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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of earliest event reported) February 18, 1999
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United States Satellite Broadcasting Company, Inc.
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(Exact Name of Registrant as Specified in Charter)
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Minnesota 0-27492 41-1407853
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(State or Other Jurisdiction of (Commission File Number) (IRS Employer
Incorporation) Identification No.)
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3415 University Avenue, Saint Paul, Minnesota 55114
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (651) 645-4500
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(Former Name or Former Address, if Changed Since Last Report)
This Current Report on Form 8-K includes the following information as of or
for the Year Ended December 31, 1998:
Item 5:
Management's Discussion and Analysis of Financial Condition and Results
of Operations
Legal Proceedings
Exhibit 99.1 Selected Financial Data
Exhibit 99.2 Consolidated Financial Statements and Report of
Independent Public Accountants
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INFORMATION TO BE INCLUDED IN THE REPORT
ITEM 5. OTHER EVENTS.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The Company believes that forward-looking statements contained in this
Report on Form 8-K (statements which are phrased in terms of anticipation,
expectation, belief or the like or which refer to future events, developments
or conditions) are "forward-looking statements" within the meaning of and
are made pursuant to the safe harbor provisions contained in the Private
Securities Litigation Reform Act of 1995. Investors are cautioned that all
forward-looking statements involve risks and uncertainty. There are certain
important factors that could cause results to differ materially from those
anticipated by the statements made in this Report. Several of these factors
are discussed under the headings "Overview" and "Risk Factors" below.
AGREEMENT AND PLAN OF MERGER
The Company has entered into an Agreement and Plan of Merger dated as of
December 11, 1998 (the "Merger Agreement") with General Motors Corporation, a
Delaware corporation ("GM"), and its subsidiary, Hughes Electronics Corporation,
a Delaware corporation ("Hughes"), pursuant to which, if certain conditions are
satisfied, the Company will be merged with and into Hughes (the "Merger"). The
Merger, which is subject to regulatory and shareholder approval, and to the
satisfaction of other conditions contained in the Merger Agreement, is expected
to take place in the first half of 1999. If the Merger is completed, each share
of USSB stock will be converted, subject to certain limitations, into either (i)
a fraction of a share of Class H Common Stock of GM equal to the exchange ratio
provided in the Merger Agreement or (ii) cash equal to that exchange ratio
multiplied by the 20-day volume-weighted average price of the GM Class H Common
Stock (the "Merger Consideration"). The Merger Consideration is dependent upon
the GM Class H common stock price and will not exceed $18.00 per share.
OVERVIEW
The Company provides subscription television programming via a high-power
direct broadcast satellite ("DBS") to households throughout the continental
United States. The Company broadcasts a high quality digital television signal
using a digital satellite system ("DIRECTV/USSB system"). The Company's
programming is available to customers who have a DIRECTV/USSB system, which
consists of an 18-inch satellite dish, a receiver/decoder and a remote control.
At December 31, 1998, approximately 4.32 million households were authorized to
receive programming services using the DIRECTV/USSB system, up from 3.24 million
at December 31, 1997. All of the Company's gross revenues and identifiable
assets relate to the Company's activities in this industry.
The Company commenced commercial operations in June 1994 and has not
generated net earnings to date. Excluding special merger-related charges, the
Company achieved positive adjusted cash flow of $1.7 million (defined as
earnings before interest, taxes, depreciation and amortization and the non-cash
component of the Manufacturer Incentive program) in 1998. Management expects
that losses will continue into 1999.
To simplify the DIRECTV/USSB system offering at retail, the Company and
DIRECTV integrated the basic channels carried by USSB into DIRECTV's programming
line-up and the Company added two new commercial-free premium movie channels
during the first quarter of 1998.
SUMMARY OF SUBSCRIBER AND REVENUE DATA
Management measures the Company's performance by two key measures:
subscriber base and revenues.
The number of USSB paying subscribers grew to approximately 2,028,000 at
December 31, 1998 from approximately 1,740,000 at December 31, 1997.
Approximately 202,000 additional households were receiving a free promotional
month of USSB programming as of December 31, 1998.
In addition to tracking the absolute number of subscribers, management
assesses the Company's penetration of its potential DIRECTV/USSB System
market by comparing the number of USSB paying subscribers to the total number
of households that have received the free promotional month of USSB
programming ("convertible households"). Since the first month is free, the
consumer's decision to purchase USSB programming is generally made by the
consumer only after the free promotional month has been received. As a
result, the category of
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DIRECTV/USSB system households includes households receiving the free
promotional month that have not yet made their subscription decision.
The following summary table shows, as of the end of each period, USSB
paying subscribers, USSB promotional activations, USSB convertible households
and the percentage of convertible households served by the Company. The
estimated number of DIRECTV/USSB households is also shown.
SUBSCRIBER BASE:
(In thousands)
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Total USSB
Paying Percent of
Subscribers USSB
For the USSB USSB and USSB Convertible
Quarter Paying Promotional Promotional Convertible Households Estimated
Ended Subscribers (a) Activations (b) Activations Households (c) Served (d) Households (e)
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Dec. 31,
1997 1,740 215 1,955 2,757 63% 3,238
March 31,
1998 1,799 106 1,905 3,128 58% 3,467
June 30,
1998 1,842 111 1,953 3,312 56% 3,667
Sept. 30,
1998 1,929 150 2,079 3,522 55% 3,945
Dec. 31,
1998 2,028 202 2,230 3,778 54% 4,324
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(a) USSB paying subscribers as of the end of such period.
(b) USSB household activations that were receiving a free promotional month of
USSB programming as of the end of such period. These activations are not
counted as USSB Convertible Households until they have completed the free
promotional month.
(c) Total number of USSB household activations since July 1994 that have
completed a free promotional month of USSB programming. The amounts shown
reflect the elimination of certain DIRECTV/USSB system deactivations. See
note (e).
(d) Total USSB Paying Subscribers as of the end of the period as a percent of
USSB Convertible Households.
(e) Total estimated number of households with active DIRECTV/USSB system units
which are authorized to receive either USSB or DIRECTV programming as of
the end of the period. Estimate based on cumulative DIRECTV/USSB system
activations, less: (i) cumulative DIRECTV/USSB deactivations, (ii)
activations by dealers, manufacturing facilities, technical facilities and
commercial locations known to the Company, and (iii) additional receivers
in a single household, as of the end of such period. The Company makes
periodic reconciliations to estimate the number of DIRECTV/USSB system
households as accurately as possible.
As of December 31, 1998, the Company achieved a penetration of convertible
households of approximately 54%. Management believes that the reduction in the
penetration percentage compared to previous quarters was affected by the closure
of the Company's primary vendor of outbound telemarketing services without
notice to the Company in November 1998, and by the announcement of the Merger,
which created some consumer and retail confusion about the on-going need to
subscribe to USSB services, as well as the remaining impact of the March 1998
change to an all-premium movie channel line-up.
The Company's per subscriber and total revenues are shown below for the
periods indicated. From time to time, the Company engages in certain
promotional activities that include special rates for limited periods, which
typically result in lower average per subscriber revenues for such promotional
periods.
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REVENUES:
(In thousands, except per subscriber data)
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For the Quarter Ended
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Dec. 31 Sept. 30 June 30 March 31 Dec. 31
1998 1998 1998 1998 1997
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Average monthly subscription revenue
per paying subscriber (a) $23.58 $23.53 $23.60 $24.22 $24.66
Total revenues (b) $144,685 $136,567 $132,710 $136,839 $128,769
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(a) Excludes pay-per-view event, commercial and TV GUIDE-TM- revenues.
(b) Includes pay-per-view event, commercial and TV GUIDE revenues.
The Company's annual churn rate for the year ended December 31, 1998 was
38.2%, compared to 24.7% for the year ended December 31, 1997. Churn rate
represents the number of the Company's paying customers who terminated their
subscriptions or whose subscriptions were terminated by the Company during such
twelve month period, and who did not resubscribe during that period, expressed
as a percentage of the total number of paying subscribers at the end of such
period. Management believes that churn on an annual basis was significantly
affected by the March 1998 programming changes. However, by the fourth quarter,
churn had returned to levels experienced prior to the programming changes.
Certain of the Company's promotional efforts may attract a higher percentage of
short-term subscribers, thus increasing the Company's churn rate from time to
time.
RESULTS OF OPERATIONS
COMPARISON OF THE YEAR ENDED DECEMBER 31, 1998 TO 1997.
REVENUE OVERVIEW. The Company's total revenues increased to $550.8
million for 1998 compared to $456.6 million for 1997. The revenue increase
was primarily attributable to a larger subscriber base, offset by generally
reduced subscription prices which were implemented March 10, 1998.
REVENUES. The Company derives its revenues principally from monthly fees
from subscribers for television programming. Revenues are primarily a
function of the number of subscribers, the mix of programming packages
selected by customers and the rates charged. The increase in revenues for
the year ended December 31, 1998 compared to 1997 was primarily attributable
to the increase in the number of paying subscribers to approximately
2,028,000 at December 31, 1998, up from approximately 1,740,000 at December
31, 1997, offset by a reduction in the average revenue per subscriber. The
larger subscriber base increased revenues by approximately $116.8 million,
and the reduction in the average revenue per subscriber decreased revenues by
approximately $23.3 million.
Pay-per-view revenues are included in the Company's total revenue. The
revenues from such events are highly dependent on the type and number of
pay-per-view events offered, which are expected to vary.
COST OF SALES. Cost of sales consists of payments to programmers and the
purchase of rights to broadcast event programming on a pay-per-view basis.
The cost of programming increased to $327.7 million for the year ended
December 31, 1998, compared to $292.9 million for the comparable period in
1997. The increase in the cost of programming was primarily the result of an
increased number of subscribers from 1997. The Company's gross margin
percentage increased to 40.5% for the year ended December 31, 1998 compared
to 35.9% for the comparable period in 1997. The increase reflects the higher
margins associated with the Company's all-premium movie channel line-up, as
well as the achievement of certain volume-based discounts in programming
costs. Generally, the gross margin percentage will vary based on the mix of
programming packages taken by subscribers, the pay-per-view events, and the
extent to which volume-based discounts from the Company's programming
providers are realized.
