<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1997
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)
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)
Registrant's telephone number, including area code: (303) 712-4600
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months, and (2) has been subject to such filing
requirements for the past 90 days [X] Yes [ ] No
The number of shares outstanding of TCI Satellite Entertainment, Inc.'s
common stock as of October 31, 1997, was:
Series A common stock - 58,239,114 shares; and
Series B common stock - 8,465,234 shares.
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Consolidated Balance Sheets
(unaudited)
<TABLE>
<CAPTION>
September 30, December 31,
1997 1996
------------- ------------
amounts in thousands
<S> <C> <C>
Assets
- - ------
Cash and cash equivalents $ 19,279 6,560
Accounts receivable 25,466 24,731
Less allowance for doubtful accounts 4,872 4,666
---------- ---------
20,594 20,065
---------- ---------
Prepaid expenses 1,384 927
Investment in, and related advances to,
PRIMESTAR Partners L.P.
("PRIMESTAR Partners") (note 7) 19,952 32,240
Property and equipment, at cost:
Satellite reception equipment 642,440 595,249
Subscriber installation costs 199,544 175,553
Support equipment 33,671 28,332
Satellites (note 8) 463,133 457,685
---------- ---------
1,338,788 1,256,819
Less accumulated depreciation 239,430 149,165
---------- ---------
1,099,358 1,107,654
---------- ---------
Other assets, net of accumulated amortization (note 9) 28,479 12,827
---------- ---------
$1,189,046 1,180,273
========== =========
</TABLE>
(continued)
I-1
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Consolidated Balance Sheets, continued
(unaudited)
<TABLE>
<CAPTION>
September 30, December 31,
1997 1996
---------------- ----------------
amounts in thousands
<S> <C> <C>
Liabilities and Stockholders' Equity
- - ------------------------------------
Accounts payable $ 42,298 18,860
Accrued charges from PRIMESTAR
Partners (note 7) 44,591 37,943
Accrued interest payable 2,855 70
Other accrued expenses (note 11) 35,735 23,878
Subscriber advance payments 27,000 22,249
Due to PRIMESTAR Partners (note 8) 463,133 457,685
Debt (note 10) 365,760 247,230
---------------- ----------------
Total liabilities 981,372 807,915
---------------- ----------------
Stockholders' Equity:
Preferred stock, $.01 par value;
authorized 5,000,000;
none issued -- --
Series A common stock, $1 par value;
authorized 185,000,000;
issued 58,237,114 in 1997, and
57,946,044 in 1996 58,237 57,946
Series B common stock, $1 par value;
authorized 10,000,000 shares; issued
8,465,324 in 1997 and 8,466,564 in 1996 8,465 8,467
Additional paid-in capital 523,295 521,724
Accumulated deficit (382,323) (215,779)
---------------- ----------------
Total stockholders' equity 207,674 372,358
---------------- ----------------
Commitments and contingencies
(notes 2, 3, 7, 8, 10, 11 and 12)
$ 1,189,046 1,180,273
================ ================
</TABLE>
See accompanying notes to financial statements.
I-2
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Statements of Operations
(unaudited)
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
-------------------- -------------------
1997 1996 1997 1996
---------- -------- --------- --------
amounts in thousands
<S> <C> <C> <C> <C>
Revenue:
Programming and equipment
rental $133,952 92,569 374,182 249,439
Installation 11,475 14,033 31,890 50,810
-------- ------- -------- -------
145,427 106,602 406,072 300,249
-------- ------- -------- -------
Operating costs and expenses:
Charges from PRIMESTAR
Partners (note 7):
Programming 44,693 30,543 126,681 88,007
Satellite, marketing and
distribution 21,187 17,359 61,568 46,781
Other operating (note 11) 7,920 9,059 18,992 23,909
Selling, general and administrative
(note 11) 47,784 51,100 139,557 136,166
Stock compensation (note 11) 3,055 (377) 4,607 (553)
Depreciation (note 4) 64,149 33,678 177,415 87,205
-------- ------- -------- -------
188,788 141,362 528,820 381,515
-------- ------- -------- -------
Operating loss (43,361) (34,760) (122,748) (81,266)
Other income (expense):
Interest expense (12,557) -- (33,965) --
Interest income 694 -- 2,464 --
Share of earnings (losses) of
PRIMESTAR Partners (note 7) (3,681) 1 (11,610) (1,445)
Other, net (49) 117 (685) 311
-------- ------- -------- -------
(15,593) 118 (43,796) (1,134)
-------- ------- -------- -------
Loss before income taxes (58,954) (34,642) (166,544) (82,400)
Income tax benefit -- 10,936 -- 25,806
-------- ------- -------- -------
Net loss $(58,954) (23,706) (166,544) (56,594)
======== ======= ======== =======
Net loss per common share (note 5):
Historical $ (.88) -- (2.50) --
======== ======= ======== =======
Pro forma $ -- (.36) -- (.85)
======== ======= ======== =======
</TABLE>
See accompanying notes to financial statements.
