<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
F O R M 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission File Number: 0-21317
TCI SATELLITE ENTERTAINMENT, INC.
---------------------------------
(Exact name of Registrant as specified in its charter)
<TABLE>
<CAPTION>
<S> <C>
State of Delaware 84-1299995
- - ------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
8085 South Chester, Suite 300
Englewood, Colorado 80112
- - ---------------------------------------- ------------------------------------
(Address of principal executive offices) (Zip Code)
</TABLE>
Registrant's telephone number, including area code: (303) 712-4600
Indicate by check mark whether the Registrant has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports).
Yes X No
--- ---
Indicate by check mark whether the Registrant has been subject to such
filing requirements for the past 90 days.
Yes No X
--- ---
Following the December 4, 1996 distribution of 100% of the issued and
outstanding common stock of TCI Satellite Entertainment, Inc. to holders of
Tele-Communications, Inc. Series A and Series B TCI Group Common Stock, it is
estimated that the approximate number of shares outstanding of TCI Satellite
Entertainment, Inc. common stock will be:
Series A common stock - 57,940,000 shares; and
Series B common stock - 8,466,000 shares.
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Combined Balance Sheets
(unaudited)
<TABLE>
<CAPTION>
September 30, December 31,
1996 1995
------------- ------------
<S> <C> <C>
amounts in thousands
Assets
- - ------
Cash $ 1,988 1,801
Accounts receivable 25,484 29,192
Less allowance for doubtful accounts 3,876 4,819
---------- -------
21,608 24,373
---------- -------
Prepaid expenses 705 86
Investment in, and related advances to,
PRIMESTAR Partners L.P.
("PRIMESTAR Partners") (note 4) 30,345 17,963
Property and equipment, at cost:
Satellite reception equipment 588,271 422,070
Subscriber installation costs 211,324 128,870
Support equipment 20,319 12,395
Cost of satellites under construction 452,830 382,900
(note 5) ---------- -------
1,272,744 946,235
Less accumulated depreciation 136,360 57,015
---------- -------
1,136,384 889,220
---------- -------
$1,191,030 933,443
========== =======
</TABLE>
(continued)
I-1
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Combined Balance Sheets, continued
(unaudited)
<TABLE>
<CAPTION>
September 30, December 31,
1996 1995
-------------- -------------
<S> <C> <C>
amounts in thousands
Liabilities and Parent's Investment
- - -----------------------------------
Accounts payable $ 8,024 11,378
Accrued charges from PRIMESTAR Partners
(note 4) 35,556 26,420
Other accrued expenses 10,710 11,483
Subscriber advance payments 19,689 13,244
Due to PRIMESTAR Partners (note 5) 386,219 382,900
Deferred income taxes 23,082 4,434
---------- -------
Total liabilities 483,280 449,859
---------- -------
Parent's investment:
Accumulated deficit (132,369) (75,775)
Due to TCI Communications, Inc.
("TCIC") (notes 2 and 6) 840,119 559,359
---------- -------
Total parent's investment 707,750 483,584
---------- -------
Commitments and contingencies
(notes 2, 4, 5, 6, and 7)
$1,191,030 933,443
========== =======
</TABLE>
See accompanying notes to combined financial statements.
I-2
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Combined Statements of Operations
(unaudited)
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
-------------------- -------------------
1996 1995 1996 1995
---------- -------- --------- --------
<S> <C> <C> <C> <C>
amounts in thousands
Revenue:
Programming and equipment rental $ 92,569 35,990 249,439 73,352
Installation 14,033 22,818 50,810 47,067
-------- ------- ------- -------
106,602 58,808 300,249 120,419
-------- ------- ------- -------
Operating costs and expenses:
Charges from PRIMESTAR Partners
(note 4):
Programming 30,543 15,672 88,007 29,981
Satellite, marketing and
distribution 17,359 6,761 46,781 14,148
Other operating:
TCIC (note 6) 5,941 4,002 16,446 11,138
Other 3,118 960 7,463 1,665
Selling, general and administrative:
TCIC (note 6) 5,024 1,880 14,600 4,103
Other 45,699 27,467 121,013 52,424
Depreciation 33,678 11,966 87,205 31,881
-------- ------- ------- -------
141,362 68,708 381,515 145,340
-------- ------- ------- -------
Operating loss (34,760) (9,900) (81,266) (24,921)
-------- ------- ------- -------
Other income (expense):
Share of earnings (losses)
of PRIMESTAR Partners (note 4) 1 (3,131) (1,445) (8,119)
Other, net 117 78 311 221
-------- ------- ------- -------
118 (3,053) (1,134) (7,898)
-------- ------- ------- -------
Loss before income taxes (34,642) (12,953) (82,400) (32,819)
Income tax benefit 10,936 3,603 25,806 10,433
-------- ------- ------- -------
Net loss $(23,706) (9,350) (56,594) (22,386)
======== ======= ======= =======
</TABLE>
See accompanying notes to combined financial statements.
I-3
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Combined Statement of Parent's Investment
(unaudited)
<TABLE>
<CAPTION>
Total
Accumulated Due to parent's
deficit TCIC investment
------------ -------- -----------
<S> <C> <C> <C>
amounts in thousands
Balance at January 1, 1996 $ (75,775) 559,359 483,584
Net loss (56,594) -- (56,594)
Allocation of TCIC expenses -- 31,046 31,046
Allocation of TCIC installation costs -- 37,470 37,470
Intercompany income tax allocation -- (44,454) (44,454)
Net cash transfers from TCIC -- 256,698 256,698
----------- ------- -------
Balance at September 30, 1996 $(132,369) 840,119 707,750
=========== ======= =======
</TABLE>
See accompanying notes to combined financial statements.
I-4
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Combined Statements of Cash Flows
(unaudited)
<TABLE>
<CAPTION>
Nine months ended
September 30,
----------------------
1996 1995
----------- ---------
<S> <C> <C>
amounts in thousands
(see note 3)
Cash flows from operating activities:
Net loss $ (56,594) (22,386)
Adjustments to reconcile net loss to
net cash provided by operating
activities:
Depreciation 87,205 31,881
Share of losses of PRIMESTAR
Partners 1,445 8,119
Deferred income tax expense 18,648 6,179
Other non-cash charges (credits) (553) 179
Changes in operating assets and
liabilities:
Change in receivables 2,765 (18,859)
Change in prepaids (619) (29)
Change in accruals and payables 5,009 30,951
Change in subscriber advance
payments 6,445 6,481
--------- --------
Net cash provided by operating
activities 63,751 42,516
--------- --------
Cash flows from investing activities:
Capital expended for construction of
satellites (69,930) (79,932)
Capital expended for property and
equipment (264,439) (268,909)
Additional investments in and loans to
PRIMESTAR Partners (13,827) (13,210)
--------- --------
Net cash used in investing
activities (348,196) (362,051)
--------- --------
Cash flows from financing activities:
Increase in amounts due to PRIMESTAR
Partners 3,319 79,932
Increase in amounts due to TCIC 281,313 239,603
--------- --------
Net cash provided by financing
activities 284,632 319,535
--------- --------
Net increase in cash 187 --
Cash at beginning of period 1,801 --
--------- --------
Cash at end of period $ 1,988 --
========= ========
</TABLE>
See accompanying notes to combined financial statements.
I-5
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Combined Financial Statements
September 30, 1996
(unaudited)
(1) Basis of Presentation
---------------------
The accompanying combined financial statements of TCI Satellite
Entertainment, Inc. ("TSEI") represent a combination of the historical
financial information of certain satellite television assets (collectively,
"TCI SATCO") of TCIC, a subsidiary of Tele-Communications, Inc. ("TCI").
Upon consummation of the spinoff transaction described in note 2, TSEI will
own the assets that comprise TCI SATCO, which assets include (i) a 100%
ownership interest in "PRIMESTAR By TCI," the TCIC business that
distributes the PRIMESTAR(R) programming service to subscribers within
specified areas of the continental United States, (ii) a 100% ownership
interest in Tempo Satellite, Inc. ("Tempo"), and (iii) a 20.86% aggregate
ownership interest in PRIMESTAR Partners.
Tempo holds a construction permit (the "Construction Permit") issued by the
Federal Communications Commission ("FCC") authorizing construction of a
direct broadcast satellite ("DBS") system. Tempo is also a party to a
construction agreement (the "Satellite Construction Agreement") with Space
Systems/Loral, Inc. ("Loral"), pursuant to which Loral is currently
constructing two high power communications satellites (the "Company
Satellites"). PRIMESTAR Partners, which was formed as a limited
partnership in 1990 by subsidiaries of TCIC, several other cable operators,
and General Electric Company, broadcasts satellite entertainment services
that are delivered to the home through PRIMESTAR By TCI and certain other
authorized distributors.
In the following text, the "Company" may, as the context requires, refer to
"TCI SATCO" (prior to the completion of the spinoff transaction described
in note 2), TSEI and its consolidated subsidiaries (subsequent to the
completion of the spinoff transaction described in note 2) or both.
Additionally, unless the context indicates otherwise, references to "TCI"
and "TCIC" herein are to TCI and TCIC and their respective consolidated
subsidiaries (other than the Company).
All significant inter-entity transactions have been eliminated.
As further discussed in note 6, the accompanying combined statements of
operations include allocations of certain costs and expenses of TCIC.
Although such allocations are not necessarily indicative of the costs that
would have been incurred by the Company on a stand-alone basis, management
believes the resulting allocated amounts are reasonable.
The accompanying interim financial statements are unaudited but, in the
opinion of management, reflect all adjustments (consisting of normal
recurring accruals) necessary for a fair presentation of the results of
such periods. The results of operations for any interim period are not
necessarily indicative of results for the full year. The unaudited interim
combined financial statements should be read in conjunction with the
Company's December 31, 1995 audited combined financial statements and notes
thereto.
(continued)
I-6
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Combined Financial Statements
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 at
the date of the financial statements and the reported amounts of revenue
and expenses during the reporting period. Actual results could differ from
those estimates.
(2) Spinoff Transaction
-------------------
On June 17, 1996, the Board of Directors of TCI (the "TCI Board") announced
its intention to spin off all the capital stock of the Company to the
holders of Tele-Communications, Inc. Series A TCI Group Common Stock (the
"Series A TCI Group Common Stock") and Tele-Communications, Inc. Series B
TCI Group Common Stock (the "Series B TCI Group Common Stock" and, together
with the Series A TCI Group Common Stock, the "TCI Group Common Stock").