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OPERATING EXPENSE OVERVIEW. Total operating expenses increased to $283.8
million for the year ended December 31, 1998, compared to $255.8 million for
the comparable period in 1997. Excluding the special charges for early
cancellation of contracts required by the Merger Agreement totaling $22.1
million, the total expenses increased $5.9 million, or 2.3%, from 1997. This
increase was primarily attributable to the cost of providing the Company's
services to a growing subscriber base, offset by reductions in the
Manufacturer Incentive program expense.
SELLING AND MARKETING. Selling and marketing costs include promotional and
advertising costs, the costs of direct marketing and customer service and
amounts expended pursuant to joint marketing efforts with other DIRECTV/USSB
system participants. Selling and marketing expenses increased to $115.0 million
for the year ended December 31, 1998 compared to $99.4 million for the
comparable period in 1997. This increase was primarily attributable to
increased customer service and on-going marketing expenditures associated with
the growth of the Company's subscriber base which, together, totaled
approximately $22.2 million, offset by a reduction in advertising expenditures
of approximately $8.8 million. Expenses associated with the Company's
telemarketing and direct mail marketing programs, which are directed at
purchasers of DIRECTV/USSB Systems who activate with the Company, have increased
as the number of such system activations has increased and as a result of
increased costs under the Company's arrangements with its third-party customer
service provider.
MANUFACTURER INCENTIVE PROGRAM. Manufacturer Incentive program expense
relates to financial incentive arrangements with certain manufacturers of
DIRECTV/USSB System equipment. These arrangements have had the effect of
contributing to certain DIRECTV/USSB System manufacturers lowering the price
of systems. Such arrangements commit the Company to pay the manufacturers
over a five-year period from the date new DIRECTV/USSB system households are
authorized to receive programming. The entire expense and liability for such
future commitments are established and recorded upon activation of the
related DIRECTV/USSB system. Manufacturer Incentive program expenses totaled
$44.8 million for the year ended December 31, 1998, compared to $66.7 million
for the comparable period in 1997. The decrease in the Manufacturer
Incentive program expense resulted primarily from lower rates with one
manufacturer and a temporary reduction of costs with another manufacturer in
accordance with the arrangement with such manufacturer. The Company expects
the total expenses under the Manufacturer Incentive program to continue to be
a significant component of the Company's operating expenses and cash flows.
GENERAL AND ADMINISTRATIVE. General and administrative costs include
in-orbit and general insurance costs, billing and remittance processing, staff
functions such as finance and information services, and various administrative
services provided by HBI. General and administrative expenses increased to $57.6
million for the year ended December 31, 1998, compared to $46.9 million for the
comparable period in 1997. The increase was primarily attributable to increased
billing and remittance processing costs of approximately $5.0 million resulting
from the growth of the Company's subscriber base, and increased costs for
certain other services under the Company's arrangements with its third-party
subscriber management services provider of approximately $2.7 million.
COMMISSIONS TO RETAILERS. Commissions to retailers consist of amounts
paid by the Company to eligible DIRECTV/USSB system retailers whose customers
become paying subscribers, and are intended to encourage retailers to promote
the sale of DIRECTV/USSB systems and subscriptions to USSB programming. These
expenses generally run for three years at decreasing rates for each
subscriber year. Commissions to retailers were $13.2 million for the year
ended December 31, 1998, compared to $14.5 million in the comparable period
in 1997. The decrease in commission expense was primarily due to higher
customer churn in 1998.
ENGINEERING AND OPERATIONS. Engineering and operations expenses include
the operation of the National Broadcast Center and the Auxiliary Broadcast
Center, fees charged in connection with the operation of the conditional
access system (which fees increase as subscriber levels increase) and
satellite telemetry, tracking and control expenses. Engineering and
operations expenses were $13.8 million for the year ended December 31, 1998,
compared to $9.8 million for the comparable period ended 1997, which included
a positive adjustment of $2.6 million to the previously recorded expense of a
security card changeout program. In 1999, the Company may incur additional
expenses in connection with its periodic upgrade to the security feature of
the conditional access system.
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DEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses
relate mainly to the Company's five-sixteenths ownership of DBS-1 and
transmission equipment located both at the Company's National Broadcast Center
and its Auxiliary Broadcast Center. Depreciation and amortization was $17.3
million for the year ended December 31, 1998, compared to $18.4 million for the
comparable period in 1997.
EARLY CANCELLATION OF CONTRACTS. As required by the Merger Agreement,
the Company has canceled contracts with Lockheed Martin and Convergys
Information Management Group Inc. In connection with the cancellation of
these contracts, the Company has recorded a special one-time charge in the
fourth quarter of 1998 of $20.7 million. This charge represents the total
amount of the charge associated with such contract cancellations. The fourth
quarter charge includes non-cash write-offs of satellite deposits of $7.6
million and development costs for subscriber management and billing systems
of $1.3 million. The remainder of the fourth quarter charge consists of net
contract termination fees, which were paid in January 1999. The charge of
$22.1 million included in the statement of operations for the year ended
December 31, 1998 also includes a write-off of satellite deposits of $1.43
million recorded in June 1998.
NET LOSS. The Company recorded a net loss for the year ended December
31, 1998 of $56.6 million or $.63 per share, compared to a net loss of $87.3
million or $.97 per share, for 1997.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 1997 AND 1996.
REVENUE OVERVIEW. The Company's total revenues increased to $456.6
million for 1997, compared to $292.6 million for 1996. The revenue increase
from year to year was primarily attributable to a larger subscriber base.
REVENUES. The increase in revenues for the year ended December 31, 1997
compared to 1996 was primarily attributable to the increase in the number of
paying subscribers to approximately 1,740,000 at December 31, 1997, up from
approximately 1,220,000 at December 31, 1996, offset by a reduction in average
revenue per subscriber. The increase in the subscriber base increased revenue
by approximately $163.0 million, and the reduction in average revenue per
subscriber decreased revenue by approximately $6.0 million.
COST OF SALES. The cost of programming increased to $292.9 million for
the year ended December 31, 1997, compared to $193.4 million for 1996. The
increase in cost of programming for these periods was primarily the result of
an increased number of subscribers. The Company's gross margin percentage
increased to 35.9% for the year ended December 31, 1997 compared to 33.9% for
the comparable period in 1996. Programming costs as a percent of programming
revenues will vary based on the mix of programming packages taken by
subscribers, the number and type of pay-per-view events, and the extent to
which volume-based discounts from the Company's programming providers are
realized.
OPERATING EXPENSE OVERVIEW. Total operating expenses increased to $255.8
million for 1997, compared to $198.3 million for 1996. The increase was
primarily attributable to the cost of providing the Company's services to a
growing subscriber base, including increased marketing, customer service,
security and encryption fees. The Manufacturer Incentive program also
contributed to the increase.
SELLING AND MARKETING. Selling and marketing expenses were $99.4
million for the year ended December 31, 1997, compared to $102.7 million for
1996. The decrease was primarily attributable to reduced advertising and
marketing expenditures of approximately $14.2 million, offset partially by
increased customer service expenditures of approximately $9.0 million
associated with the growth of the Company's subscriber base.
MANUFACTURER INCENTIVE PROGRAM. Manufacturer Incentive program expenses
totaled $66.7 million for the year ended December 31, 1997, compared to $18.4
million for 1996. The Company began incurring expenses under the Manufacturer
Incentive program in August 1996.
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GENERAL AND ADMINISTRATIVE. General and administrative expenses increased
to $46.9 million for 1997, compared to $32.0 million for 1996. The increase was
primarily attributable to increased billing and remittance processing costs of
approximately $4.0 million and increased bad debt expense of approximately $6.1
million, both resulting from the approximately 60% growth of the Company's
subscriber base.
COMMISSIONS TO RETAILERS. Commissions to retailers increased to $14.5
million for 1997, compared to $13.9 million for 1996. The increase reflected
greater numbers of USSB subscribers, offset by the effect of lower
per-subscriber commission rates over the lifetime of a subscriber.
ENGINEERING AND OPERATIONS. Engineering and operations expenses were $9.8
million for 1997, compared to $11.6 million for 1996. Such expenses were higher
during 1996 because the Company incurred significant costs in connection with an
upgrade to the conditional access system of approximately $4.2 million.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization was $18.4
million for 1997, compared to $19.7 million for 1996.
NET OPERATING LOSS. The Company recorded a net operating loss for 1997
of $92.1 million, compared to a net operating loss of $99.1 million for 1996.
INTEREST EXPENSE. The Company incurred no interest expense for 1997,
compared to $2.3 million for 1996. The change in interest expense reflects
changes in the amount and duration of the Company's borrowings during these
periods.
INTEREST INCOME. Interest income for 1997 was $4.9 million, compared to
$6.2 million for 1996. Interest income in 1996 included the investment of
the proceeds of the public offering of the Company's Class A Common Stock,
which closed on February 6, 1996.
NET LOSS. The Company recorded a net loss for 1997 of $87.3 million, or $.97
per share compared to $105.0 million, or $1.17 per share for 1996.
FINANCIAL POSITION, LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY AND CAPITAL RESOURCES. Cash and cash equivalents decreased to
$66.3 million at December 31, 1998 from $68.6 million and $86.5 million at
December 31, 1997 and 1996, respectively. The decrease in cash at December 31,
1998 from prior years primarily reflects the net operating results of the
Company.
The Company's cash flow from operations is primarily impacted by the net
loss, depreciation and amortization, and the non-cash component of the
Manufacturer Incentive program. In addition, cash and cash equivalents may
fluctuate based upon subscriber growth and the timing of annual subscription
renewals. Management believes that the Company's current cash position and cash
generated from operations is adequate to meet anticipated operating expenses.
