294,900 customers at March
31, 2003, compared to approximately 222,700 at March 31, 2002. The growth in
subscriber revenue was reduced by decreases in ARPU resulting from lower minute
sensitive and monthly recurring fees.
Roaming revenues. Roaming revenues increased from approximately $10.8
million during the three months ended March 31, 2002, to approximately $13.8
million for the three months ended March 31, 2002, an increase of approximately
$3.0 million. This increase resulted from launching additional markets over the
past year as well as expanding roaming agreements with wireless carriers, offset
by the decrease in the reciprocal roaming rate described above.
Equipment revenues. Equipment revenues for the three months ended March 31,
2003, were approximately $1.8 million, compared to approximately $2.4 million
for the three months ended March 31, 2002, representing a decrease of
approximately $600,000. The decrease is attributable to a decline in the sales
price of handsets as the average sales price, net of discounts and rebates,
decreased to $59 for the three months ended March 31, 2003, from $129 for the
same period in 2002, partially offset by an increase in the number of handsets
sold. We expect the sales price to remain at this lower level, or perhaps
decline further, for the next few quarters.
Cost of PCS and other equipment sales. Cost of equipment for the three
months ended March 31, 2003, was approximately $5.8 million, compared to
approximately $4.9 million for the three months ended March 31, 2002, an
increase of approximately $900,000. The increase in the cost of equipment is the
result of the growth in our wireless customers. We sold approximately 31,000
handsets through our direct sales channels during the three months ended March
31, 2003, compared to approximately 18,000 during the same period in 2002. This
was partially offset by the decreasing unit cost of the handsets. For
competitive and marketing reasons, we have sold handsets to our customers below
our cost and expect to continue to sell handsets at a price below our cost for
the foreseeable future.
Cost of service. Cost of service for the three months ended March 31, 2003,
was approximately $43.8 million, compared to approximately $35.7 million for the
three months ended March 31, 2002, an increase of approximately $8.1 million.
This increase reflects an increase in roaming expense and long distance charges
of approximately $1.7 million and the increase in costs incurred under our
network services agreement with the Alliances of approximately $3.0 million,
both as a result of our subscriber growth during 2002 and the first quarter of
2003. Additionally, at March 31, 2003, our network covered approximately 7.4
million people compared to approximately 7.2 million at March 31, 2002. As a
result, cost of service in 2003 was higher than 2002 due to the increase in
26
network operations, including tower lease expense, circuit costs and payroll
expense, of approximately $1.4 million. Growth in our customer base resulted in
increased customer care, activations, and billing expense of approximately $1.2
million and other variable expenses, including increased switching and national
platform expenses, of approximately $800,000.
Selling and marketing expenses. Selling and marketing expenses decreased to
approximately $12.4 million for the three months ended March 31, 2003, compared
to approximately $14.7 million for the three months ended March 31, 2002, a
decrease of approximately $2.3 million. This decrease includes a reduction to
marketing and advertising in our sales territory of approximately $600,000, the
decrease in subsidies and rebates on handsets sold by third parties of
approximately $1.0 million and the decrease in commissions paid to third parties
of approximately $700,000. Commissions and rebates related to third party
activations declined in the first quarter of 2003 due to less activations out of
those channels compared to the prior year. Sales out of our retail stores were
greater in 2003, thus offsetting the decline out of the other channels.
General and administrative expenses. General and administrative expenses
for the three months ended March 31, 2003, were essentially flat compared to the
same period in 2002 at approximately $7.6 million. A decrease in the provision
for doubtful accounts of approximately $2.1 million was offset by an increase in
the Sprint PCS management fee of approximately $900,000 and other general
expenses of approximately $1.2 million. The decrease in the provision for
doubtful accounts was partially due to an approximate $900,000 non-recurring
credit received from Sprint related to deposits that should have offset the
write off amounts provided by Sprint. We were notified of this error by Sprint
during the first quarter and the cash was received subsequently thereafter,
reducing our bad debt expense from approximately 5% to 3% of subscriber revenue.
As we are focusing our subscriber efforts on better credit quality customers, we
anticipate bad debt expense to remain at the 5% to 7% of revenue level for the
second quarter.
Non-cash compensation expense. Horizon PCS recorded approximately $100,000
for the three months ended March 31, 2003 and 2002, for certain stock options
granted in November 1999. Stock-based compensation expense will continue to be
recognized through the conclusion of the vesting period for these options in
2005. The annual non-cash compensation expense expected to be recognized for
these stock options is approximately $400,000 in 2003, $200,000 in 2004, and
$100,000 in 2005.
Loss on sale of property and equipment. During the three months ended March
31, 2003, we incurred a loss of approximately $300,000 related to closing of two
of our retail stores and a planned store that never opened.
Depreciation and amortization expense. Depreciation and amortization
expenses increased by approximately $3.0 million to a total of approximately
$10.9 million during the three months ended March 31, 2003. The increase
reflects the continuing construction of our network as we funded approximately
$63.1 million of capital expenditures during 2002.
Amortization expense includes amortization of an intangible asset recorded
in September 2000 related to the new markets granted to us by Sprint PCS in
September 2000. Amortization expense related to this intangible asset was
approximately $200,000 for the three months ended March 31, 2003 and 2002.
Interest expense, net. Interest expense for the three months ended March
31, 2003, was approximately $16.3 million, compared to approximately $12.7
million in 2002.
At March 31, 2003, the interest rate on the $105.0 million term loan A
borrowed under our secured credit facility was 5.40%, while the interest rate on
the $50.0 term loan B was 5.86%. Interest expense on the secured credit facility
was $2.4 million and $1.2 million during the three months ended March 31, 2003
and 2002, respectively.
We accrue interest at a rate of 14.00% annually on our discount notes
issued in September 2000 and will pay interest semi-annually in cash beginning
in October 2005. Unaccreted interest expense on the discount notes was
approximately $101.4 million at March 31, 2003. Interest expense on the discount
notes was approximately $7.3 million and $6.4 million during the three months
ended March 31, 2003 and 2002, respectively.
27
On June 15, 2002, we began making semi-annual interest payments on our
senior notes issued in December 2001 at an annual rate of 13.75%. Interest
expense accrued on the senior notes was approximately $6.0 million during the
three months ended March 31, 2003 and 2002. Under the terms of the senior notes,
cash to cover the first four semi-annual interest payments was placed in an
escrow account.
Interest expense also includes approximately $700,000 and $600,000 during
the three months ended March 31, 2003 and 2002, respectively, of amortization
from the deferred financing fees related to our secured credit facility, our
discount notes and our senior notes. Also contributing to interest expense was
approximately $400,000 and $600,000 during the three months ended 2003 and 2002,
respectively, in commitment fees we paid on the unused portion of our secured
credit facility.
Capitalized interest during the three months ended March 31, 2003 and 2002,
was approximately $500,000 and $2.1 million, respectively.
Preferred stock dividend. Our convertible preferred stock pays a stock
dividend at the rate of 7.5% per annum, payable semi-annually commencing May 1,
2001. The dividends are paid with additional shares of convertible preferred
stock. Through May 1, 2003, we have issued an additional 5,486,298 shares of
convertible preferred stock in payments of all dividends through April 30, 2003,
including 1,141,206 shares on May 1, 2003.
Interest income and other, net. Interest income and other income for the
three months ended March 31, 2003, was approximately $300,000 compared to
approximately $700,000 in 2002 and consisted primarily of interest income. This
decrease was due primarily to a lower average balance of cash investments during
the first quarter of 2003 as compared to the same period in 2002 and a lower
short-term interest rates.
Net loss. Horizon PCS' net loss for the three months ended March 31, 2003,
was approximately $40.6 million compared to approximately $37.9 million for the
three months ended March 31, 2002. The increase in our loss reflects the
continued expenses related to launching our markets and building our customer
base.
Other comprehensive income. During 2001, Horizon PCS entered into two
two-year interest rate swaps, effectively fixing $50.0 million of the term loan
B borrowed under the secured credit facility. The first swap expired on January
27, 2003, and the amounts effected remained unhedged. We do not expect the
effect of the remaining swap to have a material impact to interest expense for
the remainder of its life. Other comprehensive income of approximately $300,000
and $400,000 were recorded for the three months ended March 31, 2003 and 2002,
respectively.
LANDLINE TELEPHONE SERVICES SEGMENT AND ALL OTHER SERVICES
The following discussion details the results of operations of our landline
telephone services segment and all other services not assigned to a segment for
the last fiscal quarter.
RESULTS OF OPERATIONS
Revenues. Network access revenue increased by approximately $800,000 for
the three months ended March 31, 2003, to approximately $5.4 million. The
Company saw an increase in access revenues due to an increase in Universal
Service Fund ("USF") revenues for the three months ended March 31, 2003 compared
to the same period in 2002. USF revenues have increased from an added element,
Interstate Safety Net Support, and we have also benefited from an increase in
loop costs. Long distance charges decreased by approximately $100,000 due to
lower usage by our customers, as usage for long distance continues to shift to
wireless devices. Directory advertising revenue increased by approximately
$100,000.
Internet access and other revenues increased by approximately $100,000 to
$2.2 million for the three months ended March 31, 2003. Other revenues were
impacted by increased VDSL revenue as we continue to build our customer base,
which was somewhat offset by lower bright.net dial-up Internet service
subscribers. We believe a number of these lost dial-up customers have switched
to high-speed VDSL service.
Cost of PCS and other equipment sales. Cost of goods sold primarily
consists of business system sales and customer maintenance expenses. Cost of
28
goods sold for corporate and other services was essentially flat for the three
months ended March 31, 2003 as compared to the same period in 2002.
Cost of services. Cost of services includes customer care support, and
network-related costs, including switching, access and circuit expenses. Cost of
services also includes expenses related to the installation of Chillicothe
Telephone's VDSL service.
Cost of services for the three months ended March 31, 2003, was
approximately $2.5 million for the landline telephone segment, compared to
approximately $2.3 million for the three months ended March 31, 2002, an
increase of approximately $200,000 due to increased personnel wages and other
related expenses.
Cost of services for the three months ended March 31, 2003 for Corporate
and Other Services, was approximately $1.8 million compared to approximately
$1.6 million for the same period in 2002, an increase of approximately $200,000.
The increase is related to the continued installation and programming expenses
associated with our VDSL service.
Selling and marketing expenses. Selling and marketing expenses consist of
costs associated with local marketing and advertising programs including
marketing for VDSL. Selling and marketing expenses for landline telephone and
other related services was approximately $200,000 for the three months ended
March 31, 2003, compared to approximately $100,000 for the three months ending
March 31, 2002. The increase of approximately $100,000 is related to additional
payroll and related benefit expenses.
Selling and marketing expenses for corporate and other services was
essentially flat for the three months ended March 31, 2003 compared to the same
three months in 2002.
General and administrative expenses. General and administrative expenses
include the costs related to corporate support functions. These include finance
functions, billing and collections, accounting services, computer access and
administration, executive, supervisory, consulting, customer relations, human
resources and other administrative services. General and administrative expenses
for the landline telephone and other services increased by approximately
$300,000 to approximately $1.9 million for the three months ended March 31,
2003, primarily due to an increase in the provision for uncollectibles.
General and administrative expenses for corporate and other services
decreased by approximately $300,000 to approximately $3.4 million for the three
months ended March 31, 2003. The decrease is related to lower administrative and
other general operating expenses such as legal fees and external technical
support.
Non-cash compensation expense. Non-cash compensation expense is the
amortization of the value of stock options granted in November 1999. Stock-based
compensation expense will continue to be recognized through the conclusion of
the vesting period for these options in 2005. Non-cash compensation expense for
the landline telephone, corporate and other services was essentially flat for
the three months ended March 31, 2003 compared to the same three months in 2002.