The spinoff will be effected as a distribution (the "Distribution") by TCI
to holders of its TCI Group Common Stock of shares of the Series A Common
Stock of the Company (the "Series A Common Stock") and Series B Common
Stock of the Company (the "Series B Common Stock"). The Distribution will
not involve the payment of any consideration by the holders of TCI Group
Common Stock (such holders, the "TCI Group Stockholders"), and is intended
to qualify as a tax-free spinoff. The Distribution will occur on December
4, 1996, (the "Distribution Date") and will be made as a dividend to
holders of record of TCI Group Common Stock as of the close of business on
November 12, 1996 (the "Record Date").
Stockholders of record of TCI Group Common Stock on the Record Date will
receive one share of Series A Common Stock for each ten shares of Series A
TCI Group Common Stock owned of record at the close of business on the
Record Date and one share of Series B Common Stock for each ten shares of
Series B TCI Group Common Stock owned of record as of the close of business
on the Record Date. Fractional shares will not be issued. Fractions of
one-half or greater of a share will be rounded up and fractions of less
than one-half of a share will be rounded down to the nearest whole number
of shares of Series A Common Stock and Series B Common Stock.
Following the Distribution, the Company and TCI will operate independently,
and neither will have any stock ownership, beneficial or otherwise, in the
other. For the purposes of governing certain of the ongoing relationships
between the Company and TCI after the Distribution, and to provide
mechanisms for an orderly transition, the Company and TCI have entered, or
prior to the Distribution will enter, into various agreements, including
the "Reorganization Agreement," the "Fulfillment Agreement," the "TCIC
Credit Facility," the "Transition Services Agreement," an amendment to
TCI's existing "Tax Sharing Agreement" and the "Indemnification
Agreements."
(continued)
I-7
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Combined Financial Statements
Reorganization Agreement
The Reorganization Agreement will provide for, among other things, the
transfer to the Company of the assets of TCI SATCO, and for the assumption
by the Company of related liabilities. No consideration will be payable by
the Company for these transfers, except that two subsidiaries of the
Company will purchase TCIC's partnership interests in PRIMESTAR Partners
for consideration payable by delivery of promissory notes issued by such
subsidiaries, which notes will be assumed by TCI on or before the
Distribution Date, in the form of a capital contribution to the Company.
The Reorganization Agreement will also provide for certain cross-
indemnities designed to make the Company financially responsible for all
liabilities relating to the digital satellite business conducted by TCI
prior to the Distribution, as well as for all liabilities incurred by the
Company after the Distribution, and to make TCI financially responsible for
all potential liabilities of the Company which are not related to the
digital satellite business, including, for example, liabilities arising as
a result of the Company having been a subsidiary of TCI.
Pursuant to the Reorganization Agreement, on or before the Distribution
Date, the Company will issue to TCIC a promissory note (the "Company
Note"), in the principal amount of $250,000,000, representing a portion of
the Company's intercompany balance owed to TCIC on such date. See related
discussion below.
Pursuant to the Reorganization Agreement, the remainder of the Company's
intercompany balance owed to TCIC on the Distribution Date will be assumed
by TCI in the form of a capital contribution to the Company. In addition,
the Company will (i) assume TCI's obligations under options to be granted
on the Distribution Date to certain key employees of TCI (who are not
employees of the Company) representing, in aggregate, 2.5% of the shares of
Company Common Stock issued and outstanding on the Distribution Date, after
giving effect to the Distribution, and (ii) grant to TCI an option to
purchase up to 4,765,000 shares of Series A Common Stock, at an exercise
price of $1.00 per share, as required by TCI from time to time to meet its
obligations under the conversion features of the TCI Series D Preferred
Stock and the Convertible Notes due December 12, 2021, of TCI UA, Inc., as
such conversion features are adjusted as a result of the Distribution. See
related discussion below.
(continued)
I-8
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Combined Financial Statements
Fulfillment Agreement
TCIC historically has provided the Company with certain customer
fulfillment services for PRIMESTAR(R) customers enrolled by the Company's
direct sales force and National Call Center. Charges for such services have
been allocated to the Company by TCIC based on scheduled rates.
Pursuant to the Fulfillment Agreement entered into by TCIC and the Company,
TCIC will continue to provide fulfillment services to the Company following
the Distribution with respect to customers of the PRIMESTAR(R) medium power
service. Such services will include installation, maintenance, retrieval,
inventory management and other customer fulfillment services. The
Fulfillment Agreement will become effective on the first day of the month
following the Distribution Date. Among other matters, the Fulfillment
Agreement (i) sets forth the responsibilities of TCIC with respect to
fulfillment services, including performance standards and penalties for
non-performance, (ii) provides for TCIC's fulfillment sites to be
connected to the billing and information systems used by the Company,
allowing for on-line scheduling and dispatch of installation and other
service calls, and (iii) provides scheduled rates to be charged to the
Company for the various customer fulfillment services to be provided by
TCIC. The Company retains sole control under the Fulfillment Agreement to
establish the retail prices and other terms and conditions on which
installation and other services will be provided to the Company's
customers. The Fulfillment Agreement also provides that, during the term of
the Fulfillment Agreement, TCIC will not provide fulfillment services to
any other similar or competitive provider or distributor of television
programming services (other than traditional cable). The Fulfillment
Agreement will have an initial term of two years and is terminable, on 180
days notice to TCIC, by the Company at any time during the first six months
following the Distribution Date.
There can be no assurance that the terms of the Fulfillment Agreement are
not more or less favorable than those which could be obtained from
unaffiliated third parties, or that comparable services could be obtained
by the Company from third parties on any terms if the Fulfillment Agreement
is terminated. The cost to the Company of the services provided by TCIC
under the Fulfillment Agreement will exceed the current standard charges
allocated to the Company for such services, reflecting in part the value to
the Company, as determined by Company management, of the performance
standards, exclusivity, termination right and certain other provisions
included in the Fulfillment Agreement. See notes 1 and 6.
(continued)
I-9
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Combined Financial Statements
TCIC Credit Facility
TCIC has agreed to make loans to the Company from time to time up to an
aggregate outstanding principal amount of $500,000,000 (the ''TCIC
Revolving Loans''). The terms and conditions of the TCIC Revolving Loans
and Company Note will be provided for in a credit agreement, dated as of
the Distribution Date, between the Company and TCIC (the ''TCIC Credit
Facility''). The TCIC Revolving Loans and the Company Note will bear
interest at 10% per annum, compounded semi-annually. Commitment fees equal
to 3/8% of the average unborrowed availability of TCIC's $500,000,000
commitment under the TCIC Credit Facility will be payable to TCIC annually.
Proceeds from the TCIC Revolving Loans may be used to fund (i) working
capital requirements, (ii) capital expenditures contemplated by the October
1996 business plan of the Company, (iii) up to $75,000,000 of other capital
expenditures and investments and (iv) the commitment fees payable under the
TCIC Credit Facility. The TCIC Credit Facility requires the Company to use
its best efforts to obtain external debt or equity financing after the
Distribution Date. The TCIC Credit Facility further provides for mandatory
prepayment of the TCIC Revolving Loans and the Company Note if and in the
amount that the Company has obtained such external financing. Any such
prepayment from the proceeds of external financing is required to be
applied first to the Company Note and then to repay borrowings and
correspondingly reduce the commitments under the TCIC Credit Facility. The
outstanding principal of the TCIC Revolving Loans and the Company Note,
together with accrued interest, will be due and payable September 30, 2001,
the final maturity date of the TCIC Credit Facility, whether or not
sufficient external financing has then been obtained by the Company.
Borrowings under the TCIC Credit Facility are subject to, among other
things, (a) the Company's representations and warranties being true and
correct on the date of borrowing, (b) the Company's being in compliance
with its covenants in the TCIC Credit Facility, (c) no default having
occurred and being continuing on the borrowing date or being caused by such
borrowing and (d) the Company's being in compliance, in all material
respects, with the terms and conditions of the Indemnification Agreements,
the Transition Services Agreement, the Reorganization Agreement and the
Fulfillment Agreement. The TCIC Credit Facility sets forth the covenants
the Company has agreed to comply with during the term of the TCIC Credit
Facility, including its covenants (i) not to sell, transfer or otherwise
dispose of any asset (other than sales of inventory in the ordinary course
of business), without the prior written consent of TCIC (other than the
sale of assets or securities of a subsidiary if the aggregate consideration
payable to the seller in respect of such sale is not less than the fair
market value of such assets), (ii) not to merge into or consolidate or
combine with any other person, without the prior written consent of TCIC,
(iii) not to declare or pay any dividend or make any distribution on its
capital stock (other than in common stock), or purchase, redeem or
otherwise acquire or retire for value any capital stock of the Company,
(iv) to maintain specified minimum numbers of qualified subscribers from
December 31, 1996 through December 31, 1997, (v) not to incur indebtedness
at any time prior to and including December 31, 1997 that would exceed a
specified amount per qualified subscriber, (vi) to maintain specified
leverage ratios from January 1, 1998 through September 30, 2001, (vii) to
maintain specified minimum ratios of annualized cash flow to annual
interest expense and (viii) to maintain a specified minimum ratio of
annualized cash flow to pro forma debt service.
(continued)
I-10
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Combined Financial Statements
Transition Services Agreement
Pursuant to the Transition Services Agreement between TCI and the Company,
following the Distribution, TCI will provide to the Company certain
services and other benefits, including certain administrative and other
services that were provided by TCI prior to the Distribution. Pursuant to
the Transition Services Agreement, TCI has also agreed to provide the
Company with certain most-favored-customer rights to programming services
that TCI or a wholly-owned subsidiary of TCI may own in the future and
access to any volume discounts that may be available to TCI for purchase of
home satellite dishes, satellite receivers and other equipment. As
compensation for the services rendered and for the benefits made available
to the Company pursuant to the Transition Services Agreement, the Company
will pay TCI a monthly fee of $1.50 per qualified subscribing household or
other residential or commercial unit (counted as one subscriber regardless
of the number of satellite receivers), commencing with the month of
January, 1997, up to a maximum of $3,000,000 per month, and reimburse TCI
quarterly for direct, out-of-pocket expenses incurred by TCI to third
parties in providing the services. The Transition Services Agreement will
continue in effect until the close of business on December 31, 1999, and
will be renewed automatically for successive one-year periods thereafter,
unless earlier terminated by (i) either party at the end of the initial
term or the then current renewal term, as applicable, on not less than 180
days' prior written notice to the other party, (ii) TCI upon written notice
to the Company following certain changes in control of the Company, and
(iii) either party if the other party is the subject of certain bankruptcy
or insolvency-related events.