I-3
<PAGE>
Consolidated Statement of Stockholders' Equity
Nine months ended September 30, 1997
(unaudited)
<TABLE>
<CAPTION>
Common stock Additional Total
----------------------- paid-in Accumulated Stockholders'
Series A Series B capital deficit equity
----------- ---------- ---------- ------------ -----------
amounts in thousands
<S> <C> <C> <C> <C> <C>
Balance at January 1, 1997 $ 57,946 8,467 521,724 (215,779) 372,358
Net loss -- -- -- (166,544) (166,544)
Recognition of stock compensation related to
stock options and restricted stock awards -- -- 1,391 -- 1,391
Issuance of Series A Common Stock related to
restricted stock awards 33 -- 180 -- 213
Issuance of Series A Common Stock upon conversion
of convertible securities of
Tele-Communications, Inc. 256 -- -- -- 256
Conversion of Series B common stock into Series A
common stock 2 (2) -- -- --
----------- ---------- ---------- ------------ -----------
Balance at September 30, 1997 $ 58,237 8,465 523,295 (382,323) 207,674
=========== ========== ========== ============ ===========
</TABLE>
See accompanying notes to financial statements.
I-4
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Statements of Cash Flows
(unaudited)
<TABLE>
<CAPTION>
Nine months ended
September 30,
-------------------------
1997 1996
----------- ----------
amounts in thousands
(see note 6)
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (166,544) (56,594)
Adjustments to reconcile net loss to
net cash provided by operating activities:
Depreciation 177,415 87,205
Share of losses of PRIMESTAR Partners 11,610 1,445
Accretion of debt discount 11,573 --
Stock compensation 4,607 (553)
Deferred income tax expense -- 18,648
Other non-cash items 4,158 --
Changes in operating assets and liabilities:
Change in receivables (529) 2,765
Change in prepaids (457) (619)
Change in accruals and payables 28,131 (523)
Change in subscriber advance payments 4,751 6,445
---------- ----------
Net cash provided by operating activities 74,715 58,219
---------- ----------
Cash flows from investing activities:
Capital expended for property and equipment (151,062) (258,907)
Capital expended for satellites (5,448) (69,930)
Additional investments in and advances to
PRIMESTAR Partners (7,060) (13,827)
Repayment received on advances to PRIMESTAR
Partners 7,806 --
---------- ----------
Net cash used in investing activities (155,764) (342,664)
---------- ----------
Cash flows from financing activities:
Borrowings of debt 405,061 --
Repayments of debt (299,461) --
Payment of deferred financing costs (17,749) --
Increase in due to PRIMESTAR Partners 5,448 3,319
Proceeds from issuance of common stock 469 --
Increase in due to TCI Communications, Inc. -- 281,313
---------- ----------
Net cash provided by financing activities 93,768 284,632
---------- ----------
Net increase in cash and cash equivalents 12,719 187
Cash and cash equivalents:
Beginning of period 6,560 1,801
---------- ----------
End of period $ 19,279 1,988
========== ==========
</TABLE>
See accompanying notes to financial statements.
I-5
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Financial Statements
September 30, 1997
(unaudited)
(1) Basis of Presentation
---------------------
The accompanying financial statements of TCI Satellite Entertainment,
Inc. ("TSEI") include the historical financial information of (i)
certain satellite television assets (collectively, "TCI SATCO") of TCI
Communications, Inc. ("TCIC"), a subsidiary of Tele-Communications,
Inc. ("TCI") for periods prior to the December 4, 1996 consummation of
the spin-off transaction (the "TSAT Spin-off") described in note 3, and
(ii) TSEI and its consolidated subsidiaries for the period following
such date. Upon consummation of the TSAT Spin-off, TSEI became the
owner of the assets that comprised TCI SATCO, which assets included (i)
a 100% ownership interest in the TCIC business that distributes the
PRIMESTAR(R) programming service ("PRIMESTAR(R)") to subscribers within
certain 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, which owns and
operates the PRIMESTAR(R) service. PRIMESTAR Partners was formed as a
limited partnership in 1990 by subsidiaries of TCIC, subsidiaries of
several other cable operators, and a subsidiary of General Electric
Company. PRIMESTAR Partners, among other things, transmits satellite
entertainment services that are delivered to subscribers through TSEI
and certain other authorized distributors.