Depreciation and amortization expense. Depreciation and amortization
expenses for landline telephone and other services was essentially flat at
approximately $1.7 million for each of the three months ended March 31, 2003 and
2002. Depreciation and amortization expense for corporate and other services
increased by approximately $100,000 to $600,000 for the three months ended March
31, 2003. This increase was related to the additional VDSL assets that have been
added to our network and its build-out.
Interest expense, net. Interest expense for the landline telephone and
other services for the three months ended March 31, 2003, was approximately
$700,000, compared to approximately $500,000 for the three months ended March
31, 2002. The increase in interest expense was a result of our additional debt
outstanding during the three months ended March 31, 2003, compared to the same
period in 2002. We expect further increases in interest expense in 2003 due to
anticipated higher average debt levels.
29
In August 2002, Chillicothe Telephone issued $30,000,000 of 6.64% Senior
Notes. A portion of the proceeds was used to retire the line of credit on
September 28, 2002. Interest expense on the 2002 Senior Notes was approximately
$500,000 for the three months ended March 31, 2003. Interest expense on the
retired line of credit and the retired 1993 Senior Notes was approximately
$300,000 for the three months ended March 31, 2002. Interest expense on
Chillicothe Telephone's 1998 Senior Notes was approximately $200,000 in the
first quarter of both 2003 and 2002. Capitalized construction interest was
approximately $10,000 and $28,000, for the three months ended March 31, 2003 and
2002, respectively.
Interest income and other, net. The landline telephone service segment
recorded approximately $12,000 of other income in the three months ended March
31, 2003. In 2002, expense of approximately $13,000 was recorded related to
non-operating corporate activity.
Income tax expense. Income tax expense for the three months ended March 31,
2003, was approximately $300,000 compared to approximately $400,000 for the same
period in 2002, reflecting lower net income before tax in 2003.
Minority interest in loss. During the first quarter of 2003, two Horizon
PCS executives exercised 200 options for class A common stock. These
transactions created a less than 1% ownership in the equity of Horizon PCS.
Horizon Telcom accounts for this ownership by recording the portion of net loss
attributable to the minority shareholders as minority interest in loss in the
accompanying condensed consolidated statements of operations. There will not be
any further allocations to minority interests until such time as Horizon PCS
becomes profitable and any unallocated losses to minority interests are offset
with income in future periods.
Net income (loss). Landline telephone services recorded an income of
approximately $2.5 million for the three months ended March 31, 2003 compared to
an income of approximately $2.6 million for the three months ended March 31,
2002. Corporate and Other services recorded a loss of approximately $3.8 million
for each of the three month periods ended March 31, 2003 and 2002.
Other comprehensive income (loss). Chillicothe Telephone recognized
approximately $44,000 of income in the first quarter of 2003, compared to a loss
of approximately $678,000 for the same period in 2002, related to its
investments available-for-sale, net of taxes of approximately $23,000 and
$349,000, respectively.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2003, Horizon PCS was in compliance with its covenants with
regards to its outstanding debt. However, Horizon PCS believes that it is
probable that it will violate one or more of its covenants under its secured
credit facility in 2003. The failure to comply with a covenant would be an event
of default under Horizon PCS' secured credit facility, and would give the
lenders the right to pursue remedies. These remedies could include acceleration
of amounts due under the facility. If the lenders elected to accelerate the
indebtedness under the facility, this would also represent a default under the
indentures for Horizon PCS' senior notes and discount notes (see Note 9) and
would give Sprint certain remedies under our Consent and Agreement with Sprint.
Horizon PCS does not have sufficient liquidity to repay all of the indebtedness
under these obligations. Horizon PCS's independent auditors report dated March
4, 2003 states that these matters have substantial doubt about Horizon PCS'
ability to continue as a going concern.
In addition, without the additional borrowing capacity under the senior
credit facility, significant modifications in the amounts charged by Sprint
under the management agreements, significant modifications in the amounts
charged by the Alliances under the Network Service Agreement and/or a
restructuring of their capital structure, Horizon PCS likely does not have
sufficient liquidity to fund its operations so that it can pursue its desired
business plan and achieve positive cash flow from operations.
Horizon PCS plans to take the following steps (some of which it has begun)
within the next six months to achieve compliance under its debt facilities and
to fund its operations:
o Entering into negotiations with Sprint to adjust the amounts charged
by Sprint to the Company under the Sprint management agreements to
improve Horizon PCS' cash flow from operations.
30
o Entering into negotiations or arbitration with the lenders under the
senior credit facility to modify the debt covenants, and if necessary,
to obtain waivers and/or a forbearance agreement with respect to
defaults under the senior credit facility.
o Entering into negotiations with the lenders under their senior credit
facility to obtain the right to borrow under the $95 million line of
credit and to modify the repayment terms of this facility.
o If the lenders under the senior credit facility accelerate the senior
debt, negotiating a waiver or forbearance agreement with
representatives of the holders of their senior notes and discount
notes.
o Entering into negotiations with the Alliances to adjust the amounts
charged by Alliances to Horizon PCS under the network agreements to
improve Horizon PCS' cash flow from operations.
o Pursuing means to reduce operating expenses by critically analyzing
all expenses and entering into pricing negotiations with key vendors.
o Consider closing or limiting service in our under performing markets.
Horizon PCS would need to be successful in these efforts to be in position
to execute its business plan and achieve positive cash flow. Horizon PCS can
give no assurance that it will be successful in these efforts. In its early
discussions with Sprint, Sprint has indicated reluctance in modifying the fee
structure as needed under the first item listed above.
Horizon PCS has engaged Berenson & Company, an investment banking firm, to
assist in its efforts to renegotiate or restructure its equity, debt and other
contractual obligations.
If Horizon PCS is unable to satisfactorily restructure its current debt and
other contractual obligations, it would need to:
O obtain financing to satisfy or refinance its current obligations;
O find a purchaser or strategic partner for Horizon PCS' business or
otherwise dispose of its assets; or
O seek bankruptcy protection.
During the first quarter of 2003, Horizon PCS proposed a more favorable
financial arrangement with Sprint PCS relating to customer related support
charges and fees. After consideration, we were informed by Sprint PCS that they
were not willing to make any changes to the current Affiliate fee structure at
this time.
31
The following table presents the estimated future outstanding long-term
debt at the end of each year and future required annual principal payments for
each year then ended associated with our financing based on our contractual
level of long-term indebtedness:
(Dollars in millions) Years Ending December 31,
-------------------------------------------------------------------
2003 2004 2005 2006 2007 Thereafter
------------ ------------ ------------ ----------- ------------ -----------
Horizon PCS:
Secured credit facility,
due 2008....................... $ 155.0 $ 146.7 $ 126.5 $ 99.7 $ 71.6 $ --
Variable interest rate (1) . 5.55% 5.55% 5.55% 5.55% 5.55% 5.55%
Principal payments.......... $ -- $ 8.3 $ 20.2 $ 26.8 $ 28.1 $ 71.6
Discount notes, due 2010 (2)..... $ 217.5 $ 253.1 $ 283.7 $ 286.1 $ 288.5 $ --
Fixed interest rate......... 14.00% 14.00% 14.00% 14.00% 14.00% 14.00%
Principal payments.......... $ -- $ -- $ -- $ -- $ -- $ 295.0
Senior notes, due 2011........... $ 175.0 $ 175.0 $ 175.0 $ 175.0 $ 175.0 $ --
Fixed interest rate......... 13.75% 13.75% 13.75% 13.75% 13.75% 13.75%
Principal payments.......... $ -- $ -- $ -- $ -- $ -- $ 175.0
Chillicothe Telephone:
1998 Senior notes, due 2018 (3).. $ 12.0 $ 12.0 $ 12.0 $ 12.0 $ 12.0 $ --
Fixed interest rate......... 6.72% 6.72% 6.72% 6.72% 6.72% 6.72%
Principal payments.......... $ -- $ -- $ -- $ -- $ -- $ 12.0
2002 Senior notes, due 2012 (4).. $ 30.0 $ 30.0 $ 30.0 $ 30.0 $ 30.0 $ --
Fixed interest rate......... 6.64% 6.64% 6.64% 6.64% 6.64% 6.64%
Principal payments.......... $ -- $ -- $ -- $ -- $ -- $ 30.0
- ----------------------
(1) Interest rate on the secured credit facility equals LIBOR plus a margin
that varies from 400 to 450 basis points. At March 31, 2003, $25.0
million was effectively fixed at 7.65% through an interest rate swap
discussed in "ITEM 3. Quantitative and Qualitative Disclosures About
Market Risk". The nominal interest rate is assumed to equal 5.55% for
all periods ($50.0 million at 5.86% and $105.0 million at 5.40%).
(2) Face value of the discount notes is $295.0 million. End of year
balances presented here are net of the discount and net of the related
warrant value and assume accretion of the discount as interest expense
at an annual rate of 14.00%.
(3) On November 12, 2002, Chillicothe Telephone amended and restated its
1998 $12,000,000 senior notes due 2018. The interest rate on the
amended notes will be 6.72%, an increase of 10 basis points, with the
same maturity date as the 1998 Senior Notes.
(4) In August 2002, Chillicothe Telephone issued $30,000,000 of 6.64%,
10-year Senior notes due in full July 1, 2012. The proceeds of the
offering were used to retire both the short-term line of credit and the
non-current portion of the 1993 Senior Notes.
Horizon Telcom, Chillicothe Telephone, Horizon Technology, and Horizon
Services are not obligated in any form to assist Horizon PCS in their
negotiations nor are they obligated to compensate any of Horizon PCS' creditors
should Horizon PCS default on any debt agreements. While Horizon PCS faces
several liquidity issues, the liquidity of Horizon Telcom independent of Horizon
PCS is more favorable. Cash and working capital for Horizon Telcom, net of
Horizon PCS, is approximately $10.0 million and approximately $13.8 million,
respectively. We feel that this level of working capital is adequate to maintain
Horizon Telcom's operations for the foreseeable future. Horizon Telcom, net of
Horizon PCS, generated approximately $2.7 million of cash flow from operations
during 2002.
Statement of Cash Flows. At March 31, 2003, we had cash and cash
equivalents of approximately $79.3 million, including Horizon PCS' deposit
requirements discussed below, and working capital of approximately $79.3
million. At December 31, 2002, we had cash and cash equivalents of approximately
$94.9 million and working capital of approximately $100.8 million. Horizon PCS
was also required to escrow funds sufficient to cover the first four interest
payments on the senior notes. These funds are presented as restricted cash on
the consolidated balance sheet. The decrease in cash and cash equivalents of
approximately $15.6 million is primarily attributable to the funding of our loss
from continuing operations of approximately $41.9 million (this loss also
includes certain non-cash charges) and funding our capital expenditures of
approximately $4.1 million during the first quarter of 2003.
Net cash used in operating activities for the three months ended March 31,
2003, was approximately $11.6 million. This reflects the continuing use of cash
for our operations to build our customer base, including but not limited to
32
providing service in our markets and the costs of acquiring new customers. The
net loss of approximately $41.9 million was partially offset by increases to
depreciation, increases in accrued liabilities, offset by increases to accounts
receivable. We expect to continue to see negative cash flows from operations for
2003. Horizon PCS is taking additional steps, including reviewing all phases of
operations and capital expenditures, to reduce the amount of cash needed for
operations.
Net cash used in investing activities was approximately $4.1 million for
the first quarter of 2003, reflecting the continuing upgrade of our wireless
network as well as the deployment of capital necessary to offer VDSL service. We
expect future capital expenditures to be much less than 2002 and similar to the
first quarter of 2003 level as we focus more on the operation and maintenance of
our network and less on build out and expansion.
