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:
JUNE 30, 2003
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ____ TO ____
COMMISSION FILE NUMBER: 0-32617
HORIZON TELCOM, INC.
(Exact name of registrant as specified in its charter)
OHIO 31-1449037
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation 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 August 15, 2003, there were 90,561 shares of class A common stock and
271,926 shares of class B common stock outstanding.
HORIZON TELCOM, INC.
FORM 10-Q
SECOND 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................................................23
Item 3. Quantitative and Qualitative Disclosures About Market Risk...............43
Item 4. Controls and Procedures..................................................43
PART II OTHER INFORMATION
Item 1. Legal Proceedings........................................................45
Item 2. Changes in Securities and Use of Proceeds................................45
Item 3. Defaults Upon Senior Securities..........................................45
Item 4. Submission of Matters to a Vote of Security Holders......................45
Item 5. Other Information........................................................45
Item 6. Exhibits and Reports on Form 8-K.........................................50
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 June 30, 2003 and December 31, 2002
- --------------------------------------------------------------------------------
June 30, December 31,
2003 2002
--------------- ---------------
ASSETS (unaudited)
- ------
CURRENT ASSETS:
Cash and cash equivalents ($55,000,000 on deposit at December 31, 2002, in
accordance with covenant amendment in 2002).............................. $ 58,676,617 $ 94,948,351
Restricted cash............................................................ 12,032,010 24,063,259
Accounts receivable - subscriber, less allowance for doubtful accounts of
approximately $2,371,000 and $2,654,000 at June 30, 2003 and December 31,
2002, respectively....................................................... 23,686,991 20,560,658
Accounts receivable - interexchange carriers, access charge pools and other,
less allowance for doubtful accounts of approximately $168,000 as of June
30, 2003 and $71,000 as of December 31, 2002............................. 5,530,948 5,045,930
Inventories................................................................ 5,495,716 6,336,877
Investments, available-for-sale, at fair value............................. 1,282,470 745,860
Prepaid expenses and other current assets.................................. 7,292,822 5,926,816
--------------- ---------------
Total current assets................................................. 113,997,574 157,627,751
--------------- ---------------
OTHER ASSETS:
Intangible assets - Sprint PCS licenses, net of
amortization............................................................. -- 40,381,201
Debt issuance costs, net................................................... 18,859,358 20,365,415
Deferred PCS activation expense............................................ 5,247,821 6,092,645
Prepaid pension costs and other............................................ 4,694,135 5,361,994
--------------- ---------------
Total other assets................................................... 28,801,314 72,201,255
--------------- ---------------
PROPERTY, PLANT AND EQUIPMENT, NET ........................................... 266,731,021 315,921,107
--------------- ---------------
Total assets.................................................... $ 409,529,909 $ 545,750,113
=============== ===============
(Continued on next page)
The accompanying notes are an integral part of these
consolidated financial statements.
3
HORIZON TELCOM, INC. AND SUBSIDIARIES
Consolidated Balance Sheets (Continued)
As of June 30, 2003 and December 31, 2002
- --------------------------------------------------------------------------------
June 30, December 31,
2003 2002
---------------- ----------------
(unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
- ----------------------------------------------
CURRENT LIABILITIES:
Accounts payable........................................................... $ 17,654,473 $ 24,827,065
Payable to Sprint.......................................................... 13,998,869 9,910,262
Deferred PCS revenue....................................................... 6,340,000 5,308,457
Accrued personal property, real estate and other taxes..................... 6,571,996 6,514,707
Accrued interest, payroll and other accrued liabilities.................... 10,953,390 10,237,300
Lines of credit............................................................ 750,000 --
Current portion of long-term debt, net of discount......................... 531,344,322 --
---------------- ----------------
Total current liabilities............................................ 587,613,050 56,797,791
LONG-TERM DEBT AND OTHER LIABILITIES:
Long-term debt............................................................. 42,000,000 558,284,349
Deferred income taxes, net................................................. 9,916,203 15,234,409
Postretirement benefit obligation.......................................... 7,150,767 6,526,991
Deferred PCS activation revenue............................................ 5,247,821 6,092,645
Other long-term liabilities................................................ 10,671,551 11,075,183
---------------- ----------------
Total long-term debt and other liabilities........................... 74,986,342 157,105,236
---------------- ----------------
Total liabilities.................................................. 662,599,392 654,011,368
---------------- ----------------
CONVERTIBLE PREFERRED STOCK OF SUBSIDIARY..................................... 163,325,759 157,105,236
COMMITMENTS AND CONTINGENCIES (Note 11)
STOCKHOLDERS' EQUITY (DEFICIT):
Common stock - class A, no par value, 200,000 shares authorized, 99,726
shares issued and 90,561 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 - 36,689 shares, at cost.................................... (5,504,700) (5,504,700)
Accumulated other comprehensive income (loss), net......................... 748,499 (67,307)
Additional paid-in capital................................................. 72,197,212 72,197,212
Deferred stock compensation................................................ (473,503) (666,721)
Retained deficit........................................................... (485,059,248) (333,021,473)
--------------- ---------------
Total stockholders' equity (deficit)............................... (416,395,242) (265,366,491)
---------------- ----------------
Total liabilities and stockholders' equity (deficit)............ $ 409,529,909 $ 545,750,113
================ ================
The accompanying notes are in integral part of these
consolidated financial statements.
4
HORIZON TELCOM, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
For the Three and Six Months Ended June 30, 2003 and 2002 (unaudited)
- --------------------------------------------------------------------------------
For the Three Months Ended For the Six Months Ended
June 30, June 30,
------------------------------ ------------------------------
2003 2002 2003 2002
-------------- -------------- -------------- --------------
OPERATING REVENUES:
PCS subscriber and roaming.................. $ 61,419,109 $ 50,124,293 $ 118,790,756 $ 95,857,681
PCS equipment............................... 2,071,361 1,597,640 3,889,457 3,972,928
Basic local and long-distance service....... 4,707,434 4,753,442 9,084,943 9,351,273
Network access.............................. 6,342,539 6,735,297 11,769,372 11,330,767
Equipment systems sales, information
services, Internet access and other..... 2,262,594 2,061,334 4,507,418 4,167,083
-------------- -------------- -------------- --------------
Total operating revenues.............. 76,803,037 65,272,006 148,041,946 124,679,732
OPERATING EXPENSES:
Cost of goods sold ......................... 5,175,011 3,836,701 11,085,558 8,928,711
Cost of services (exclusive of items shown
separately below)....................... 50,889,739 45,337,798 98,949,166 84,829,940
Selling and marketing....................... 12,779,812 11,333,217 25,636,771 26,418,675
General and administrative (exclusive of
items shown separately below)........... 15,476,271 13,901,747 28,340,160 26,699,836
Non-cash compensation....................... 96,609 87,768 193,218 189,635
(Gain) Loss on sale of property and
equipment............................... (41,064) 355,265 216,312 641,004
Impairment of intangible assets and
property and equipment.................. 73,760,278 3,500,000 73,760,278 3,500,000
Depreciation and amortization............... 12,617,127 11,730,985 25,826,403 21,850,995
-------------- -------------- -------------- --------------
Total operating expenses.............. 170,753,783 90,083,481 264,007,866 173,058,796
-------------- -------------- -------------- --------------
OPERATING LOSS................................... (93,950,746) (24,811,475) (115,965,920) (48,379,064)
-------------- -------------- -------------- --------------
NONOPERATING INCOME (EXPENSE):
Interest expense, net....................... (17,718,757) (15,925,172) (34,693,462) (29,128,751)
Subsidiary preferred stock dividends........ (3,151,448) (2,856,397) (6,220,557) (5,712,766)
Interest income and other, net.............. 249,540 944,518 565,931 1,686,693
-------------- -------------- -------------- --------------
Total nonoperating expense......... (20,620,665) (17,837,051) (40,348,088) (33,154,824)
-------------- -------------- -------------- --------------
LOSS BEFORE INCOME TAX EXPENSE and minority
interest...................................... (114,571,411) (42,648,526) (156,314,008) (81,533,888)
INCOME TAX BENEFIT............................... 5,381,937 (972,437) 5,218,663 (1,180,071)
MINORITY INTEREST IN LOSS........................ -- -- 24 --
-------------- -------------- -------------- --------------
NET LOSS......................................... $(109,189,474) $ (43,620,963) $(151,095,321) $ (82,713,959)
============== ============== ============== ==============
Basic and diluted net loss per share............. $ (301.22) $ (120.36) $ (416.83) $ (228.25)
============== ============== ============== ==============
Weighted-average common shares outstanding ...... 362,487 362,429 362,487 362,379
============== ============== ============== ==============
5
HORIZON TELCOM, INC. AND SUBSIDIARIES
Consolidated Statements of Other Comprehensive Income (Loss)
For the Three and Six Months Ended June 30, 2003 and 2002 (unaudited)
- --------------------------------------------------------------------------------
For the Three Months Ended For the Six Months Ended
June 30, June 30,
------------------------------ -------------------------------
2003 2002 2003 2002
-------------- -------------- -------------- ---------------
NET LOSS.......................................... $(109,189,474) $ (43,620,963) $(151,095,321) $ (82,713,959)
============== ============== ============== ===============
OTHER COMPREHENSIVE INCOME (LOSS)
Net unrealized gain (loss) on hedging activities.. 127,737 (269,901) 461,644 120,042
Net unrealized gain (loss) on securities
available-for-sale net of taxes of $159,681
and $182,447 for the three and six months
ended June 30, 2003, respectively............ 309,969 (1,215,938) 354,162 (1,893,573)
-------------- -------------- -------------- ---------------
COMPREHENSIVE INCOME (LOSS)....................... $(108,751,768) $ (45,106,802) $(150,279,515) $ (84,487,490)
============== ============== ============== ===============
The accompanying notes are an integral part of these
consolidated financial statements.