As a result of the pending merger with Hughes, the Company has terminated
its contracts requiring material capital expenditures, and had no material
commitments for capital expenditures as of December 31, 1998. The Company does
not expect to incur significant future capital expenditures. In connection with
the Merger Agreement, the Company and Hughes have entered into a Replacement
Payload Option Agreement which clarifies USSB's right to transponder capacity on
a replacement satellite if the Merger Agreement is terminated due to the failure
of the transponders on DBS-1. The Replacement Payload Option Agreement provides
that USSB may elect to purchase five transponders at a fixed price of $90.0
million on DIRECTV 1-R, a satellite under construction by Hughes. In the event
the merger is not consummated because of the failure of DBS-1, the Company would
require external financing for such satellite capacity. The Company believes
that such financing would be available.
WORKING CAPITAL. Working capital at December 31, 1998 was a negative
$34.5 million compared to a negative $8.3 million at December 31, 1997. This
change resulted primarily from the Company's net loss in 1998, the increase
in the current portion of the Manufacturer Incentive program obligation, and
the payable resulting from the early cancellation of contracts required by
the Merger Agreement. Management expects that working capital will remain
negative through 1999 as the current portion of the Manufacturer Incentive
program obligation increases. The Company's working capital at December 31,
1996 was $31.1 million, which reflected the proceeds of the public offering
of the Company's Class A Common Stock in February 1996.
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LITIGATION. Personalized Media Communications, L.L.C. ("PMC") has commenced
two legal proceedings against Hughes Network Systems, Thomson Consumer
Electronics and other DIRECTV/USSB System manufacturers, DIRECTV, Inc., and the
Company.
IPPV Enterprises, a Georgia partnership, has commenced a legal proceeding
against Thomson Consumer Electronics, Hughes Network Systems, other DIRECTV/USSB
System manufacturers, DIRECTV, Inc., and the Company.
WIC Premium Television, Ltd., an Edmonton, Alberta, Canada corporation,
("WIC") initiated two separate legal proceedings in the Federal Court of Canada
Trial Division and in the Judicial District of Edmonton against numerous
retailers, programming providers, and programming distributors, including the
Company.
The ultimate outcome of these matters and the resulting effect on the
liquidity and financial position of the Company cannot be determined with
certainty. The "Legal Proceedings" section of this Item 5 contains additional
information on these matters.
CAPITAL EXPENDITURES. Capital expenditures for the year ended December 31,
1998 totaled $12.7 million, consisting primarily of satellite deposits and
purchased computer hardware and software.
NET OPERATING LOSS CARRYFORWARD. At December 31, 1998, the Company's net
operating loss carryforward was $344.3 million for federal tax purposes. Such
carryforwards expire in the years 2000 through 2014.
YEAR 2000
The Company has analyzed Year 2000 compliance issues related to its
computer systems and technologies associated with delivering programming.
Based on its current assessment, management believes that Year 2000
compliance will not pose significant operational issues. The Company is
executing an implementation plan whereby all systems critical to managing the
business will be made Year 2000 compliant. The implementation plan includes
assessing and evaluating compliance and criticality of the various computer
systems, executing resolution strategies, and testing and certification of
the resolution efforts. Most of the Company's internal computer systems and
applications and programming technologies were developed during the past
several years and are substantially Year 2000 compliant. In addition, the
Company is working with its other key vendors and suppliers, including its
programming providers and current customer service and billing vendor, to
assure that the vendors' systems will be Year 2000 compliant. The Company
has been informed in writing by its current customer service and billing
vendor that such vendor expects to be substantially Year 2000 compliant by
July 1999, and the Company believes that all its key vendors will be Year
2000 Compliant, and expects to receive written assurance from such vendors.
If the pending Merger closes, Hughes, as the surviving corporation, will
acquire all of the assets and vendor contracts of the Company.
If the Merger does not close, the Company and DIRECTV have agreed that
DIRECTV will provide USSB with billing and subscriber management services
commencing July 1, 1999. The Company has been informed in writing by DIRECTV
that DIRECTV expects its billing and customer management system to be
substantially Year 2000 compliant by June 1999.
In the event the Merger is not completed, and DIRECTV is not Year 2000
compliant, the Company would continue to use its current customer service and
billing vendor to provide customer service and billing services at an
increased cost. The Company believes the worst case scenario would occur if
both its current billing and customer service provider and DIRECTV failed to
become Year 2000 compliant. Under these circumstances, the Company's
operations and its ability to provide customer service and billing would be
materially adversely affected.
The Company has begun to incur expenses related to the analysis and
implementation of Year 2000 resolution. The cost of all Year 2000 renovation
has been expensed in accordance with the Company's financial policies. The
Company's current and expected costs relating to Year 2000 issues are not
material to its results of operations.
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SEASONALITY
Sales of DIRECTV/USSB System units are subject to seasonal sales patterns
experienced by the consumer electronics industry. As the Company's subscriber
base has increased, it does not appear that seasonality has had a material
effect on the Company's revenues to date, although seasonality may affect the
rate of subscriber growth and levels of prepaid subscriptions in any given
quarter.
RISK FACTORS
The Company is preparing to close the Merger at the earliest practicable time
and has commenced steps to integrate its business into DIRECTV's. So long as
the Company continues to operate on a stand-alone basis, or if the Merger is
not completed, there are certain important factors that could cause actual
results to differ materially from those anticipated by the statements made in
this Report on Form 8-K. Such factors include the uncertain level of
ultimate demand for the DIRECTV/USSB System and USSB's programming, the
effects of changes in USSB's and DIRECTV's programming offerings, USSB's
continuing ability to offer competitive programming, and the competitive
disadvantage of not closing the announced Merger.
In addition, competitive issues, including changes by other DBS competitors
to their product offerings and pricing strategies, and the effect of digital
cable programming and digital broadcast television service, which may be used
for multichannel programming or high definition television (HDTV) and the entry
of new competitors into video programming, such as electric utilities and
regional operating telephone companies, could adversely affect the Company. The
Company anticipates that other DBS satellites will be launched at the 110 DEG.
west longitude and other orbital locations, thereby increasing the competition
in the satellite broadcasting market.
All of the Company's programming is carried on a single satellite, DBS-1,
which the Company co-owns with DIRECTV. In connection with the execution of the
Merger Agreement, DIRECTV and the Company entered into a Channel Services
Provision Agreement which provides that, subject to the terms of that Agreement,
DIRECTV will provide to USSB, on a full time basis, channel capacity and related
services on two other satellites owned by Hughes at the 101 DEG. orbital
location sufficient to transmit and deliver a limited number of premium movie
services to USSB subscribers. Not all of the channels currently carried by the
Company could be carried under this arrangement.
The Company is also subject to the effects of, and costs associated
with, litigation involving the technology and the intellectual property
associated with the DIRECTV/USSB System. DIRECTV has initiated the use of
the mark "DIRECTV System" to identify the DIRECTV/USSB system in lieu of the
formerly-used "DSS" mark. If the Merger is not completed, such use could
adversely affect the Company.
The Company is also dependent on third-party programmers, and on
vendors, including those providing customer service and billing services. If
the Merger is not completed, DIRECTV has agreed in the Merger Agreement to
provide billing and customer management systems to the Company commencing on
the later of July 1, 1999 or upon termination of the Merger Agreement. The
Company has terminated its contract for subscriber management services with
Convergys Information Management Group Inc. as required by the Merger
Agreement, and the Company will be dependent upon DIRECTV to provide such
services if the Merger is not completed. The Company is also dependent upon
the continued effectiveness of the security and signal encryption features of
the DIRECTV/USSB System.
Such factors as increases in costs, including programming costs, in excess
of those anticipated by the Company; sufficient availability of DIRECTV/USSB
systems at retail; potential adverse governmental regulations and actions; and
overall economic conditions may also adversely affect the Company. The
Telecommunications Act of 1996 significantly deregulated the telecommunications
industry. The effect of such deregulation on the Company's business, results of
operations and financial condition cannot be predicted. See Part I, Item I,
"Business - Competition" of the Company's Report on Form 10-K for the Transition
Period ended December 31, 1997 for a further discussion of certain of these
risks.
<PAGE>
LEGAL PROCEEDINGS
The Company is exposed to litigation encountered in the normal course of
business. In the opinion of management, the resolution of such litigation
matters of which the Company is aware will not have a material adverse effect on
the Company's financial position, results of operations or cash flows. In
addition, the Company is a party to the following actions:
IN THE MATTER OF CERTAIN DIGITAL SATELLITE SYSTEM (DSS) RECEIVERS AND
COMPONENTS THEREOF, United States International Trade Commission,
Investigation No. 337-TA-392; and PERSONALIZED MEDIA COMMUNICATIONS,
L.L.C. V. THOMSON CONSUMER ELECTRONICS, ET AL., United States District
Court, Northern District of California, Case No. C-96 20957.
In November 1996, Personalized Media Communications, L.L.C. ("PMC")
initiated a legal proceeding before the United States International Trade
Commission ("ITC") and a separate proceeding in the United States District Court
for the Northern District of California against DIRECTV/USSB system
developers, manufacturers and programmers, including, among others, Hughes
Network Systems, Thomson Consumer Electronics and other DIRECTV/USSB system
manufacturers, DIRECTV, Inc., and the Company.
In the ITC action, PMC alleges that Hughes Network Systems, Thomson
Consumer Electronics and other DIRECTV/USSB system manufacturers have infringed,
and that DIRECTV, Inc. and the Company have contributed to and/or induced the
infringement of, a patent owned by PMC and requests the ITC to (i) bar the
importing, marketing, promoting, distributing, or sale of imported infringing
DIRECTV/USSB system receivers in the United States which are covered by PMC's
patent and (ii) prohibit DIRECTV, Inc. and the Company from broadcasting
television programming to any imported infringing DIRECTV/USSB system receiver.
A trial of the ITC proceeding before an administrative law judge was conducted
in July 1997, and an initial determination by the administrative law judge was
rendered in October 1997 ruling against PMC's claims on all material issues.