Net cash provided by financing activities for the first quarter of 2003,
was approximately $29,000, reflecting Chillicothe Telephone's draw on its line
of credit for $500,000 somewhat offset by Horizon Telcom's payment of dividends
of approximately $471,000, during the first quarter of 2003.
Debt Covenants. As of March 31, 2003, Horizon PCS was in compliance with
all of the applicable covenants, as amended. However as described above, the
Company believes it is probable Horizon PCS will violate one or more of its
covenants during 2003.
The following table details the maximum amount available to be borrowed on
the line of credit under Horizon PCS' secured credit facility for the period
then ended (subject to other restrictions in the secured credit facility):
Maximum amount
available to be
borrowed
------------------
March 31, 2003....................................... --
June 30, 2003........................................ $ 16,000,000
September 30, 2003................................... 26,000,000
December 31, 2003.................................... 33,000,000
March 31, 2004....................................... 52,000,000
April 1, 2004........................................ 95,000,000
The following table details the minimum balance requirements placed on cash
and cash equivalents under the amended terms of Horizon PCS' secured credit
facility:
Deposit balance
requirement
------------------
February 16, 2003, through March 31, 2003............. $ 11,000,000
April 1, 2003, through May 15, 2003................... 5,500,000
As of March 31, 2003, Chillicothe Telephone was in compliance with the
convents set forth by its 1998 Senior Notes and its 2002 Senior Notes.
Credit Ratings. At March 31, 2003, the discount notes were rated by
Standard and Poors ("S&P") as "CCC+" with a negative outlook. On April 1, 2003,
S&P downgraded Horizon PCS' notes to "C", which is their lowest bond rating. At
March 31, 2003, Moody's Investors Services ("Moody's") rated the notes as "C,"
which is Moody's lowest bond rating. The CUSIP on the discount notes is
44043UAC4.
At March 31, 2003, the senior notes were rated by S&P as "CCC+" with a
negative outlook. On April 1, 2003, S&P downgraded Horizon PCS' senior to "C",
which is their lowest bond rating. At March 31, 2003, Moody's rated the senior
notes as "C", which is Moody's lowest bond rating. The CUSIP on the senior notes
is 44043UAH3.
Funding Requirements. At March 31, 2003, Horizon PCS had a $95.0 million
line of credit, with certain restrictions discussed above, committed under our
secured credit facility. However, if Horizon PCS violates its debt covenants
this line will not be available.
33
For the year ended December 31, 2003, we anticipate our annual funding
needs will be approximately $90.0 million, including projected operating cash
losses, cash interest payments and capital expenditures. The terms of their
respective credit agreements prohibit or severely restrict the ability of
Chillicothe Telephone and Horizon PCS to provide funds to their affiliates in
the event the affiliate experiences a shortfall. The actual funds required to
build-out and upgrade our wireless network and to fund operating losses, working
capital needs and other capital needs may vary materially from our estimates and
additional funds may be required because of unforeseen delays, cost overruns,
unanticipated expenses, regulatory changes, engineering design changes and
required technological upgrades and other technological risks. Additionally,
Sprint is planning to continually upgrade their nationwide wireless network to
deploy higher data-rate speeds, which may require us to outlay additional
capital expenditures in future years that have not been determined at this
point. Should Horizon PCS be required to upgrade its network to provide
additional 3G services that meet Sprint's standards, we may need to obtain
additional financing to fund those capital expenditures.
If we are unable to obtain any necessary additional financing, or if we
incur further restrictions on the availability of our current funding to meet
the covenants imposed under our credit facilities or Horizon PCS is unable to
complete its network upgrades and build-out as required by the management
agreements, Sprint may terminate its agreements; we will no longer be able to
offer Sprint PCS products and services. In this event, Sprint may purchase our
operating assets or capital stock under terms defined in our agreements with
Sprint. Also, any delays in our build-out may result in penalties under our
Sprint agreements, as amended.
Other factors that may impact liquidity include:
O we may not be able to sustain our growth or obtain sufficient revenue
to achieve and sustain positive cash flow from operations or
profitability;
O we may experience a higher churn rate, which could result in lower
revenue;
O new customers may be of lower credit quality, which may require a
higher provision for doubtful accounts;
O increased competition causing declines in ARPU;
O our failure to comply with restrictive financial and operational
covenants under the secured credit facility; and
O our upgrade to 3G services, due to which we have incurred significant
capital expenditures, may not be successful in the marketplace and may
not result in incremental revenue.
SEASONALITY
Our local and long-distance telephone, Internet and data services
businesses are not subject to seasonal influences. Our wireless telephone
business is subject to seasonality because the wireless industry is heavily
dependent on calendar fourth quarter results. Among other things, that industry
relies on significantly higher customer additions and handset sales in the
calendar fourth quarter as compared to the other three calendar quarters. A
number of factors contribute to this trend, including:
O the increasing use of retail distribution, which is more dependent
upon the year-end holiday shopping season;
O the timing of new product and service announcements and introductions;
O competitive pricing pressures; and
O aggressive marketing and promotions.
34
INFLATION
We believe that inflation has not had and will not have an adverse material
effect on our results of operations.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure - an amendment of FASB Statement No.
123." This Statement provides alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, this Statement requires prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. The Company adopted the disclosure requirements of SFAS No. 148 as of
December 31, 2002, but continues to account for stock compensation costs in
accordance with APB Opinion No. 25.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." This Statement addresses financial
accounting and reporting for costs associated with exit or disposal activities
by requiring that expenses related to the exit of an activity or disposal of
long-lived assets be recorded when they are incurred and measurable. Prior to
SFAS No. 146, these charges were accrued at the time of commitment to exit or
dispose of an activity. The Company adopted SFAS 146 on January 1, 2003, and it
did not have a material effect on the Company's financial position, results of
operations or cash flows.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." SFAS No. 145 addresses the accounting for gains and losses from
the extinguishment of debt, economic effects and accounting practices of
sale-leaseback transactions and makes technical corrections to existing
pronouncements. The Company adopted SFAS No. 145 on January 1, 2003, and it did
not have a material effect on the Company's financial position, results of
operations or cash flows.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." This statement addresses financial accounting and
reporting for obligations associated with the retirements of tangible long-lived
assets and the associated asset retirement costs. It applies to legal
obligations associated with the retirement of long- lived assets that result
from the acquisition, construction, development and the normal operation of a
long-lived asset. The Company adopted this statement effective January 1, 2003.
In 2002, the FASB's EITF, reached a consensus on Issue 00-21, "Revenue
Arrangements with Multiple Deliverables." Issue 00-21 provides guidance on how a
vendor should account for arrangements under which it will perform multiple
revenue-generating activities. The guidance in this Issue is effective for
revenue agreements entered into in fiscal periods beginning after June 15, 2003.
The Company is still evaluating the impact this guidance might have on its
financial position, results of operations and cash flows. The Company will adopt
the guidance in Issue 00-21 as of July 1, 2003.
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not engage in commodity futures trading activities and do not enter
into derivative financial instruments for trading purposes. We also do not
engage in transactions in foreign currencies that would expose us to market
risk.
In the normal course of business, our operations are exposed to interest
rate risk on our secured credit facility. Our primary interest rate risk
exposures relate to i) the interest rate on our financing, ii) our ability to
refinance our discount notes at maturity at market rates, and iii) the impact of
interest rate movements on our ability to meet interest expense requirements and
meet financial covenants under our debt instruments.
In the first quarter of 2001, Horizon PCS entered into a two-year interest
rate swap, effectively fixing $25.0 million of term loan B borrowed under the
secured credit facility. This swap expired in January 2003; the amounts affected
remain unhedged. In the third quarter of 2001, Horizon PCS entered into another
two-year interest rate swap, effectively fixing the remaining $25.0 million of
term loan B. The table below compares current market rates on the balances
subject to the swap agreements:
35
(Dollars in millions) At March 31, 2003
--------------------------------------
Balance Market rate Swap rate
Swap 2..................... $25.0 5.86% 7.65%
Since our swap interest rate is currently greater than the market interest
rate on our underlying debt, our results from operations currently reflect a
higher interest expense than had we not hedged our position. At March 31, 2003,
the Company recorded approximately $334,000 in other comprehensive gains related
to the swap on the balance sheet.
While we cannot predict our ability to refinance existing debt, we continue
to evaluate our interest rate risk on an ongoing basis. If we do not renew our
swaps, or, if we do not hedge incremental variable-rate borrowings under our
secured credit facility, we will increase our interest rate risk, which could
have a material impact on our future earnings. As of March 31, 2003,
approximately 81% of our long-term debt is fixed rate or is variable rate that
has been swapped under fixed-rate hedges, thus reducing our exposure to interest
rate risk. Currently, a 100 basis point increase in interest rates would
increase our interest expense approximately $1.3 million.
ITEM 4. CONTROLS AND PROCEDURES
Our Chief Executive Officer and Chief Financial Officer are responsible for
establishing and maintaining "disclosure controls and procedures" (as defined in
the Securities Exchange Act of 1934 Rules 13a-14(c) and 15d-14(c)) for the
Company. With the participation of management, the Company's Chief Executive
Officer and Chief Financial Officer evaluated the Company's disclosure controls
and procedures within 90 days preceding the filing date of this quarterly
report. Based upon this evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that the Company's disclosure controls and
procedures are effective in ensuring that material information required to be
disclosed is included in the reports that it files with the Securities and
Exchange Commission.
Under Horizon PCS' agreements with Sprint, Sprint provides Horizon PCS with
billing, collections, customer care and other back office services. Horizon PCS,
as a result, necessarily relies on Sprint to provide accurate, timely and
sufficient data and information to properly record its revenues, expenses and
accounts receivable which underlie a substantial portion of its periodic
financial statements and other financial disclosures. The relationship with
Sprint is established by Horizon PCS' agreements and its flexibility to use a
service provider other than Sprint is limited.
Because of Horizon PCS' reliance on Sprint for financial information,
Horizon PCS must depend on Sprint to design adequate internal controls with
respect to the processes established to provide this data and information to
Horizon PCS and Sprint's other network partners. To address this issue, Sprint
engages its independent auditors to perform a periodic evaluation of these
controls and to provide a "Report on Controls Placed in Operation and Tests of
Operating Effectiveness for Affiliates" under guidance provided in Statement of
Auditing Standards No. 70. These reports are provided annually to Horizon PCS
and covers Horizon PCS' entire fiscal year.
There were no significant changes in the Company's internal controls or, to
the knowledge of the management of the Company, in other factors that could
significantly affect these controls subsequent to the evaluation date.
36
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
NONE.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
During February 2003, two people holding options to acquire Horizon PCS
class A common stock each exercised the vested portions of the options (100
shares each at $0.12 per share). Each was an executive officer or director.
Exemption from the registration provisions of the Securities Act for the
transactions was claimed under Section 4(2) of the Securities Act and the rules
and regulations promulgated thereunder on the basis that such transactions did
not involve any public offering, the purchasers were sophisticated with access
to the kind of information registration would provide and that such purchasers
acquired such securities without a view towards distribution thereof. In
addition, exemption form the registration provisions of the Securities Act for
the transactions was claimed under Section 3(b) of the Securities Act on the
basis that such securities were sold pursuant to a written compensatory benefit
plan or pursuant to a written contract relating to compensation and not for
capital raising purposes.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
RISK FACTORS
You should carefully consider the risks described below in evaluating our
businesses.