Indemnification Agreements
On or before the Distribution Date, the Company will enter into
Indemnification Agreements (the ''Indemnification Agreements'') with TCIC
and TCI UA 1, Inc. (''TCI UA 1''). The Indemnification Agreement with TCIC
will provide for the Company to reimburse TCIC for any amounts drawn under
an irrevocable transferable letter of credit issued for the account of TCIC
to support the Company's share of PRIMESTAR Partners' obligations under an
Amended and Restated Memorandum of Agreement, effective as of October 18,
1996, between the Partnership and GE Americom, with respect to PRIMESTAR
Partners' use of transponders on a medium power satellite (''GE-2''), to be
launched by GE Americom to replace the existing satellite used by PRIMESTAR
Partners (the "GE-2 Agreement"). The original drawable amount of such
letter of credit is $25,000,000, increasing to $75,000,000 if PRIMESTAR
Partners exercises its option under the GE-2 Agreement to extend the term
of such agreement for the remainder of the useful life of GE-2. See notes 4
and 7.
The Indemnification Agreement with TCI UA 1 will provide for the Company
to reimburse TCI UA 1 for any amounts drawn under an irrevocable
transferable letter of credit issued for the account of TCI UA 1 (the "TCI
UA 1 Letter of Credit"), which supports a credit facility (the "PRIMESTAR
Credit Facility") that was obtained by PRIMESTAR Partners to finance
advances to Tempo for payments due in respect of the construction of the
Company Satellites, and that is supported by letters of credit arranged for
by affiliates of all but one of the partners of PRIMESTAR Partners. See
note 7.
(continued)
I-11
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Combined Financial Statements
The Indemnification Agreements further provide for the Company to indemnify
and hold harmless TCIC and TCI UA 1 and certain related persons from and
against any losses, claims, and liabilities arising out of the respective
letters of credit or any drawings thereunder. The payment obligations of
the Company to TCIC and TCI UA 1 under such Indemnification Agreements will
be subordinated in right of payment with respect to certain future
obligations of the Company to financial institutions.
Other Arrangements
In June 1996, the TCI Board authorized TCI to permit certain of its
executive officers to acquire equity interests in certain of TCI's
subsidiaries. In connection therewith, the TCI Board approved the
acquisition by each of two executive officers of TCI who are not employees
of the Company (the ''TCI Officers''), of 1.0% of the net equity of the
Company. The TCI Board also approved the acquisition by an executive
officer of TCIC who is also the chief executive officer and a director of
the Company (the ''Company Officer''), of 1.0% of the net equity of the
Company and the acquisition by an executive officer of certain TCI
subsidiaries who is also a director, but not an employee, of the Company
(the ''TCI Subsidiary Officer''), of 0.5% of the net equity of the Company.
The TCI Board determined to structure such transactions as grants by the
Company to such persons of options to purchase shares of Series A Common
Stock representing 1.0% (in the case of each of the TCI Officers and the
Company Officer) and 0.5% (in the case of the TCI Subsidiary Officer) of
the shares of Series A Common Stock and Series B Common Stock issued and
outstanding on the Distribution Date, determined immediately after giving
effect to the Distribution, but before giving effect to any exercise of
such options. The aggregate exercise price for each such option is equal to
1.0% (in the case of each of the TCI Officers and the Company Officer) and
0.5% (in the case of the TCI Subsidiary Officer) of TCI's Net Investment
(as defined below) as of the first to occur of the Distribution Date and
the date on which such option first becomes exercisable, but excluding any
portion of TCI's Net Investment that as of such date is represented by a
promissory note or other evidence of indebtedness from the Company to TCI.
TCI's Net Investment is defined for this purpose as the cumulative amount
invested by TCI and its predecessor in the Company and its predecessors
prior to and including the applicable date of determination, less the
aggregate amount of all dividends and distributions made by the Company and
its predecessors to TCI and its predecessor prior to and including such
date. The options will be granted on the Distribution Date, will vest in
20% cumulative increments on each of the first five anniversaries of
February 1, 1996, and will be exercisable for up to ten years following
February 1, 1996. Pursuant to the Reorganization Agreement, and (in the
case of the TCI Officers and the TCI Subsidiary Officer) in partial
consideration for the capital contribution to be made by TCI to the Company
in connection with the Distribution, the Company has agreed, effective as
of the Distribution Date, to bear all obligations under such options and to
enter into stock option agreements with respect to such options with each
of the TCI Officers, the Company Officer and the TCI Subsidiary Officer.
(continued)
I-12
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Combined Financial Statements
In connection with the Distribution, TCI and the Company will also enter
into a ''Share Purchase Agreement'' to sell to each other from time to
time, at the then current market price, shares of Series A TCI Group Common
Stock and Series A Common Stock, respectively, as necessary to satisfy
their respective obligations after the Distribution Date under certain
stock options and stock appreciation rights held by their respective
employees and non-employee directors. At September 30, 1996, the maximum
number of shares of Series A Common Stock that would have been issuable by
the Company to TCI under the Share Purchase Agreement was 1,940,973. On or
prior to the Distribution, the Company will also enter into an amendment to
TCI's existing ''Tax Sharing Agreement.'' See note 6.
(3) Supplemental Disclosures to Combined Statements of Cash Flows
-------------------------------------------------------------
Cash paid for interest and income taxes was not material during the nine
months ended September 30, 1996 and 1995.
With the exception of certain non-cash transactions described in note 6,
transactions effected through the intercompany account with TCIC have been
considered to be constructive cash receipts and payments for purposes of
the accompanying combined statements of cash flows.
(4) Investment in PRIMESTAR Partners
--------------------------------
Summarized unaudited operating information for PRIMESTAR Partners is as
follows (amounts in thousands):
<TABLE>
<CAPTION>
Nine months ended
September 30,
----------------------
1996 1995
----------- ---------
<S> <C> <C>
Results of Operations
- - ---------------------
Revenue $ 294,634 108,033
Operating, selling,
general and administrative expenses (299,294) (145,112)
Depreciation and amortization (2,390) (2,116)
--------- --------
Operating loss (7,050) (39,195)
Other income, net 842 993
--------- --------
Net loss $ (6,208) (38,202)
========= ========
</TABLE>
PRIMESTAR Partners' indebtedness under the PRIMESTAR Credit Facility
aggregated $440,000,000 at September 30, 1996. The PRIMESTAR Credit Facility
matures on June 30, 1997 and borrowings thereunder are collateralized by
letters of credit issued by all but one of the general partners or their
affiliated designees. See notes 5 and 7.
(continued)
I-13
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Combined Financial Statements
PRIMESTAR Partners currently broadcasts from Satcom K-2 ("K-2"), a medium
power satellite that is nearing the end of its operational life. Although
the Company believes that GE-2 will be successfully deployed prior to the
expiration of the operational life of K-2, such deployment is dependent on
a number of factors that are outside of the Company's control and no
assurance can be given as to the successful deployment of GE-2. The
failure to deploy a fully operational satellite by the end of K-2's
operational life (or the operational life of any temporary in-orbit
replacement that might be available) could have a material adverse effect
on both the Company and PRIMESTAR Partners. See note 2.
PRIMESTAR Partners is obligated to make certain minimum lease payments
throughout the remaining operational life of K-2. Pursuant to the GE-2
Agreement, it is anticipated that PRIMESTAR Partners will be required to
make minimum lease payments for an initial term of four years from the date
of commercial operation, extendible, at the option of PRIMESTAR Partners
exercised prior to December 31, 1996, for the remainder of the operational
life of GE-2 (the "End-Of-Life Option"). See notes 2 and 7.
PRIMESTAR Partners provides programming services to the Company and other
authorized distributors in exchange for a fee based upon the number of
subscribers receiving the respective programming services. In addition,
PRIMESTAR Partners arranges for satellite capacity and uplink services, and
provides national marketing and administrative support services in exchange
for a separate authorization fee.
Under the PRIMESTAR Partners partnership agreement, the Company has agreed
to fund its share of any capital contributions and/or loans to PRIMESTAR
Partners that might be agreed upon from time to time by the partners of
PRIMESTAR Partners. Additionally, as a general partner of PRIMESTAR
Partners, the Company is liable as a matter of partnership law for all
debts of PRIMESTAR Partners in the event the liabilities of PRIMESTAR
Partners were to exceed its assets. PRIMESTAR Partners has contingent
liabilities related to legal and other matters arising in the ordinary
course of business. Management of PRIMESTAR Partners is unable at this
time to assess the impact, if any, of such matters on PRIMESTAR Partners'
results of operations, financial position or cash flows.
(5) Satellites under Construction
-----------------------------
Tempo DBS System
The Company, through Tempo, holds a Construction Permit issued by the FCC
authorizing construction of a DBS system consisting of two or more
satellites delivering DBS service in 11 frequencies at the 119 (Degrees)
West Longitude (''W.L.'') orbital position and 11 frequencies at the 166
(Degrees) W.L. orbital position. The 119 (Degrees) W.L. orbital position is
generally visible to home satellite dishes throughout all fifty states; the
166 (Degrees) W.L. orbital position is visible only in the western half of
the continental U.S. as well as Alaska and Hawaii.
(continued)
I-14
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Combined Financial Statements
Tempo is also a party to the Satellite Construction Agreement with Loral,
pursuant to which Tempo has agreed to purchase the Company Satellites at a
fixed contract price of $487,159,500, and has an option to purchase up to
three additional satellites. The cost of constructing the Company
Satellites is reflected in "Cost of satellites under construction" in the
accompanying combined balance sheets.
Construction of each of the Company Satellites has been completed. One of
the Company Satellites ("Satellite No. 1") has been outfitted with an
antenna suitable for operation at the 119 (Degrees) W.L. orbital location.