On December 4, 1997, the ITC determined not to review the Administrative
Law Judge's determination. On January 8, 1998, PMC filed a Petition to Review
this decision of the ITC in the Court of Appeals for the Federal Circuit. The
Court of Appeals for the Federal Circuit issued an opinion on November 24, 1998
(i) reversing the finding of the ITC that the claims in suit were invalid for
indefiniteness, (ii) vacating the finding of the ITC that claim 7 was infringed
and remanding that issue to the ITC for further consideration, (iii) affirming
the ruling of the ITC that claim 6 was not infringed, and (iv) declining to
review the holding of the ITC that claim 44 was likewise not infringed. The
Company, DIRECTV and the manufacturers filed a Petition for Rehearing and
Suggestion for Rehearing IN BANC on January 8, 1999.
In the second action, PMC filed a complaint in the United States District
Court for the Northern District of California alleging, among other things, that
USSB and DIRECTV directly infringe at least one claim of each of three patents.
PMC also alleges that USSB and DIRECTV have contributed to and induced the
infringement of two of said patents by the other respondents. PMC has alleged
that the Company's infringement of the said patents is willful. PMC has
requested an award of damages, that such damages be trebled, that the Company
and the other respondents be enjoined from further infringement of said patents,
and award of its attorneys' fees.
The Company denies that it has engaged in any acts of infringement, either
directly or indirectly as alleged in PMC's complaint. Pursuant to a stipulated
motion to stay the district court action pending the resolution of the ITC
investigation , the district court entered an order to that effect.
IPPV ENTERPRISES V. THOMSON CONSUMER ELECTRONICS, INC., HUGHES NETWORK
SYSTEMS, SONY CORPORATION OF AMERICA, HITACHI HOME ELECTRONICS
(AMERICA), INC., UNIDEN AMERICA CORPORATION, DIRECTV, INC., AND UNITED
STATES SATELLITE BROADCASTING COMPANY, INC., United States District
Court, District of Delaware, Case No. 97-288.
In June 1997, IPPV Enterprises, a Georgia partnership ("IPPV"), initiated a
legal proceeding in the United States District Court for the District of
Delaware against digital satellite system developers, manufacturers, including,
among others, Hughes Network Systems, Thomson Consumer Electronics and other
DIRECTV/USSB system manufacturers, DIRECTV, Inc., and the Company.
IPPV alleges that the defendants, including DIRECTV, Inc. and the Company,
have infringed five IPPV patents relating to parental control, pay-per-view and
other features used in the DIRECTV/USSB system. IPPV has requested the court to
award IPPV damages, and to treble such damages. Four of the five IPPV patents in
the suit have expired and the fifth will expire in 2002.
<PAGE>
The Company has denied all material allegations in the complaint. While it
is not possible to estimate the probable outcome of this proceeding at this time
the Company intends to vigorously defend the action.
WIC PREMIUM TELEVISION LTD. V. GENERAL INSTRUMENT CORPORATION, NEXT
LEVEL SYSTEMS, INC., NEXT LEVEL SYSTEMS OF DELAWARE, INC., ET AL.,
SHOWTIME NETWORKS, INC., ET AL., RETAIL SALES AND MARKETING, INC.,.,,
HOME BOX OFFICE, INC., WARNER COMMUNICATIONS, INC., JOHN DOE, ECHOSTAR
COMMUNICATIONS CORPORATION, DISH LTD., ECHOSPHERE CORPORATION, UNITED
STATES SATELLITE BROADCASTING COMPANY, INC., CORMAN PARK SATELLITE
LTD., WARREN SUPPLY COMPANY, PROGRAMMERS CLEARING HOUSE, INC., RALPH
WARREN, RONALD WARREN, RALPH WARREN AND RONALD WARREN CARRYING ON
BUSINESS AS "PROGRAMMERS CLEARING HOUSE," AND AS "WARREN ACTIVATIONS,"
AND AS "WARREN RADIO & TELEVISION," AND AS "ENTERTAINMENT DIRECT,"
WARREN SUPPLY COMPANY CARRYING ON BUSINESS AS "BUILDERS EXPRESS," 4-12
ELECTRONICS CORPORATION, FREEDOM SATELLITE CORPORATION, CHRISTOPHER
NELSON PERSONALLY AND CARRYING ON BUSINESS AS "SKYLIGHT HOME SATELLITE
THEATER," CHRISTIAN NELSON, SHELDON NELSON AND VIACOM ENTERPRISES
CANADA LIMITED, ET AL., in the Federal Court of Canada Trial Division,
Court File No. T-1538-98 and in Judicial District of Edmonton, Court
File No. 970316746-1998.
In September 1998, WIC Premium Television Ltd. of Edmonton, Alberta, Canada
("WIC") served on USSB, among others, a statement of claim issued by the Federal
Court of Canada. WIC alleges that USSB breached Canadian law by participating
in the broadcast and illegal reception of its services by customers located in
Canada. WIC seeks injunctive relief prohibiting such action by USSB.
In October 1998, WIC commenced a similar action against USSB in Alberta's
Court of Queen's Bench. WIC alleges that USSB breached Canadian law by
participating in the broadcast and illegal reception of its services by
customers located in Canada. This action seeks injunctive relief and damages.
The Company has not yet defended either complaint and is challenging the
personal jurisdiction of the Canadian Courts over the Company. While it is not
possible to estimate the probable outcome of these proceedings at this time, the
Company intends to vigorously defend the actions.
<PAGE>
ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS.
(c) EXHIBITS.
99.1 Selected Financial Data
99.2 Consolidated Financial Statements and Report of Independent
Public Accountants
<PAGE>
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 hereunto duly authorized.
UNITED STATES SATELLITE
BROADCASTING COMPANY, INC.
Date February 18, 1999 By /s/ Stanley E. Hubbard
----------------------------
Stanley E. Hubbard
Its President and CEO
4
<PAGE>
EXHIBIT INDEX
99.1 Selected Financial Data
99.2 Consolidated Financial Statements and Report of Independent
Public Accountants
<PAGE>
United States Satellite Broadcasting Company, Inc. and Subsidiaries
SELECTED FINANCIAL AND OPERATING DATA
<TABLE>
<CAPTION>
For the Years Ended December 31
(In thousands, except per share data) 1998 1997 1996 1995 1994
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA
Revenues $ 550,801 $ 456,619 $ 292,624 $ 107,926 $ 5,132
Cost of sales 327,676 292,917 193,356 70,961 3,362
- -------------------------------------------------------------------------------------------------------------------------------
Gross margin 223,125 163,702 99,268 36,965 1,770
Operating expenses:
Selling and marketing 114,983 99,399 102,715 62,922 17,598
Manufacturer incentive 44,778 66,726 18,387 - -
Depreciation and amortization 17,316 18,426 19,687 21,323 19,775
General and administrative 57,571 46,935 31,992 17,040 10,539
Engineering and operations 13,834 9,801 11,644 4,564 3,022
Commissions to retailers 13,232 14,537 13,909 6,813 307
Early cancellation of contracts due to merger 22,130 - - - -
Management fees (a) - - - 6,667 -
- -------------------------------------------------------------------------------------------------------------------------------
Net operating loss (60,719) (92,122) (99,066) (82,364) (49,471)
Other (income) expense:
Interest expense - - 2,326 9,081 8,218
Interest (income) (4,067) (4,919) (6,244) (1,556) (1,352)
Cost to terminate Credit Agreement - - 9,504 - -
Other (49) 103 307 1,489 526
- -------------------------------------------------------------------------------------------------------------------------------
Net loss ($ 56,603) ($ 87,306) ($104,959) ($ 91,378) ($ 56,863)
- -------------------------------------------------------------------------------------------------------------------------------
Net loss per share - basic and diluted ($ 0.63) ($ 0.97) ($ 1.17) ($ 1.02) ($ 0.63)
- -------------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------------
Weighted average shares outstanding 89,811 89,811 89,811 89,811 89,811
</TABLE>
<TABLE>
<CAPTION>
At December 31
(In thousands) 1998 1997 1996 1995 1994
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA
Cash and cash equivalents $ 66,297 $ 68,646 $ 86,518 $ 19,683 $ 1,817
Working capital (deficit) (34,482) (8,308) 31,065 (17,786) (27,353)
Long-term investments 4,501 3,970 6,941 13,001 15,298
Total assets 190,111 206,310 217,354 149,571 130,472
Long-term debt - - - 128,456 68,775
Shareholders' equity (deficit) (54,470) 2,099 89,477 (48,972) 41,728
</TABLE>
(a) In connection with management services performed by Hubbard Broadcasting,
Inc. ("HBI") for the Company during 1991 through 1994, the Company agreed to pay
HBI an aggregate of $10.0 million, of which $3.3 million was accrued in 1992 and
the remainder accrued in the third quarter of 1995, when it became likely
certain preconditions to payment would be satisfied.
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To United States Satellite Broadcasting Company, Inc.
We have audited the consolidated balance sheets of United States
Satellite Broadcasting Company, Inc. (a Minnesota corporation) and Subsidiaries
as of December 31, 1998 and 1997, and the related consolidated statements of
operations, shareholders' equity (deficit) and cash flows for each of the three
years in the period ended December 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of United States
Satellite Broadcasting Company, Inc. and Subsidiaries as of December 31, 1998
and 1997, and the results of their operations and their cash flows for each of
the three years in the period ended December 31, 1998 in conformity with
generally accepted accounting principles.