RISKS RELATED TO CHILLICOTHE TELEPHONE, LONG DISTANCE AND INTERNET BUSINESS
The information set forth under this heading describes risk factors
relating to the business of our wholly-owned subsidiaries the Chillicothe
Telephone Company, Horizon Technology and Horizon Services. References under
this heading to "we," "us" and "our" are to those subsidiaries.
SIGNIFICANT COMPETITION IN TELECOMMUNICATIONS SERVICES IN OUR MARKETS MAY CAUSE
US TO LOSE CUSTOMERS, OR INCUR LOWER NETWORK ACCESS SERVICE MINUTES OF USE.
We face, or will face, significant competition in the markets in which we
currently provide local telephone, long distance, data and Internet services.
Many of our competitors are substantially larger and have greater financial,
technical and marketing resources than we do. In particular, larger competitors
have certain advantages over us, which could cause us to lose customers and
impede our ability to attract new customers, including:
O long-standing relationships and greater name recognition with
customers;
O financial, technical, marketing, personnel and other resources
substantially greater than ours;
O more capital to deploy services; and
O potential to lower prices of competitive services.
37
These factors place us at a disadvantage when we respond to our
competitors' pricing strategies, technological advances and other initiatives.
Additionally, our competitors may develop services that are superior to ours or
that achieve greater market acceptance.
We face competition from other current and potential market entrants,
including:
O domestic and international long distance providers seeking to enter,
re-enter or expand entry into our local communications marketplace;
O other domestic and international competitive communications providers,
resellers, cable television companies and electric utilities; and
O providers of broadband and Internet services.
A continuing trend toward combinations and strategic alliances in the
communications industry could give rise to significant new competitors. This
could cause us to lose customers and impede our ability to attract new
customers.
A RESTRUCTURING OF HORIZON PCS MAY CAUSE A SUBSTANTIAL REDUCTION IN THE NATURE
AND VALUE OF HORIZON TELCOM'S OWNERSHIP INTEREST IN HORIZON PCS.
There is a substantial risk that Horizon Telcom would lose all or a
substantial portion of the value of its investment in Horizon PCS in connection
with any restructuring of Horizon PCS. While Horizon Telcom may retain an equity
interest in a restructuring of Horizon PCS, it is possible that Horizon Telcom
will lose voting control of Horizon PCS and will lose all of the value of its
investment in Horizon PCS in connection with any restructuring. See "Risks
Related To Horizon PCS."
THE RESTRUCTURING OF HORIZON PCS MAY HAVE ADVERSE EFFECTS ON HORIZON TELCOM.
Horizon Telcom has agreements and relationships with third parties,
including suppliers, subscribers and vendors that are integral to conducting its
day to day operations. A restructuring of Horizon PCS in or out of a bankruptcy
proceeding could have a material adverse affect on the perception of Horizon
Telcom and the Horizon Telcom business and its prospects in the eyes of
subscribers, employees, suppliers, creditors and vendors. These persons may
perceive that there is increased risk in doing business with Horizon Telcom as a
result of Horizon PCS' restructuring. Some of these persons may terminate their
relationships with Horizon Telcom which would make it more difficult for Horizon
Telcom to conduct is business.
IN THE EVENT THAT THE SERVICES AGREEMENT BETWEEN HORIZON TELCOM AND HORIZON PCS
IS TERMINATED FOR ANY REASON, HORIZON TELCOM MAY NOT BE ABLE TO REDUCE ITS
GENERAL AND ADMINISTRATIVE COSTS IN AN AMOUNT SUFFICIENT TO SUBSIDIZE THE
PORTION OF THE COMBINED COMPANY'S COSTS CURRENTLY BORNE BY HORIZON PCS.
On a net basis, we estimate that Horizon PCS will incur approximately $5.5
million of charges from Horizon Services (a subsidiary of Horizon Telcom) in
fiscal 2003. If the services agreement between Horizon Telcom and Horizon PCS is
terminated for any reason, Horizon Telcom and its subsidiaries (excluding
Horizon PCS) will lose this source of revenue and will be required to lower its
costs and expenses to meet its business plan. Horizon Telcom may have little
notice of any such termination. A failure to reduce these expenses in a timely
manner could adversely affect Horizon Telcom's liquidity, financial condition
and results of operations.
WE MAY NOT BE ABLE TO SUCCESSFULLY INTEGRATE NEW TECHNOLOGIES OR RESPOND
EFFECTIVELY TO CUSTOMER REQUIREMENTS.
The communications industry is subject to rapid and significant changes in
technology, frequent new service introductions and evolving industry standards.
We cannot predict the effect of these changes on us or our industry.
Technological developments may reduce the competitiveness of our networks and
require unbudgeted upgrades or the procurement of additional products that could
be expensive and time consuming. If we fail to adapt successfully to
technological changes or obsolescence or fail to obtain access to important new
technologies, we could lose customers and be limited in our ability to attract
new customers.
38
IF OUR BACK OFFICE AND CUSTOMER CARE SYSTEMS ARE UNABLE TO MEET THE NEEDS OF OUR
CUSTOMERS, WE MAY LOSE CUSTOMERS.
Sophisticated back office processes and information management systems are
vital to our anticipated growth and our ability to achieve operating
efficiencies. Horizon PCS is dependent on third-party vendors for billing,
service and customer support systems. We cannot assure you that these systems
will perform as expected as we increase our number of customers. If they fail to
perform as expected, we could lose customers. The following could prevent our
back office and customer care systems from meeting the needs of our customers:
O failure of third-party vendors to deliver products and services in a
timely manner at acceptable costs;
O our failure to identify key information and processing needs;
O our failure to integrate products or services effectively;
O our failure to upgrade systems as necessary; or
O our failure to attract and retain qualified systems support personnel.
Furthermore, as our suppliers revise and upgrade their hardware, software
and equipment technology, we could encounter difficulties in integrating this
new technology into our business or find that such new hardware, software and
technology is not appropriate for our business. In addition, our right to use
such hardware, software and technology depends upon license agreements with
third party vendors. Vendors may cancel or elect not to renew some of these
agreements, which may adversely affect our business.
BECAUSE WE OPERATE IN A HEAVILY REGULATED INDUSTRY, CHANGES IN REGULATION COULD
HAVE A SIGNIFICANT EFFECT ON OUR REVENUES AND COMPLIANCE COSTS.
We are subject to significant regulation that could change in a manner
adverse to us. We operate in a heavily regulated industry, and the majority of
our revenues generally have been supported by regulations, including in the form
of support for the provision of telephone services in rural areas. Laws and
regulations applicable to us and our competitors may be, and have been,
challenged in the courts, and could be changed by Congress or regulators at any
time. In addition, any of the following have the potential to have a significant
impact on us:
RISK OF LOSS OR REDUCTION OF NETWORK ACCESS CHARGE REVENUES. Approximately
8% of the Company's total revenues for the three months ended March 31,
2003, came from network access charges, which are paid to us by intrastate
carriers and interstate long distance carriers for originating and
terminating calls in the regions we serve. The amount of access charge
revenues that we receive is calculated based on guidelines set by federal
and state regulatory bodies, and such guidelines could change at any time.
The FCC continues to reform the federal access charge system. States often
mirror these federal rules in establishing intrastate access charges. It is
unknown at this time how changes to the FCC's access charge regime will
affect us. Federal policies being implemented by the FCC strongly favor
access charge reform, and our revenues from this source could be at risk.
Regulatory developments of this type could adversely affect our business.
RISK OF LOSS OR REDUCTION OF UNIVERSAL SERVICE SUPPORT. We receive
Universal Service Support Fund, or USSF, revenues to support the high cost
of our operations in rural markets. In the first quarter of 2003, USSF
revenues accounted for approximately 2% of total revenues. If Chillicothe
Telephone were unable to receive support from the Universal Service Support
Fund, or if such support was reduced, Chillicothe Telephone would be unable
to operate as profitably as before such reduction.
In addition, potential competitors generally cannot, under current laws,
receive the same universal service support enjoyed by Chillicothe
Telephone. Chillicothe Telephone therefore enjoys a competitive advantage,
which could, however, be removed by regulators at any time. The
Telecommunications Act of 1996 (the "Telecom Act") provides that
39
competitors could obtain the same support as we do if the PUCO determines
that granting such support to competitors would be in the public interest.
If such universal service support were to become available to potential
competitors, we might not be able to compete as effectively or otherwise
continue to operate as profitably in our Chillicothe Telephone markets. Any
shift in universal service regulation could, therefore, have an adverse
effect on our business.
The method for calculating the amount of such support could change in 2003.
It is unclear whether the chosen methodology will accurately reflect the
costs incurred by Chillicothe Telephone, and whether it will provide for
the same amount of universal service support that Chillicothe Telephone
enjoyed in the past. The outcome of any of these proceedings or other
legislative or regulatory changes could affect the amount of universal
service support that we receive, and could have an adverse effect on our
business.
RISK OF LOSS OF PROTECTED STATUS UNDER INTERCONNECTION RULES. Chillicothe
Telephone takes the position that it does not have to comply with more
burdensome requirements in the Telecom Act governing the rights of
competitors to interconnect to our traditional telephone companies'
networks due to our status as a rural telephone company. If state
regulators decide that it is in the public's interest to impose these
interconnection requirements on us, more competitors could enter our
traditional telephone markets than are currently expected and we could
incur additional administrative and regulatory expenses as a result of such
newly imposed interconnection requirements.
RISKS POSED BY COSTS OF REGULATORY COMPLIANCE. Regulations create
significant compliance costs for us. Our subsidiary that provides
intrastate services is also generally subject to certification, tariff
filing and other ongoing regulatory requirements by state regulators.
Challenges to these tariffs by regulators or third parties could cause us
to incur substantial legal and administrative expenses.
REGULATORY CHANGES IN THE TELECOMMUNICATIONS INDUSTRY INVOLVE UNCERTAINTIES, AND
THE RESOLUTION OF THESE UNCERTAINTIES COULD ADVERSELY AFFECT OUR BUSINESS BY
FACILITATING GREATER COMPETITION AGAINST US, REDUCING POTENTIAL REVENUES OR
RAISING OUR COSTS.
The Telecom Act provides for significant changes in the telecommunications
industry, including the local telecommunications and long distance industries.
This federal statute and the related regulations remain subject to judicial
review and additional rulemakings of the FCC, thus making it difficult to
predict what effect the legislation will have on us, our operations and our
competitors. Several regulatory and judicial proceedings have recently
concluded, are underway or may soon be commenced, that address issues affecting
our operations and those of our competitors, which may cause significant changes
to our industry. We cannot predict the outcome of these developments, nor can we
assure that these changes will not have a material adverse effect on us.
RISKS RELATED TO HORIZON PCS
The information set forth under this heading describes risk factors
relating to the business of our majority-owned subsidiary Horizon PCS.
References under this heading to "we," "us" and "our" are to Horizon PCS.
WE DO NOT HAVE SUFFICIENT CASH AND CASH COMMITMENTS TO ENABLE US TO PURSUE OUR
DESIRED BUSINESS PLAN TO ACHIEVE POSITIVE CASH FLOW.
Our business and prospects have been significantly adversely affected by a
number of factors. These factors include the general economic recession in the
U.S., the significant slow down in subscriber acquisition over the past two
quarters throughout most of the wireless telecommunications industry, aggressive
pricing competition which has developed within the wireless telecommunications
industry, the greater than expected churn which we have suffered and several
factors which arise from our relationship with Sprint. As a result of these and
other factors, we likely will not have sufficient cash and cash commitments to
enable us to pursue our desired business plan to achieve positive cash flow.