Tempo holds a permit (the "FCC Permit") issued by the Federal
Communications Commission ("FCC") authorizing construction of a high
power direct broadcast satellite ("DBS") system. Tempo is also a party
to a satellite construction agreement (the "Satellite Construction
Agreement") with Space Systems/Loral, Inc. ("Loral"), pursuant to which
Tempo has arranged for the construction of two high power direct
broadcast satellites (the "Tempo Satellites") and has an option to
purchase up to three additional satellites.
In the following text, "TSAT" may, as the context requires, refer to
"TCI SATCO" (prior to the December 4, 1996 completion of the TSAT
Spin-off), TSEI and its consolidated subsidiaries (subsequent to the
December 4, 1996 completion of the TSAT Spin-off) or both. See note 3.
Additionally, unless the context indicates otherwise, references to
"TCI" and "TCIC" herein are to TCI and TCIC and their respective
consolidated subsidiaries (other than TSAT).
All significant inter-entity and intercompany transactions have been
eliminated.
As further discussed in note 11, the accompanying statements of
operations include allocations of certain costs and expenses of TCI.
Although such allocations are not necessarily indicative of the costs
that would have been incurred by TSAT on a stand-alone basis,
management believes the resulting allocated amounts are reasonable.
(continued)
I-6
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to 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.
The accompanying interim financial statements of TSAT are unaudited. In the
opinion of management, all adjustments (consisting only of normal recurring
accruals) have been made which are necessary to present fairly the
financial position of TSAT as of September 30, 1997 and the results of its
operations for the periods ended September 30, 1997 and 1996. The results
of operations for any interim period are not necessarily indicative of the
results for the entire year.
These financial statements should be read in conjunction with the financial
statements and related notes thereto included in TSAT's December 31, 1996
Annual Report on Form 10-K.
(2) Proposed Transactions
---------------------
PRIMESTAR Partners Restructuring
On June 11, 1997, TSAT entered into a binding letter agreement, including
an attached summary of business terms (collectively, the "Restructuring
Agreement") with PRIMESTAR Partners, affiliates of each of the other
partners of PRIMESTAR Partners, and a stockholder of TSAT. The
Restructuring Agreement sets forth the principal terms and conditions of a
proposed transaction (the "Restructuring Transaction"), through which
PRIMESTAR Partners, TSAT and the PRIMESTAR(R)-related distribution
businesses of such affiliates will be consolidated into a newly-formed
company. The other parties to the Restructuring Agreement include Time
Warner Cable ("TWC"), Advance/Newhouse Partnership ("Newhouse"), Cox
Communications, Inc. ("Cox"), Comcast Corporation ("Comcast"), MediaOne of
Delaware Inc. ("MediaOne"), and GE American Communications, Inc. ("GE
Americom"). Affiliates of TSAT, TWC, Newhouse, Cox, Comcast, MediaOne and
GE Americom are general and limited partners of PRIMESTAR Partners, and
TSAT, TWC, Newhouse, Cox, Comcast and MediaOne (or their affiliates) are
also distributors of PRIMESTAR Partners' medium power satellite television
service.
(continued)
I-7
<PAGE>
The Restructuring Agreement provides for the formation of a new corporation
("New PRIMESTAR"), which will initially be a wholly-owned subsidiary of
TSAT. New PRIMESTAR will acquire partnership interest of PRIMESTAR
Partners, subscribers and related assets, as applicable, of the other
parties to the Restructuring Transaction in exchange for (i) cash (or the
assumption of debt), (ii) shares of Series A Common Stock, $.01 par value
per share, of New PRIMESTAR ("New PRIMESTAR Series A Common Stock") and
(iii) except for GE Americom, shares of Series C Common Stock, $.01 par
value per share, of New PRIMESTAR ("New PRIMESTAR Series C Common Stock"),
in each case in an amount determined pursuant to the Restructuring
Agreement. Concurrently, TSAT would merge with a wholly-owned subsidiary of
New PRIMESTAR, with TSAT surviving, and the outstanding shares of Series A
Common Stock, $1.00 par value per share, of TSAT ("Series A Common Stock")
and Series B Common Stock, $1.00 par value per share, of TSAT ("Series B
Common Stock," and together with the Series A Common Stock, the "TSAT
Common Stock") would be converted into New PRIMESTAR Series A Common Stock,
and Series B Common Stock, $.01 par value per share, of New PRIMESTAR ("New
PRIMESTAR Series B Common Stock"), respectively. It is expected that upon
consummation of the Restructuring Transaction, shares of the New PRIMESTAR
Series A Common Stock and New PRIMESTAR Series B Common Stock will be
publicly traded on the Nasdaq National Market tier of The Nasdaq Stock
Market.