/s/ Arthur Andersen LLP
Minneapolis, Minnesota,
January 22, 1999
<PAGE>
United States Satellite Broadcasting Company, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
As of December 31,
- ------------------------------------------------------------------------------------------------------------------
(In thousands, except share and per share data) 1998 1997
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 66,297 $ 68,646
Trade accounts receivable, less allowance of $5,986 and $6,074
at December 31, 1998 and 1997, respectively 47,843 44,992
Prepaid expenses and other 8,856 11,832
- ------------------------------------------------------------------------------------------------------------------
Total current assets 122,996 125,470
- ------------------------------------------------------------------------------------------------------------------
PROPERTY AND EQUIPMENT
Land 351 351
Buildings and improvements 5,106 5,075
Equipment 150,249 138,264
- ------------------------------------------------------------------------------------------------------------------
155,706 143,690
Less - Accumulated depreciation (96,548) (79,235)
- ------------------------------------------------------------------------------------------------------------------
Total property and equipment, net 59,158 64,455
- ------------------------------------------------------------------------------------------------------------------
OTHER ASSETS
Satellite deposits - 8,380
Long-term investments 4,501 3,970
Other 3,456 4,035
- ------------------------------------------------------------------------------------------------------------------
Total other assets 7,957 16,385
- ------------------------------------------------------------------------------------------------------------------
$ 190,111 $ 206,310
- ------------------------------------------------------------------------------------------------------------------
Liabilities and Shareholders' Equity (Deficit)
CURRENT LIABILITIES
Accounts payable and accrued expenses $ 65,743 $ 60,599
Deferred revenue 52,956 56,156
Manufacturer Incentive obligation 25,579 17,023
Contract cancellation payable 13,200 -
- ------------------------------------------------------------------------------------------------------------------
Total current liabilities 157,478 133,778
- ------------------------------------------------------------------------------------------------------------------
MANUFACTURER INCENTIVE OBLIGATION 77,103 60,433
DUE TO HBI 10,000 10,000
COMMITMENTS AND CONTINGENCIES (NOTE 4)
SHAREHOLDERS' EQUITY (DEFICIT)
Preferred Stock, $.01 par value, 50 million shares authorized; none issued
or outstanding - -
Class A Common Stock -
Participating, voting, $.0001 par value, 500 million shares authorized,
29,390,450 and 16,172,601 shares issued and outstanding at December 31, 1998
and 1997, respectively 2 2
Common Stock -
Participating, voting, $.0001 par value, 100 million shares authorized,
60,422,825 and 73,638,174 shares issued and outstanding at December 31, 1998
and 1997, respectively 7 7
Additional paid-in capital 374,896 374,877
Accumulated deficit (429,380) (372,777)
Accumulated other comprehensive income (deficit) 5 (10)
- ------------------------------------------------------------------------------------------------------------------
Total shareholders' equity (deficit) (54,470) 2,099
- ------------------------------------------------------------------------------------------------------------------
$ 190,111 $ 206,310
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
<PAGE>
United States Satellite Broadcasting Company, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Years Ended December 31,
(In thousands, except per share data) 1998 1997 1996
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
REVENUES $ 550,801 $ 456,619 $ 292,624
COST OF SALES 327,676 292,917 193,356
- -----------------------------------------------------------------------------------------------------------
GROSS MARGIN 223,125 163,702 99,268
OPERATING EXPENSES
Selling and marketing 114,983 99,399 102,715
Manufacturer Incentive 44,778 66,726 18,387
General and administrative 57,571 46,935 31,992
Commissions to retailers 13,232 14,537 13,909
Engineering and operations 13,834 9,801 11,644
Depreciation and amortization 17,316 18,426 19,687
Early cancellation of contracts due to merger (Note 2) 22,130 - -
- -----------------------------------------------------------------------------------------------------------
Net operating loss (60,719) (92,122) (99,066)
- -----------------------------------------------------------------------------------------------------------
OTHER (INCOME) EXPENSE
Interest expense - - 2,326
Interest (income) (4,067) (4,919) (6,244)
Cost to terminate Credit Agreement - - 9,504
Other (49) 103 307
- -----------------------------------------------------------------------------------------------------------
Net loss ($ 56,603) ($ 87,306) ($104,959)
- -----------------------------------------------------------------------------------------------------------
Net loss per share - basic and diluted ($ 0.63) ($ 0.97) ($ 1.17)
- -----------------------------------------------------------------------------------------------------------
Weighted average shares outstanding - basic and diluted 89,811 89,811 89,811
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
United States Satellite Broadcasting Company, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
Class A
-------
Common Stock Common Stock
------------ ------------
(In thousands, except per share data) Shares Amount Shares Amount
<S> <C> <C> <C> <C>
- -----------------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY (DEFICIT) AT DECEMBER 31, 1995 16,876 $ 2 72,935 $ 7
Conversion of shares pursuant to
Recapitalization (16,876) (2) 16,876 2
Conversion of notes and cancellation of
warrants - - 7,412 1
Conversion of shares available for
overallotment 1,245 - (1,245) -
Transfer of common stock from HBI - - (15,712) (2)
Sale of Class A common stock for
$27 per share, net 8,300 1 - -
Conversion of shares pursuant to
certain shareholder rights 5,570 1 (5,570) (1)
Media credits utilized - - - -
Unrealized loss on investments - - - -
Net loss - - - -
- -----------------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY (DEFICIT) AT DECEMBER 31, 1996 15,115 2 74,696 7
Conversion of shares pursuant to
certain shareholder rights 1,058 - (1,058) -
Media credits utilized - - - -
Media credits cancelled - - - -
Unrealized gain on investments - - - -
Net loss - - - -
- -----------------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY (DEFICIT) AT DECEMBER 31, 1997 16,173 2 73,638 7
Conversion of shares pursuant to
certain shareholder rights 13,215 - (13,215) -
Issuance of Class A Common stock 2 - - -
Unrealized gain on investments - - - -
Net loss - - - -
- -----------------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY (DEFICIT) AT DECEMBER 31, 1998 29,390 $ 2 60,423 $ 7
- -----------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------
<CAPTION>
Additional Accumulated
Paid-In Accumulated Other
(In thousands, except per share data) Warrants Capital Deficit Comprehensive
Income (Deficit)
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
SHAREHOLDERS' EQUITY (DEFICIT) AT DECEMBER 31, 1995 $ 7,350 $ 127,423 ($180,512) $ 154
Conversion of shares pursuant to
Recapitalization - - - -
Conversion of notes and cancellation of
warrants (7,350) 44,491 - -
Conversion of shares available for
overallotment - - - -
Transfer of common stock from HBI - - - -
Sale of Class A common stock for
$27 per share, net - 206,200 - -
Conversion of shares pursuant to
certain shareholder rights - - - -
Media credits utilized - - - -
Unrealized loss on investments - - - (176)
Net loss - - (104,959) -
- --------------------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY (DEFICIT) AT DECEMBER 31, 1996 - 378,114 (285,471) (22)
Conversion of shares pursuant to
certain shareholder rights - - - -
Media credits utilized - - - -
Media credits cancelled - (3,237) - -
Unrealized gain on investments - - - 12
Net loss - - (87,306) -
- --------------------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY (DEFICIT) AT DECEMBER 31, 1997 - 374,877 (372,777) (10)
Conversion of shares pursuant to
certain shareholder rights - - - -
Issuance of Class A Common stock - 19 - -
Unrealized gain on investments - - - 15
Net loss - - (56,603) -
- --------------------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY (DEFICIT) AT DECEMBER 31, 1998 - $ 374,896 ($429,380) $ 5
- --------------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------------
<CAPTION>
Unused
Media
(In thousands, except per share data) Credits Total
- ------------------------------------------------------------------------------------
<S> <C> <C>
SHAREHOLDERS' EQUITY (DEFICIT) AT DECEMBER 31, 1995 ($ 3,396) ($ 48,972)
Conversion of shares pursuant to
Recapitalization - -
Conversion of notes and cancellation of
warrants - 37,142
Conversion of shares available for
overallotment - -
Transfer of common stock from HBI - (2)
Sale of Class A common stock for
$27 per share, net - 206,201
Conversion of shares pursuant to
certain shareholder rights - -
Media credits utilized 243 243
Unrealized loss on investments - (176)
Net loss - (104,959)
- ------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY (DEFICIT) AT DECEMBER 31, 1996 (3,153) 89,477
Conversion of shares pursuant to
certain shareholder rights - -
Media credits utilized (84) (84)
Media credits cancelled 3,237 -
Unrealized gain on investments - 12
Net loss - (87,306)
- ------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY (DEFICIT) AT DECEMBER 31, 1997 - 2,099
Conversion of shares pursuant to
certain shareholder rights - -
Issuance of Class A Common stock - 19
Unrealized gain on investments - 15
Net loss - (56,603)
- ------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY (DEFICIT) AT DECEMBER 31, 1998 - ($ 54,470)
- ------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
United States Satellite Broadcasting Company, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the Years Ended December 31
(In thousands) 1998 1997 1996
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net Loss ($ 56,603) ($ 87,306) ($104,959)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities -
Depreciation and amortization 17,316 18,426 19,687
Deferred loan origination fees charged to expense in
connection with termination of Credit Agreement -- -- 5,465
Early cancellation of contracts due to merger 9,030 -- --
Media credits utilized -- (84) 243
Change in operating items:
Trade accounts receivable (2,850) (2,590) (25,532)
Prepaid expenses and other current assets 2,975 (6,969) (278)
Accounts payable and accrued expenses 5,144 8,679 19,851
Contract cancellation payable 13,200 -- --
Deferred revenue (3,200) 9,036 23,943
Manufacturer Incentive 25,225 59,146 14,632
Other 563 (3,829) (852)
- --------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities 10,800 (5,491) (47,800)
- --------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Purchase of and deposits on equipment (12,668) (14,854) (5,487)
Purchase of investments (500) -- --
Proceeds from sale of investments -- 3,000 5,996
- --------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities (13,168) (11,854) 509
- --------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Advances from (repayments to) affiliated companies -- (527) (637)
Proceeds from debt borrowings -- -- 485
Repayment of debt -- -- (91,922)
Proceeds from sale of common stock 19 -- 206,200
- --------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities 19 (527) 114,126
- --------------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents (2,349) (17,872) 66,835
CASH AND CASH EQUIVALENTS, beginning of period 68,646 86,518 19,683
- --------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, end of period $ 66,297 $ 68,646 $ 86,518
- --------------------------------------------------------------------------------------------------------------------
NONCASH TRANSACTIONS
Conversion of notes and cancellation of warrants $ -- $ -- $ 44,491
- --------------------------------------------------------------------------------------------------------------------
Expiration of unused media credits $ -- $ 3,237 $ --
- --------------------------------------------------------------------------------------------------------------------
SUPPLEMENTARY CASH FLOW INFORMATION
Cash paid during the period for -
Interest $ -- $ -- $ --
Income taxes $ -- $ -- $ --
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES
United States Satellite Broadcasting Company, Inc. and Subsidiaries ("USSB" or
the "Company") provide subscription television programming via a high-power
direct broadcast satellite ("DBS") to households throughout the continental
United States. The Company broadcasts a high quality digital television signal
using a digital satellite system ("DIRECTV/USSB System"). The Company's
programming is available to customers who have a DIRECTV/USSB unit, which
consists of an 18-inch satellite dish, a receiver/decoder and a remote control.