6
HORIZON TELCOM, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Six Months Ended June 30, 2003 and 2002 (unaudited)
- --------------------------------------------------------------------------------
Six Months Ended June 30,
2003 2002
---------------- ----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss............................................................... $ (151,095,321) $ (82,713,959)
---------------- ----------------
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Depreciation and amortization....................................... 25,826,403 21,850,995
Impairment of intangible assets and property and equipment.......... 73,760,278 3,500,000
Deferred income tax benefit......................................... (6,031,000) --
Non-cash compensation expense....................................... 193,218 189,635
Non-cash interest expense........................................... 16,275,128 12,993,755
Loss on disposal of property, plant and equipment................... 216,312 641,004
Non-cash preferred stock dividend of subsidiary..................... 6,220,557 5,712,766
Minority interest in subsidiary..................................... (24) --
Provision for bad debt expense...................................... 3,843,309 7,368,879
Loss on hedging activities.......................................... -- 34,103
Decrease (Increase) in certain assets:
Accounts receivable............................................... (7,454,660) (13,280,531)
Inventories....................................................... 841,161 2,008,333
Prepaid expenses and other current assets......................... (1,366,006) (2,048,175)
Increase (Decrease) in certain liabilities:
Accounts payable.................................................. (7,172,592) (4,448,623)
Payable to Sprint................................................. 4,088,607 4,597,189
Accrued liabilities and deferred PCS service revenue.............. 13,836,172 8,211,315
Other accrued liabilities......................................... -- --
Postretirement benefit obligation................................. 623,776 424,129
Other assets and liabilities, net................................. 1,239,731 (58,950)
---------------- ---------------
Total adjustments............................................... 124,940,370 47,695,824
---------------- ----------------
Net cash used in operating activities......................... (26,154,951) (35,018,135)
---------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures, net........................................... (9,924,353) (54,634,274)
Proceeds from sale of property and equipment........................ -- 1,543,482
Purchase of short-term investments.................................. -- (6,525,263)
---------------- ----------------
Net cash used in investing activities......................... (9,924,353) (59,616,055)
---------------- ----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings on line of credit........................................ 750,000 --
Borrowings on long-term debt........................................ -- 105,000,000
Repayments on long-term debt........................................ -- (767,338)
Deferred financing fees............................................. -- (2,461,230)
Exercise of subsidiary stock options................................ 24 --
Dividends paid...................................................... (942,454) (906,009)
---------------- ----------------
Net cash provided by (used in) financing activities........... (192,430) 100,865,423
---------------- ----------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS................... (36,271,734) 6,231,233
CASH AND CASH EQUIVALENTS, beginning of period......................... 94,948,351 127,154,227
---------------- ----------------
CASH AND CASH EQUIVALENTS, end of period............................... $ 58,676,617 $ 133,385,460
================ ================
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 June 30, 2003 and December 31, 2002
And for the Three and Six Months Ended June 30, 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 excluding the impairment of Horizon PCS' intangible
assets and property and equipment (see Note 8) and the reclassification of
Horizon PCS' long-term debt to short-term debt (see Note 10). 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 June 30, 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 not in compliance with its covenants
with regard to its senior secured debt. Horizon PCS represents approximately 83%
of total consolidated revenues for the quarter ended June 30, 2003 and 74% of
the total consolidated assets at June 30, 2003. The failure to comply with a
covenant is an event of default under the secured credit facility, which gives
the lenders the right to pursue remedies against Horizon PCS. These remedies
could include acceleration of amounts due under the facility. An acceleration of
the amounts due under the facility would also represent a default under the
indentures for the senior notes and discount notes. Therefore, all of the
Horizon PCS' long-term debt has been classified as short-term as of June 30,
2003.
On August 15, 2003, Horizon PCS delivered to the lenders under its senior
secured credit facility a certificate that indicated that Horizon PCS failed to
comply with a financial covenant for the second quarter of 2003 as required by
the senior secured credit facility. On August 15, 2003, the lenders elected to
declare an acceleration of the loans under the senior secured credit facility.
On August 15, 2003, Horizon PCS and its subsidiaries filed voluntary petitions
for reorganization under Chapter 11 of the Bankruptcy Code. See Note 13.
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 its
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 Horizon
Telcom's ownership fall below 50% or Horizon Telcom otherwise loses 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.
8
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
As of June 30, 2003 and December 31, 2002
And for the Three and Six Months Ended June 30, 2003 and 2002 (unaudited)
- --------------------------------------------------------------------------------
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.
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 June 30, 2003 and at December 31,
2002:
June 30, December 31,
2003 2002
------------- -------------
Equipment held for resale.................. $ 3,257,997 $ 4,204,296
Materials, supplies and work in progress... 2,237,719 2,132,581
------------- -------------
Total inventories....................... $ 5,495,716 $ 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") No. 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 June 30, 2003, the Company has recorded regulatory liabilities of
approximately $1,498,000. As of December 31, 2002, regulatory assets and
liabilities were approximately $63,000 and $480,000, respectively.
9
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
As of June 30, 2003 and December 31, 2002
And for the Three and Six Months Ended June 30, 2003 and 2002 (unaudited)
- --------------------------------------------------------------------------------
NOTE 4 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RESTRICTED CASH
In connection with Horizon PCS' December 2001 offering of $175,000,000 of
senior notes due in 2011 (Note 10), 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. Horizon PCS paid
approximately $12,031,000 and $24,596,000, during six months June 30, 2003, and
year ended December 31, 2002, respectively, representing the first three
installments. The remaining interest payment has been classified as short-term
and is scheduled for payment in December of 2003.
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 $645,000 and
$3,185,000 for the six months ended June 30, 2003 and 2002, respectively. In
addition, the Company capitalized labor costs of approximately $1,148,000 and
$3,377,000 for the six months ended June 30, 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
10
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
As of June 30, 2003 and December 31, 2002
And for the Three and Six Months Ended June 30, 2003 and 2002 (unaudited)
- --------------------------------------------------------------------------------
NOTE 4 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
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.
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 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", 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 exceeds 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 June 30, 2003 and December 31, 2002
And for the Three and Six Months Ended June 30, 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 and six month periods ending June 30:
Three Months Ended June 30, Six Months Ended June 30,
2003 2002 2003 2002
--------------- --------------- --------------- ---------------
Net loss
As reported............................. $ (109,189,474) $ (43,620,963) $ (151,095,321) $ (82,713,959)
Add: Stock-based employee compensation
expense included in reported net loss... 96,609 87,768 193,218 189,635
Deduct: Total stock-based employee
compensation expense determined under
fair value base method for all awards... (182,626) (292,428) (397,137) (584,856)
--------------- --------------- --------------- ---------------
Pro Forma net loss........................ $ (109,275,491) $ (43,825,623) $ (151,299,240) $ (83,109,180)
=============== =============== =============== ===============
Basic and diluted loss per share
As reported............................... $ (301.22) $ (120.36) $ (416.83) $ (228.25)
Pro forma................................. $ (301.46) $ (120.92) $ (417.39) $ (229.34)
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 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 May 2003, the FASB issued SFAS No.150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within the scope
of SFAS No. 150 as a liability (or an asset in some circumstances). Many of
those instruments were previously classified as equity. The application of SFAS
No. 150 is not expected to have a material effect on the Company's consolidated
financial statements. This Statement is effective for financial instruments
entered into or modified after May 31, 2003, and otherwise is effective at the
beginning of the first interim period beginning after June 15, 2003.
12
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
As of June 30, 2003 and December 31, 2002
And for the Three and Six Months Ended June 30, 2003 and 2002 (unaudited)
- --------------------------------------------------------------------------------
NOTE 4 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
In April 2003, the FASB issued SFAS No.149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amendments require
that contracts with comparable characteristics be accounted for similarly,
clarifies when a contract with an initial investment meets the characteristic of
a derivative and clarifies when a derivative requires special reporting in the
statement of cash flows. SFAS No. 149 is effective for hedging relationships
designated and for contracts entered into or modified after June 30, 2003,
except for provisions that relate to SFAS No. 133 Statement Implementation
Issues that have been effective for fiscal quarters prior to June 15, 2003,
which should be applied in accordance with their respective effective dates, and
certain provisions relating to forward purchases or sales of when-issued
securities or other securities that do not exist, which should be applied to
existing contracts as well as new contracts entered into after June 30, 2003.
The application of SFAS No. 149 is not expected to have a material effect on the
Company's consolidated financial statements.
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 No. 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 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.
13
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
As of June 30, 2003 and December 31, 2002
And for the Three and Six Months Ended June 30, 2003 and 2002 (unaudited)
- --------------------------------------------------------------------------------
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.