The other Company Satellite ("Satellite No. 2") has been outfitted with an
antenna suitable for operation at the 82 (Degrees) W.L. orbital location, a
Canadian DBS slot for which Telesat Canada, a Canadian corporation, not
related to the Company ("Telesat"), has received preliminary Canadian
governmental authorizations. As constructed, each Company Satellite can
operate in either ''single transponder'' mode (with 32 transponders
broadcasting at 113 watts per channel) or in "paired transponder" mode
(with 16 transponders broadcasting at 226 watts per channel). Each such
configuration can be selected at any time, either before or after launch.
The Company has arranged for the launch of Satellite No. 1 into the 119
(Degrees) W.L. orbital location on an Atlas rocket scheduled for launch
from Cape Canaveral by International Launch Services on behalf of Lockheed
Martin Corporation on February 27, 1997. If the launch of Satellite No. 1
is successful, the Company intends to operate such satellite in "paired
transponder" mode, broadcasting on 11 of the 16 available transponder
pairs, in accordance with the Construction Permit. The remaining five
transponder pairs would be available as in-orbit spares. The Company
believes that the signal broadcast by Satellite No. 1 operating in "paired
transponder" mode at 226 watts per channel, could be received by
households in the majority of the U.S. using home satellite dishes of less
than 14 inches in diameter.
The Company and PRIMESTAR Partners have been in discussions which
contemplate that the Company would make 100% of the capacity of Satellite
No. 1 available to PRIMESTAR Partners and that PRIMESTAR Partners would
reimburse the Company for the costs of operating such satellite. In such
event, PRIMESTAR Partners would also determine the disposition of Satellite
No. 2 and the Company would be unconditionally released from any obligation
it may have to repay PRIMESTAR Partners for its funding of the costs of
constructing and launching the Company Satellites. However, if the Company
and PRIMESTAR Partners are unable to reach agreement with respect to the
foregoing, the Company will consider other potential uses for the available
capacity on Satellite No. 1, which could include using such capacity to
provide its own DBS service. Such service, whether offered by PRIMESTAR
Partners or the Company, would be a limited service complementary to off-
the-air television, basic cable and other programming services, or subject
to future advances in digital channel compression, a full-service, stand-
alone offering. See related discussion below.
(continued)
I-15
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Combined Financial Statements
The Company does not currently have definite plans for deployment of
Satellite No. 2. The Company is currently engaged in discussions with
Telesat, with respect to the possible purchase of Satellite No. 2 by
Telesat, but there can be no assurance that any such transaction will
occur. If the Company does not enter into a binding agreement to sell
Satellite No. 2 by the end of this year, the Company currently intends to
place Satellite No. 2 in storage, for such future deployment or disposition
as the Company (or PRIMESTAR Partners if the potential agreement described
above is reached) may determine. The Company is currently in discussions
with Loral and other parties with respect to the possibility of obtaining
an additional launch window to be used as a backup for the Company's
February 1997 launch window. However, there can be no assurance that such a
launch window can be arranged at this time or will be available on terms
acceptable to the Company.
Competitive Position of the Company's Proposed High Power DBS System.
It is expected that the Company's proposed high power DBS system will
broadcast from 11 transponders at the 119 (Degrees) W.L. orbital position.
At current compression ratios, the Company's 11 transponders could be used
to broadcast 65 to 80 channels of entertainment and/or information
programming, depending on the type of programming. Although such a
programming service would have relatively limited channel capacity compared
to that of other DBS providers, the Company believes that such potential
competitive disadvantage may be offset in part (i) by the possibility of
using smaller (less than 14 inches in diameter) home satellite dishes and
(ii) by offering programming such as multiplexed premium movies, sports,
pay-per-view and a selection of popular cable networks on an "a la carte"
basis.
However, the Company does not currently have any agreements with PRIMESTAR
Partners or any programming vendors with respect to the operation of any
such DBS programming service, and does not currently have agreements with
any antenna manufacturers with respect to the purchase of sub-14 inch home
satellite dishes. No assurances can be given that any such agreements can
be obtained on terms satisfactory to the Company, or that the Company or
PRIMESTAR Partners will be successful in pursuing such a strategy, or will
not elect to pursue an alternative strategy with respect to Satellite No.
1.
(continued)
I-16
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Combined Financial Statements
Moreover, although advances in digital compression technology currently
under development may in the future enable the Company to obtain greater
channel capacity from the 11 transponders on Satellite No. 1, there can be
no assurance that such new technology will be successfully implemented or
that, if implemented, the Company or PRIMESTAR Partners will be able to
obtain the rights to use such technology on satisfactory terms. However,
Western Tele-Communications, Inc. ("WTCI"), an indirect subsidiary of
TCI, has agreed that if, prior to March 1, 1997, the Company engages WTCI
to provide digitization, compression and uplinking services for any high
power DBS system operated by the Company, and WTCI is then authorized to
use certain proprietary technology of Imedia Corporation currently under
development or other proprietary technologies to provide multiplexing of
digitally compressed video signals for the Company, WTCI shall provide such
multiplexing services to the Company for an agreed fee, based on WTCI's
incremental costs and other factors. The Company's rights under its
agreement with WTCI are assignable by the Company to any affiliate of the
Company, including for this purpose PRIMESTAR Partners.
If advanced digital compression technology becomes available to the
Company, such technology (or similar technology) will likely also be made
available to cable operators and/or other competitors of the Company and
PRIMESTAR Partners.
Satellite Launches
Pursuant to the Satellite Construction Agreement, following the launch of a
satellite, Loral will conduct in-orbit testing. Delivery of a satellite
takes place upon Tempo's acceptance of such satellite after completion of
in-orbit testing ("Delivery"). Subject to certain limits, Loral must
reimburse Tempo for Tempo's actual and reasonable expenses directly
incurred as a result of any delays in the Delivery of satellites. The in-
orbit useful life of each satellite is designed to be a minimum of 12
years. If in-orbit testing confirms that the satellite conforms fully to
specifications and the service life of the satellite will be at least 12
years, Tempo is required to accept the satellite. If in-orbit testing
determines that the satellite does not fully conform to specifications but
at least 50% of its transponders are functional and the service life of the
satellite will be at least six years, Tempo is required to accept the
satellite but is entitled to receive a proportionate decrease in the
purchase price. If Loral fails to deliver a satellite, it has 29 months to
deliver, at its own expense, a replacement satellite. Loral may make four
attempts to launch the two Company Satellites; however, if the two Company
Satellites are not delivered in such four attempts, Tempo may terminate the
Satellite Construction Agreement. Tempo also may terminate the contract in
the event of two successive satellite failures.
(continued)
I-17
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Combined Financial Statements
Loral has warranted that, until the satellites are launched, the satellites
will be free from defects in materials or workmanship and will meet the
applicable performance specifications. In addition, Loral has warranted
that all items other than the satellites delivered under the Satellite
Construction Agreement will be free from defects in materials or
workmanship for one year from the date of their acceptance and will perform
in accordance with the applicable performance specifications. Loral bears
the risk of loss of the Company Satellites until Delivery. Upon Delivery,
title and risk of loss pass to Tempo. However, Loral is obligated to carry
risk insurance on each satellite covering the period from the launch of the
satellite through an operating period of 180 days. Such risk insurance will
cover (i) the cost of any damages due under the Satellite Construction
Agreement; (ii) the cost of delivery of a replacement satellite in the
event of a satellite failure; and (iii) the refund of the full purchase
price for each undelivered Company Satellite if Loral fails to deliver both
Company Satellites after four attempts. Loral is also required to obtain
insurance indemnifying Tempo from any third party claims arising out of the
launch of a satellite.
Tempo Option
In February 1990, Tempo entered into an option agreement with PRIMESTAR
Partners (the "Option Agreement"), granting PRIMESTAR Partners the right
and option (the "Tempo Option"), upon exercise, to purchase or lease 100%
of the capacity of the DBS system to be built, launched and operated by
Tempo pursuant to the Construction Permit. Under the Option Agreement, upon
the exercise of the Tempo Option, PRIMESTAR Partners would be obligated to
pay Tempo $1,000,000 (the "Exercise Price") and lease or purchase the
entire capacity of the DBS system with the purchase price (or aggregate
lease payments) being sufficient to cover the costs of constructing,
launching and operating such DBS system. In connection with the Tempo
Option and certain related matters, Tempo and PRIMESTAR Partners
subsequently entered into two letter agreements (the "Tempo Letter
Agreements"), which provided for, among other things, the funding by
PRIMESTAR Partners of milestone and other payments due under the Satellite
Construction Agreement, and certain related costs, through advances by
PRIMESTAR Partners to Tempo. PRIMESTAR Partners financed such advances to
Tempo through borrowings under the PRIMESTAR Credit Facility which was in
turn supported by letters of credit arranged for by affiliates of all but
one of the partners of the Partnership. The aggregate funding provided to
Tempo by PRIMESTAR Partners is reflected in "Due to PRIMESTAR Partners"
in the accompanying combined balance sheets. At September 30, 1996, the
amount borrowed by PRIMESTAR Partners under the PRIMESTAR Credit Facility
was $440,000,000, including accrued interest. See note 4.
The Tempo Letter Agreements permit PRIMESTAR Partners to apply its advances
to Tempo against any payments (other than the Exercise Price) due under the
Tempo Option and would not require Tempo to repay such advances unless
PRIMESTAR Partners elected to stop funding amounts due under the Satellite
Construction Agreement or failed to exercise the Tempo Option within the
period provided for in the Tempo Letter Agreements, in which event Tempo
could, in lieu of making such repayment, elect to assign all of its rights
relating to the Company Satellites to PRIMESTAR Partners.
(continued)
I-18
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Combined Financial Statements
On February 29, 1996, Tempo notified PRIMESTAR Partners of Tempo's belief
that PRIMESTAR Partners had failed to effectively exercise the Tempo Option
and that such failure had resulted in the termination of the Tempo Option
pursuant to the Tempo Letter Agreements. In that connection, Tempo advised
PRIMESTAR Partners that, based on and assuming the effective termination of
the Tempo Option, Tempo would reimburse PRIMESTAR Partners for its advances
to Tempo by assuming PRIMESTAR Partner's indebtedness for borrowed money
under the PRIMESTAR Credit Facility, to the extent used to fund such
advances.