All of the Company's gross revenues and identifiable assets relate to the
Company's activities in this industry.
Hubbard Broadcasting, Inc. ("HBI") beneficially owned 51.8% of the Company
as of December 31, 1998 and 1997, and had approximately 73.4% of the total
voting power at December 31, 1998.
Until July 1, 1994, the Company was a development stage company. The
Company has incurred losses since its inception and had an accumulated deficit
of approximately $429.4 million as of December 31, 1998. Management anticipates
that losses will continue into 1999.
The Company has entered into an Agreement and Plan of Merger dated as of
December 11, 1998 (the "Merger Agreement") with General Motors Corporation, a
Delaware corporation ("GM"), and its subsidiary Hughes Electronics
Corporation, a Delaware corporation ("Hughes"), pursuant to which, if certain
conditions are satisfied, the Company will be merged with and into Hughes
(the "Merger") (See Note 2).
PRINCIPLES OF CONSOLIDATION
<PAGE>
The consolidated financial statements include the accounts of the Company and
its wholly owned Subsidiaries, including USSB II, Inc. ("USSB II"). USSB II owns
the Company's satellite transponders and holds the Company's FCC licenses and
permits (see Note 4). All significant intercompany accounts and transactions
have been eliminated in consolidation.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Ultimate results could differ from those estimates.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents, which consist primarily of short-term United States
Treasury-backed securities with original maturities of less than 90 days, are
stated at cost, which approximates fair value.
INVESTMENTS
Long-term investments at December 31, 1998, consist primarily of a U.S. Treasury
security maturing in 1999, which the Company classifies as available-for-sale.
The Treasury security bears interest at 5.5% and its aggregate amortized cost
approximated its market value of $4,001,000 at December 31, 1998. Unrealized
gains and losses are reported as other comprehensive income.
MANUFACTURER INCENTIVE PROGRAM
2
<PAGE>
The Company's costs under its financial incentive arrangements with
manufacturers of DIRECTV/USSB System equipment are charged to expense as
incurred. See Note 4 for additional disclosure regarding these arrangements.
RETAILER COMMISSIONS
The Company generally pays commissions to eligible retailers for their customers
who are current USSB subscribers. Commissions paid are charged to expense over
the related subscription period. Accrued retailer commissions totaled
$5,262,000 at December 31, 1998 and $5,996,000 at December 31, 1997.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Depreciation is provided using
accelerated and straight-line methods based on estimated useful lives as
follows:
Satellite Transponders 10 years
Other Equipment 5-10 years
Buildings & Improvements 31 years
FINANCIAL INSTRUMENTS
Unless otherwise indicated, the recorded value of the Company's financial
instruments approximates their fair value.
REVENUE RECOGNITION
Programming revenues are recorded when the respective services are rendered.
Subscriptions received in advance of the delivery of the related programming are
recorded as deferred revenue.
ADVERTISING AND PROMOTIONS
3
<PAGE>
Costs for advertising and promotional materials and activities (including the
cost, if any, of programming provided to current or prospective customers free
of charge) are charged to expense as incurred.
RESEARCH AND DEVELOPMENT
Costs related to the Company's research and development efforts are charged to
expense as incurred.
INCOME TAXES
Deferred income tax assets and liabilities are computed annually for differences
between the financial statement and tax bases of assets and liabilities. These
differences will result in taxable or deductible amounts in the future based on
enacted tax laws and are applicable to the periods in which the differences are
expected to affect taxable income.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
The Company adopted FASB Statement No. 130, "Reporting Comprehensive
Income" (SFAS No. 130), effective January 1, 1998. SFAS No. 130 establishes
standards for reporting and display of comprehensive earnings and its components
in financial statements. Comprehensive income is defined as changes in equity
of a business enterprise during a period except those resulting from investment
by owners and distributions to owners. The adoption of SFAS No. 130 had no
impact on the Company's statements of operations or shareholders' equity as of
December 31, 1998.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 "Accounting for Derivative Instruments
and Hedging Activities" (SFAS No. 133). SFAS No. 133 establishes accounting and
reporting standards requiring that every derivative financial instrument
(including certain derivative instruments embedded in other
4
<PAGE>
contracts) be recorded in the balance sheet either as an asset or liability
measured at its fair value. SFAS No. 133 requires that changes in the
derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. Special accounting for qualifying hedges
allows a derivative's gains and losses to offset related results on the hedged
item in the income statement, and requires that a company must formally
document, designate, and assess the effectiveness of transactions that receive
hedge accounting. The Company will be required to adopt SFAS No. 133 no later
than January 1, 2000. The Company has not entered into any derivative financial
instruments as of December 31, 1998. As a result, adoption of SFAS No. 133
would currently have no impact on the Company. In the future, if the Company
were to enter into derivative financial instruments which are covered by SFAS
No. 133, volatility in earnings and other comprehensive income could be
increased.
2. AGREEMENT AND PLAN OF MERGER
The Company has entered into an Agreement and Plan of Merger dated as of
December 11, 1998 (the "Merger Agreement") with General Motors Corporation, a
Delaware corporation ("GM"), and its subsidiary Hughes Electronics
Corporation, a Delaware corporation ("Hughes"), pursuant to which, if certain
conditions are satisfied, the Company will be merged with and into Hughes
(the "Merger"). The Merger, which is subject to regulatory and shareholder
approval, and to the satisfaction of other conditions contained in the Merger
Agreement, is expected to take place in the first half of 1999. If the
Merger is completed, each share of USSB stock will be converted, subject to
certain limitations, into either (i) a fraction of a share of Class H Common
Stock of GM equal to the exchange ratio provided in the Merger Agreement or
(ii) cash equal to that exchange ratio multiplied by the 20-day
volume-weighted average price of the GM Class H
5
<PAGE>
Common Stock (the "Merger Consideration"). The Merger Consideration is dependent
upon the GM Class H Common Stock price and will not exceed $18.00 per share.
As required by the Merger Agreement, the Company has canceled contracts
with Lockheed Martin and Convergys Information Management Group Inc. In
connection with the cancellation of these contracts, the Company recorded a
special one-time charge in the fourth quarter of 1998 of $20.7 million. This
charge represents the total amount of the charge associated with such contract
cancellations. The fourth quarter charge includes non-cash write-offs of
satellite deposits of $7.6 million and development costs for subscriber
management and billing systems of $1.3 million. The remainder of the fourth
quarter charge consists of net contract termination fees, which were paid in
January 1999. The charge of $22.1 million included in the statement of
operations for the year ended December 31, 1998 also includes a write-off of
satellite deposits of $1.43 million recorded in June 1998.
3. SHAREHOLDERS' EQUITY
RECAPITALIZATION AND INITIAL PUBLIC OFFERING
In the third quarter of 1995, the Company decided to proceed with an initial
public offering of its Class A Common Stock. In connection with the offering, on
January 31, 1996, the Company effected a recapitalization of the Company's
capital structure.
Prior to the recapitalization, the Company's capitalization consisted of
two classes of common stock (referred to herein as "old common stock" and "old
class A common stock"). Terms of the recapitalization included (i) a change in
the authorized capital of the Company to consist of 100,000,000 shares of Common
Stock, 500,000,000 shares of Class A Common Stock and 50,000,000 shares of
undesignated Preferred Stock; (ii) the conversion of the Company's old common
stock and old class A common stock into shares of Common Stock; (iii) the
conversion
6
<PAGE>
of certain convertible subordinated promissory notes into shares of Common Stock
and the cancellation of warrants issued to the holders of those notes; (iv) a
75-for-one split of the new capital stock; and (v) the contribution by HBI of
8,300,000 shares of Common Stock in connection with the public offering and
7,411,950 shares of Common Stock in connection with conversion of the
convertible subordinated promissory notes, pursuant to HBI's agreements with
certain current shareholders, in order to prevent those shareholders from
experiencing dilution in their ownership of the Company. The Company's
consolidated financial statements are presented as if the above changes in
authorized capital and the 75-for-one split of new capital stock had been
effective for all periods presented.
The offering (which closed on February 6, 1996) consisted of the sale by
the Company of 8,300,000 shares of Class A Common Stock at $27.00 per share,
generating proceeds of approximately $206.2 million, net of underwriting
commissions and other expenses incurred in connection with the offering.
Pursuant to the over-allotment provisions in the underwriting agreement,
certain shareholders who had purchased shares of the Company's capital stock in
previous private placements sold 1,245,000 shares of newly converted Class A
Common Stock in connection with the offering. The Company did not receive any of
the proceeds of such sales.
CONVERSION RIGHTS
On May 1, 1996, approximately 3.1 million shares of the Company's Common Stock,
with 10 votes per share, automatically converted into Class A Common Stock, with
one vote per share, at a conversion ratio of 1:1. On July 30, 1996, the
remainder of the Company's Common Stock, with 10 votes per share, became
eligible, at the option of the holders thereof, to convert into Class A Common
Stock, with one vote per share, at a conversion ratio of 1:1.
7
<PAGE>
In accordance with certain shareholder agreements, prior to the Company's
initial public offering, the ownership percentages of certain shareholders,
other than HBI, were protected from dilution, based on total outstanding shares
of 89,810,775, until the ownership of HBI was reduced to 51%. In connection
with the Company's initial public offering, 15,711,950 shares of old common
stock were contributed by HBI to the Company for no consideration in 1996. In
addition, certain shareholders holding 22,645,350 shares of Common Stock have
certain "piggy-back" rights to participate in certain public offerings of the
Company's stock and certain "co-sale" rights to include all or a portion of
their shares in certain sales by HBI of its stock of the Company.