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 June 30, 2003 and 2002, and assets as of June 30, 2003
and December 31, 2002, for each segment and reconciling items necessary to total
to amounts reported in the financial statements:
Net Revenue
Three Months Ended June 30, Six Months Ended June 30,
----------------------------- ----------------------------
2003 2002 2003 2002
------------- ------------- ------------ -------------
Wireless personal communications services.. $ 63,490,470 $ 51,721,933 $122,680,213 $ 99,830,609
Landline telephone services................ 11,049,973 11,488,739 20,854,315 20,682,040
All other.................................. 2,262,594 2,061,334 4,507,418 4,167,083
------------- ------------- ------------ -------------
Total net revenues........................ $ 76,803,037 $ 65,272,006 $148,041,946 $124,679,732
============= ============= ============= =============
Intercompany Revenue
Three Months Ended June 30, Six Months Ended June 30,
----------------------------- -----------------------------
2003 2002 2003 2002
------------- ------------- ------------ -------------
Wireless personal communications services... $ 17,351 $ 91,986 $ 22,531 $ 193,092
Landline telephone services................. 294,637 403,341 609,212 805,255
All other................................... 174,509 111,422 306,153 218,739
------------- ------------- ------------ -------------
Total intercompany revenues............. $ 486,497 $ 606,749 $ 937,896 $ 1,217,086
============= ============= ============= =============
14
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
As of June 30, 2003 and December 31, 2002
And for the Three and Six Months Ended June 30, 2003 and 2002 (unaudited)
- --------------------------------------------------------------------------------
NOTE 5 - SEGMENT INFORMATION (CONTINUED)
Operating Earnings (Loss)
Three Months Ended June 30, Six Months Ended June 30,
------------------------------ ------------------------------
2003 2002 2003 2002
-------------- -------------- --------------- --------------
Wireless personal communications services.. $ (94,930,836) $(26,667,777) $(116,501,478) $(49,743,322)
Landline telephone services................ 4,794,325 5,416,299 8,300,947 8,964,841
All other.................................. (878,131) (810,890) (1,905,384) (1,783,945)
Unallocated administrative expenses........ (2,936,104) (2,749,107) (5,860,005) (5,816,638)
-------------- -------------- --------------- --------------
Total operating loss................... $ (93,950,746) $ (24,811,475) $(115,965,920) $ (48,379,064)
============== ============== ============== ==============
Depreciation and Amortization
Three Months Ended June 30, Six Months Ended June 30,
------------------------------ -----------------------------
2003 2002 2003 2002
-------------- -------------- --------------- -------------
Wireless personal communications services... $ 10,291,619 $ 9,479,776 $ 21,152,305 $ 17,429,407
Landline telephone services................. 1,695,936 1,723,654 3,434,249 3,403,328
All other................................... 629,572 527,555 1,239,849 1,018,260
-------------- -------------- -------------- --------------
Total depreciation and amortization..... $ 12,617,127 $ 11,730,985 $ 25,826,403 $ 21,850,995
============== ============== ============== ==============
Capital Expenditures
Three Months Ended June 30, Six Months Ended June 30,
----------------------------- ---------------------------
2003 2002 2003 2002
------------- ------------- ------------- -------------
Wireless personal communications services.. $ 3,440,316 $ 25,675,000 $ 5,649,629 $ 49,113,012
Landline telephone services................ 2,121,249 1,851,251 3,622,445 3,853,782
All other.................................. 289,061 774,777 652,279 1,667,480
------------- ------------- ------------- -------------
Total capital expenditures............. $ 5,850,626 $ 28,301,028 $ 9,924,353 $ 54,634,274
============= ============= ============= =============
Assets
June 30, December 31,
2003 2002
-------------- --------------
Wireless personal communications services........ $ 303,510,054 $ 443,116,762
Landline telephone services...................... 87,710,171 83,258,131
All other........................................ 18,309,684 19,375,220
-------------- --------------
Total assets................................. $ 409,529,909 $ 545,750,113
============== ==============
15
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
As of June 30, 2003 and December 31, 2002
And for the Three and Six Months Ended June 30, 2003 and 2002 (unaudited)
- --------------------------------------------------------------------------------
NOTE 5 - SEGMENT INFORMATION (CONTINUED)
Net operating revenues by product and services were as follows for the
three and six months ended June 30:
Three Months Ended June 30, Six Months Ended June 30,
----------------------------- -----------------------------
2003 2002 2003 2002
------------- ------------- ------------- -------------
Wireless personal communications services:
PCS subscriber revenue..................... $ 47,840,415 $ 37,008,341 $ 91,414,189 $ 71,922,441
PCS roaming revenue........................ 13,578,695 13,115,952 27,376,568 23,935,240
PCS equipment sales........................ 2,071,360 1,597,640 3,889,456 3,972,928
------------- ------------- ------------- -------------
Total personal communication services.... 63,490,470 51,721,933 122,680,213 99,830,609
------------- ------------- ------------- -------------
Landline telephone services:
Basic local service........................ 3,483,204 3,658,433 6,871,340 7,263,689
Long-distance service...................... 230,190 269,022 478,735 578,414
Network access............................. 6,342,539 6,735,297 11,769,372 11,330,767
Other related telephone service............ 994,040 825,987 1,734,868 1,509,170
------------- ------------- ------------- -------------
Total landline telephone services........ 11,049,973 11,488,739 20,854,315 20,682,040
------------- ------------- ------------- -------------
Other:
Internet access services................... 668,302 818,577 1,372,043 1,625,405
Equipment system sales..................... 202,723 240,617 482,051 620,953
Other miscellaneous revenues............... 1,391,569 1,002,140 2,653,324 1,920,725
------------- ------------- ------------- -------------
Total other.............................. 2,262,594 2,061,334 4,507,418 4,167,083
------------- ------------- ------------- -------------
Total operating revenues............. $ 76,803,037 $ 65,272,006 $ 148,041,946 $ 124,679,732
============= ============= ============= =============
16
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
As of June 30, 2003 and December 31, 2002
And for the Three and Six Months Ended June 30, 2003 and 2002 (unaudited)
- --------------------------------------------------------------------------------
NOTE 6 - INVESTMENTS
The following summarizes unrealized gains and losses on investments at June
30, 2003, and December 31, 2002:
2003:
----
Unrealized Unrealized Fair
Cost Gain Loss Value
---------- ---------- ---------- ----------
Equity securities available-for-sale $ 250,000 $1,032,470 $ -- $1,282,470
========== ========== ========== ==========
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:
June 30, December 31,
2003 2002
------------- -------------
Network assets.................................. $229,663,299 $293,825,031
Switching equipment............................. 64,037,616 63,294,413
Land and buildings.............................. 15,997,233 15,856,491
Computer and telecommunications equipment....... 13,923,784 13,369,767
Furniture, vehicles and office equipment........ 12,572,461 12,518,760
------------- -------------
Property, plant and equipment in-service, at cost. 36,194,393 398,864,462
Accumulated depreciation........................ (74,937,977) (99,376,895)
------------- -------------
Property, plant and equipment in-service, net 261,256,416 299,487,567
Construction work in progress................... 5,474,605 16,433,540
------------- -------------
Total property, plant and equipment, net $266,731,021 $315,921,107
============= =============
During the six months ended June 30, 2003, Horizon PCS incurred a loss of
approximately $216,000 related to the disposal of assets from two of our retail
stores closed during 2003. During the six months ended June 30, 2002, Horizon
PCS retired certain network assets and replaced them with equipment to upgrade
the network resulting in a loss of approximately $641,000.
During the six months ended June 30, 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 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.
During the second quarter of 2003, Horizon PCS reduced the book value of
the network assets related to an impairment recorded on property and equipment
discussed below in Note 8.
NOTE 8 - IMPAIRMENT OF HORIZON PCS INTANGIBLE ASSETS AND PROPERTY AND EQUIPMENT
Horizon PCS was not in compliance with the loan covenants as of June 30,
2003. This created the need for an impairment assessment of its intangible
assets and property and equipment as required by SFAS No. 144. Therefore,
Horizon PCS projected future undiscounted cash flows and determined they were
insufficient to recover the carrying amounts for the intangible assets and
property and equipment. This required Horizon PCS to recognize an impairment
loss for the excess of carrying value over fair value. To determine fair value,
Horizon PCS performed a valuation utilizing a cost approach adjusted for items
such as technological and functional obsolescence as appropriate.
17
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
As of June 30, 2003 and December 31, 2002
And for the Three and Six Months Ended June 30, 2003 and 2002 (unaudited)
- --------------------------------------------------------------------------------
NOTE 8 - IMPAIRMENT OF HORIZON PCS INTANGIBLE ASSETS AND PROPERTY AND EQUIPMENT
(CONTINUED)
Horizon PCS determined that the carrying value of the intangible assets
exceeded the fair value of the assets. As a result, Horizon PCS recorded
impairment on the intangible assets of approximately $39,152,000. As a result of
the impairment charge, Horizon PCS recorded a tax benefit of $6,031,000 due to
the reduction of a deferred tax liability related to the intangibles. As of June
30, 2003, net deferred income taxes were zero.
Additionally, Horizon PCS determined the fair market value of the property
and equipment was less than the carrying value of the assets. As a result,
Horizon PCS recorded an impairment on property and equipment of approximately
$34,609,000.
During 2002, Horizon PCS launched switches in Tennessee and Pennsylvania
and disconnected some switching equipment in Chillicothe, Ohio. As a result,
approximately $6.2 million of switching equipment was considered an impaired
asset as defined by SFAS No. 144. Accordingly, impairment expense for the three
and six months ended June 30, 2002, includes approximately $3.5 million of
expense related to the impaired assets. The total amount of depreciation
recorded to date on this equipment was approximately $5.6 million. This
equipment was sold for book value during 2003.
NOTE 9 - 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 June 30, 2003, the interest rate on the line of
credit was 2.73%. As of June 30, 2003, Chillicothe Telephone had drawn $750,000
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 June 30, 2003, Chillicothe Telephone was in compliance with these
covenants.
NOTE 10 - LONG-TERM DEBT
The components of long-term debt outstanding are as follows:
Interest Rate at
June 30, June 30, 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 5.10% 105,000,000 105,000,000
Secured credit facility-term loan B 5.60% 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........ (93,655,678) (108,715,651)
Less: debt classified as short-term
due to covenant violation.......... (531,344,322) --
------------- -------------
Total long-term debt............ $ 42,000,000 $558,284,349
------------- -------------
As of June 30, 2003, Horizon PCS was not in compliance with the covenants
under the agreements for the senior credit facility, therefore, Horizon PCS'
indebtedness is classified as short-term. On August 15, 2003, the lenders
18
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
As of June 30, 2003 and December 31, 2002
And for the Three and Six Months Ended June 30, 2003 and 2002 (unaudited)
- --------------------------------------------------------------------------------
NOTE 10 - LONG-TERM DEBT (CONTINUED)
accelerated the indebtedness under the senior credit facility. The acceleration
also caused a default under Horizon PCS' senior and discount notes. Therefore,
all of Horizon PCS' long-term debt has been classified as short-term as of June
30, 2003. On August 15, 2003, Horizon PCS and its subsidiaries filed voluntary
petitions for reorganization under Chapter 11 of the Bankruptcy Code. See Note
13.
Horizon PCS' secured credit facility includes financial covenants including
restrictions of its ability to draw on the $95.0 million line of credit. Due to
the aforementioned covenant violation, the entire $95.0 million line of credit
is unavailable.
NOTE 11 - COMMITMENTS AND CONTINGENCIES
SPRINT 3G DEVELOPMENT FEES
Over the past 18 months, 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 June 30, 2003, Horizon PCS has not recorded or paid amounts
billed by Sprint for 3G development costs of approximately $1,100,000.
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 June 30, 2003,
Horizon PCS leased 42 retail stores operating throughout its territories. See
Note 12 for additional detail on stores closing after June 30, 2003.
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 Horizon PCS closed two retail stores. In
conjunction with these closings, 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. See Note
12 for additional detail on stores closing after June 30, 2003.
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
19
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
As of June 30, 2003 and December 31, 2002
And for the Three and Six Months Ended June 30, 2003 and 2002 (unaudited)
- --------------------------------------------------------------------------------
NOTE 11 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
by the NTELOS agreement, were approximately $20,467,000 and $14,429,000 for
the six months ended June 30, 2003 and 2002, respectively, and approximately
$33,036,000, for the year ended December 31, 2002.
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 June 30, 2003. The balance of the
asset will be depreciated over the remaining lives of the land leases associated
with the towers.
NOTE 12 - SUBSEQUENT EVENTS
On July 28, 2003, Horizon PCS implemented a company-wide work force
reduction to further reduce costs that are within Horizon PCS' control. The
employment of approximately 300 employees has been terminated, and Horizon PCS
has closed approximately 19 of its 42 company-owned sales and service centers to
reduce costs in areas where revenues are not currently meeting criteria for
return on investment. Horizon PCS is also converting approximately 13 of its
other company-owned sales and service centers to customer service centers.
Horizon PCS expects to record a restructuring charge in the third quarter of
2003 but has not determined the financial impact.