As a result of this situation, we have embarked on a number of initiatives
to attempt to:
O reduce operating expenses;
O reduce churn;
40
O negotiate a modification in the fees we pay to Sprint;
O negotiate or otherwise achieve a reduction in the fees we pay to
NTELOS;
O negotiate modifications to the covenants and payment terms of our
senior secured facility; and
O negotiate the right to obtain funding under our $95.0 million
revolving line of credit under our senior secured facility.
There can be no assurance that we will achieve any of these goals or that
we will be able to develop a business plan which is reasonably designed to
achieve positive cash flow.
Because of the status of the financing market for telecommunications
companies, we believe that it is unlikely that we could raise a sufficient
amount of financing to cure our anticipated cash shortfall.
WE ANTICIPATE THAT, DURING 2003, HORIZON PCS WILL BECOME IN NON-COMPLIANCE WITH
ONE OR MORE OF THE FINANCIAL COVENANTS UNDER ITS SENIOR SECURED FACILITY.
Horizon PCS' secured credit facility provides for aggregate borrowings of
$250.0 million of which $155.0 million was borrowed as of March 31, 2003.
Horizon PCS' secured credit facility includes financial covenants that must be
met each quarter.
We anticipate that, during 2003, Horizon PCS will become non-compliant with
one or more of the financial covenants under its senior secured facility. If
Horizon PCS does so, it will not have the right to borrow under its revolving
line of credit. In addition, the banks would have the right to accelerate the
indebtedness under the senior secured facility and to pursue remedies. In the
event that the lenders under the senior secured facility accelerate Horizon PCS'
indebtedness, such acceleration would cause an event of default under the
indentures for its senior discount notes and its senior notes.
OUR SUBSTANTIAL INDEBTEDNESS COULD ADVERSELY AFFECT OUR FINANCIAL HEALTH AND
PREVENT US FROM FULFILLING OUR LONG-TERM DEBT OBLIGATIONS.
As of March 31, 2003, Horizon PCS' total debt outstanding was $625.0
million, comprised of $155.0 million borrowed under its secured credit facility,
$175.0 million due under its senior notes issued in December 2001 and $295.0
million represented by its discount notes (which are reported on our balance
sheet at March 31, 2003, net of a discount of approximately $101.4 million).
Horizon PCS' substantial debt will have a number of important consequences,
including the following:
O we may not have sufficient funds to pay interest on, and principal of,
our debt;
O we have to dedicate a substantial portion of any positive cash flow
from operations to the payment of interest on, and principal of, our
debt, which will reduce funds available for other purposes;
O we may not be able to obtain additional financing for currently
unanticipated capital requirements, capital expenditures, working
capital requirements and other corporate purposes;
O some borrowings likely will be at variable rates of interest, which
will result in higher interest expense in the event of increases in
market interest rates;
O due to the liens on substantially all of our assets and the pledges of
equity ownership of our subsidiaries that secure our secured credit
facility, our lenders may control our assets upon a default;
O our debt increases our vulnerability to general adverse economic and
industry conditions;
41
O our debt limits our flexibility in planning for, or reacting to,
changes in our business and the industry in which we operate; and
O our debt places us at a competitive disadvantage compared to our
competitors that have less debt.
TO SERVICE OUR INDEBTEDNESS, WE WILL REQUIRE A SIGNIFICANT AMOUNT OF CASH. OUR
ABILITY TO GENERATE CASH DEPENDS ON MANY FACTORS BEYOND OUR CONTROL.
Our ability to make payments on and to refinance our indebtedness, and to
fund our network build-out, anticipated operating losses and working capital
requirements will depend on our ability to generate cash in the future. This, to
a certain extent, is subject to general economic, financial, competitive,
legislative, regulatory and other factors that are beyond our control.
We cannot be certain that our business will generate sufficient cash flow
from operations or that future borrowings will be available to us under our
secured credit facility in an amount sufficient to enable us to pay our
indebtedness or to fund our other liquidity needs. We may need to refinance all
or a portion of our indebtedness, including the notes, on or before maturity. We
may not be able to refinance any of our indebtedness on commercially reasonable
terms, or at all.
IF WE FAIL TO PAY OUR DEBT, OUR LENDERS MAY SELL OUR LOANS TO SPRINT PCS GIVING
SPRINT PCS THE RIGHTS OF A CREDITOR TO FORECLOSE ON OUR ASSETS.
If the lenders accelerate the amounts due under our secured credit
facility, Sprint has the right to purchase our obligations under that facility
and become a senior lender. To the extent Sprint purchases these obligations,
Sprint's interests as a creditor could conflict with ours. Sprint's rights as a
senior lender would enable it to exercise rights with respect to our assets and
Sprint's continuing relationship in a manner not otherwise permitted under the
Sprint PCS agreements.
IF WE FAIL TO COMPLETE THE BUILD-OUT OF OUR NETWORK, SPRINT PCS MAY TERMINATE
THE SPRINT PCS AGREEMENTS AND WE WOULD NO LONGER BE ABLE TO OFFER SPRINT PCS
PRODUCTS AND SERVICES FROM WHICH WE GENERATE SUBSTANTIALLY ALL OUR REVENUES.
Our long-term affiliation agreements with Sprint, which we refer to as the
Sprint PCS agreements, require us to build and operate the portion of the Sprint
PCS network located in our territory in accordance with Sprint's technical
specifications and coverage requirements. The agreements also require us to
provide minimum network coverage to the population within each of the markets
that make up our territory by specified dates.
Under our original Sprint PCS agreements, we were required to complete the
build-out in several of our markets in Pennsylvania and New York by December 31,
2000. Sprint and HPC agreed to an amendment of the build-out requirements, which
extended the dates by which we were to launch coverage in several markets. The
amended Sprint PCS agreement provides for monetary penalties to be paid by us if
coverage is not launched by these extended contract dates. The amounts of the
penalties depends on the market and length of delay in launch, and in some
cases, whether the shortfall relates to an initial launch in the market or
completion of the remaining build-out. The penalties must be paid in cash or, if
both Horizon PCS and Sprint agree, in shares of Horizon PCS stock.
Under the amended Sprint PCS agreement, portions of the New York, Sunbury,
Williamsport, Oil City, Dubois, Erie, Meadville, Sharon, Olean, Jamestown,
Scranton, State College, Stroudsburg, Allentown and Pottsville markets were
required to be completed and launched by October 31, 2001. Although we launched
service in portions of each of these markets, we did not complete all of the
build-out requirements. We notified Sprint PCS in November 2001 that it was our
position that the reasons for the delay constitutes events of "force majeure" as
described in the Sprint PCS agreements and that, consequently, no monetary
penalties or other remedies were applicable. The delay was primarily caused due
to delays in obtaining the required backhaul services from local exchange
carriers and zoning and other approvals from governmental authorities. On
January 30, 2002, Sprint notified us that, as a result of these force majeure
events, it does not consider our build-out delay to be a breach of the Sprint
PCS agreement. We agreed to use commercially reasonable efforts to complete the
build-out by June 30, 2002. Although we have not been able to complete some of
42
the sites in some markets due to continuing force majeure issues, we believe
that we are in substantial compliance with our build-out requirements.
We will require additional expenditures of significant funds for the
continued development, construction, testing, deployment and operation of our
network. These activities are expected to place significant demands on our
managerial, operational and financial resources. A failure to meet our build-out
requirements for any of our markets, or to meet Sprint's technical requirements,
would constitute a breach of the Sprint PCS agreements that could lead to their
termination if not cured within the applicable cure period. If Sprint terminates
these agreements, we will no longer be able to offer Sprint PCS products and
services.
IF SPRINT TERMINATES THE SPRINT PCS AGREEMENTS, THE BUY-OUT PROVISIONS OF THOSE
AGREEMENTS MAY DIMINISH THE VALUATION OF OUR COMPANY.
Provisions of the Sprint PCS agreements could affect our valuation and
decrease our ability to raise additional capital. If Sprint terminates these
agreements, the Sprint PCS agreements provide that Sprint may purchase our
operating assets or capital stock for 80% of the "Entire Business Value" as
defined by the agreement. If the termination is due to our breach of the Sprint
PCS agreements, the percent is reduced to 72% instead of 80%. Under our Sprint
PCS agreements, the Entire Business Value is generally the fair market value of
our wireless business valued on a going concern basis as determined by an
independent appraiser and assumes that we own the FCC licenses in our territory.
In addition, the Sprint PCS agreements provide that Sprint must approve any
change of control of our ownership and consent to any assignment of the Sprint
PCS agreements. Sprint also has a right of first refusal if we decide to sell
our operating assets in our Bright PCS markets. We are also subject to a number
of restrictions on the transfer of our business including a prohibition on
selling our company or our operating assets to a number of identified and yet to
be identified competitors of Sprint. These and other restrictions in the Sprint
PCS agreements may limit the marketability of and reduce the price a buyer may
be willing to pay for the Company and may operate to reduce the Entire Business
Value of the Company.
THE TERMINATION OF OUR STRATEGIC AFFILIATION WITH SPRINT PCS OR SPRINT PCS'
FAILURE TO PERFORM ITS OBLIGATIONS UNDER THE SPRINT PCS AGREEMENTS WOULD
SEVERELY RESTRICT OUR ABILITY TO CONDUCT OUR BUSINESS.
Because Sprint owns the FCC licenses that we use in our territory, our
ability to offer Sprint PCS products and services on our network is dependent on
the Sprint PCS agreements remaining in effect and not being terminated. Sprint
may terminate the Sprint PCS agreements for breach by us of any material terms.
We also depend on Sprint's ability to perform its obligations under the Sprint
PCS agreements. The termination of the Sprint PCS agreements or the failure of
Sprint to perform its obligations under the Sprint PCS agreements would severely
restrict our ability to conduct our wireless digital communications business.
IF THE WEST VIRGINIA PCS ALLIANCE AND VIRGINIA PCS ALLIANCE FAIL TO PROVIDE
THEIR NETWORK TO US IN THEIR MARKETS, OR IF OUR NETWORK SERVICES AGREEMENT WITH
THE ALLIANCES IS OTHERWISE TERMINATED, WE WILL LOST THE ABILITY TO USE THE
ALLIANCES' NETWORK.
West Virginia PCS Alliance and Virginia PCS Alliance, which we refer to as
the Alliances, are two related, independent PCS providers whose network is
managed by NTELOS. On March 4, 2003, NTELOS and certain of its subsidiaries
filed voluntarily petitions for reorganization under Chapter 11 of the U.S.
Bankruptcy Code in the U.S. Bankruptcy Court for the Eastern District of
Virginia. The results of NTELOS' restructuring could have a material adverse
impact on our operations. Pursuant to bankruptcy law, the Alliances have the
right to assume or reject the network services agreement. If the Alliances
reject the network services agreement, we will lose the ability to provide
service to our subscribers in Virginia and West Virginia through the Alliances'
Network, and Sprint may take the position that we would be in breach of our
management agreements with Sprint.
Prior to the Alliances' bankruptcy filing, Horizon had asserted that the
Alliances had overcharged Horizon approximately $4,799,000 for charges that were
neither authorized nor contemplated by the network services agreement. As a
result of the Alliances' bankruptcy filing, Horizon was at risk that any
subsequent payments that it would make for services under the network services
agreement could impair its setoff or recoupment rights with respect to its claim
43
for a repayment of the unauthorized charges. Consequently, Horizon declined to
make a scheduled payment of $3 million to the Alliances on March 11, 2003 for
services rendered by the Alliances in January 2003 and, on that date, filed a
motion in the Alliances' bankruptcy case to protect its rights.
On March 12, 2003, the Alliances telecopied to Horizon a letter notifying
Horizon of the failure to make payment on the January 2003 invoice, which letter
purported to be a ten-business day notice under the network services agreement
that would give the Alliances the right to terminate the agreement at the
conclusion of such ten-day period.