UNUSED MEDIA CREDITS
In connection with a sale of old class A common stock in 1994, the Company
received a $5.0 million media credit. The unused balance of the media credit at
December 31, 1997 ($3.2 million) was canceled by the Company. Such cancellation
was recorded as a reduction of additional paid-in capital to reflect the actual
net proceeds realized from the original stock sale.
CONVERTIBLE SUBORDINATED PROMISSORY NOTES
During 1994, the Company issued and sold unsecured convertible subordinated
promissory notes (the "Notes") for $34.5 million. The Notes were subject to
mandatory conversion into shares of old class A common stock equal to the face
amount of the Notes divided by $5.66 if the gross proceeds of an initial public
offering of the Company were to exceed $50 million at an offering price of at
least $7.00 per share. Such conversion occurred as part of the recapitalization
at which time the Notes (including cumulative accretion) had a recorded balance
of $37.1 million. Issued with the convertible subordinated promissory notes
were warrants valued at $7.5 million, which were canceled as a part of the
recapitalization.
8
<PAGE>
STOCK-BASED COMPENSATION
In December 1995, the Company's shareholders approved a stock option plan (the
"1995 Plan") and, in November 1996, the Company's shareholders approved a
Non-Employee Director Stock Option Plan (the "1996 Non-Employee Director Plan")
(together, the "Option Plans"). The Option Plans authorize the granting of
options to purchase up to an aggregate of 2,150,000 shares of Class A Common
Stock. The 1995 Plan provides for employees, officers and consultants of the
Company to be granted options to purchase Class A Common Stock of two types: (i)
those that qualify as incentive stock options ("Incentive Options") within the
meaning of Section 422 of the Internal Revenue Code of 1986, as amended, and
(ii) those that do not qualify as Incentive Options ("Nonstatutory Options").
All options granted under the 1996 Non-Employee Director Plan are Nonstatutory
Options. The Option Plans are administered by the Compensation Committee.
Under the 1995 Plan, the Compensation Committee determines the persons who are
to receive options, the terms and the number of shares subject to each option
and whether the option is to be an Incentive Option or a Nonstatutory Option.
The options vest equally over a four or five year period, and are exercisable
over ten years from the date of grant. The 1996 Non-Employee Director Plan
provides for the automatic, non-discretionary, grant of options.
9
<PAGE>
Information regarding the Option Plans is as follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31,
----------------------------------------------------------------------------------------------------------------
1998 1997 1996
----------------------------------------------------------------------------------------------------------------
Shares Weighted Shares Weighted Shares Weighted
Under Average Under Average Under Average
Option Exercise Price Exercise Option Exercise Price Exercise Option Exercise Price Exercise
Plan Price Plan Price Plan Price
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Outstanding
at beginning
of year 690,000 $7.75 - $36.00 $19.58 439,700 $11.50 - $36.00 $26.55 -- -- --
Granted 60,000 $6.19 - $10.00 $8.20 260,300 $7.75 - $12.00 $8.04 475,300 $11.50 - $36.00 $26.62
Exercised (2,500) $13.75 $13.75 - - - -- -- --
Forfeited (42,600) $7.75 - $27.00 $17.12 (10,000) $11.50 - $27.0 $24.45 (35,600) $27.00 - $28.50 $27.45
------- -------------- ------ ------- --------------- ------- ------- --------------- ------
Outstanding 704,900 $6.19 - $36.00 $18.82 690,000 $7.75 - $36.00 $19.58 439,700 $11.50 - $36.00 $26.55
at end of year
Exercisable 217,547 $7.75 - $36.00 $21.87 103,946 $7.75 - $36.00 $23.64 11,000 $11.50 $11.50
at end of year
Weighted average $5.92 $5.24 $17.72
fair value
of options
granted
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
As of December 31, 1998, the outstanding stock options granted in 1996 have
a remaining contractual life of approximately seven years and the outstanding
stock options granted in 1997 have a remaining contractual life of approximately
eight years.
The Company accounts for the Option Plans under APB Opinion No. 25, under
which no compensation cost has been recognized. Had compensation cost for the
Option Plans been determined consistent with Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS No. 123), the
Company's pro forma net loss and pro forma loss per share would have been as
follows (in thousands):
<TABLE>
<CAPTION>
Years Ended December 31
1998 1997 1996
---- ---- ----
<S> <C> <C> <C> <C>
Net loss As Reported $(56,603) $(87,306) $(104,959)
Pro Forma $(58,418) $(88,670) $(112,750)
Net loss per share - basic and diluted As Reported $(.63) $(.97) $(1.17)
Pro Forma $(.65) $(.99) $(1.26)
</TABLE>
The fair value of each option grant is estimated on the date of the grant using
the Black-Scholes option pricing model with the following weighted average
assumptions: risk-free interest rates
10
<PAGE>
of 5.1% in 1998 and 6.3% in 1997; expected life of 10 years for 1998 and 1997;
expected volatility of 57.3% in 1998 and 39.5% in 1997.
4. COMMITMENTS AND CONTINGENCIES
REGULATORY MATTERS
USSB II, Inc. (a wholly owned subsidiary of the Company) holds a license
from the Federal Communications Commission (the "FCC") to broadcast from five
transponders at 101 DEG. west longitude (the "License"). The Company must
continue to maintain the License to operate its business. The License expires
in June 2004 and is renewable at ten-year intervals. Although the Company
expects to obtain such renewals in the ordinary course, there can be no
assurance that such renewals will be granted.
The construction and launch of broadcasting satellites and the operation of
satellite broadcasting systems are subject to substantial regulation by the FCC.
Under the License, the Company is subject to FCC review primarily for the
following: (i) standards regarding individual satellites (e.g., meeting minimum
financial, legal and technical standards); (ii) avoiding interference with other
satellites; and (iii) complying with rules the FCC has established specifically
for high-power DBS satellite licenses. In addition, uplink facilities are
separately licensed by the FCC. The Company's National Broadcast Center and the
Auxiliary Broadcast Center have each received its FCC license. FCC rules are
subject to change in response to industry developments, new technology and
political considerations.
The FCC granted the Company a Construction Permit and Launch Authority (the
"Permit"), held by USSB II, for satellites with three transponders at 110 DEG.
west longitude and eight transponders at 148 DEG. west longitude. On June 24,
1998, the Company voluntarily returned
11
<PAGE>
to the FCC its authorization for eight transponders at 148 DEG. west longitude.
This action has no effect on the status of the Company's Permit for the 110 DEG.
orbital location.
The Permit requires the Company to comply with specified construction and
launch schedules. The FCC has the authority to revoke the Permit for the
110 DEG. orbital location if the Company fails to comply with the FCC schedule
for construction and launch. Under the Merger Agreement, the Company and Hughes
have agreed to cooperate and use their reasonable best efforts to maintain the
Permit at the 110 DEG. orbital location. In connection therewith, the Company
and Hughes have jointly filed an application with the FCC. This application for
modification of authorization contemplates moving the DBS-1 satellite, which
presently operates at the 101 DEG. orbital location, to the 110 DEG. orbital
location to satisfy the FCC's due diligence requirements.
Under the Merger Agreement, on December 17, 1998, Hughes, DIRECTV
Enterprises, Inc., a wholly-owned subsidiary of Hughes, and the Company also
filed applications with the FCC requesting consent to the transfer of control of
all of the FCC authorizations held by USSB II, Inc. to Hughes.
While the Company has generally been successful to date with respect to
compliance with regulatory matters, there can be no assurance that the Company
will succeed in obtaining and maintaining all requisite regulatory approvals for
its operations.
LOCKHEED MARTIN ASTRO SPACE AGREEMENT
The Company originally entered into contracts with Lockheed Martin for the
construction of direct broadcast satellites at the 110 DEG. orbital location
(the "110 DEG. Contract") and at the 148 DEG. orbital location (the "148 DEG.
Contract"). As required by the Merger Agreement, the Company has canceled the
110 DEG. Contract and has allowed the 148 DEG. Contract to expire in accordance
with its terms. Both actions were effective December 31, 1998. The Company has
recorded charges
12
<PAGE>
related to these cancellations, which represent the total amount of the
charges associated with such cancellations (See Note 2).
ADVERTISING AND PROMOTIONS
The Company has entered into commitments to purchase or participate in joint
purchases of broadcast, print and other media for advertising and promotional
purposes. At December 31, 1998, such commitments totaled $4.0 million due
through June 30, 1999, with the non-cancelable portion of such commitments
totaling $3.0 million.
INSURANCE
The Company maintains business interruption and in-orbit insurance coverages at
levels management considers necessary to address the normal risks of operating
via communications satellite, including damage, destruction or failure of the
satellite or its transponders. Additionally, the Company maintains general
liability and directors' and officers' insurance coverages.
SATELLITE
All of the Company's programming is carried on a single satellite, DBS-1, which
the Company co-owns with DIRECTV, Inc., a subsidiary of Hughes Electronics
Corporation. As previously reported, a spacecraft control processor ("SCP")
aboard the DBS-1 satellite failed on July 4, 1998, and control of DBS-1 was
automatically switched to the spare SCP without interruption of service. In
connection with the execution of the Merger Agreement, DIRECTV and the Company
entered into a Channel Services Provision Agreement which provides that, subject
to the terms of that Agreement, DIRECTV will provide to USSB, on a full time
basis, channel capacity and related services on two other satellites owned by
Hughes at the 101 DEG. orbital location sufficient to transmit and deliver a
limited number of premium movie services to USSB
13
<PAGE>
subscribers. At the same time, the Company and Hughes also entered into a
Replacement Payload Option Agreement which clarifies USSB's right to transponder
capacity on a replacement satellite , in the event the Merger Agreement is
terminated due to the failure of the transponders on DBS-1. The Replacement
Payload Option Agreement provides that USSB may elect to purchase five
transponders at a fixed price on DIRECTV 1-R, a satellite under construction by
Hughes.