NOTE 13 - SUBSEQUENT EVENT - BANKRUPTCY OF HORIZON PCS
VOLUNTARY BANKRUPTCY FILING
On August 15, 2003, Horizon PCS, Inc., a Delaware corporation ("Horizon
PCS"), Horizon Personal Communications, Inc., an Ohio corporation and subsidiary
of Horizon PCS ("Percom") and Bright Personal Communications Services LLC, an
Ohio limited liability company and subsidiary of Horizon PCS ("Bright") (Horizon
PCS, Bright, and Percom collectively, the "Debtors"), filed voluntary petitions
for relief under Chapter 11 of Title 11 of the United States Code (the
"Bankruptcy Code") in the United States Bankruptcy Court for the Southern
District of Ohio (the "Bankruptcy Court"). The Debtors expect to continue to
manage their properties and operate their businesses in the ordinary course of
business as "debtors-in-possession" subject to the supervision and orders of
the Bankruptcy Court pursuant to Sections 1107(a) and 1108 of the Bankruptcy
Code (the "Bankruptcy Case"). In general, as a debtor-in-possession, Horizon PCS
is authorized under Chapter 11 to continue to operate as an ongoing business,
but may not engage in transactions outside the ordinary course of business
without the prior approval of the Bankruptcy Court. Under Section 362 of the
Bankruptcy Code, the filing of a bankruptcy petition automatically stays most
actions against Horizon PCS, including most actions to collect pre-petition
indebtedness or to exercise control of the property of Horizon PCS' estate.
Absent an order of the Bankruptcy Court, substantially all pre-petition
liabilities will be subject to settlement under a plan of reorganization.
20
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
As of June 30, 2003 and December 31, 2002
And for the Three and Six Months Ended June 30, 2003 and 2002 (unaudited)
- --------------------------------------------------------------------------------
NOTE 13 - SUBSEQUENT EVENT - BANKRUPTCY OF HORIZON PCS (CONTINUED)
Under Section 365 of the Bankruptcy Code, Horizon PCS may assume or reject
certain executory contracts and unexpired leases, including leases of real
property, subject to the approval of the Bankruptcy Court and certain other
conditions. In general, rejection of an unexpired lease or executory contract is
treated as a pre-petition breach of the lease or contract in question.
Counterparties to these rejected contracts or leases may file proofs of claim
against Horizon PCS' estate for damages relating to such breaches. The United
States Trustee for the Southern District of Ohio will appoint an official
committee of unsecured creditors (the "Creditors' Committee"). The Creditors'
Committee and its legal representatives have a right to be heard on all matters
that come before the Bankruptcy Court. The rights and claims of various
creditors and security holders will be determined by a plan of reorganization
that is confirmed by the Bankruptcy Court. Under the priority rules established
by the Bankruptcy Code, certain post-petition liabilities and pre-petition
liabilities are given priority over pre-petition indebtedness and need to be
satisfied before unsecured creditors or stockholders are entitled to any
distribution.
REORGANIZATION PLAN
In order to exit Chapter 11 successfully, Horizon PCS will need to propose,
and obtain confirmation by the Bankruptcy Court of, a plan of reorganization
(the "Reorganization Plan") that satisfies the requirements of the Bankruptcy
Code. As provided by the Bankruptcy Code, Horizon PCS initially has the
exclusive right to solicit a plan of reorganization for 120 days from the date
of filing its petition for relief. At this time, it is not possible to predict
accurately the effect of the Chapter 11 reorganization process on Horizon PCS'
business, creditors or stockholders or when Horizon PCS may emerge from Chapter
11. Horizon PCS future results depend on the timely and successful confirmation
and implementation of a plan of reorganization.
The Bankruptcy Case was commenced in order to implement a comprehensive
financial restructuring of Horizon PCS, including the senior credit facility,
the senior notes, the discount notes and preferred and common equity securities.
No Reorganization Plan has been submitted to the Bankruptcy Court. It is likely
that, in connection with the final Reorganization Plan, the liabilities of
Horizon PCS will be found in the Bankruptcy Case to exceed the fair value of its
assets. This would result in claims being paid at less than 100% of their face
value and holders of preferred and common stock being entitled to little or no
recovery. At this time, it is not possible to predict with certainty the
outcome of the bankruptcy proceedings.
ACCOUNTING IMPACT
In accordance with Statement of Financial Accounting Standards (SFAS) No.
94 "Consolidation of All Majority-Owned Subsidiaries" and Accounting Research
Bulletin (ARB) No. 51 "Consolidated Financial Statements," when control of a
majority-owned subsidiary does not rest with the majority owners (as, for
instance, where the subsidiary is in legal reorganization or in bankruptcy), ARB
No. 51 precludes consolidation of the majority-owned subsidiary. As a result,
subsequent to August 14, 2003, Horizon Telcom will no longer consolidate the
accounts and results of operations of Horizon PCS and the accounts of Horizon
PCS will be recorded as an investment using the cost method of accounting. The
accompanying consolidated balance sheet as of June 30, 2003 does include the
consolidated accounts of Horizon PCS; however, future quarters' balance sheets
will not include such accounts and instead will include Horizon Telcom's
investment at cost in Horizon PCS as of August 14, 2003. The accompanying
consolidated statement of operations for the period ended June 30, 2003 includes
the consolidated results of operations of Horizon PCS through such date;
however, the consolidated statement of operations for the third quarter of 2003
will only include the operations of Horizon PCS through August 14, 2003. When
Horizon Telcom no longer has an ownership interest in Horizon PCS, which may
occur upon emergence of Horizon PCS from bankruptcy, the investment in Horizon
PCS will be reduced proportionately to the remaining ownership percentage, if
any, retained by Horizon Telcom.
21
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
As of June 30, 2003 and December 31, 2002
And for the Three and Six Months Ended June 30, 2003 and 2002 (unaudited)
- --------------------------------------------------------------------------------
NOTE 13 - SUBSEQUENT EVENT - BANKRUPTCY OF HORIZON PCS (CONTINUED)
GOING CONCERN
Our independent auditors have issued their Independent Auditors' Report on
Horizon PCS' consolidated financial statements for the fiscal year ended
December 31, 2002 with an explanatory paragraph regarding Horizon PCS' ability
to continue as a going concern. The consolidated financial statements have been
prepared on a going concern basis, which contemplates continuity of operations,
realization of assets and satisfaction of liabilities in the ordinary course of
business. However, as a result of recurring operating losses, such realization
of assets and satisfaction of liabilities are subject to uncertainty, which
raises 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.
22
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 estimates for churn and ARPU (defined below);
o statements regarding the effects of, or the outcome of, Horizon PCS'
bankruptcy case;
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:
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;
23
o changes in government regulation; and
o general political economic and business conditions.
And, in addition the following factors related to Horizon PCS:
o the filing by Horizon PCS of a voluntary petition for reorganization
under Chapter 11 of the Bankruptcy Code;
o Horizon PCS' breach of a financial covenant in the credit agreement
for the senior secured credit facility, and the acceleration of
Horizon PCS' senior secured debt by the lenders;
o Horizon PCS' ability to continue as a going concern;
o potential effect of the bankruptcy proceeding on Horizon PCS' business
and assets;
o Horizon PCS' significant level of indebtedness; 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
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 June 30, 2003, Chillicothe Telephone serviced approximately 37,500
access lines in Chillicothe, Ohio and the surrounding area. Horizon Technology
provided Internet service to approximately 11,100 customers through its
bright.net Internet service. At June 30, 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 310,000 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 and six months ended June 30:
24
Three Months Ended June 30, Six Months Ended June 30,
2003 2002 2003 2002
------------- ------------- ------------- -------------
Provision as a percent of wireless subscriber 5% 11% 4% 10%
revenue......................................
Write-offs, net of recoveries as a percent
of wireless subscriber revenue.............. 4% 10% 5% 10%
Allowance for doubtful accounts as a
percent of PCS accounts receivable........... 8% 10% 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
75% at June 30, 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, recognized in our financial results in the first
quarter 2003.
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.
Approximately 50% of this was recovered in the second quarter of 2003.
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
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
25
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.
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.
SUBSEQUENT EVENTS
Based primarily upon the failure of Horizon PCS' attempt to negotiate a
restructuring of the fees paid to Sprint, on July 28, 2003, Horizon PCS
implemented a company-wide work force reduction to further reduce costs that are
within the its control. The employment of approximately 300 employees has been
terminated, and Horizon PCS has closed approximately 19 of its 42 company-owned
sales and service centers to reduce costs in areas where revenues are not
currently meeting criteria for return on investment. Horizon PCS is also
converting approximately 13 of its other company-owned sales and service centers
to customer service centers. Horizon PCS expects to record a restructuring
charge in the third quarter of 2003 but has not determined the financial impact.
26
In connection with its cost reduction efforts, Horizon PCS has
significantly reduced work on the expansion of its network and the enhancement
of its network capacity. Horizon PCS expects the reduction in work force and
network improvements to have a significant impact on its results of operations
for the remaining six months of 2003.