Tempo's belief that PRIMESTAR Partners failed to effectively exercise the
Tempo Option is based, among other things, on the fact that despite
PRIMESTAR Partners' notice to Tempo at the July 29, 1994 meeting of the
Partners Committee of its exercise of the Tempo Option, since such date,
PRIMESTAR Partners has failed to take any of the actions contemplated by
the Option Agreement to be taken following exercise of the Tempo Option,
including (i) advising Tempo whether it intends to purchase or lease the
capacity of the DBS system referred to in the Option Agreement, (ii)
negotiating an agreement of purchase or lease with Tempo and (iii) paying
Tempo the Exercise Price. Moreover, in December 1995, a representative of
PRIMESTAR Partners informed the Company that the July 1994 exercise of the
Tempo Option had been intended as a conditional exercise, although
conditional exercises are not contemplated by the Option Agreement, and
that the conditions upon which the Tempo Option had purportedly been
exercised had not been met.
Counsel for PRIMESTAR Partners subsequently notified Tempo that PRIMESTAR
Partners disagreed with the positions advanced by Tempo in the February 29
letter and believed that PRIMESTAR Partners had effectively and irrevocably
exercised the Tempo Option and was asserting certain rights to the Company
Satellites. Counsel for PRIMESTAR Partners also advised Tempo that
PRIMESTAR Partners would impede any attempt by Tempo to repay PRIMESTAR
Partners' advances. The Partners Committee of PRIMESTAR Partners has
failed, however, to vote to confirm that PRIMESTAR Partners has irrevocably
and unconditionally exercised the Tempo Option. The Company believes that
PRIMESTAR Partners' position is based primarily on equitable arguments
relating to the advances made by PRIMESTAR Partners to Tempo under the
Tempo Letter Agreements and their misreading of the terms of the Option
Agreement and the Tempo Letter Agreements. The Company believes the
PRIMESTAR Partners' claims regarding the Company Satellites and the Tempo
Option are without merit, but there can be no assurance that Tempo's
position would prevail in the event of any litigation regarding this
controversy.
(continued)
I-19
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Combined Financial Statements
The Company and PRIMESTAR Partners are currently attempting to resolve
their disagreement regarding the Tempo Option. In that connection, the
Company and PRIMESTAR Partners have discussed the alternatives available to
the Company for deployment of the Company Satellites and the terms and
provisions under which the Company would make available to PRIMESTAR
Partners 100% of the capacity of one or more Company Satellites as so
deployed. Although the Company and PRIMESTAR Partners have not reached
agreement with respect to any such resolution of their dispute, and there
can be no assurance that any such resolution can be reached, or can be
reached on terms acceptable to the Company, the Company does currently
believe that its dispute with PRIMESTAR Partners will be resolved and does
not believe that such dispute or its resolution is reasonably likely to
have a material adverse effect on the Company.
Regardless of the outcome of the uncertainties with respect to the Company
Satellites, the Company believes that, although no assurance can be given,
alternative courses of action are available that would allow the Company to
recover the Company's costs of constructing the Company Satellites.
(6) Transactions with Related Parties
---------------------------------
The effects of all transactions between the Company and TCIC have been
reflected as adjustments to the non-interest bearing intercompany account
between the Company and TCIC. For a description of certain agreements that
the Company and TCI will enter into in connection with the Distribution,
see note 2.
TCIC provides certain installation, maintenance, retrieval and other
customer fulfillment services to the Company. The costs associated with
such services have been allocated to the Company based upon a standard
charge for each of the various customer fulfillment activities performed by
TCIC. During the nine months ended September 30, 1996 and 1995, the
Company's capitalized installation costs included amounts allocated from
TCIC of $37,470,000 and $38,424,000, respectively. Maintenance, retrieval
and other operating expenses allocated from TCIC to the Company aggregated
$16,446,000 and $11,138,000 during the nine months ended September 30, 1996
and 1995, respectively. Following the Distribution, charges for customer
fulfillment services provided by TCIC will be made pursuant to the
Fulfillment Agreement. See note 2.
TCIC also provides corporate administrative services to the Company.
Charges for such administrative services, which were allocated from TCIC to
the Company based primarily on the estimated cost of providing the service,
aggregated $14,600,000 and $4,103,000 during the nine months ended
September 30, 1996 and 1995, respectively. Following the Distribution,
charges for administrative services provided by TCIC will be made pursuant
to the Transition Services Agreement. See note 2.
(continued)
I-20
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Combined Financial Statements
Certain key employees of the Company hold stock options in tandem with
stock appreciation rights with respect to certain common stock of TCI.
Estimates of the compensation related to the options and/or stock
appreciation rights granted to employees of the Company have been recorded
in the accompanying financial statements, but are subject to future
adjustment based upon the market value of the underlying TCI common stock
and, ultimately, on the final determination of market value when the rights
are exercised. Non-cash increases (decreases) to the Company's share of
TCI's estimated stock compensation liability, which are included in the
above-described TCIC administrative expense allocations, aggregated
$(553,000) and $179,000 during the nine months ended September 30, 1996 and
1995, respectively.
A tax sharing agreement (the "Tax Sharing Agreement") among TCIC and
certain other subsidiaries of TCI was implemented effective July 1, 1995.
The Tax Sharing Agreement formalizes certain of the elements of a pre-
existing tax sharing arrangement and contains additional provisions
regarding the allocation of certain consolidated income tax attributes and
the settlement procedures with respect to the intercompany allocation of
current tax attributes. The Tax Sharing Agreement encompasses U.S.
Federal, state, local and foreign tax consequences and relies upon the U.S.
Internal Revenue Code of 1986 as amended, and any applicable state, local
and foreign tax law and related regulations. Beginning on the July 1, 1995
effective date, TCIC is responsible to TCI for its share of current
consolidated income tax liabilities. TCI is responsible to TCIC to the
extent that TCIC's income tax attributes generated after the effective date
are utilized by TCI to reduce its consolidated income tax liabilities.
Accordingly, all tax attributes generated by TCIC's operations after the
effective date including, but not limited to, net operating losses, tax
credits, deferred intercompany gains and the tax basis of assets are
inventoried and tracked for the entities comprising TCIC. The Company's
intercompany income tax allocation for the nine months ended September 30,
1996 and the three months ended September 30, 1995, has been calculated in
accordance with the Tax Sharing Agreement, and is not materially different
from the intercompany allocation that would have been calculated under the
pre-existing tax sharing arrangement. In connection with the Distribution,
the Tax Sharing Agreement will be amended to provide that the Company will
be treated as if it had been a party to the Tax Sharing Agreement effective
July 1, 1995.
On February 22, 1995, the assets (primarily property and equipment) and
liabilities comprising PRIMESTAR By TCI were transferred from certain
subsidiaries of TCIC to the predecessor of TSEI. In connection therewith,
the Company recorded a non-cash $12,136,000 increase to the intercompany
amount owed to TCIC, and a non-cash $12,136,000 decrease to the Company's
deferred tax liability.
(7) Commitments and Contingencies
-----------------------------
At September 30, 1996, the Company's future minimum commitments to purchase
satellite reception equipment aggregated approximately $25,500,000.
(continued)
I-21
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Combined Financial Statements
The Company has engaged master sales agents (the "Master Agents") to
recruit, train and maintain a network of sub-agents to sell services on
behalf of the Company and to install, service and maintain equipment
located at the premises of the subscribers. As a part of the compensation
paid for such services, the Company has agreed to pay certain residual
sales commissions equal to a percentage of the programming revenue
collected from subscribers installed by Master Agents during specified
periods following the initiation of service (generally five years).
Residual payments to Master Agents aggregated $7,887,000 and $739,000
during the nine months ended September 30, 1996 and 1995, respectively.
TCI UA 1 has arranged for the issuance of the TCI UA 1 Letter of Credit to
support the Company's pro rata share of the PRIMESTAR Credit Facility. The
amount of the TCI UA 1 Letter of Credit was $141,250,000 at September 30,
1996. In connection with the Distribution, the Company will agree to
indemnify TCI for any loss, claim or liability that TCI may incur by reason
of the TCI UA 1 Letter of Credit. See notes 2, 4 and 5.
TCIC has arranged for the issuance of a standby letter of credit to support
the Company's share of PRIMESTAR Partners' obligations under the GE-2
Agreement with respect to PRIMESTAR Partners' use of GE-2. The original
maximum drawable amount of such letter of credit is approximately
$25,000,000, increasing to approximately $75,000,000 if PRIMESTAR Partners
exercises the End-Of-Life Option, as described in note 4. In connection
with the Distribution, the Company will agree to indemnify TCIC for any
loss, claim or liability that TCIC may incur by reason of this standby
letter of credit. See note 2.
At September 30, 1996, the Company had guaranteed approximately $2,000,000
of certain minimum commitments of PRIMESTAR Partners to purchase satellite
reception equipment.
The Company has contingent liabilities related to legal proceedings and
other matters arising in the ordinary course of business. In the opinion
of management, it is expected that amounts, if any, which may be required
to satisfy such contingencies will not be material in relation to the
accompanying combined financial statements.
(8) Subsequent Events
-----------------
Change in Accounting
During the fourth quarter of 1996, the Company began to assess the
accounting for a recently implemented marketing program that allows
subscribers to purchase the Company's proprietary satellite reception
equipment at a price that is less than the Company's cost.
(continued)
I-22
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Combined Financial Statements
After considering current accounting practices in similar industries,
relevant accounting literature and other factors, the Company concluded
that the most appropriate depreciation policy for its subscriber
installation costs was to depreciate subscriber installation costs on a
straight line basis over the estimated average life of a subscriber, and
charge to depreciation expense the unamortized balance of installation
costs associated with customers who have terminated service with the
Company. The Company believes the new policy is more appropriate than the
prior method since, under the new policy, subscriber installation costs
associated with subscribers whose service has been terminated are no longer
carried on the Company's balance sheet after the date of termination. This
change will be adopted effective October 1, 1996 and will be treated as a
change in accounting policy that is inseparable from a change in estimate.
Accordingly, the cumulative effect of such change for periods prior to
October 1, 1996, together with the fourth quarter 1996 effect of such
change, will be included in the Company's depreciation expense for the
fourth quarter of 1996. Had the new policy been applied as of September 30,
1996, the inception-to-date effect of such application would have resulted
in increases to the Company's depreciation expense and net loss of
$44,679,000 (including $8,754,000 related to periods prior to January 1,
1996) and $26,807,000 (including $5,252,000 related to periods prior to
January 1, 1996), respectively. The fourth quarter 1996 effect of this
change in accounting will, in part, be a function of the subscriber churn
rate experienced by the Company during the remainder of 1996.