On March 24, 2003, Horizon and the Alliances entered into a Stipulation
which provided that Horizon would pay the January 2003 and February 2003
invoices, the bankruptcy court would provide procedural protection of Horizon's
claim, the Alliances would withdraw the default notice and the parties would
move forward to settle or arbitrate the merits of Horizon's claim. On March 26,
2003, the Court in the NTELOS bankruptcy case approved the Stipulation.
Under our network services agreement, the Alliances provide us with the use
of and access to key components of their network in most of our markets in
Virginia and West Virginia. We directly compete with the Alliances in the
markets where we use their network. If the Alliances fail to maintain the
standards for their network as set forth in our network services agreement with
them or otherwise fail to provide their network for our use, our ability to
provide wireless services in these markets may be adversely affected, and we may
not be able to provide seamless service for our customers. If we breach our
obligations to the Alliances, or if the Alliances otherwise terminate the
network services agreement, we will lose our right to use the Alliances' network
to provide service in these markets. In that event, it is likely that we will be
required to build our own network in those markets and incur the substantial
costs associated with doing so.
IF OTHER SPRINT NETWORK PARTNERS HAVE FINANCIAL DIFFICULTIES, THE SPRINT PCS
NETWORK COULD BE DISRUPTED.
Sprint's national network is a combination of networks. The large
metropolitan areas are owned and operated by Sprint, and the areas in between
them are owned and operated by Sprint network partners, all of which are
independent companies like we are. We believe that most, if not all, of these
companies have incurred substantial debt to pay the large cost of building out
their networks. If other network partners experience financial difficulties,
Sprint's PCS network could be disrupted. If Sprint's agreements with those
network partners are like ours, Sprint would have the right to exercise various
remedies. In such event, there can be no assurance that Sprint or the network
partner could restore the disrupted service in a timely and seamless manner.
One of the network partners, iPCS, Inc., recently filed a chapter 11
bankruptcy petition. In connection with its bankruptcy filing, iPCS filed a
Complaint against Sprint Corporation and Sprint PCS alleging that Sprint PCS
breached its management agreement and services agreement with iPCS, seeking an
equitable accounting of alleged overcharges and underpayments by Sprint PCS to
iPCS, and seeking specific performance of (i) Sprint PCS' obligation to purchase
the operating assets of iPCS by virtue of iPCS' purported exercise of its
contractual "put" right as a result of the alleged material breaches, and (ii)
Sprint's obligation to pay an increased share of Collected Revenue as a result
of iPCS' lenders issuing a notice of acceleration. Finally, iPCS alleges that
Sprint Corporation is liable on each of the claims because it allegedly
controls, authorizes, directs and/or ratifies the conduct of Sprint PCS under
the management agreement and services agreement. Because we believe that the
iPCS claims allege conduct under agreements which are similar to our Sprint
agreements, we are reviewing the iPCS lawsuit to determine the extent to which
the factual and legal assertions of iPCS have similarities to our relationship
with Sprint.
IF SPRINT PCS DOES NOT COMPLETE THE CONSTRUCTION OF ITS NATIONWIDE PCS
NETWORK, WE MAY NOT BE ABLE TO ATTRACT AND RETAIN CUSTOMERS, WHICH WOULD
ADVERSELY AFFECT OUR REVENUES.
Sprint's PCS network may not provide nationwide coverage to the same extent
as its competitors' networks, which could adversely affect our ability to
attract and retain customers. Sprint is creating a nationwide PCS network
through its own construction efforts and those of its affiliates. Today, neither
Sprint nor any other PCS provider offers service in every area of the United
States. Sprint has entered into affiliation agreements similar to ours with
companies in other territories pursuant to its nationwide PCS build-out
strategy. Our business and results of operations depend on Sprint PCS' national
network and, to a lesser extent, on the networks of its other affiliates. Sprint
44
and its PCS affiliate program are subject, in varying degrees, to the economic,
administrative, logistical, regulatory and other risks described in this
document. Sprint and its other affiliates' PCS operations may not be successful,
which in turn could adversely affect our ability to generate revenues.
OUR REVENUES MAY BE LESS THAN WE ANTICIPATE WHICH COULD MATERIALLY ADVERSELY
AFFECT OUR LIQUIDITY, FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Revenue growth is primarily dependent on the size of our subscriber base,
average monthly revenues per user and roaming revenue. During the year ended
December 31, 2002, we experienced slower net subscriber growth rates than
planned, which we believe is due in large part to increased churn, declining
rates of wireless subscriber growth in general, the re-imposition of deposits
for most sub-prime credit subscribers during the last half of the year, the
current economic slowdown and increased competition. Other carriers also have
reported slower subscriber growth rates compared to prior periods. We have seen
a continuation of competitive pressures in the wireless telecommunications
market causing some major carriers to offer plans with increasingly large
bundles of minutes of use at lower prices which may compete with the calling
plans we offer, including the Sprint calling plans we support. Increased price
competition may lead to lower average monthly revenues per user than we
anticipate. In addition, the lower reciprocal roaming rate that Sprint has
announced for 2003 will reduce our roaming revenue, which may not be offset by
the reduction in our roaming expense. If our revenues are less than we
anticipate, it could materially adversely affect our liquidity, financial
condition and results of operation.
WE ARE DEPENDENT UPON SPRINT PCS' BACK OFFICE SERVICES AND ITS THIRD-PARTY
VENDORS' BACK OFFICE SYSTEMS. PROBLEMS WITH THESE SYSTEMS, OR TERMINATION OF
THESE ARRANGEMENTS, COULD DISRUPT OUR BUSINESS AND POSSIBLY INCREASE OUR COSTS.
Because Sprint provides our back office systems such as billing, customer
care and collections, our operations could be disrupted if Sprint is unable to
maintain and expand its back office services, or to efficiently outsource those
services and systems through third-party vendors. The rapid expansion of
Sprint's business will continue to pose a significant challenge to its internal
support systems. Additionally, Sprint has relied on third-party vendors for a
significant number of important functions and components of its internal support
systems and may continue to rely on these vendors in the future. We depend on
Sprint's willingness to continue to offer these services to us and to provide
these services at competitive costs. We paid Sprint approximately $20.6 million
for these services during 2002. The Sprint PCS agreements provide that, upon
nine months' prior written notice, Sprint may elect to terminate any of these
services. If Sprint terminates a service for which we have not developed a
cost-effective alternative, our operating costs may increase beyond our
expectations and restrict our ability to operate successfully.
Further, our ability to replace Sprint in providing back office services
may be limited. While the services agreements allow the Company to use
third-party vendors to provide certain of these services instead of Sprint, the
high startup costs and necessary cooperation associated with interfacing with
Sprint's system may significantly limit our ability to use back office services
provided by anyone other than Sprint. This could limit our ability to lower our
operating costs.
WE DEPEND ON OTHER TELECOMMUNICATIONS COMPANIES FOR SOME SERVICES THAT, IF
DELAYED, COULD DELAY OUR PLANNED NETWORK BUILD-OUT AND DELAY OUR EXPECTED
INCREASES IN CUSTOMERS AND REVENUES.
We depend on other telecommunications companies to provide facilities and
transport to interconnect portions of our network and to connect our network
with the landline telephone system. American Electric Power, Ameritech, AT&T,
Verizon and Sprint (long distance) are our primary suppliers of facilities and
transport. Without these services, we could not offer Sprint PCS services to our
customers in some areas. From time to time, we have experienced delays in
obtaining facilities and transport from some of these companies, and in
obtaining local telephone numbers for use by our customers, which are sometimes
in short supply, and we may continue to experience delays and interruptions in
the future. Delays in obtaining facilities and transport could delay our
build-out and capacity plans and our business may suffer. Delays could also
result in a breach of our Sprint PCS agreements, subjecting these agreements to
potential termination by Sprint.
45
MATERIAL RESTRICTIONS IN OUR DEBT INSTRUMENTS MAY MAKE IT DIFFICULT TO OBTAIN
ADDITIONAL FINANCING OR TAKE OTHER NECESSARY ACTIONS TO REACT TO CHANGES IN OUR
BUSINESS.
The indenture governing the senior notes contains various covenants that
limit our ability to engage in a variety of transactions. In addition, the
indenture governing our discount notes and the secured credit agreement both
impose additional material operating and financial restrictions on us. These
restrictions, subject to ordinary course of business exceptions, limit our
ability to engage in some transactions, including the following:
O designated types of mergers or consolidations;
O paying dividends or other distributions to our stockholders;
O making investments;
O selling assets;
O repurchasing our common stock;
O changing lines of business;
O borrowing additional money; and
O transactions with affiliates.
In addition, our secured credit facility requires us to maintain certain
ratios, including:
O leverage ratios;
O an interest coverage ratio; and
O a fixed charges ratio,
and to satisfy certain tests, including tests relating to:
O minimum covered population;
O minimum number of PCS subscribers in our territory;
O minimum total revenues; and
O minimum EBITDA.
These restrictions could limit our ability to obtain debt financing,
repurchase stock, refinance or pay principal or interest on our outstanding
debt, consummate acquisitions for cash or debt or react to changes in our
operating environment. An event of default under the secured credit facility may
prevent the Company and the guarantors of the senior notes and the discount
notes from paying those notes or the guarantees of those notes.
THE TERMS OF THE CONVERTIBLE PREFERRED STOCK MAY AFFECT OUR FINANCIAL RESULTS.
The terms of the convertible preferred stock give the holders of the
preferred stock the following principal rights:
O to initially designate two members of our board of directors, subject
to reduction based on future percentage ownership;
O to approve or disapprove fundamental corporate actions and
transactions;
46
O to receive dividends in the form of additional shares of our
convertible preferred stock, which may increase and accelerate upon a
change in control; and
O to require us to redeem the convertible preferred stock in 2005.
If we become subject to the repurchase right or change of control
redemption requirements under the convertible preferred stock while our secured
credit facility, our discount notes or the senior notes are outstanding, we will
be required to seek the consent of the lenders under our secured credit
facility, the holders of the discount notes and the holders of the senior notes
to repurchase or redeem the convertible preferred stock, or attempt to refinance
the secured credit facility, the discount notes and the senior notes. If we fail
to obtain these consents, there will be an event of default under the terms
governing our secured credit facility. In addition, if we do not repurchase or
redeem the convertible preferred stock and the holders of the convertible
preferred stock obtain a judgment against us, any judgment in excess of $5.0
million would constitute an event of default under the indentures governing the
discount notes and the senior notes.
IF WE BREACH OUR AGREEMENT WITH SBA COMMUNICATIONS CORP. ("SBA"), OR IT
OTHERWISE TERMINATES ITS AGREEMENT WITH US, OUR RIGHT TO PROVIDE WIRELESS
SERVICE FROM MOST OF OUR CELL SITES WILL BE LOST.
We lease cell sites from SBA. We rely on our contract with SBA to provide
us with access to most of our cell sites and to the towers located on these
sites. If SBA were to lose its underlying rights to these sites, our ability to
provide wireless service from these sites would end, subject to our right to
cure defaults by SBA. If SBA terminates our agreement as a result of our breach,
we will lose our right to provide wireless services from most of our cell sites.
WE MAY HAVE DIFFICULTY OBTAINING INFRASTRUCTURE EQUIPMENT AND HANDSETS, WHICH
COULD RESULT IN DELAYS IN OUR NETWORK BUILD-OUT, DISRUPTION OF SERVICE OR LOSS
OF CUSTOMERS.