On August 15, 2003, Horizon PCS and its subsidiaries filed voluntary
petitions for reorganization under Chapter 11 of the Bankruptcy Code. See Note
13 to the Financial Statements.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2003 COMPARED TO THE
THREE MONTHS ENDED JUNE 30, 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 June 30, 2003 and 2002:
For the Three Months Ended, June 30,
-----------------------------------------------------------------------------
Wireless Personal
Communications Corporate and
Services Landline Telephone Other Services
---------------------- ----------------------- ------------------------
(Dollars in thousands)
OPERATING REVENUES: 2003 2002 2003 2002 2003 2002
---------- ---------- ---------- ---------- ---------- ----------
PCS subscriber and roaming..... $ 61,419 $ 50,124 $ -- $ -- $ -- $ --
PCS equipment.................. 2,071 1,598 -- -- -- --
Basic local and long-distance
and other landline........... -- -- 4,707 4,754 -- --
Network access................. -- -- 6,343 6,735 -- --
Equipment systems sales,
information services,
Internet access and other.... -- -- -- -- 2,263 2,061
---------- ---------- ---------- ---------- ---------- ----------
Total operating revenues.... 63,490 51,722 11,050 11,489 2,263 2,061
---------- ---------- ---------- ---------- ---------- ----------
OPERATING EXPENSES:
Cost of PCS and other
equipment sale.............. 5,074 3,742 -- -- 101 95
Cost of services.............. 46,841 41,535 2,382 2,394 1,667 1,409
Selling and marketing......... 12,351 10,880 180 148 249 305
General and administrative.... 10,051 8,806 1,997 1,806 3,427 3,290
Non-cash compensation......... 93 92 1 1 3 (6)
Loss (Gain) on disposal of
assets...................... (41) 355 -- -- -- --
Depreciation and amortization. 10,292 9,480 1,696 1,724 630 528
Impairment of Horizon PCS
Assets...................... 73,760 3,500 -- -- -- --
---------- ---------- ---------- ---------- ---------- ----------
Total operating expenses.... 158,421 78,390 6,256 6,073 6,077 5,621
---------- ---------- ---------- ---------- ---------- ----------
OPERATING INCOME (LOSS).......... (94,931) (26,668) 4,794 5,416 (3,814) (3,560)
---------- ---------- ---------- ---------- ---------- ----------
NONOPERATING INCOME (EXPENSE):
Interest expense, net......... (17,011) (15,456) (707) (469) -- --
Subsidiary preferred stock
dividends................... (3,151) (2,856) -- -- -- --
Interest income and other, net 226 1,001 22 (57) 1 --
---------- ---------- ---------- ---------- ---------- ----------
Total nonoperating expense.... (19,936) (17,311) (685) (526) 1
---------- ---------- ---------- ---------- ---------- ----------
LOSS BEFORE INCOME TAX EXPENSE
AND MINORITY INTEREST......... (114,867) (43,979) 4,109 4,890 (3,813) (3,560)
INCOME TAX (EXPENSE) BENEFIT..... 6,031 -- (820) (1,107) 171 135
MINORITY INTEREST IN LOSS........ -- -- -- -- -- --
---------- ---------- ---------- ---------- ---------- ----------
NET INCOME (LOSS)................ $(108,836) $ (43,979) $ 3,289 $ 3,783 $ (3,642) $ (3,425)
========== ========== ========== ========== ========== ==========
OTHER COMPREHENSIVE INCOME (LOSS)
Net realized gain (loss) on
hedging activities............. 127 (270) -- -- -- --
Net unrealized gain (loss) on
securities available-for-sale,
net of taxes................... -- -- 310 (1,216) -- --
---------- ---------- ---------- ---------- ---------- ----------
COMPREHENSIVE INCOME (LOSS)...... $(108,709) $ (44,249) $ 3,599 $ 2,567 $ (3,642) $ (3,425)
========== ========== ========== ========== ========== ==========
27
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 June 30, 2003 compared to three months ended
June 30, 2002. Our wireless personal communications segment consists entirely of
the operations of Horizon PCS. Note: beginning August 14, 2003, our results of
operations will no longer include the operations of Horizon PCS.
RESULTS OF OPERATIONS
Subscriber revenues. Subscriber revenues for the three months ended June
30, 2003, were approximately $47.8 million, compared to approximately $37.0
million for the three months ended June 30, 2002, an increase of approximately
$10.8 million. The growth in subscriber revenues is primarily the result of the
growth in our customer base. We provided PCS services to approximately 310,000
customers at June 30, 2003, compared to approximately 235,100 at June 30, 2002.
The growth in subscriber revenue was reduced by decreases in average revenue per
user "ARPU" resulting from lower minute sensitive revenue as subscribers are
purchasing plans with more minutes included. We expect subscriber revenue to
fall below or remain at their current levels for the remainder of the year.
Roaming revenues. Roaming revenues were relatively flat, increasing from
approximately $13.1 million during the three months ended June 30, 2002, to
approximately $13.6 million for the three months ended June 30, 2003, an
increase of approximately $500,000. This reflects an increase in the number of
roaming minutes of approximately 51% offset by a decrease in the rate paid by
Sprint for roaming. Excluding the effects of a change in the reciprocal roaming
rate, we expect roaming revenues to remain at similar levels for the remainder
of the 2003.
Equipment revenues. Equipment revenues for the three months ended June 30,
2003, were approximately $2.1 million, compared to approximately $1.6 million
for the three months ended June 30, 2002, representing an increase of
approximately $500,000. The increase is attributable to an increase in the
number of handsets sold. We expect the reduction in the number of company-owned
Sprint PCS retail outlets to have a negative effect on equipment revenues.
Cost of PCS and other equipment sales. Cost of equipment for the three
months ended June 30, 2003, was approximately $5.1 million, compared to
approximately $3.7 million for the three months ended June 30, 2002, an increase
of approximately $1.4 million. The increase in the cost of equipment is the
result of the growth in our wireless customers. We sold approximately 27,400
handsets through our direct sales channels during the three months ended June
30, 2003, compared to approximately 20,900 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. Overall we expect cost of equipment to decline as an
effect of the reduction in company-owned Sprint PCS retail stores.
Cost of service. Cost of service for the three months ended June 30, 2003,
was approximately $46.8 million, compared to approximately $41.5 million for the
three months ended June 30, 2002, an increase of approximately $5.3 million.
This increase reflects the increase in costs incurred under our network services
agreement with the Alliances of approximately $3.0 million, as a result of an
increase in usage charges, due in part to our subscriber growth during the last
half of 2002 and the first half of 2003. Additionally, cost of service in 2003
was higher than 2002 due to the increase in network operations, including tower
lease expense, circuit costs and payroll expense, of approximately $700,000.
Growth in our customer base resulted in increased customer care, activations,
and billing expense of approximately $1.0 million and other variable expenses,
including increased switching and national platform expenses of approximately
$800,000. The increase in cost of service was offset by a decrease in long
distance charges of approximately $200,000 due to enhancement of our network
capabilities. The workforce reduction discussed above is expected to have a
positive impact on our cost of service.
Selling and marketing expenses. Selling and marketing expenses increased to
approximately $12.4 million for the three months ended June 30, 2003, compared
to approximately $10.9 million for the three months ended June 30, 2002, an
increase of approximately $1.5 million. This includes an increase in marketing
and advertising in our sales territory of approximately $600,000, an increase in
28
subsidies and rebates on handsets sold by third parties of approximately
$200,000 and an increase in commissions paid to third parties of approximately
$700,000. Selling and marketing expenses increased due to higher activations in
the second quarter of 2003. We expect significant reductions in selling and
marketing expense due to the workforce reduction and corporate strategy of
limiting our subscriber additions.
General and administrative expenses. General and administrative expenses
for the three months ended June 30, 2003, were approximately $10.1 million
compared to approximately $8.8 million in for the three months ended June 30,
2002, an increase of approximately $1.3 million. The increase reflects an
increase in the Sprint PCS management fee of approximately $1.0 million, an
increase in fees paid for outside financial services including bank group
consultants, financial advisors, and legal advice of approximately $1.0 million
and other general expenses of approximately $1.1 million. The increase was
offset by a decrease in the provision for doubtful accounts of approximately
$1.8 million as we continue to see positive effects from the increased credit
quality of our subscriber base.
Non-cash compensation expense. Horizon PCS recorded approximately $100,000
for the three months ended June 30, 2003 and 2002, for certain stock options
granted in November 1999.
Gain on sale of property and equipment. During the three months ended June
30, 2003, we incurred a gain of approximately $41,000 related to the disposal of
various assets.
Depreciation and amortization expense. Depreciation and amortization
expenses increased by approximately $800,000 to a total of approximately $10.3
million during the three months ended June 30, 2003. The increase reflects the
continuing construction of our network as we funded approximately $63.1 million
of capital expenditures during 2002.
Impairment of Horizon PCS' intangible assets and property and equipment
Horizon PCS was not in compliance with the loan covenants as of June 30, 2003.
This created the need for an impairment assessment of Horizon PCS' intangible
assets and property and equipment as required by SFAS No. 144. As a result
Horizon PCS recorded impairment on the intangible assets of approximately $39.2
million and on the property and equipment of approximately $34.6 million. During
the second quarter of 2002, Horizon PCS had approximately $6.2 million of
switching equipment become impaired as defined by SFAS No. 144. Accordingly,
impairment expense for the three months ended June 30, 2002, includes $3.5
million of expense related to the impaired assets. We performed these valuations
utilizing the best information available at the time. These impairment charges
represent an estimate that may change in the future.
Interest expense, net. Interest expense for the three months ended June 30,
2003, was approximately $17.0 million, compared to approximately $15.5 million
for the same period in 2002.
At June 30, 2003, the interest rate on the $105.0 million term loan A
borrowed under our secured credit facility was 5.10%, while the interest rate on
the $50.0 term loan B was 5.60%. Interest expense on the secured credit facility
was $2.3 million and $2.9 million during the three months ended June 30, 2003
and 2002, respectively.
Interest expense on the discount notes was approximately $7.8 million and
$6.8 million during the three months ended June 30, 2003 and 2002, respectively.
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 June 30, 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 $800,000 and $600,000 during
the three months ended June 30, 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 $300,000 and $200,000 during the three months ended June 30, 2003
and 2002, respectively, in commitment fees we paid on the unused portion of our
secured credit facility.
29
Capitalized interest during the three months ended June 30, 2003 and 2002,
was approximately $200,000 and $1.0 million, respectively.
Income tax benefit. As a result of the impairment charge, Horizon PCS
recorded a tax benefit of approximately $6.0 million due to the reduction of a
deferred tax liability related to the intangibles. As of June 30, 2003, net
deferred income taxes on Horizon PCS were zero.
Preferred stock dividend. On May 1, 2001, our convertible preferred stock
began paying a stock dividend at the rate of 7.5% per annum, payable
semi-annually. 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 June 30, 2003, was approximately $200,000 compared to
approximately $1.0 million in 2002 and consisted primarily of interest income.
This decrease was due primarily to a lower average balance of cash investments
during the second quarter of 2003 as compared to the same period in 2002 and
lower short-term interest rates.
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 remain 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 $100,000 was
recorded for the three months ended June 30, 2003.
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 decreased by approximately $400,000 for
the three months ended June 30, 2003, to approximately $6.3 million. Universal
Service Fund ("USF") revenues increased in 2003. In 2002, revenues were
increased from a one time adjustment to reverse approximately $2.1 million that
had been set aside to settle future over earnings claims by other carriers. This
reversal was a result of a ruling by the United States Court of Appeals that
dealt with a similar landline telecommunications company and its related carrier
access rates. Basic local and long distance revenues were essentially flat at
$4.7 million for the three months ended June 30, 2003, and June 30, 2002.
Internet access and other revenues increased by approximately $200,000 to
$2.3 million for the three months ended June 30, 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
goods sold for corporate and other services was essentially flat for the three
months ended June 30, 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 June 30, 2003 for the landline
telephone segment was essentially flat at $2.4 million as compared to the three
months ended June 30, 2002.