In connection with the aforementioned discussion of the Company's
accounting policies with respect to subscriber installation costs, the
Company also determined that a reduction in the estimated useful life of
certain satellite reception equipment was appropriate in light of certain
changes in the Company's expectations with respect to technological and
other factors. This change in estimate will be given effect on a
prospective basis as of October 1, 1996. Based on the September 30, 1996
historical cost of the satellite reception equipment that is subject to
such change in useful life, the Company estimates that the annualized
effect of such change would have been an increase of $18,368,000 and
$11,021,000 to depreciation expense and net loss, respectively.
(continued)
I-23
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Combined Financial Statements
ResNet Transaction
Effective as of October 21, 1996, the Company acquired 4.99% of the issued
and outstanding capital stock of ResNet Communications, Inc., a Delaware
corporation ("ResNet") for a purchase price of $5,396,000. ResNet was
formed by LodgeNet Entertainment Corporation, a Delaware corporation, in
February 1996 to engage in the business of providing video services to
subscribers in multiple dwelling units (the "ResNet Business"). ResNet
agreed to purchase from the Company up to $40 million in satellite
reception equipment to be used in connection with the ResNet Business
exclusively, over a five year period (subject to a one-year extension at
the option of ResNet if ResNet has not purchased the full $40 million in
equipment during the five-year initial term). The Company also agreed to
make a subordinated convertible term loan to ResNet, in the principal
amount of $34,604,000, the proceeds of which can be used only to purchase
such equipment from the Company. The term of the loan is five years with an
option by ResNet to extend the term for one additional year. The total
principal and accrued and unpaid interest under the loan is convertible
over a four-year period into shares of common stock of ResNet that will
provide the Company with the right to acquire an additional 32% of the
issued and outstanding common stock of ResNet. The Company's only recourse
with respect to repayment of the loan is conversion into ResNet stock or
warrants as described below. Under current interpretations of the FCC rules
and regulations related to restrictions on the provision of cable and
satellite master antenna television services in certain areas, the Company
could be prohibited from holding 5% or more of the stock of ResNet and
consequently could not exercise the conversion rights under the convertible
loan agreement. The Company is required to convert the convertible loan at
such time as conversion would not violate such currently applicable
regulatory restrictions. In addition, ResNet granted the Company an option
to acquire an additional 13.01% of the issued and outstanding common stock
of ResNet at appraised fair market value at the time of exercise of the
option. The option is exercisable between December 21, 1999 and the
maturity of the convertible loan. Upon the maturity date of the convertible
loan, if the Company has been prevented from converting the loan or
exercising the option in full due to the previously described regulatory
restrictions, ResNet will issue warrants to the Company to acquire the
stock that has not been issued pursuant to conversion of the loan and the
stock that the Company has a right to acquire by exercise of the option.
The exercise price of the warrants to be issued in respect of the
convertible loan will be de minimis, and the exercise price of the warrants
to be issued in respect of the option will be equivalent to the exercise
price under such option. The Company has agreed to customary standstill
provisions with respect to acquisitions of more than 10% of the outstanding
stock of LodgeNet and any additional shares of ResNet.
(continued)
I-24
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Combined Financial Statements
The Company also entered into a long-term signal availability agreement
with ResNet, pursuant to which the Company will transport to certain
defined private cable systems owned and operated by ResNet, the satellite
signal used by PRIMESTAR Partners to transmit the PRIMESTAR(R) programming
service (the "PRIMESTAR Satellite Signal") or the signal of a
substantially comparable service. The Company is acting solely to make the
PRIMESTAR Satellite Signal available to ResNet and is not acting as a
distributor of any PRIMESTAR(R) programming services to ResNet. ResNet must
obtain its own rights from the applicable programming networks to receive
the programming services and to distribute them to ResNet's subscribers.
WTCI has the right from PRIMESTAR Partners to use the PRIMESTAR Satellite
Signal for delivery of programming for the benefit of third parties,
including private cable systems (the "Simultaneous Use Rights"). WTCI has
agreed with the Company that private cable systems designated by the
Company, including the ResNet private cable systems, will receive the
transport of the PRIMESTAR Satellite Signal by WTCI in exchange for the
payment by the Company of a fee per subscriber per video program signal.
The agreement between the Company and WTCI is coexistive with the agreement
between WTCI and PRIMESTAR Partners expiring on March 31, 2001, and there
is no assurance that the Company will continue to have the ability to make
the PRIMESTAR Satellite Signal available after that date. In its agreement
with ResNet, the Company has committed to make the PRIMESTAR Satellite
Signal or the signal of a substantially comparable service available for a
term that extends substantially beyond March 31, 2001. If the Company loses
its contractual ability to make the PRIMESTAR Satellite Signal available
and is not able to make the signal of a substantially comparable service
available, the Company is obligated to reimburse ResNet for its costs in
obtaining a digital signal from another source, including the cost of
replacement equipment if the new digital signal is not comparable with
ResNet's equipment. While it is not possible at this time to quantify the
amount that the Company would be obligated to pay to ResNet under the
circumstances described above, the Company believes that the costs could be
significant, particularly if it were to lose its ability to make a signal
available towards the end of its agreement with ResNet.
Counsel to PRIMESTAR Partners has advised the Company of PRIMESTAR
Partners' position that there are certain preconditions to WTCI's
Simultaneous Use Rights which have not yet been satisfied and that such
rights are not assignable by WTCI to the Company. The Company believes that
its transaction with ResNet and similar transactions are permitted under
the agreements between WTCI and PRIMESTAR Partners. The Company does not
believe that any potential dispute with PRIMESTAR Partners regarding this
issue is likely to have a material adverse effect on the Company.
I-25
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1 to the accompanying combined financial statements)
Management's Discussion and Analysis of Financial Condition and
- - ---------------------------------------------------------------
Results of Operations
---------------------
General
- - -------
The following discussion and analysis provides information concerning the
financial condition and results of operations of the Company and should be read
in conjunction with the Company's historical combined financial statements.
The following discussion contains certain forward-looking statements
regarding future subscriber churn rates, future financial performance and other
matters. Such statements involve many risks and uncertainties that could cause
actual results to differ materially from such statements.
Material Changes in Results of Operations
- - -----------------------------------------
As described in greater detail below, the Company reported net losses of
$56,594,000 and $22,386,000 during the nine months ended September 30, 1996 and
1995, respectively. Improvements in the Company's results of operations are
largely dependent upon its ability to increase its customer base while
maintaining its pricing structure, reducing subscriber churn and effectively
managing the Company's costs. No assurance can be given that any such
improvements will occur. In addition, the Company incurs significant sales
commission and installation costs when its customers initially subscribe to the
service. Accordingly, management expects that operating costs will remain high
as a percentage of revenue so long as the Company maintains its rapid growth in
subscribers. The high cost of obtaining new subscribers also magnifies the
negative effects of subscriber churn.
During the nine months ended September 30, 1996, and the years ended
December 31, 1995, 1994 and 1993, (i) the Company's subscriber churn rate (which
represents the number of subscriber terminations divided by the weighted average
number of subscribers during the period) was 38.9%, 24.7%, 16.1% and 23.2%,
respectively, and (ii) the average subscriber life implied by such subscriber
churn rate was 2.6 years, 4.1 years, 6.2 years and 4.3 years, respectively.
As set forth above, the Company has experienced an increase during 1996 in
the rate of subscriber churn, as compared to prior periods. The Company believes
that the higher 1996 subscriber churn rate is primarily attributable to
identifiable circumstances that are not expected to have a continuing impact. In
general, these circumstances stemmed from the Company's efforts to maximize its
subscriber growth during the fourth quarter of 1995 and the first three quarters
of 1996. See related discussion below.
(continued)
I-26
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1 to the accompanying combined financial statements)
Material Changes in Results of Operations (continued)
- - -----------------------------------------------------
One result of the Company's subscriber maximization efforts, which
included, for example, marketing programs that allowed subscribers to initiate
service by paying 33% of the normal installation fee with no credit approval
(the "33% Install Program"), was that the Company added, during the fourth
quarter of 1995 and the first three quarters of 1996, a significant number of
customers whose service was terminated during 1996 after their accounts became
delinquent. As set forth below, such delinquent accounts contributed to a
significant increase in the Company's bad debt expense during 1996. The Company
has addressed this issue by implementing more stringent credit policies. In this
regard, the Company began to institute more selective credit policies during the
third quarter of 1996 and further tightened such policies during the fourth
quarter of 1996. The Company believes that a significant percentage of the
subscribers whose service was terminated during 1996 would not have been allowed
to initiate service if the credit policies that are currently in effect had been
in place during 1995.
Although no assurance can be given, the Company expects future churn rates
to be more consistent with its previous annual history. If the Company's churn
rates were to continue at 1996 levels or increase, the Company believes that its
financial condition and results of operations would be adversely affected.
In October 1996, the Company initiated a marketing program that allows
subscribers to purchase the Company's proprietary satellite reception equipment
at a price that is less than the Company's cost. There is no assurance that the
difference between the Company's costs and the revenue generated from the sale
of the equipment would be recoverable. To date, the number of customers
selecting this marketing program has been insignificant. The Company cannot
presently predict whether a significant number of customers will take advantage
of this marketing program in the future.
Since July 1994, when PRIMESTAR Partners completed its conversion from an
analog to a digital signal, the Company has experienced significant growth in
Authorized Units. In this regard, the number of Authorized Units was 735,000
and 345,000 at September 30, 1996 and 1995, respectively, and 535,000, 100,000
and 35,000 at December 31, 1995, 1994 and 1993, respectively. To the extent not
otherwise described, increases in the Company's revenue and operating, selling,
general and administrative expenses, as detailed below, are primarily related to
such growth in Authorized Units. The Company is operating in an increasingly
competitive environment. No assurance can be given that such increasing
competition will not adversely affect the Company's ability to continue to
achieve significant growth in Authorized Units and revenue.