The Restructuring Agreement provides that the board of directors of New
PRIMESTAR will initially consist of eleven members, of which three (the
"Class B Directors") will be elected by holders of the New PRIMESTAR Series
B Common Stock and six (the "Class C Directors") will be elected by holders
of the New PRIMESTAR Series C Common Stock. Of the six Class C Directors,
three will be nominated by TWC (and TWC has agreed with Newhouse that of
such three, one will be nominated by Newhouse) and one will be nominated by
each of Cox, Comcast and MediaOne. The remaining two directors (the "Common
Directors") will be nominated by a super-majority vote of the Class B
Directors and Class C Directors, and elected by the holders of the New
PRIMESTAR Series A Common Stock, New PRIMESTAR Series B Common Stock and
New PRIMESTAR Series C Common Stock, voting together as a single class. The
number of Class B Directors will decrease as the number of shares of New
PRIMESTAR Series B Common Stock outstanding decreases, and the number of
Class C Directors will decrease as the number of shares of New PRIMESTAR
Series C Common Stock outstanding decreases, in each case in accordance
with a schedule set forth in the Restructuring Agreement. The special class
rights of the holders of New PRIMESTAR Series B Common Stock and New
PRIMESTAR Series C Common Stock, each voting as a separate class, to elect
the Class B Directors and Class C Directors, respectively, will
automatically terminate at such time as the holders of the New PRIMESTAR
Series C Common Stock, voting as a class, shall no longer be entitled to
elect at least three Class C Directors. At any time that the maximum number
of Class B Directors or Class C Directors is decreased, the number of
Common Directors will be correspondingly increased, so that the total
number of directors constituting the whole board of directors of New
PRIMESTAR remains eleven.
The New PRIMESTAR Series A Common Stock will be substantially identical to
the Series A Common Stock of TSAT, and the New PRIMESTAR Series B Common
Stock and the New PRIMESTAR Series C Common Stock will be substantially
identical to the New PRIMESTAR Series A Common Stock, except in each case
with respect to the election of directors as provided above and except in
each case as follows: (i) holders of the New PRIMESTAR Series B Common
Stock and the New PRIMESTAR Series C Common Stock will be entitled to ten
votes per share, while holders of the New PRIMESTAR Series A Common Stock
will be entitled to one vote per share, on all matters as to which such
holders are entitled to vote; (ii) each share of New PRIMESTAR Series B
Common Stock will be convertible into one share of New PRIMESTAR Series A
Common Stock at the option of the holder, and each share of New PRIMESTAR
Series C Common Stock will be convertible into one share of New PRIMESTAR
Series B Common Stock at the option of the holder, but the New PRIMESTAR
Series A Common Stock will not be convertible; and (iii) the affirmative
vote of the holders of a majority of the outstanding shares of New
PRIMESTAR Series B Common Stock and 83% of the outstanding shares of New
PRIMESTAR Series C Common Stock, each voting as a separate class, will be
required to approve certain actions by New PRIMESTAR, including substantive
charter and by-law amendments, mergers and consolidations, the sale of
substantially all the assets of New PRIMESTAR, dissolution, certain stock
issuances, the filing of a voluntary bankruptcy petition, and, with certain
exceptions, engagement by New PRIMESTAR in any business outside the
Satellite Television Business (as defined in the Restructuring Agreement).
On the tenth anniversary of the first issue of New PRIMESTAR Series C
Common Stock, all New PRIMESTAR Series C Common Stock will be mandatorily
converted into New PRIMESTAR Series B Stock on a one-to-one basis.
Under the terms of the Restructuring Agreement, current stockholders of
TSAT would hold approximately 37% of the outstanding shares of common
equity of New PRIMESTAR at the closing of the Restructuring Transaction,
and TWC and Newhouse (collectively), Comcast, MediaOne, Cox and GE Americom
would own approximately 31%, 9%, 9%, 9% and 5%, respectively, of the
outstanding shares of common equity of New PRIMESTAR at closing, subject in
each case to adjustments based on closing subscriber counts, inventory
amounts and other factors.