If we cannot acquire the equipment required to build or upgrade our network
in a timely manner, we may be unable to provide wireless communications services
comparable to those of our competitors or to meet the requirements of the Sprint
PCS agreements. Manufacturers of this equipment could have substantial order
backlogs. Accordingly, the lead-time for the delivery of this equipment may be
longer than anticipated. In addition, the manufacturers of specific types
handsets may have to distribute their limited supply of products among their
numerous customers. Some of our competitors purchase large quantities of
communications equipment and may have established relationships with the
manufacturers of this equipment. Consequently, they may receive priority in the
delivery of this equipment. If we do not obtain equipment or handsets in a
timely manner, we could suffer delays in the build-out of our network,
disruptions in service and a reduction in customers.
SPRINT'S VENDOR DISCOUNTS MAY BE DISCONTINUED, WHICH COULD INCREASE OUR
EQUIPMENT COSTS AND REQUIRE MORE CAPITAL THAN WE HAD PROJECTED TO BUILD-OUT OR
UPGRADE OUR NETWORK.
We intend to continue to purchase our infrastructure equipment under
Sprint's vendor agreements that include significant volume discounts. If Sprint
were unable to continue to obtain vendor discounts for its affiliates, the loss
of vendor discounts could increase our equipment costs for our network
build-out.
CONFLICTS WITH SPRINT MAY NOT BE RESOLVED IN OUR FAVOR, WHICH COULD RESTRICT OUR
ABILITY TO MANAGE OUR BUSINESS AND PROVIDE SPRINT PCS PRODUCTS AND SERVICES,
ADVERSELY AFFECTING OUR RELATIONSHIPS WITH OUR CUSTOMERS, INCREASE OUR EXPENSES
OR DECREASE OUR REVENUES.
Under the Sprint PCS agreements, Sprint has a substantial amount of control
over the conduct of our business. Conflicts between us may arise, and as Sprint
owes us no duties except as set forth in the Sprint PCS agreements, these
conflicts may not be resolved in our favor. The conflicts and their resolution
may harm our business. For example:
O Sprint may price its national plans based on its own objectives and
may set price levels and customer credit policies that may not be
economically sufficient for our business;
47
O Sprint may increase the prices we pay for our back office services;
and
O Sprint may make decisions that adversely affect our use of the Sprint
and Sprint PCS brand names, products or services.
WE MAY NOT BE ABLE TO COMPETE WITH LARGER, MORE ESTABLISHED WIRELESS PROVIDERS
WHO HAVE RESOURCES TO COMPETITIVELY PRICE THEIR PRODUCTS AND SERVICES, WHICH
COULD IMPAIR OUR ABILITY TO ATTRACT AND RETAIN CUSTOMERS.
Our ability to compete will depend in part on our ability to anticipate and
respond to various competitive factors affecting the telecommunications
industry, including new services that may be introduced, changes in consumer
preferences, demographic trends, economic conditions and discount pricing
strategies by competitors. In each market, we compete with at least two cellular
providers that have had their infrastructure in place and have been operational
for a number of years. They may have significantly greater financial and
technical resources than we do, they could offer attractive pricing options and
they may have a wider variety of handset options. We expect existing cellular
providers will continue to upgrade their systems and provide expanded digital
services to compete with the Sprint PCS products and services we offer. Many of
these wireless providers generally require their customers to enter into
long-term contracts, which may make it more difficult for us to attract
customers away from them.
We will also compete with several PCS providers and other existing
communications companies in our markets and expect to compete with new entrants
as the FCC licenses additional spectrum to mobile services providers. A number
of our cellular, PCS and other wireless competitors have access to more licensed
spectrum than the amount licensed to Sprint in most of our territory and
therefore will be able to provide greater network call volume capacity than our
network to the extent that network usage begins to reach or exceed the capacity
of our licensed spectrum. Our inability to accommodate increases in call volume
could result in more dropped or disconnected calls. In addition, any competitive
difficulties that Sprint may experience could also harm our competitive position
and success.
We anticipate that market prices for two-way wireless voice services and
products generally will continue to decline as a result of increased
competition. Consequently we may be forced to increase spending for advertising
and promotions. Increased competition also may lead to continued increases in
customer churn. Those trends could cause further delays in our expected dates to
achieve positive EBITDA.
WE MAY NOT BE ABLE TO OFFER COMPETITIVE ROAMING CAPABILITY, WHICH COULD IMPAIR
OUR ABILITY TO ATTRACT AND RETAIN CUSTOMERS.
We rely on agreements with competitors to provide automatic roaming
capability to our PCS customers in many of the areas of the United States not
covered by the Sprint PCS network, which primarily serves metropolitan areas.
Some competitors may be able to offer coverage in areas not served by the Sprint
PCS network or may be able to offer roaming rates that are lower than those
offered by Sprint and its PCS affiliates. Some of our competitors are seeking to
reduce access to their networks through actions pending with the FCC. Moreover,
the engineering standard for the dominant air interface upon which PCS customers
roam is currently being considered for elimination by the FCC as part of a
streamlining proceeding. If the FCC eliminates this standard, our Sprint PCS
customers may have difficulty roaming in some markets.
THERE IS NO UNIFORM SIGNAL TRANSMISSION TECHNOLOGY AND IF WE DECIDE TO USE OTHER
TECHNOLOGIES IN THE FUTURE, THIS DECISION COULD SUBSTANTIALLY INCREASE OUR
EQUIPMENT EXPENDITURES TO REPLACE THE TECHNOLOGY USED ON OUR NETWORK.
The wireless telecommunications industry is experiencing evolving industry
standards. We have employed code division multiple access (CDMA) technology,
which is the digital wireless communications technology selected by Sprint PCS
for its network. CDMA may not provide the advantages expected by us and by
Sprint PCS. In addition to CDMA, there are two other principal signal
transmission technologies, time division multiple access, or TDMA, and global
systems for mobile communications, or GSM. These three signal transmission
technologies are not compatible with each other. If one of these technologies or
another technology becomes the preferred industry standard, we may be at a
competitive disadvantage and competitive pressures may require Sprint PCS to
change its digital technology which, in turn, may require us to make changes at
substantially increased costs.
48
WE MAY NOT RECEIVE AS MUCH SPRINT PCS ROAMING REVENUE AS WE ANTICIPATE AND OUR
NON-SPRINT PCS ROAMING REVENUE IS LIKELY TO BE LOW.
We are paid a fee from Sprint or a Sprint PCS affiliate for every minute
that a Sprint PCS subscriber based outside of our territory uses our network.
Similarly, we pay a fee to Sprint PCS or a Sprint PCS affiliate for every minute
that our customers use the Sprint PCS network outside our territory. Our
customers may use the Sprint PCS network outside our territory more frequently
than we anticipate, and Sprint PCS subscribers based outside our territory may
use our network less frequently than we anticipate. As a result, we may receive
less Sprint PCS roaming revenue in the aggregate, than we previously anticipated
or we may have to pay more Sprint PCS roaming fees in the aggregate than we
anticipate. The fee for each Sprint PCS roaming minute used was decreased from
$0.20 per minute before June 1, 2001, to $0.15 per minute effective June 1,
2001, and further decreased to $0.12 per minute effective October 1, 2001. The
Sprint PCS roaming rate was changed to $0.10 per minute in 2002. After 2002, the
rate will be changed to "a fair and reasonable return." Sprint has reduced the
reciprocal roaming rate to $0.058 per minute of use as of January 1, 2003. As a
result, we may receive less Sprint PCS roaming revenue in the aggregate, than we
previously anticipated. Furthermore, we do not expect to receive substantial
non-Sprint PCS roaming revenue.
IF SPRINT PCS CUSTOMERS ARE NOT ABLE TO ROAM INSTANTANEOUSLY OR EFFICIENTLY ONTO
OTHER WIRELESS NETWORKS, WE MAY SUFFER A REDUCTION IN OUR REVENUES AND NUMBER OF
CUSTOMERS.
The Sprint PCS network operates at a different frequency and uses or may use
a different signal transmission technology than many analog cellular and other
digital systems. To access another provider's analog cellular, TDMA or GSM
digital system when outside the territory served by the Sprint PCS network, a
Sprint PCS customer is required to utilize a dual-band/dual-mode handset
compatible with that provider's system. Generally, because dual-band/dual-mode
handsets incorporate two radios rather than one, they are more expensive, larger
and heavier than single-band/single-mode handsets. Sprint's PCS network does not
allow for call hand-off between the Sprint PCS network and another wireless
network, so a customer must end a call in progress on the Sprint PCS network and
initiate a new call when outside the territory served by the Sprint PCS network.
In addition, the quality of the service provided by a network provider during a
roaming call may not approximate the quality of the service provided by Sprint
PCS. The price of a roaming call may not be competitive with prices of other
wireless companies for roaming calls, and Sprint customers may not be able to
use Sprint PCS advanced features, such as voicemail notification, while roaming.
These roaming issues may cause us to suffer a reduction in our revenues and
number of customers.
PARTS OF OUR TERRITORIES HAVE LIMITED LICENSED SPECTRUM, WHICH MAY ADVERSELY
AFFECT THE QUALITY OF OUR SERVICE.
In the majority of our markets, Sprint has licenses covering 20 MHz or 30
MHz of spectrum. However, Sprint has licenses covering only 10 MHz in parts of
our territory covering approximately 3.8 million residents out of a total
population of over 10.2 million residents. In the future, as our customers in
those areas increase in number, this limited licensed spectrum may not be able
to accommodate increases in call volume and may lead to increased dropped calls
and may limit our ability to offer enhanced services.
NON-RENEWAL OR REVOCATION BY THE FCC OF THE SPRINT PCS LICENSES WOULD
SIGNIFICANTLY HARM OUR BUSINESS BECAUSE WE WOULD NO LONGER HAVE THE RIGHT TO
OFFER WIRELESS SERVICE THROUGH OUR NETWORK.
We are dependent on Sprint's PCS licenses, which are subject to renewal and
revocation by the FCC. Sprint's PCS licenses in many of our territories will
expire as early as 2005 but may be renewed for additional ten-year terms. There
may be opposition to renewal of Sprint's PCS licenses upon their expiration and
the Sprint PCS licenses may not be renewed. The FCC has adopted specific
standards to apply to PCS license renewals. For example, if Sprint does not
demonstrate to the FCC that Sprint has met the five-year construction
requirements for each of its PCS licenses, it can lose those licenses. Failure
to comply with these standards in our territory could cause the imposition of
fines on Sprint by the FCC or the revocation or forfeiture of the Sprint PCS
licenses for our territory, which would prohibit us from providing service in
our markets.
49
IF THE SPRINT PCS AGREEMENTS DO NOT COMPLY WITH FCC REQUIREMENTS, SPRINT PCS MAY
TERMINATE THE SPRINT PCS AGREEMENTS, WHICH COULD RESULT IN OUR INABILITY TO
PROVIDE SERVICE.
The FCC requires that licensees like Sprint maintain control of their
licensed spectrum and not delegate control to third-party operators or managers
like us. Although the Sprint PCS agreements reflect an arrangement that the
parties believe meets the FCC requirements for licensee control of licensed
spectrum, we cannot be certain the FCC will agree with us. If the FCC determines
that the Sprint PCS agreements need to be modified to increase the level of
licensee control, we have agreed with Sprint to use our best efforts to modify
the Sprint PCS agreements to comply with applicable law. If we cannot agree with
Sprint to modify the Sprint PCS agreements, they may be terminated. If the
Sprint PCS agreements are terminated, we would no longer be a part of the Sprint
PCS network and we would have extreme difficulty in conducting our business.