(continued)
I-27
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1 to the accompanying combined financial statements)
Material Changes in Results of Operations (continued)
- - -----------------------------------------------------
TCIC has historically provided the Company with certain customer
fulfillment services for PRIMESTAR(R) customers enrolled by the Company's direct
sales force or National Call Center. Charges for such services have been
allocated to the Company by TCIC based on scheduled rates. TCIC will continue to
provide fulfillment services to the Company following the Distribution with
respect to customers of the PRIMESTAR(R) medium power service, pursuant to the
Fulfillment Agreement. For a description of the Fulfillment Agreement, see note
2 to the accompanying combined financial statements of the Company.
Installation charges from TCIC include direct and indirect costs of
performing installations. The Company has capitalized a portion of such charges
based upon amounts charged by unaffiliated third parties to perform similar
services. Following the Distribution, the Company will capitalize the full
amount of installation fees paid to TCIC pursuant to the Fulfillment Agreement.
Additionally, the scheduled rates for the services to be provided by TCIC under
the Fulfillment Agreement exceed the scheduled rates upon which charges,
historically, have been allocated to the Company for such services, reflecting
in part the value to the Company, as determined by Company management, of the
performance standards, exclusivity, termination right and certain other
provisions included in the Fulfillment Agreement. In this regard, the
installation charges allocated to the Company by TCIC aggregated $45,313,000 and
$46,600,000 during the nine months ended September 30, 1996 and 1995,
respectively. If the Fulfillment Agreement had been in effect on January 1,
1995, the estimated installation fees payable by the Company to TCIC would have
been $59,727,000 and $61,310,000 during the nine months ended September 30, 1996
and 1995, respectively. The amounts payable in future periods by the Company to
TCIC under the Fulfillment Agreement will be dependent upon the level of
fulfillment services provided by TCIC to the Company.
In connection with the Distribution, the Company and TCI also will enter
into the Transition Services Agreement, the Stock Option Agreements and the TCIC
Credit Facility. In general, such agreements will result in increases in the
expenses to be incurred by the Company following the Distribution, as compared
to the amounts allocated to the Company by TCI prior to the Distribution.
(continued)
I-28
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1 to the accompanying combined financial statements)
Material Changes in Results of Operations (continued)
- - -----------------------------------------------------
Certain financial information concerning the Company's operations is
presented below (dollar amounts in thousands):
<TABLE>
<CAPTION>
Nine months ended September 30,
------------------------------------------------
1996 1995
----------------------- -----------------------
Percentage Percentage
of total of total
Amount revenue Amount revenue
---------- ----------- ---------- -----------
<S> <C> <C> <C> <C>
Revenue:
Programming and equipment rental $ 249,439 83% $ 73,352 61%
Installation 50,810 17 47,067 39
---------- ----------- ---------- -----------
Total revenue 300,249 100 120,419 100
---------- ----------- ---------- -----------
Operating costs and expenses:
Charges from PRIMESTAR Partners:
Programming (88,007) (29) (29,981) (25)
Satellite, marketing and distribution (46,781) (16) (14,148) (12)
---------- ----------- ---------- -----------
(134,788) (45) (44,129) (37)
Other operating:
Allocations from TCIC (16,446) (5) (11,138) (9)
Other (7,463) (3) (1,665) (2)
---------- ----------- ---------- -----------
(23,909) (8) (12,803) (11)
Selling, general and administrative:
Selling and marketing (81,554) (27) (41,352) (34)
Bad debt (14,179) (5) (2,745) (2)
Allocations from TCIC (14,600) (5) (4,103) (4)
Other general and administrative (25,280) (8) (8,327) (7)
---------- ----------- ---------- -----------
(135,613) (45) (56,527) (47)
---------- ----------- ---------- -----------
Operating income before
depreciation and amortization (1) 5,939 2 6,960 6
Depreciation (87,205) (29) (31,881) (26)
---------- ----------- ---------- -----------
Operating loss $ (81,266) (27)% $(24,921) (21)%
========== =========== ========== ===========
</TABLE>
____________________
(1) Operating income before depreciation and amortization ("Operating Cash
Flow") is a commonly used measure of value and borrowing capacity within
the Company's industry, and is not intended to be a substitute for a
measure of performance in accordance with generally accepted accounting
principles and should not be relied upon as such.
(continued)
I-29
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1 to the accompanying combined financial statements)
Material Changes in Results of Operations (continued)
- - -----------------------------------------------------
Revenue increased $179,830,000 or 149% during the nine months ended
September 30, 1996, as compared to the corresponding prior year period.
Exclusive of installation revenue, the Company's average monthly revenue per
Authorized Unit increased from $40 during the 1995 period to $44 during the 1996
period. Such increase occurred as the positive effects of (i) an increase in
the average monthly revenue derived from premium and pay-per-view services and
(ii) a March 1995 increase in the monthly equipment rental fee more than offset
the effects of a 1996 promotional campaign that provided certain new customers
with one month of free service. The average revenue earned for each Authorized
Unit installed decreased from $168 during the 1995 period to $132 during the
1996 period. Such decrease is primarily attributable to certain promotional
campaigns that were in effect during the 1996 period.
PRIMESTAR Partners provides programming services to the Company and other
authorized distributors in exchange for a fee based upon the number of
Authorized Units receiving the respective programming services. PRIMESTAR
Partners also arranges for satellite capacity and uplink services, and provides
national marketing and administrative support services, in exchange for a
separate authorization fee from each distributor, including the Company, based
on such distributor's total number of Authorized Units. The aggregate charges
for such programming and other services increased $90,659,000 or 205% during the
nine months ended September 30, 1996, as compared to the corresponding prior
year period. The average aggregate monthly amount per Authorized Unit charged
by PRIMESTAR Partners was $24 during both of the 1996 and 1995 periods. For
additional information concerning the operations of PRIMESTAR Partners, see
related discussion below.
Other operating costs and expenses, which are primarily comprised of
amounts related to customer fulfillment activities, increased $11,106,000 or 87%
during the nine months ended September 30, 1996, as compared to the
corresponding prior year period. Most of such operating costs and expenses were
allocated from TCIC to the Company based upon a standard charge for each of the
various customer fulfillment activities performed by TCIC. As discussed above,
TCIC and the Company have entered into a Fulfillment Agreement with respect to
installation, maintenance, retrieval and other customer fulfillment services to
be provided by TCIC following the Distribution.
Selling, general and administrative expenses increased $79,086,000 or 140%
during the nine months ended September 30, 1996, as compared to the
corresponding prior year period. Selling and marketing expenses, which
represented 27% of revenue during the 1996 period, include sales commissions,
marketing and advertising expenses, and costs associated with the operation of a
customer service call center. Bad debt expense represented 5% of revenue during
the 1996 period. The Company is attempting to reduce the percentage of revenue
represented by selling, marketing and bad debt expenses. No assurance can be
given that such attempts will be successful. See related discussion above.
General and administrative allocations from TCIC are generally based upon
the estimated cost of the general and administrative services provided to the
Company. Following the Distribution, charges for administrative services
provided by TCIC will be made pursuant to the Transition Services Agreement.
For additional information, see related discussion above and note 2 to the
accompanying combined financial statements of the Company.
(continued)
I-30
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1 to the accompanying combined financial statements)
Material Changes in Results of Operations (continued)
- - -----------------------------------------------------
The $55,324,000 or 174% increase in depreciation during the nine months
ended September 30, 1996, as compared to the corresponding prior year period, is
the result of increases in the Company's depreciable assets that are due
primarily to capital expenditures with respect to the Company's satellite
reception equipment. Effective October 1, 1996, the Company will effect two
changes in its depreciation policies and estimates. The inception-to-date effect
of one of the changes will be recorded during the fourth quarter of 1996 and the
effect of the other change will be accounted for on a prospective basis. For
additional information concerning the nature and quantified effects of such
accounting changes, see note 8 to the accompanying combined financial statements
of the Company.
The Company's share of PRIMESTAR Partners' net losses decreased $6,674,000
or 82% during the nine months ended September 30, 1996, as compared to the
corresponding prior year period. Such decrease is primarily attributable to a
significant increase in the revenue derived by PRIMESTAR Partners' from the
Company and other distributors of PRIMESTAR Partners' programming.
Historically, PRIMESTAR Partners' operating deficits have been funded by capital
contributions from the Company and the other partners of PRIMESTAR Partners. To
the extent that future Authorized Unit growth does not generate increases in
PRIMESTAR Partners' revenue sufficient to offset its operating costs and
expenses, the Company anticipates that any such operating deficit would be
funded by PRIMESTAR Partners' then existing external sources of liquidity (which
may include capital contributions from the Company and PRIMESTAR Partners' other
partners), or by increases in the above-described programming and authorization
fees charged by PRIMESTAR Partners to the Company and other authorized
distributors.
The Company's income tax benefit was $25,806,000 and $10,433,000 during the
nine months ended September 30, 1996 and 1995, respectively. The effective tax
rate associated with such benefits was 31% and 32%, respectively. In connection
with the Distribution, the Company expects to become a party to the Tax Sharing
Agreement that currently exists among TCI, TCIC and certain other subsidiaries
of TCI. For additional information, see note 6 to the accompanying combined
financial statements of the Company. The Company's income tax benefits include
intercompany allocations from TCI of current income tax benefits of $44,454,000
and $16,612,000 during the nine months ended September 30, 1996 and 1995,
respectively. Following the Distribution the Company will cease to be a part of
the TCI consolidated tax group, and will only be able to realize current income
tax benefits to the extent that the Company generates taxable income. During
the first several years following the Distribution, the Company believes that it
will incur net losses for income tax purposes, and accordingly, will not be in a
position to realize income tax benefits on a current basis.
(continued)
I-31
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1 to the accompanying combined financial statements)
Material Changes in Financial Condition
- - ---------------------------------------
In recent periods, the Company has relied upon non-interest bearing
advances from TCI in order to fund the majority of the Company's working capital
requirements and capital expenditures. During the nine months ended September
30, 1996 and 1995, such advances aggregated $281,313,000 and $239,603,000,
respectively. Following the Distribution, it is anticipated that TCIC will
provide the Company with funding pursuant to the TCIC Credit Facility, subject
to the Company's best efforts obligations to refinance the TCIC Credit Facility.
Following the termination of the TCIC Credit Facility, whether at maturity or in
connection with any such refinancing, it is not expected that TCI will continue
to be a source of long term financing for the Company. For a description of the
terms of the TCIC Credit Facility, see note 2 to the accompanying combined
financial statements of the Company.