Although the parties contemplate the negotiation, execution and delivery of
definitive documentation with respect to the Restructuring Transaction,
such documentation is not a condition to the closing of the Restructuring
Transaction, and in the absence of such documentation, the Restructuring
Agreement will remain a binding agreement among the parties. The parties
are currently engaged in the negotiation and preparation of such definitive
documentation, which is expected to be completed during the fourth quarter
of 1997. As currently contemplated by the drafts of such documentation,
TSAT would be merged with and into New PRIMESTAR, and the current
stockholders of TSAT would receive common stock of New PRIMESTAR on
substantially the same basis as described above.
The consummation of the Restructuring Transaction is subject to certain
closing conditions, including receipt of necessary regulatory approvals,
approval of TSAT stockholders and certain due diligence matters. In
connection with the execution of the Restructuring Agreement, John C.
Malone, a stockholder of TSAT and the Chairman of its Board of Directors,
has agreed to vote all shares of TSAT Common Stock owned by him in favor of
the Restructuring Transaction, in any vote of the stockholders of TSAT to
approve such transaction.
(continued)
I-8
<PAGE>
For accounting purposes, the Restructuring Transaction will be treated
as the acquisition by TSAT of certain net assets of the parties to the
Restructuring Agreement other than TSAT (the "Non-TSAT Parties"), and
such acquisition will be accounted for using the purchase method of
accounting. The fair value of the consideration to be issued to the
Non-TSAT Parties will be allocated to the assets and liabilities
acquired based upon the estimated fair values of such assets and
liabilities.
Acquisition of Certain Satellite Assets
In a separate transaction (the "ASkyB Transaction"), pursuant to an
asset acquisition agreement, dated as of June 11, 1997 (together with
the exhibits and schedules thereto, the "ASkyB Agreement") among
PRIMESTAR Partners, The News Corporation Limited ("News Corp."), MCI
Telecommunications Corporation, the principal domestic operating
subsidiary of MCI Communications Corporation ("MCI"), American Sky
Broadcasting LLC, a joint venture between News Corp. and MCI ("ASkyB"),
and for certain purposes only, each of the partners of PRIMESTAR
Partners (collectively, the "Partners"), New PRIMESTAR will acquire
from MCI two high-power communications satellites currently under
construction (the "MCI Satellites"), certain authorizations granted to
MCI by the FCC to operate a direct broadcast satellite business at the
110(0) West Longitude ("W.L.") orbital location using 28 transponder
channels, and certain related contracts (the "MCI FCC Licenses"). In
consideration, ASkyB will receive non-voting convertible securities of
New PRIMESTAR, comprising approximately $600 million liquidation value
of non-voting convertible preferred stock, $.01 par value per share, of
New PRIMESTAR (the "New PRIMESTAR Convertible Preferred Stock")
(convertible into approximately 52 million shares of non-voting
Series D Common Stock, $.01 par value per share, of New PRIMESTAR (the
"New PRIMESTAR Series D Common Stock"), subject to adjustment) and
approximately $516 million principal amount of convertible subordinated
notes of New PRIMESTAR (the "New PRIMESTAR Convertible Subordinated
Notes") (convertible into approximately 43 million shares of New
PRIMESTAR Series D Common Stock).
The New PRIMESTAR Convertible Preferred Stock will accrue cumulative
dividends at the annual rate of 5% of the liquidation value of such
shares and the New PRIMESTAR Convertible Subordinated Notes will have
an interest rate of 5%. Dividends on the New PRIMESTAR Convertible
Preferred Stock and interest on the New PRIMESTAR Convertible
Subordinated Notes will be payable in cash or, at the option of New
PRIMESTAR, in shares of the non-voting New PRIMESTAR Series D Common
Stock, for a period of four years. Thereafter, all dividend and
interest payments will be made solely in cash. Such convertible
securities, and the shares of New PRIMESTAR Series D Common Stock to be
issued to ASkyB or any of its affiliates upon conversion of such New
PRIMESTAR Convertible Preferred Stock and New PRIMESTAR Convertible
Subordinated Notes, or in payment of dividend or interest obligations
thereunder, will be non-voting; however, shares of New PRIMESTAR Series
D Common Stock will in turn automatically convert into shares of New
PRIMESTAR Series A Common Stock, on a one-to-one basis, upon transfer
to any person other than ASkyB, News Corp. or any of their respective
affiliates.
(continued)
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Financial Statements
Consummation of the ASkyB Transaction is contingent on, among other things,
receipt of all necessary government and regulatory approvals, and
accordingly, no assurance can be given that the ASkyB Transaction will be
consummated.