Cost of services for the three months ended June 30, 2003 for Corporate and
Other Services, was approximately $1.7 million compared to approximately $1.4
million for the same period in 2002, an increase of approximately $300,000. The
increase is related to the continued installation and programming expenses
associated with our VDSL service.
30
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 essentially flat for the three months ended June 30,
2003 compared to the same three months in 2002.
Selling and marketing expenses for corporate and other services was
essentially flat for the three months ended June 30, 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 was relatively flat, increasing by
approximately $200,000 to approximately $2.0 million for the three months ended
June 30, 2003.
General and administrative expenses for corporate and other services was
also essentially flat, increasing by approximately $100,000 to approximately
$3.4 million for the three months ended June 30, 2003.
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 June 30, 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 June 30, 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 June
30, 2003. This increase was related to the additional VDSL assets that have been
added to our network.
Interest expense, net. Interest expense for the landline telephone and
other services for the three months ended June 30, 2003, was approximately
$700,000, compared to approximately $500,000 for the three months ended June 30,
2002. The increase in interest expense was a result of our additional debt
outstanding during the three months ended June 30, 2003, compared to the same
period in 2002. We expect further increases in interest expense in 2003 due to
anticipated higher average debt levels.
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 June 30, 2003. Interest expense on the
retired line of credit and the retired 1993 Senior Notes was approximately
$300,000 for the three months ended June 30, 2002. Interest expense on
Chillicothe Telephone's 1998 Senior Notes was approximately $200,000 in the
second quarter of both 2003 and 2002. Capitalized construction interest was
approximately $5,000 and $31,000, for the three months ended June 30, 2003 and
2002, respectively.
Interest income and other, net. The landline telephone service segment
recorded approximately $22,000 of other income in the three months ended June
30, 2003. In 2002, expense of approximately $57,000 was recorded related to
non-operating corporate activity.
Income tax expense. Income tax expense for the three months ended June 30,
2003, was approximately $800,000 compared to approximately $1,100,000 for the
same period in 2002, reflecting lower net income before tax in 2003.
31
Other comprehensive income (loss). Chillicothe Telephone recognized
approximately $310,000 of income in the second quarter of 2003, compared to a
loss of approximately $1,216,000 for the same period in 2002, related to its
investments available-for-sale, net of tax expense of approximately $160,000 and
net of tax benefit of approximately $626,000, respectively.
RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2003 COMPARED TO THE SIX
MONTHS ENDED JUNE 30, 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 six months ended June 30, 2003 and 2002:
For the Six Months Ended June 30,
-------------------------------------------------------------------------------------
Wireless Personal Corporate and
Communications Services Landline Telephone Other Services
--------------------------- -------------------------- ---------------------------
(Dollars in thousands) 2003 2002 2003 2002 2003 2002
------------ ------------ ------------ ------------ ------------ ------------
OPERATING REVENUES:
PCS subscriber and roaming..... $ 118,791 $ 95,858 $ -- $ -- $ -- $ --
PCS equipment.................. 3,889 3,973 -- -- -- --
Basic local and long-distance
and other landline........... -- -- 9,085 9,351 -- --
Network access................. -- -- 11,769 11,331 -- --
Equipment systems sales,
information services,
Internet access and other.... -- -- -- -- 4,508 4,167
------------ ------------ ------------ ------------ ------------ ------------
Total operating revenues.... 122,680 99,831 20,854 20,682 4,508 4,167
------------ ------------ ------------ ------------ ------------ ------------
OPERATING EXPENSES:
Cost of PCS and other
equipment sale.............. 10,829 8,661 -- -- 257 268
Cost of services.............. 90,638 77,185 4,872 4,679 3,438 2,966
Selling and marketing......... 24,792 25,588 363 261 482 570
General and administrative.... 17,608 16,372 3,882 3,371 6,851 6,957
Non-cash compensation......... 186 198 2 3 5 (11)
Loss on disposal of assets.... 216 641 -- -- -- --
Depreciation and amortization. 21,152 17,429 3,434 3,403 1,240 1,018
Impairment of Horizon PCS Assets 73,760 3,500 -- -- -- --
------------ ------------ ------------ ------------ ------------ ------------
Total operating expenses.... 239,181 149,574 12,553 11,717 12,273 11,768
------------ ------------ ------------ ------------ ------------ ------------
OPERATING INCOME (LOSS).......... (116,501) (49,743) 8,301 8,965 (7,765) (7,601)
------------ ------------ ------------ ------------ ------------ ------------
NONOPERATING INCOME (EXPENSE):
Interest expense, net......... (33,284) (28,194) (1,409) (934) -- (1)
Subsidiary preferred stock dividends (6,221) (5,713) -- -- -- --
Interest income and other, net 526 1,745 34 (70) 6 12
------------ ------------ ------------ ------------ ------------ ------------
Total nonoperating expense.... (38,979) (32,162) (1,375) (1,004) 6 11
------------ ------------ ------------ ------------ ------------ ------------
LOSS BEFORE INCOME TAX EXPENSE
AND MINORITY INTEREST......... (155,480) (81,905) 6,926 7,961 (7,759) (7,590)
INCOME TAX (EXPENSE) BENEFIT..... 6,031 -- (1,162) (1,547) 349 367
MINORITY INTEREST IN LOSS........ -- -- -- -- -- --
------------ ------------ ------------ ------------ ------------ ------------
NET INCOME (LOSS)................ $ (149,449) $ (81,905) $ 5,764 $ 6,414 $ (7,410)$ (7,223)
============ ============ ============ ============ ============ ============
OTHER COMPREHENSIVE INCOME (LOSS)
Net realized gain on hedging
activities....................... 462 120 -- -- -- --
Net unrealized gain (loss) on
securities available-for-sale,
net of taxes..................... -- -- 354 (1,894) -- --
------------ ------------ ------------ ------------ ------------ ------------
COMPREHENSIVE INCOME (LOSS)........ $ (148,987) $ (81,785) $ 6,118 $ 4,520 $ (7,410) $ (7,223)
============ ============ ============ ============ ============ ============
32
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 six months ended June 30, 2003 compared to six months ended
June 30, 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 United States
("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 for the quarter ended June 30, 2003 for a discussion
of its key metrics.
RESULTS OF OPERATIONS
Subscriber revenues. Subscriber revenues for the six months ended June 30,
2003, were approximately $91.4 million, compared to approximately $71.9 million
for the six months ended June 30, 2002, an increase of approximately $19.5
million. The growth in subscriber revenues is primarily the result of the growth
in our customer base. We provided PCS services to approximately 310,000
customers at June 30, 2003, compared to approximately 235,100 at June 30, 2002.
The growth in subscriber revenue was reduced by decreases in ARPU resulting from
lower minute sensitive revenue as subscribers are purchasing plans with more
minutes included. We expect this trend in ARPU to continue. We expect subscriber
revenue to fall below or remain at their current levels for the remainder of the
year.
Roaming revenues. Roaming revenues increased from approximately $23.9
million during the six months ended June 30, 2002, to approximately $27.4
million for the six months ended June 30, 2002, an increase of approximately
$3.5 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 with Sprint PCS. Excluding the
effects of a change in the reciprocal roaming rate, we expect roaming revenues
to remain at similar levels for the remainder of the 2003.
Equipment revenues. Equipment revenues for the six months ended June 30,
2003, were approximately $3.9 million, compared to approximately $4.0 million
for the six months ended June 30, 2002, representing a decrease of approximately
$100,000. 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
$67 for the six months ended June 30, 2003, from $107 for the same period in
2002, partially offset by an increase in the number of handsets sold. We expect
the reduction in the number of company-owned Sprint PCS retail outlets to have a
negative effect on equipment revenues.
Cost of PCS and other equipment sales. Cost of equipment for the six months
ended June 30, 2003, was approximately $10.8 million, compared to approximately
$8.7 million for the six months ended June 30, 2002, an increase of
approximately $2.1 million. The increase in the cost of equipment is the result
of the growth in our wireless customers. We sold approximately 58,400 handsets
through our direct sales channels during the six months ended June 30, 2003,
compared to approximately 37,100 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. Overall we expect cost of equipment to decline as an effect
of the reduction in company-owned Sprint PCS retail stores.
Cost of service. Cost of service for the six months ended June 30, 2003,
was approximately $90.6 million, compared to approximately $77.2 million for the
six months ended June 30, 2002, an increase of approximately $13.4 million. This
33
increase reflects an the increase in roaming expense and long distance charges
of approximately $1.4 million and the increase in costs incurred under our
network services agreement with the Alliances of approximately $6.0 million,
both as a result of our subscriber growth during the last half of 2002 and the
first half of 2003. Additionally, cost of service in 2003 was higher than 2002
due to the increase in network operations, including tower lease expense,
circuit costs and payroll expense, of approximately $2.1 million. Growth in our
customer base resulted in increased customer care, activations, and billing
expense of approximately $2.2 million and other variable expenses, including
increased switching and national platform expenses of approximately $1.7
million. The workforce reduction discussed above is expected to have a positive
impact on our cost of service.
Selling and marketing expenses. Selling and marketing expenses decreased to
approximately $24.8 million for the six months ended June 30, 2003, compared to
approximately $25.6 million for the six months ended June 30, 2002, a decrease
of approximately $800,000. This decease is attributable to a decline in
subsidies paid to third parties of approximately $800,000. We expect significant
reductions in selling and marketing expense due to the workforce reduction and
corporate strategy of limiting our subscriber additions.
General and administrative expenses. General and administrative expenses
for the six months ended June 30, 2003, were approximately $17.6 million
compared to approximately $16.4 million in for the six months ended June 30,
2002, an increase of approximately $1.2 million. The increase reflects an
increase in the Sprint PCS management fee of approximately $1.8 million, an
increase in fees paid for outside financial services including bank group
consultants, financial advisors, and legal advice of approximately $1.4 million,
and other general expenses of approximately $1.9 million. The increase was
offset by a decrease in the provision for doubtful accounts of approximately
$3.9 million as we continue to see positive effects from the increased credit
quality of our subscriber base. In addition, the decrease in the provision for
doubtful accounts was partially due to an approximately $900,000 non-recurring
credit received from Sprint related to deposits that should have offset amounts
previously written-off. Sprint corrected its error by rightfully remitting these
funds to Horizon PCS in the first quarter of 2003.
Non-cash compensation expense. Horizon PCS recorded approximately $200,000
for the six months ended June 30, 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 six months ended June
30, 2003, we incurred a loss of approximately $200,000 related to the disposal
of assets from two of our closed retail stores and a planned store that never
opened.