The Company also has relied upon advances from PRIMESTAR Partners to
finance the majority of the cost of constructing the Company Satellites. Such
advances, which aggregated $386,219,000 at September 30, 1996, are reflected as
a liability in the combined balance sheets included in the accompanying combined
financial statements. PRIMESTAR Partners financed such advances to the Company
through borrowings under the PRIMESTAR Credit Facility, which was in turn
supported by letters of credit arranged for by affiliates of all but one of the
partners of PRIMESTAR Partners. PRIMESTAR Partners' indebtedness under the
PRIMESTAR Credit Facility aggregated $440,000,000 at September 30, 1996. The
Company expects that the amount due to PRIMESTAR Partners will be settled
through the sale or lease of all the capacity of the Company Satellites, or by
the assumption by the Company of all or a portion of the indebtedness incurred
by PRIMESTAR Partners to fund the advances. The ultimate settlement of the
amounts advanced from PRIMESTAR Partners is dependent, in part, on the outcome
of certain uncertainties. For additional information concerning such
uncertainties, see note 5 to the accompanying combined financial statements of
the Company.
During the nine months ended September 30, 1996 and 1995, the Company's
operating activities provided cash of $63,751,000 and $42,516,000, respectively.
Most of the cash provided by the Company's operating activities during such
periods is attributable to the intercompany allocation of current income tax
benefits from TCI, and to net changes in the Company's receivables, prepaids,
accruals and payables and subscriber advance payments ("Operating Assets and
Liabilities"). As described above, during the first several years following
the Distribution, the Company believes that it will not be in a position to
realize income tax benefits on a current basis. In addition, the timing and
amount of changes in the balances of the Company's Operating Assets and
Liabilities are subject to a variety of factors, certain of which are outside of
the control of, or not easily predicted by, the Company. Exclusive of the
effects of intercompany allocations of current income tax benefits, and changes
in the Company's Operating Assets and Liabilities, the Company's operating
activities provided cash of $5,697,000 and $7,360,000 during the nine months
ended September 30, 1996 and 1995, respectively. For the first several years
following the Distribution, the Company believes that its operating activities
will represent a reliable source of liquidity only to the extent that the
Company is able to generate Operating Cash Flow.
(continued)
I-32
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1 to the accompanying combined financial statements)
Material Changes in Financial Condition (continued)
- - ---------------------------------------------------
During the nine months ended September 30, 1996 and 1995, the Company used
cash of $69,930,000 and $79,932,000, respectively, to fund the cost of
constructing the Company Satellites and $264,439,000 and $268,909,000,
respectively, to fund (i) the acquisition and installation of satellite
reception equipment and (ii) certain other capital expenditures. The amount of
capital required to fund the acquisition and installation of satellite reception
equipment in the future will be primarily a function of (i) subscriber growth
and churn rates, and (ii) the outcome of the uncertainties associated with the
deployment of the Company Satellites. As described above, the capitalized
installation fees that will be paid to TCIC following the Distribution are
expected to exceed the corresponding capitalized installation fees that were
paid to TCIC prior to the Distribution. See the combined statements of cash
flows included in the accompanying combined financial statements of the Company.
At September 30, 1996, the Company's future minimum commitments to purchase
satellite reception equipment aggregated approximately $25,500,000.
As a part of the compensation paid to the Company's Master Agents, the
Company has agreed to pay certain residual sales commissions equal to a
percentage of the programming revenue collected from subscribers installed by
Master Agents during specified periods following the initiation of service
(generally five years). During the nine months ended September 30, 1996 and
1995, residual payments to Master Agents aggregated $7,887,000 and $739,000,
respectively.
PRIMESTAR Partners currently broadcasts from K-2, a medium power satellite
that is nearing the end of its operational life. Although the Company believes
that a replacement satellite will be successfully deployed prior to the
expiration of K-2's operational life, such deployment is dependent on a number
of factors that are outside of the Company's control and no assurance can be
given as to the successful deployment of a replacement satellite. The failure
to deploy a fully operational replacement satellite by the end of K-2's
operational life (or the operational life of any temporary in-orbit replacement
that might be available) could have a material adverse effect on both the
Company and PRIMESTAR Partners.
On or before the Distribution Date, the Company will enter into the
Indemnification Agreements with TCIC and TCI UA 1. For additional information
concerning the Indemnification Agreements, see notes 2 and 7 to the accompanying
combined financial statements of the Company.
(continued)
I-33
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1 to the accompanying combined financial statements)
Material Changes in Financial Condition (continued)
- - ---------------------------------------------------
At September 30, 1996, the Company had guaranteed approximately $2,000,000
of certain minimum commitments of PRIMESTAR Partners to purchase satellite
reception equipment.
Under the PRIMESTAR Partners partnership agreement, the Company has agreed
to fund its share of any capital contributions and/or loans to PRIMESTAR
Partners that might be agreed upon from time to time by the partners of
PRIMESTAR Partners. Additionally, as a general partner of PRIMESTAR Partners,
the Company is liable as a matter of partnership law for all debts of PRIMESTAR
Partners in the event the liabilities of PRIMESTAR Partners were to exceed its
assets. The Company has additional contingent liabilities related to PRIMESTAR
Partners. See note 4 to the accompanying combined financial statements of the
Company.
The Company has agreed to bear all obligations with respect to stock
options that will be granted on the Distribution Date pursuant to the Stock
Option Agreements. Assuming the Distribution had occurred on September 30, 1996,
options would have been granted pursuant to the Stock Option Agreements to
purchase an aggregate of approximately 2,342,000 shares of Series A Common Stock
at a per share exercise price of approximately $8.82. The actual exercise price
to be calculated on the Distribution Date is expected to be higher than such
assumed exercise price due to increases in TCI's Net Investment that are
expected to occur between September 30, 1996 and the Distribution Date. Such
obligation will be settled by the Company's issuance of Series A Common Stock to
the extent options are exercised in accordance with the terms of the Stock
Option Agreements. The Company will also grant to TCI an option to purchase up
to 4,765,000 shares of Series A Common Stock, at an exercise price of $1.00 per
share, as required by TCI from time to time to meet its obligations under the
conversion features of the TCI Series D Preferred Stock and the Convertible
Notes due December 12, 2021, of TCI UA, Inc., as such conversion features are
adjusted as a result of the Distribution. Additionally, the Company will be
obligated to issue shares of Series A Common Stock to TCI pursuant to the Share
Purchase Agreement. At September 30, 1996, the maximum number of shares that
would have been issuable by the Company to TCI under the Share Purchase
Agreement was 1,940,973. For additional information, see note 2 to the
accompanying combined financial statements of the Company.
(continued)
I-34
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1 to the accompanying combined financial statements)
Material Changes in Financial Condition (continued)
- - ---------------------------------------------------
Effective as of October 21, 1996, the Company entered into the ResNet
Transaction. For information concerning the ResNet Transaction, see note 8 to
the accompanying combined financial statements of the Company.
Following the Distribution, the Company will require significant additional
capital to meet its operating plan. Such capital will be used primarily to
purchase additional inventory of satellite reception equipment for sale or
rental to subscribers, to finance the cost of installing new customers and to
provide for working capital and other liquidity requirements that may arise.
As described above, the TCIC Credit Facility is intended to provide the
Company with a source of liquidity until such time as the Company is able to
arrange for permanent financing. In this regard, the Company currently is
seeking to arrange for a possible bank financing and may, in the future seek to
obtain additional financing through an institutional private placement, a public
offering of debt securities or a combination of such sources. The Company
anticipates that it will use proceeds from any bank or other permanent
financing, together with any net cash provided by operations, to (i) repay all
amounts due under the TCIC Credit Facility and (ii) fund the Company's projected
liquidity requirements for the next eighteen months. Although the Company
believes that it will be able to obtain such permanent financing, there can be
no assurance that this will be the case. Additionally, faster-than-anticipated
subscriber growth or other contingencies may require additional financing. The
Company expects that, if additional financing is needed, it would seek to obtain
such financing through the capital markets, including the high-yield debt
market. No assurance can be given however that such additional financing would
be available on terms satisfactory to the Company, or that sufficient financing
to meet the Company's needs would be available on any terms.
The degree to which the Company becomes leveraged may adversely affect the
Company's ability to compete effectively against better capitalized competitors
and to withstand downturns in its business or the economy generally, and could
limit its ability to pursue business opportunities that may be in the interests
of the Company and its stockholders. The Company's ability to service its debt
will require growth in the Company's Operating Cash Flow. There can be no
assurance that the Company will be successful in increasing its Operating Cash
Flow by a sufficient magnitude or in a timely manner, or in raising additional
equity or debt financing to enable it to meet its debt service requirements. In
addition, a failure of the Company to have adequate access to capital may
adversely affect the Company's ability, or choice, to launch proposed products
and services.
I-35
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.
- - ------- ---------------------------------
(a) Exhibits
27 - Financial Data Schedule
(b) Reports on Form 8-K filed during quarter ended September 30,
1996- None
II-1
<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 thereunto duly authorized.
TCI SATELLITE ENTERTAINMENT, INC.
Date: November 27, 1996 By: /s/ Gary S. Howard
--------------------------------
Gary S. Howard
President and
Chief Executive Officer
Date: November 27, 1996 By: /s/ Kenneth G. Carroll
--------------------------------
Kenneth G. Carroll
Senior Vice President and
Chief Financial Officer
(Principal Financial Officer and
Chief Accounting Officer)
II-2
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE FORM
10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 1996 AND IS QUALIFIED IN ITS ENTIRETY
BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<CASH> 1,988
<SECURITIES> 0
<RECEIVABLES> 25,484
<ALLOWANCES> 3,876
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 1,272,744
<DEPRECIATION> 136,360
<TOTAL-ASSETS> 1,191,030
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
0
<COMMON> 0
<OTHER-SE> 707,750
<TOTAL-LIABILITY-AND-EQUITY> 1,191,030
<SALES> 0
<TOTAL-REVENUES> 300,249
<CGS> 0
<TOTAL-COSTS> 158,697
<OTHER-EXPENSES> 87,205
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (82,400)
<INCOME-TAX> (25,806)
<INCOME-CONTINUING> (56,594)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (56,594)
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