WE MAY NEED MORE CAPITAL THAN WE CURRENTLY ANTICIPATE TO COMPLETE THE BUILD-OUT
AND UPGRADE OF OUR NETWORK, AND A DELAY OR FAILURE TO OBTAIN ADDITIONAL CAPITAL
COULD DECREASE OUR REVENUES.
The completion of our network build-out will require substantial capital.
Additional funds would be required in the event of:
O significant departures from our current business plan;
O unforeseen delays, cost overruns, unanticipated expenses; or
O regulatory, engineering design and other technological changes.
For example, it is possible that we will need substantial funds if we find
it necessary or desirable to overbuild the territory currently served through
our arrangements with the Alliances. Due to our highly leveraged capital
structure, additional financing may not be available or, if available, may not
be obtained on a timely basis or on terms acceptable to us or within limitations
permitted under our existing debt covenants. Failure to obtain additional
financing, should the need for it develop, could result in the delay or
abandonment of our development and expansion plans, and we may be unable to fund
our ongoing operations.
BECAUSE SPRINT HAS REQUIRED US TO UPGRADE OUR NETWORK TO PROVIDE "THIRD
GENERATION" TECHNOLOGY, WE WILL FACE ADDITIONAL CAPITAL EXPENSES.
The wireless industry is seeking to implement new "third generations," or
"3G", technology. Sprint has selected a version of 3G technology (1XRTT) for its
own networks and required us to upgrade our network to provide those services.
Sprint launched the new 3G technology in August 2002 under the brand, PCS
Vision. We participated in that launch along with other Sprint PCS affiliates.
We still have additional expenditures pending to complete the full
implementation of 3G in all of our markets. If other wireless carriers implement
their 3G upgrades on a more rapid timetable, or on a more cost efficient basis,
or on a more advanced technology basis, we will likely suffer competitive
disadvantages in our markets. While there are potential advantages with 3G
technology, such as increased network capacity and additional capabilities for
wireless data applications, the technology has not been proven in the
marketplace and has the risks inherent in other technological innovations.
Recently, Sprint has sought to increase service fees in connection with its
development of 3G-related back-office systems and platforms. Horizon PCS, along
with the other PCS affiliates of Sprint, are currently disputing the validity of
Sprint's right to pass through this fee to Horizon PCS. If this dispute is
resolved unfavorably to Horizon PCS, then Horizon PCS will incur additional
expenses.
UNAUTHORIZED USE OF OUR NETWORK AND OTHER TYPES OF FRAUD COULD DISRUPT OUR
BUSINESS AND INCREASE OUR COSTS.
We will likely incur costs associated with the unauthorized use of our
network, including administrative and capital costs associated with detecting,
monitoring and reducing the incidence of fraud. Fraud impacts interconnection
costs, capacity costs, administrative costs, fraud prevention costs and payments
to other carriers for unbillable fraudulent roaming. Although we believe that
Sprint has implemented appropriate controls to minimize the effect to us of
fraudulent usage, our efforts may not be successful.
50
EXPANDING OUR TERRITORY MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS.
As part of our business strategy, we may expand our territory through the
grant of additional markets from Sprint PCS or through acquisitions of other
Sprint PCS affiliates. We will evaluate strategic acquisitions and alliances
principally relating to our current operations. These transactions may require
the approval of Sprint PCS and commonly involve a number of risks, including:
O difficulty assimilating acquired operations and personnel;
O diversion of management attention;
O disruption of ongoing business;
O inability to retain key personnel;
O inability to successfully incorporate acquired assets and rights into
our service offerings;
O inability to maintain uniform standards, controls, procedures and
policies; and
O impairment of relationships with employees, customers or vendors.
Failure to overcome these risks or any other problems encountered in these
transactions could have a material adverse effect on our business. In connection
with these transactions, we may also issue additional equity securities and
incur additional debt.
THE SPRINT AGREEMENTS AND OUR RESTATED CERTIFICATE OF INCORPORATION INCLUDE
PROVISIONS THAT MAY DISCOURAGE, DELAY OR RESTRICT ANY SALE OF OUR OPERATING
ASSETS OR COMMON STOCK TO THE POSSIBLE DETRIMENT OF OUR NOTEHOLDERS.
The Sprint PCS agreements restrict our ability to sell our operating assets
and common stock. Generally, Sprint must approve a change of control of our
ownership and consent to any assignment of the Sprint PCS agreements. The Sprint
PCS agreements also give Sprint a right of first refusal if we decide to sell
the operating assets of our Bright PCS markets to a third party. In addition,
provisions of our restated certificate of incorporation could also operate to
discourage, delay or make more difficult a change in control of our company. For
example, our restated certificate of incorporation provides for:
O two classes of common stock, with our class B common stock having ten
votes per share;
O the issuance of preferred stock without stockholder approval; and
O a classified board, with each board member serving a three-year term.
The restrictions in the Sprint PCS agreements and the provisions of our
restated certificate of incorporation could discourage any sale of our operating
assets or common stock.
WE MAY EXPERIENCE A HIGH RATE OF CUSTOMER TURNOVER, WHICH WOULD INCREASE OUR
COSTS OF OPERATIONS AND REDUCE OUR REVENUE AND POTENTIALLY CAUSE A VIOLATION OF
THE COVENANTS UNDER HPCS' SECURED CREDIT FACILITY.
Our strategy to minimize customer turnover, commonly known as churn, may
not be successful. As a result of customer turnover, we lose the revenue
attributable to these customers and increase the costs of establishing and
growing our customer base. The PCS industry has experienced a higher rate of
customer turnover as compared to cellular industry averages. We experienced an
increase in churn during 2002, primarily caused by NDASL customers' inability to
pay for services billed. Current and future strategies to reduce customer churn
may not be successful.
The rate of customer turnover is affected by the following factors, several
of which are not within our ability to address:
51
O credit worthiness of customers;
O extent of network coverage;
O reliability issues such as blocked calls, dropped calls and handset
problems;
O non-use of phones;
O change of employment;
O a lack of affordability;
O price competition;
O Sprint's PCS customer credit policies;
O customer care concerns; and
O other competitive factors.
A high rate of customer turnover could adversely affect our competitive
position, results of operations and our costs of, or losses incurred in,
obtaining new customers, especially because we subsidize some of the cost of the
handsets purchased by our customers.
OUR ALLOWANCE FOR DOUBTFUL ACCOUNTS MAY NOT BE SUFFICIENT TO COVER UNCOLLECTIBLE
ACCOUNTS.
On an ongoing basis, we estimate the amount of customer receivables that we
may not collect to reflect the expected loss on such accounts in the current
period. However, our allowance for doubtful accounts may underestimate actual
unpaid receivables for various reasons, including:
O adverse changes in our churn rate exceeding our estimates;
O adverse changes in the economy generally exceeding our expectations;
or
O unanticipated changes in Sprint PCS' products and services.
If our allowance for doubtful accounts is insufficient to cover losses on
our receivables, our business, financial position or results of operations could
be materially adversely affected.
BECAUSE THE WIRELESS INDUSTRY HAS EXPERIENCED HIGHER CUSTOMER ADDITIONS AND
HANDSET SALES IN THE FOURTH CALENDAR QUARTER AS COMPARED TO THE OTHER THREE
CALENDAR QUARTERS, A FAILURE BY US TO ACQUIRE SIGNIFICANTLY MORE CUSTOMERS IN
THE FOURTH QUARTER COULD HAVE A DISPROPORTIONATE NEGATIVE EFFECT ON OUR RESULTS
OF OPERATIONS.
The wireless industry is historically dependent on fourth calendar quarter
results. Our overall results of operations could be significantly reduced if we
have a worse than expected fourth calendar quarter for any reason, including the
following:
O our inability to match or beat pricing plans offered by competitors;
O our failure to adequately promote Sprint PCS' products, services and
pricing plans;
O our inability to obtain an adequate supply or selection of handsets;
O a downturn in the economy of some or all of the markets in our
territory; or
52
O a generally poor holiday shopping season.
REGULATION BY GOVERNMENT AGENCIES MAY INCREASE OUR COSTS OF PROVIDING SERVICE OR
REQUIRE US TO CHANGE OUR SERVICES, WHICH COULD IMPAIR OUR FINANCIAL PERFORMANCE.
The licensing, construction, use, operation, sale and interconnection
arrangements of wireless telecommunications systems are regulated to varying
degrees by the FCC, the Federal Aviation Administration and, depending on the
jurisdiction, state and local regulatory agencies and legislative bodies.
Adverse decisions regarding these regulatory requirements could negatively
impact our operations and our cost of doing business.
USE OF HAND-HELD PHONES MAY POSE HEALTH RISKS, REAL OR PERCEIVED, WHICH COULD
RESULT IN THE REDUCED USE OF OUR SERVICES OR LIABILITY FOR PERSONAL INJURY
CLAIMS.
Media reports have suggested that radio frequency emissions from wireless
handsets may be linked to various health problems, including cancer, and may
interfere with various electronic medical devices, including hearing aids and
pacemakers. Concerns over radio frequency emissions may discourage use of
wireless handsets or expose us to potential litigation. Any resulting decrease
in demand for our services, or costs of litigation and damage awards, could
impair our ability to profitably operate our business.
REGULATION BY GOVERNMENT OR POTENTIAL LITIGATION RELATING TO THE USE OF WIRELESS
PHONES WHILE DRIVING COULD ADVERSELY AFFECT OUR RESULTS OF OPERATIONS.
Some studies have indicated that some aspects of using wireless phones
while driving may impair drivers' attention in certain circumstances, making
accidents more likely. These concerns could lead to litigation relating to
accidents, deaths or serious bodily injuries, or to new restrictions or
regulations on wireless phone use, any of which also could have material adverse
effects on our results of operations. A number of U.S. states and local
governments are considering or have recently enacted legislation that would
restrict or prohibit the use of a wireless handset while driving a vehicle or,
alternatively, require the use of a hands-free telephone. Legislation of this
sort, if enacted, would require wireless service providers to provide hands-free
enhanced services, such as voice activated dialing and hands-free speaker phones
and headsets, so that they can keep generating revenue from their subscribers,
who make many of their calls while on the road. If we are unable to provide
hands-free services and products to our subscribers in a timely and adequate
fashion, the volume of wireless phone usage would likely decrease, and our
ability to generate revenues would suffer.
53
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
EXHIBITS AND REPORTS ON FORM 8-K
(A) Exhibits
3.1(a) Articles of Incorporation of Horizon Telcom, Inc.
3.2(a) Bylaws of Incorporation of Horizon Telcom, Inc.
4.1(a) Form of Stock Certificate.
99.1 Certification pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.
99.2 Certification pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
------------------------
(a) Incorporated by reference to the exhibit with the same number
previously filed by the Registrant on Form 10 (Reg. No. 0-32617).
(b) Filed herewith.
(B) Reports on Form 8-K
None.
54
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HORIZON TELCOM, INC.
(Registrant)
Date: May 14, 2003 By: /s/ Thomas McKell
----------------------------------
Thomas McKell
Chief Executive Officer
Date: May 14, 2003 By: /s/ Peter M. Holland
----------------------------------
Peter M. Holland
Chief Financial Officer
(Principal Financial and
Chief Accounting Officer)
55
Horizon Telcom, Inc., Certification for Quarterly Report on Form 10-Q
I, Thomas McKell, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Horizon Telcom, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrants other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b)any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 14, 2003 /s/ Thomas McKell
--------------------------
Thomas McKell
President and Chief Executive Officer
Horizon Telcom, Inc., Certification for Quarterly Report on Form 10-Q
I, Peter M. Holland, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Horizon Telcom, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrants other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 14, 2003 /s/ Peter M. Holland
--------------------------
Peter M. Holland
Chief Financial Officer
1614131