Depreciation and amortization expense Depreciation and amortization
expenses increased by approximately $3.8 million to a total of approximately
$21.2 million during the six months ended June 30, 2003. The increase reflects
the continuing construction of our network as we funded approximately $63.1
million of capital expenditures during 2002.
Impairment of Horizon PCS' intangible assets and property and equipment
Horizon PCS was not in compliance with the loan covenants as of June 30, 2003.
This created the need for an impairment assessment of Horizon PCS' intangible
assets and property and equipment as required by SFAS No. 144. As a result
Horizon PCS recorded impairment on the intangible assets of approximately $39.2
million and on the property and equipment of approximately $34.6 million. During
the second quarter of 2002, Horizon PCS had approximately $6.2 million of
switching equipment become impaired as defined by SFAS No. 144. Accordingly,
impairment expense for the three months ended June 30, 2002, includes $3.5
million of expense related to the impaired assets. We performed these valuations
utilizing the best information available at the time. These impairment charges
represent an estimate that may change in the future.
Interest expense, net. Interest expense for the six months ended June 30,
2003, was approximately $33.3 million, compared to approximately $28.2 million
for the same period in 2002.
34
At June 30, 2003, the interest rate on the $105.0 million term loan A
borrowed under our secured credit facility was 5.10%, while the interest rate on
the $50.0 term loan B was 5.60%. Interest expense on the secured credit facility
was $4.7 million and $3.9 million during the six months ended June 30, 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 $93.7 million at June 30, 2003. Interest expense on the discount
notes was approximately $15.0 million and $13.2 million during the six months
ended June 30, 2003 and 2002, respectively.
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 $12.0 million during the
six months ended June 30, 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 $1.5 million and $1.2 million
during the six months ended June 30, 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 $700,000 and $1.0 million during the six months ended
June 30, 2003 and 2002, respectively, in commitment fees we paid on the unused
portion of our secured credit facility.
Capitalized interest during the six months ended June 30, 2003 and 2002,
was approximately $600,000 and $3.1 million, respectively.
Income tax benefit. As a result of the impairment charge, Horizon PCS
recorded a tax benefit of approximately $6.0 million due to the reduction of a
deferred tax liability related to the intangibles. As of June 30, 2003, net
deferred income taxes on Horizon PCS were zero.
Preferred stock dividend. On May 1, 2001, our convertible preferred stock
began paying a stock dividend at the rate of 7.5% per annum, payable
semi-annually. 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
six months ended June 30, 2003, was approximately $500,000 compared to
approximately $1.7 million in 2002 and consisted primarily of interest income.
This decrease was due primarily to a lower average balance of cash investments
during the second quarter of 2003 as compared to the same period in 2002 and
lower short-term interest rates.
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 remain 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 $500,000 was
recorded for the six months ended June 30, 2003.
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 past two fiscal quarters.
RESULTS OF OPERATIONS
Revenues. Network access revenues increased by approximately $500,000 for
the six months ended June 30, 2003, to approximately $11.8 million. The Company
saw an increase in access revenues due to an increase in Universal Service Fund
("USF") revenues for the six months ended June 30, 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.
Basic local and long distance revenues were essentially flat decreasing to
approximately $9.1 million for the six months ended June 30, 2003.
35
Internet access and other revenues increased by approximately $300,000 to
$4.5 million for the six months ended June 30, 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
goods sold for corporate and other services was essentially flat for the six
months ended June 30, 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 six months ended June 30, 2003, was approximately
$4.9 million for the landline telephone segment, compared to approximately $4.7
million for the six months ended June 30, 2002, an increase of approximately
$200,000 due to increased personnel wages and other related expenses.
Cost of services for the six months ended June 30, 2003 for Corporate and
Other Services, was approximately $3.4 million compared to approximately $3.0
million for the same period in 2002, an increase of approximately $400,000. 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 $400,000 for the six months ended June
30, 2003, compared to approximately $300,000 for the six months ending June 30,
2002. The increase is related to additional payroll and related benefit
expenses.
Selling and marketing expenses for corporate and other services was
essentially flat for the six months ended June 30, 2003 compared to the same six
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
$500,000 to approximately $3.9 million for the six months ended June 30, 2003,
primarily due to an increase in the provision for uncollectibles.
General and administrative expenses for corporate and other services
decreased by approximately $100,000 to approximately $6.9 million for the six
months ended June 30, 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 six months ended June 30, 2003 compared to the same six months in 2002.
Depreciation and amortization expense. Depreciation and amortization
expenses for landline telephone and other services was essentially flat at
approximately $3.4 million for each of the six months ended June 30, 2003 and
2002. Depreciation and amortization expense for corporate and other services
increased by approximately $200,000 to $1.2 million for the six months ended
June 30, 2003. This increase was related to the additional VDSL assets that have
been added to our network.
36
Interest expense, net. Interest expense for the landline telephone and
other services for the six months ended June 30, 2003, was approximately $1.4
million, compared to approximately $900,000 for the six months ended June 30,
2002. The increase in interest expense was a result of our additional debt
outstanding during the six months ended June 30, 2003, compared to the same
period in 2002. We expect further increases in interest expense in 2003 due to
anticipated higher average debt levels.
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
$1.0 million for the six months ended June 30, 2003. Interest expense on the
retired line of credit and the retired 1993 Senior Notes was approximately
$600,000 for the six months ended June 30, 2002. Interest expense on Chillicothe
Telephone's 1998 Senior Notes was approximately $400,000 in the second quarter
of both 2003 and 2002. Capitalized construction interest was approximately
$15,000 and $59,000, for the six months ended June 30, 2003 and 2002,
respectively.
Interest income and other, net. The landline telephone service segment
recorded approximately $30,000 of other income in the six months ended June 30,
2003. In 2002, expense of approximately $70,000 was recorded related to
non-operating corporate activity.
Income tax expense. Income tax expense for the landline telephone service
segment was approximately $1.2 million for the six months ended June 30, 2003,
compared to approximately $1.5 million for the same period in 2002, reflecting
lower net income before tax in 2003. Corporate and Other Services was
essentially flat at an approximate benefit of $400,000 for the six months ended
June 30, 2002, as compared to a benefit of $300,000 for the six months ended
June 30, 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.
Other comprehensive income (loss). Chillicothe Telephone recognized
approximately $354,000 of income for the six months ended June 30, 2003,
compared to a loss of approximately $1,894,000 for the same period in 2002,
related to its investments available-for-sale, net of taxes of approximately
$182,000 and $975,000, respectively.
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 2003, Horizon PCS was not in compliance with its covenants
with regards to its outstanding senior secured debt. The failure to comply with
a covenant is an event of default under Horizon PCS' secured credit facility,
which gives the lenders the right to pursue remedies. These remedies could
include acceleration of amounts due under the facility. An acceleration of the
indebtedness under the facility would also represent a default under the
indentures for Horizon PCS' senior notes and discount notes (see Note 10) 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.
On August 15, 2003, the lenders elected to accelerate the amounts due under
the facility. This acceleration also represents a default under the indentures
for Horizon PCS' senior notes and discount notes (see "Note 10" in the "Notes to
Consolidated Financial Statements") and may give Sprint certain remedies under
Horizon PCS' Consent and Agreement with Sprint. Horizon PCS does not have
sufficient liquidity to repay all of the indebtedness under these obligations.
On August 15, 2003, Horizon PCS and its subsidiaries filed voluntary petitions
for reorganization under Chapter 11 of the Bankruptcy Code. See Note 13 to the
Financial Statements.
If Horizon PCS is not able to successfully emerge from bankruptcy, or if
the lenders take possession of Horizon PCS' existing cash balances, Horizon PCS
will not be able to fund Horizon PCS' current operations, capital expenditures
and debt service requirements as contemplated in Horizon PCS' business plan.
There can be no assurance that Horizon PCS' creditors will support Horizon PCS'
proposed reorganization, that any reorganization plan Horizon PCS submits will
be confirmed by the bankruptcy court, or that it will not be subsequently
modified. If Horizon PCS is not successful, the lenders under Horizon PCS'
senior credit facilities will be entitled to exercise their remedies under the
senior credit facility, which includes the right to foreclose upon their
collateral, which includes Horizon PCS' existing cash balances. As a result,
Horizon PCS may be forced to liquidate under applicable provisions of the
Bankruptcy Code. There can be no assurance of the level of recovery to which
Horizon PCS' secured and unsecured creditors would receive in such a
liquidation.
37
The realization of Horizon PCS' assets and repayment of its liabilities is
subject to significant uncertainty. There can be no assurance that Horizon PCS
will successfully recapitalize its balance sheet, and meet the other conditions
necessary to emerge from bankruptcy, or that its liquidity and capital resources
will be sufficient to maintain its normal operations. The ability of Horizon PCS
to continue as a going concern is dependent upon a number of factors including,
but not limited to, emergence from bankruptcy, customer and employee retention,
and Horizon PCS' ability to continue to provide quality services. The bankruptcy
negotiations could materially change the amounts and classifications reported in
the consolidated financial statements, which do not give effect to any
adjustments to the carrying value or classification of assets or liabilities
that might be necessary as a consequence of any change in business strategy or
business plans as a result of these negotiations.
Horizon PCS has taken, or it intends to take in the context of the
bankruptcy case, the following steps to minimize its use of cash and continue
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.
o Entering into negotiations or arbitration with the lenders under the
senior credit facility.
o Entering into negotiations with the Alliances to adjust the amounts
charged by the 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.
o Closing or reducing operations at approximately 32 stores.
o Laying off approximately 300 employees.
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
discussions with Sprint, Sprint has effectively refused to modify the fee
structure as needed under the first item listed above.
On July 17, 2003, Horizon PCS withheld payment on, and filed a dispute with
respect to, a substantial portion of the invoice from Sprint PCS for services
rendered in May 2003. On August 11, 2003, Horizon PCS withheld payment on, and
filed a dispute with respect to, a substantial portion of the invoice from
Sprint PCS for services rendered in June 2003.
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.
As discussed in our prior SEC filings, we have been in discussions with
Sprint to negotiate more favorable and economically viable support charges from
Sprint. Our original business model established our expenses from Sprint based
on the discussions and agreements centered around the original management
agreement. Throughout the last several years, Sprint has progressively increased
the amounts charged to us, both in the form of higher fees and additional
charges, such as the 3G costs, some of which, in our view, are not substantiated
and are not supported by the Sprint/Horizon PCS management agreement.