(3) TSAT Spin-off Transaction
-------------------------
General
On June 17, 1996, the Board of Directors of TCI announced its intention to
distribute all the capital stock of TSAT to the holders of Tele-
Communications, Inc. Series A TCI Group Common Stock, $1.00 par value per
share, (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"). On December 4, 1996 (the "TSAT Spin-off Date"), the TSAT
Spin-off was effected as a distribution by TCI to holders of record of its
TCI Group Common Stock as of the close of business on November 12, 1996
(the "TSAT Spin-off Record Date") of shares of TSAT Common Stock. The TSAT
Spin-off did 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.
On the TSAT Spin-off Record Date, TCI Group Stockholders received 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 TSAT Spin-off 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
TSAT Spin-off Record Date. Fractional shares were not issued. Fractions of
one-half or greater of a share were rounded up and fractions of less than
one-half of a share were rounded down to the nearest whole number of shares
of Series A Common Stock and Series B Common Stock. Immediately following
the TSAT Spin-off, 57,941,044 shares of Series A Common Stock and 8,466,564
shares of Series B Common Stock were issued and outstanding.
(continued)
I-10
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Financial Statements
Since the TSAT Spin-off, TSAT and TCI have operated independently. For
purposes of governing certain of the ongoing relationships between TSAT and
TCI after the TSAT Spin-off, and to provide mechanisms for an orderly
transition, TSAT and TCI have entered into various agreements, including
the "Reorganization Agreement" (see below), the "Fulfillment Agreement"
(see note 11), the "Indemnification Agreements" (see note 12), the "TCIC
Credit Facility" (see note 10), the "Transition Services Agreement" (see
note 11), and an amendment to TCI's then existing "Tax Sharing Agreement"
(see note 11).
Reorganization Agreement
The Reorganization Agreement provided for, among other things, the transfer
to TSAT of the assets of TCI SATCO, and for the assumption by TSAT of
related liabilities. No consideration was payable by TSAT for these
transfers, except that two subsidiaries of TSAT purchased TCIC's
partnership interests in PRIMESTAR Partners for consideration payable by
delivery of promissory notes issued by such subsidiaries, which notes were
assumed by TCI on or before the TSAT Spin-off Date in the form of a capital
contribution to TSAT. The Reorganization Agreement also provides for
certain cross-indemnities designed to make TSAT financially responsible for
all liabilities relating to the digital satellite business conducted by TCI
prior to the TSAT Spin-off, as well as for all liabilities incurred by TSAT
after the TSAT Spin-off, and makes TCI financially responsible for all
potential liabilities of TSAT which are not related to the digital
satellite business, including, for example, liabilities arising as a result
of TSAT having been a subsidiary of TCI prior to the TSAT Spin-off.
Pursuant to the Reorganization Agreement, on the TSAT Spin-off Date, TSAT
issued to TCIC a promissory note (the "TSAT Note"), in the principal amount
of $250,000,000, representing a portion of TSAT's intercompany balance owed
to TCIC on such date. On December 31, 1996, TSAT entered into a bank credit
agreement with respect to a senior secured reducing revolving credit
facility (the "Bank Credit Facility") and used a portion of the borrowing
availability thereunder to repay in full all principal and interest due to
TCIC pursuant to the TSAT Note. See note 10.
(continued)
I-11
<PAGE>
Pursuant to the Reorganization Agreement, the remainder of TSAT's
intercompany balance owed to TCIC on the TSAT Spin-off Date (other than
certain advances made to TSAT by TCIC in 1996 to fund certain construction
and related costs associated with the Tempo Satellites, as described in
note 8) was assumed by TCI. A portion of such assumption of debt was
affected in the form of a capital contribution to TSAT; the remainder was
affected as consideration for (i) the assumption by TSAT of TCI's
obligations under options granted on the TSAT Spin-off Date to certain key
employees of TCI (who are not employees of TSAT) representing, in the
aggregate, 1,660,190 shares of Series A Common Stock and (ii) the granting
by TSAT to TCI of 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
certain convertible securities of TCI as such conversion features were
adjusted as a result of the TSAT Spin-off.
(4) Changes in Accounting
---------------------
During the fourth quarter of 1996, TSAT re-evaluated certain of its
depreciation policies. After considering relevant accounting literature,
current accounting practices in similar industries, and other factors, TSAT
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 TSAT. TSAT
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
TSAT's balance sheet after the date of termination. This change was adopted
effective October 1, 1996 and was treated as a change in accounting policy
that was 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, was included in TSAT's
depreciation expense for the fourth quarter of 1996.