LITIGATION
In November 1996, Personalized Media Communications, L.L.C. ("PMC") initiated
legal proceedings against the Company and others before the United States
International Trade Commission ("ITC"), and in the United States District Court
for the Northern District of California. The Company does not believe that PMC
is entitled to damages or any remedies from the Company, and management intends
to vigorously defend both actions.
In June 1997, IPPV Enterprises, a Georgia partnership ("IPPV") initiated a
legal proceeding against the Company and others in the United States District
Court for the District of Delaware. The Company does not believe that IPPV is
entitled to damages or any remedies from the Company, and management intends to
vigorously defend the action.
In September 1998, WIC Premium Television, Ltd., an Edmonton, Alberta,
Canada corporation, ("WIC") initiated two separate legal proceedings in the
Federal Court of Canada Trial Division and in the Judicial District of Edmonton
against numerous retailers, programming providers, and programming distributors,
including the Company. This action is in the preliminary stages of discovery
and management has not reached a judgment regarding whether WIC may be entitled
to damages or any remedies from the Company.
Item 5 of this Report on Form 8-K contains additional information on these
matters.
14
<PAGE>
The Company is also exposed to other litigation encountered in the normal
course of business. In the opinion of management, the resolution of these other
litigation matters of which the Company is aware will not have a material
adverse effect on the Company's financial position, results of operations or
cash flows.
MANUFACTURER INCENTIVE PROGRAM
On August 26, 1996, the Company, together with DIRECTV, Inc., entered into
financial incentive arrangements with certain manufacturers of DIRECTV/USSB
System equipment to assist these manufacturers in lowering the price of
DIRECTV/USSB Systems. Such arrangements, which run for up to four years
depending on manufacturer, commit the Company to pay the manufacturers over a
five-year period from the date new DIRECTV/USSB System households are authorized
to receive programming. The expense and liability for such future commitments
are established and recorded upon activation of the related DIRECTV/USSB System.
For the years ended December 31, 1998 and 1997, the Company charged to expense
$44.8 and $66.7 million, respectively, representing the full amount of those
future obligations for the Manufacturer Incentive program incurred for the sale
of DIRECTV/USSB Systems to new households. Cash paid in 1998 related to the
Manufacturers Incentive program was $21.8 million.. Future obligations totaled
$102.7 million at December 31, 1998, payable in the following years:
<TABLE>
In Thousands
<S> <C>
1999 $25,579
2000 25,417
2001 25,196
2002 18,250
2003 8,240
</TABLE>
15
<PAGE>
While the amounts to be incurred in the future by the Company under these
arrangements cannot be precisely estimated, the Company expects that as the
level of retail DIRECTV/USSB system unit sales increase, the cash flow related
to these arrangements will increase accordingly.
The fair value of the future obligation at December 31, 1998 is
approximately $86.0 million and has been calculated by discounting the future
cash flows at the Company's estimated incremental borrowing rate.
5. RELATED-PARTY TRANSACTIONS
Certain officers and directors of the Company are also employed by, and spend a
significant portion of their time on, the businesses of HBI and its affiliates
other than the Company. Each of such persons who is a director has indicated to
the Company that, should a conflict of interest arise, he will promptly disclose
such conflict to the Company's Board of Directors and refrain from voting on
such matter as a director.
DUE TO HBI
Debt due to HBI consists principally of amounts accrued for management services
valued at $10.0 million provided to the Company by HBI during the years 1992
through 1994 under an agreement which expired June 30, 1994. The balance does
not bear interest. The Company was contingently obligated to pay these amounts
and they will not become due until, in the board of director's opinion, adequate
resources exist. As a result of certain significant financial performance
thresholds, USSB management discontinued accruing the $3.3 million annual charge
after 1992 and did not intend to accrue any additional charges until and unless
it was determined payment could be considered probable. When the Company decided
to proceed with its initial public stock offering, the board of directors
determined that it became likely that certain preconditions would ultimately be
satisfied, and therefore made payment of this obligation
16
<PAGE>
probable. Accordingly, during the quarter ended September 30, 1995, the Company
accrued as an operating expense the remaining $6.7 million of its management fee
obligation. In connection with the execution of the Merger Agreement, Hughes has
agreed to pay the accrued management fee of $10 million to HBI on the first
anniversary of the closing date of the Merger, but not later than April 1, 2000.
HBI provides certain general and administrative services to the Company
under an agreement that is renewed annually. The Company incurred a charge of
$1,252,000 for such services for the year ended December 31, 1998, $1,124,000
for 1997, and $978,000 for 1996. The Company also purchases programming,
engineering services and other services from other entities affiliated with HBI.
Amounts included in the accompanying consolidated statements of operations which
were purchased from these affiliated entities were $4.6 million in 1998, $5.4
million in 1997, and $3.8 million in 1996. The Company believes that the
services provided between the Company and HBI and its subsidiaries and
affiliates, and by entities with which certain directors are affiliated, are on
terms comparable to those available from third parties and that such terms are
reasonable.
OTHER
The Company's employees participate in a 401(k) plan sponsored by HBI. Under
the terms of the plan, the Company may make annual base contributions and can
match participant contributions for each year. HBI made contributions to the
plan on behalf of the Company's employees (which amounts were reimbursed by the
Company) of $237,000 for the year ended December 31, 1998, $157,000 during 1997
and $116,000 during 1996.
6. INCOME TAXES
17
<PAGE>
The Company's deferred tax assets and liabilities, all of which are long-term,
are summarized as follows (in thousands):
<TABLE>
<CAPTION>
Deferred Tax Asset (Liability)
- -------------------------------------------------------------------------------
As of December 31
- -------------------------------------------------------------------------------
1998 1997
- -------------------------------------------------------------------------------
<S> <C> <C>
Deferred tax assets:
Manufacturer Incentive 41,073 $ 30,983
Preoperating capitalized costs 314 2,201
Capitalized interest - 181
Management services 4,000 4,337
Other 3,800 3,995
Net operating loss carryforward 137,738 121,825
--------- ----------
Total deferred tax assets 186,925 163,522
Deferred tax liabilities:
Depreciation (15,951) (15,149)
--------- ----------
Total deferred tax liability (15,951) (15,149)
- -------------------------------------------------------------------------------
Valuation allowance 170,974 (148,373)
- -------------------------------------------------------------------------------
Net deferred tax balance $ - $ -
- -------------------------------------------------------------------------------
</TABLE>
The Company has net operating losses for federal tax reporting purposes
totaling $344.3 million available for carryover to subsequent years as of
December 31, 1998, expiring in years 2000 through 2014. The valuation allowance
applied against the Company's net deferred tax assets increased by $22.6 million
for the year ended December 31, 1998, $37.5 million for 1997, and $39.3 million
for 1996.
The Company and HBI file separate federal tax returns and a combined state
tax return in Minnesota and New Mexico. HBI has benefited from this unitary
relationship as it has utilized USSB losses to reduce its combined income
subject to apportionment in Minnesota and New Mexico through December 31, 1996.
The benefit that HBI realized was approximately $0.1 million for the year ended
December 31, 1998, $0.2 million for 1997, and $1.4 million for 1996. This
unitary relationship has reduced the Company's Minnesota net operating loss
carryforward. Benefits realized by HBI in years preceding 1994 were not
significant. Under a tax sharing agreement dated November 30, 1995, HBI has
agreed to reimburse the Company for such benefits in the year they would
otherwise have been realized by the Company. In connection with
18
<PAGE>
the execution of the Merger Agreement, HBI has agreed to pay Hughes, as the
successor to the Company, an amount sufficient to satisfy this obligation on the
first anniversary of the closing date of the Merger, but not later than April 1,
2000.
7. QUARTERLY CONDENSED FINANCIAL INFORMATION (UNAUDITED)
Summarized unaudited quarterly data for 1998 and 1997 is as follows (in
thousands, except per share amounts):
<TABLE>
<CAPTION>
First Quarter Second Quarter Third Quarter Fourth Quarter Full Year
- --------------------------------------------------------------------------------------------------------------------
1998
<S> <C> <C> <C> <C> <C>
Revenues $136,839 $132,710 $136,567 $144,685 $550,801
Cost of Sales 84,656 78,742 80,225 84,053 327,676
------ ------ ------ ------ -------
Gross Margin 52,183 53,968 56,342 60,632 223,125
Operating Expenses 62,316 62,899 66,204 92,425 283,844
------ ------ ------ ------ -------
Net Operating Loss (10,133) (8,931) (9,862) (31,793) (60,719)
Other (income) expense, net (1,004) (1,041) (1,132) (939) (4,116)
------ ------ ------ ---- ------
Net Loss (9,129) (7,890) (8,730) (30,854) (56,603)
------ ------ ------ ------- -------
------ ------ ------ ------- -------
Weighted Average Shares Outstanding 89,811 89,811 89,811 89,811 89,811
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Net loss per share - basic and diluted $(0.10) $(0.09) $(0.10) $(0.34) $(0.63)
------ ------ ------ ------ ------
------ ------ ------ ------ ------
1997
Revenues $99,231 $114,236 $114,383 $128,769 $456,619
Cost of Sales 64,930 73,223 73,557 81,207 292,917
------ ------ ------ ------ -------
Gross Margin 34,301 41,013 40,826 47,562 163,702
Operating Expenses 57,925 51,620 70,082 76,197 255,824
------ ------ ------ ------ -------
Net Operating Loss (23,624) (10,607) (29,256) (28,635) (92,122)
Other (income) expense, net (1,174) (1,324) (1,109) (1,209) (4,816)
------ ------ ------ ------ ------
Net Loss (22,450) (9,283) (28,147) (27,426) (87,306)
------- ------ ------- ------- -------
------- ------ ------- ------- -------
Weighted Average Shares Outstanding 89,812 89,811 89,811 89,821 89,811
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Net loss per share - basic and diluted $(0.25) $(0.10) $(0.31) $(0.31) $(0.97)
------ ------ ------ ------ ------
------ ------ ------ ------ ------
</TABLE>
19