Regardless, these charges are significantly higher than our original business
model. In addition, Sprint has continually lowered the monthly recurring charge
offered to subscribers, while increasing the minute allotment. This has resulted
in lower revenue both from the recurring fee and from overtime usage. Lastly,
the NDASL program engineered by Sprint in 2001 and 2002 resulted in an economic
disaster for both Sprint and the affiliates. We, along with the other
affiliates, expended millions of dollars for those subscribers, only to see the
subscriber either not pay their bill or churn after a short period of time as a
customer, thus negatively impacting our cash flow. These additional charges and
reduced revenue per subscriber have impaired us to the point of our current
38
operating environment, including non-compliance with our EBITDA covenant in the
second quarter of 2003.
Horizon PCS approached Sprint with economic proposals, including fee
relief. Sprint declined our proposals. Two peer affiliates, IPCS and US Unwired,
are currently suing Sprint, citing several wrongful actions in the operations
and charges made by Sprint. Horizon PCS is monitoring these lawsuits carefully
as we consider its future actions.
In addition, Horizon PCS continues to review any and all alternatives
within its operating rights, raising prices, and lowering the cost of
acquisition of a subscriber, in order to remain financially viable. Horizon PCS
has withheld payments to Sprint with respect to invoices for alleged services
under the Sprint PCS agreements, as discussed in Note 11 in the "Notes to
Interim Consolidated Financial Statements."
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 June 30, 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
5.12% for all periods ($50.0 million at 5.60% and $105.0 million at
5.10%).
(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 its 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 $12.2 million and approximately $15.8 million, respectively. We
39
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 $7.8 million of cash flow from operations during 2003.
Statement of Cash Flows. At June 30, 2003, we had cash and cash equivalents
of approximately $58.7 million, including Horizon PCS' deposit requirements
discussed below, and a working capital deficit of approximately $473.6 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 $36.3 million is primarily attributable to the funding of our loss
from continuing operations of approximately $151.1 million (this loss also
includes certain non-cash charges) and funding our capital expenditures of
approximately $9.9 million during the first half of 2003.
Net cash used in operating activities for the six months ended June 30,
2003, was approximately $26.2 million. This reflects the continuing use of cash
for our operations to build our customer base, including but not limited to
providing service in our markets and the costs of acquiring new customers. As
discussed in Note 12 in the "Notes to Interim Consolidated Financial
Statements," Horizon PCS has taken significant steps to improve the net cash
from operations. The net loss of approximately $151.1 million was partially
offset by increases to depreciation, increases in accrued liabilities, offset by
increases to accounts receivable. Horizon PCS is 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 $9.9 million for
the first half 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 or less than
the first half of 2003 level as we focus more on the operation and maintenance
of our network and less on build out and expansion.
Net cash used in financing activities for the first half of 2003, was
approximately $192,000, reflecting Chillicothe Telephone's draw on its line of
credit for $750,000 somewhat offset by Horizon Telcom's payment of dividends of
approximately $942,000, during the first quarter of 2003.
Debt Covenants. As of June 30, 2003, Horizon PCS was not in compliance with
the minimum EBITDA covenant under its senior credit facility.
As of June 30, 2003, Chillicothe Telephone was in compliance with the
covenants set forth by its 1998 Senior Notes and its 2002 Senior Notes.
Credit Ratings. At June 30, 2003, the Horizon PCS 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 June 30, 2003, Moody's Investors Services ("Moody's") rated the notes
as "C," which is Moody's lowest bond rating. The CUSIP on the Horizon PCS
discount notes is 44043UAC4.
At June 30, 2003, the Horizon PCS 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 June 30, 2003, Moody's rated the
senior notes as "C", which is Moody's lowest bond rating. The CUSIP on the
Horizon PCS senior notes is 44043UAH3.
At June 30, 2003, the Chillicothe Telephone senior notes were rated by the
NAIC as "1". A "1" rating by the NAIC is the equivalent of an S&P rating of "A-"
or better.
Funding Requirements. At June 30, 2003, Horizon PCS had a $95.0 million
line of credit, with certain restrictions discussed above, committed under our
secured credit facility. However, this line of credit is not available due to
Horizon PCS' violation of debt covenants.
40
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 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,
unplanned charges from Sprint, regulatory changes, engineering design changes
and required technological upgrades and other technological risks.
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.
41
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 May 2003, the FASB issued SFAS No.150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within the scope
of SFAS No. 150 as a liability (or an asset in some circumstances). Many of
those instruments were previously classified as equity. The application of SFAS
No. 150 is not expected to have a material effect on the Company's consolidated
financial statements. This Statement is effective for financial instruments
entered into or modified after May 31, 2003, and otherwise is effective at the
beginning of the first interim period beginning after June 15, 2003.
In April 2003, the FASB issued SFAS No.149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amendments require
that contracts with comparable characteristics be accounted for similarly,
clarifies when a contract with an initial investment meets the characteristic of
a derivative and clarifies when a derivative requires special reporting in the
statement of cash flows. SFAS No. 149 is effective for hedging
relationships designated and for contracts entered into or modified after June
30, 2003, except for provisions that relate to SFAS No. 133 Statement
Implementation Issues that have been effective for fiscal quarters prior to June
15, 2003, which should be applied in accordance with their respective effective
dates, and certain provisions relating to forward purchases or sales of
when-issued securities or other securities that do not exist, which should be
applied to existing contracts as well as new contracts entered into after June
30, 2003. The application of SFAS No. 149 is not expected to have a material
effect on the Company's consolidated financial statements.
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 No. 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 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.
42
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:
(Dollars in millions) At June 30, 2003
----------------------------------------
Balance Market rate Swap rate
------------ ------------ ------------
Swap 2..................... $25.0 5.60% 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 June 30, 2003,
Horizon PCS recorded approximately $67,000 in other comprehensive gains related
to swap gains 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 June 30, 2003,
approximately 79% 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 as of June 30, 2003.
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.
The Company's management, including the CEO and CFO, does not expect that
its Disclosure Controls will prevent all error and all fraud. A control system,
no matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met. Further,
the design of a control system must reflect the fact that there are resource
constraints, and the benefits of controls must be considered relative to their
costs. Because of the inherent limitations in all control system, no evaluation
of controls can provide absolute assurance that all control issues and instances
of fraud, if any, within the Company have been detected. These inherent
limitations include the realities that judgments in decision-making can be
43
faulty, and that breakdown can occur because of simple error or mistake. The
design of any system of controls also is based in part upon certain assumptions
about the likelihood of future events, and there can be no assurance that any
design will succeed in achieving its stated goals under all potential future
conditions.
Based upon the Company's Disclosure Controls evaluation, the CEO and CFO
have concluded that, subject to the limitations noted above, the Company's
Disclosure Controls are effective to give reasonable assurance that the
information required to be disclosed by the Company in its periodic reports is
accumulated and communicated to management, including the CEO and CFO, as
appropriate to allow timely decisions regarding disclosure and is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission's rules and forms.
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 during the quarter ended June 30, 2003.
44
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On August 15, 2003, Horizon PCS and its subsidiaries filed voluntary
petitions for reorganization under Chapter 11 of the Bankruptcy Code. See Note
13 to the Financial Statements.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
As of June 30, 2003, Horizon PCS was not in compliance with its covenants
with regards to its outstanding debt. The failure to comply with a covenant is
an event of default under Horizon PCS' secured credit facility, which gives the
lenders the right to pursue remedies. On August 15, 2003, the lenders elected to
accelerate the amounts due under the facility. This acceleration also represents
a default under the indentures for Horizon PCS' senior notes and discount notes
(see "Note 10" in the "Notes to Consolidated Financial Statements") and may
give Sprint certain remedies under Horizon PCS' Consent and Agreement with
Sprint. Horizon PCS does not have sufficient liquidity to repay all of the
indebtedness under these obligations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 21, 2003, the Company held its Annual Meeting of Shareholders. The
following matter was voted upon:
1. The election of ten directors to serve until the next Annual Meeting
of Stockholders and until their successors are elected and have
qualified.
The following table provides the number of votes cast for and withheld as
to the election of directors.
Name of Nominee Votes For Votes Withheld
---------------------------------- -------------- ---------------
Robert McKell..................... 68,652 1,188
Thomas McKell..................... 68,660 1,180
Jack E. Thompson.................. 68,660 1,180
Joseph S. McKell.................. 68,652 1,188
David McKell...................... 68,652 1,188
Helen M. Sproat................... 68,660 1,180
John E. Herrnstein................ 68,655 1,185
Donald L. McNeal.................. 68,660 1,180
Jerry B. Whited................... 68,660 1,180
Joel Gerber....................... 68,660 1,180
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.
45
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.
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 the bankruptcy proceedings of Horizon PCS. While Horizon Telcom may retain
an equity interest in a restructuring of Horizon PCS, it is very likely that
Horizon Telcom will lose voting control of Horizon PCS and will lose
substantially 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
46
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.
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 six months ended June 30, 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
47
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 half of 2003, USSF
revenues accounted for approximately 4% 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
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
Horizon PCS has declared bankruptcy, which may cause the value of Horizon
Telcom's ownership interest in Horizon PCS to be worthless. There is a
substantial risk that Horizon Telcom will lose all of the value of its
investment in Horizon PCS in connection with the bankruptcy of Horizon PCS.
Because the amount of Horizon PCS' obligations under its credit facility and its
notes are greater than its existing cash and other assets when its payment
obligations were accelerated by the Horizon PCS lenders, there will likely be no
48
assets available for distribution to Horizon Telcom as Horizon PCS' sole
stockholder. While Horizon Telcom may request an equity participation in a
restructuring of Horizon PCS, it is likely that Horizon Telcom will lose all of
the value of its investment in Horizon PCS in connection with Horizon PCS'
bankruptcy.
HORIZON PCS IS NOT IN COMPLIANCE WITH ONE 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 June 30, 2003. Horizon
PCS' secured credit facility includes financial covenants that must be met each
quarter.
With respect to the second quarter of 2003, Horizon PCS became
non-compliant with its EBITDA covenant under its senior secured facility. As a
result, Horizon PCS does not have the right to borrow under its revolving line
of credit. In addition after the notice of non-compliance, the banks have
accelerated the indebtedness under the senior secured facility and to pursue
remedies. Such acceleration has caused an event of default under the indentures
for its senior discount notes and its senior notes.
49
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.
31.1 Certification of Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
32.2 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.
50
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: August 15, 2003 By: /s/ Thomas McKell
--------------- --------------------------------------
Thomas McKell
Chief Executive Officer
Date: August 15, 2003 By: /s/ Peter M. Holland
--------------- --------------------------------------
Peter M. Holland
Chief Financial Officer
(Principal Financial and
Chief Accounting Officer)
51
1637879