In connection with the aforementioned discussion of TSAT's accounting
policies with respect to subscriber installation costs, TSAT also
determined that a reduction in the estimated useful life of certain
satellite reception equipment was appropriate in light of certain changes
in TSAT's expectations with respect to technological and other factors.
This change in estimate was given effect on a prospective basis as of
October 1, 1996.
(continued)
I-12
<PAGE>
(5) Net Loss Per Common Share
-------------------------
As described in note 3, TSAT issued 66,407,608 shares of TSAT Common Stock
pursuant to the TSAT Spin-off. The pro forma net loss per share amounts
set forth in the accompanying statements of operations assume that the
shares issued pursuant to the TSAT Spin-off were issued and outstanding
since January 1, 1996. Accordingly, the calculation of the pro forma net
loss per share assumes 66,407,608 weighted average shares were outstanding
during the three and nine months ended September 30, 1996. The historical
net loss per common share is based on 66,676,241 and 66,642,359 weighted
average shares outstanding during the three and nine months ended September
30, 1997, respectively.
The Financial Accounting Standards Board recently issued Statement of
Financial Accounting Standards No. 128, "Earnings Per Share" ("Statement
No. 128"). Statement No. 128 requires the presentation of basic earnings
per share ("EPS") and, for companies with potentially dilutive securities,
such as convertible debt, options and warrants, diluted EPS. Statement No.
128 is effective for annual and interim periods ending after December 31,
1997. TSAT does not believe that the adoption of Statement No. 128 will
significantly impact the calculation of TSAT's net loss per common share.
(6) Supplemental Disclosures to Combined Statements of Cash Flows
-------------------------------------------------------------
Cash paid for interest was $17,837,000 during the nine months ended
September 30, 1997, and was not significant during the nine months ended
September 30, 1996. Cash paid for income taxes was not significant during
the nine months ended September 30, 1997 and 1996.
With the exception of certain non-cash stock compensation obligations (see
note 11), transactions effected through the intercompany account with TCIC
for periods prior to the TSAT Spin-off have been considered to be
constructive cash receipts and payments for purposes of the accompanying
statements of cash flows.
Accrued capital expenditures of $13,381,000 and $5,532,000 at September 30,
1997 and 1996, respectively, have been excluded from the accompanying
statements of cash flows.
(continued)
I-13
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Financial Statements
(7) Investment in PRIMESTAR Partners
--------------------------------
Summarized unaudited operating information for PRIMESTAR Partners is as
follows (amounts in thousands):
<TABLE>
<CAPTION>
Nine months ended
September 30,
---------------------
1997 1996
---------- ---------
<S> <C> <C>
Results of Operations
---------------------
Revenue $ 450,973 294,634
Operating, selling, general and
administrative expenses (480,302) (299,596)
Depreciation and amortization (2,856) (2,390)
--------- --------
Operating loss (32,185) (7,352)
Other income (expense), net (11,677) 856
--------- --------
Net loss $ (43,862) (6,496)
========= ========
</TABLE>
The bank credit facility of PRIMESTAR Partners (the "PRIMESTAR Credit
Facility") was obtained by PRIMESTAR Partners to finance advances to Tempo
for payments due in respect of the construction of the Tempo Satellites,
and is supported by letters of credit arranged for by affiliates of all but
one of the Partners. At September 30, 1997, PRIMESTAR Partners'
indebtedness under the PRIMESTAR Credit Facility aggregated $555,000,000,
including amounts borrowed to pay interest charges. The maturity date of
the PRIMESTAR Credit Facility has been extended to December 31, 1997. See
notes 8 and 12.
Since March 10, 1997, PRIMESTAR Partners has transmitted the PRIMESTAR(R)
service from GE-2, a medium power satellite owned and operated by GE
Americom ("GE-2"). GE-2 was launched on January 30, 1997, and declared
commercially operational, effective March 6, 1997. Pursuant to the Amended
and Restated Memorandum of Agreement, effective as of October 18, 1996,
between PRIMESTAR Partners and GE Americom, which provides for PRIMESTAR
Partners' use of transponders on GE-2 (the "GE-2 Agreement"), PRIMESTAR
Partners is required to make minimum lease payments for an initial term of
six years from the availability of GE-2, extendible, at the option of
PRIMESTAR Partners, for the remainder of the useful life of GE-2 (the "End-
Of-Life Option"). The End-Of-Life Option expires if not exercised by
December 31, 1997; however, PRIMESTAR Partners is currently negotiating
an extension of the End-of-Life Option with GE Americom. PRIMESTAR
Partners' obligations under the GE-2 Agreement are supported by letters of
credit arranged for by affiliates of all but one of the Partners. Upon
consummation of the Restructuring Transaction, the GE-2 Agreement will be
assumed by New PRIMESTAR. See notes 2, 8 and 12.
PRIMESTAR Partners provides programming services to TSAT and other
authorized PRIMESTAR(R) distributors in exchange for a fee based upon the
number of subscribers receiving 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.
(continued)
I-14
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Financial Statements
Under PRIMESTAR Partners' limited partnership agreement, as amended, TSAT
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. Additionally, those subsidiaries of TSAT that are general
partners of PRIMESTAR Partners are 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.
As described in note 2, TSAT has entered into a binding letter agreement
with respect to the Restructuring Transaction, whereby the businesses of
TSAT and PRIMESTAR Partners and the PRIMESTAR(R) distribution businesses of
affiliates of the other Partners will be consolidated into a newly-formed
company.
(8) Satellites
----------
Tempo DBS System
TSAT, through Tempo, holds the FCC Permit authorizing construction of a
high-power DBS system consisting of two or more satellites delivering DBS
service in 11 frequencies at the 119 (degrees) 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
("HSDs") throughout the entire continental U.S.; 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.
Tempo is also a party to the Satellite Construction Agreement with Loral,
pursuant to which Tempo has arranged for the construction of the Tempo
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
Tempo Satellites is reflected in "Satellites" in the accompanying balance
sheets.
(continued)
I-15
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Financial Statements
One of the Tempo Satellites ("Tempo DBS-1") was outfitted with an antenna
designed for operation at the 119 (degrees) W.L. orbital location, and was
launched into geosynchronous orbit on March 8, 1997. Such satellite is
currently undergoing extended in-orbit testing pursuant to the Satellite
Construction Agreement. Assuming that such in-orbit testing is completed
successfully, Tempo DBS-1 is expected to be available for commercial
operations in the first quarter of 1998. At current levels of digital
compression, TSAT believes that Tempo DBS-1 would be able to deliver
approximately 100 channels of digital video and 20 channels of digital
audio programming, as operated under the FCC Permit. TSAT intends to use 18
inch HSDs for the proposed high-power service, the same diameter currently
used by other high-power DBS providers, in most areas.
Since the launch of Tempo DBS-1, Loral has notified TSAT of three separate
occurrences of power reductions on Tempo DBS-1. No assurance can be given
that further power reductions will not occur in the future. TSAT does not
currently know the extent of such power reductions, and cannot confirm the
precise causes thereof; however, such reductions could eventually affect
the proposed operation of Tempo DBS-1, either alone or together with other
events that may arise during the expected life of the satellite.
TSAT currently intends to operate Tempo DBS-1 as a platform to provide
high-power digital video and audio programming services to residential
customers, as well as multiple dwelling units, commercial customers and
resellers. If the Restructuring Transaction is consummated, Tempo will be
a wholly-owned subsidiary of New PRIMESTAR and New PRIMESTAR will operate
Tempo's high-power DBS services. If the Restructuring Transaction is not
consummated, TSAT expects that such services will be provided through
PRIMESTAR Partners, which has exercised its option, under an option
agreement between Tempo and PRIMESTAR Partners (the "Tempo Option
Agreement"), to purchase or lease 100% of the capacity of Tempo DBS-1. The
availability and utility of Tempo DBS-1, including the power levels
provided by Tempo DBS-1, are subject to risks of satellite defect, loss, or
reduced performance. See note 2.
In light of the pendency of the Restructuring Transaction and the ASkyB
Transaction (see note 2), TSAT and PRIMESTAR Partners are evaluating
alternative future plans with respect to the second Tempo Satellite ("Tempo
DBS-2"), including its use or disposition. Tempo DBS-2 presently serves as
a ground spare for Tempo DBS-1.
(continued)
I-16
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Financial Statements
Satellite Launches
Pursuant to the Satellite Construction Agreement, Loral must conduct
in-orbit testing following the launch of a satellite. Under the
Satellite Construction Agreement, 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
Tempo Satellites; however, if the two Tempo Satellites are not
delivered in such four attempts, Tempo may terminate the Satellite
Construction Agreement and receive a refund. Tempo also may terminate
the contract in the event of two successive satellite failures.
As a result of the aforementioned power reductions, in-orbit testing
has been extended and Tempo DBS-1 has not yet been accepted; however,
it is currently expected that such testing will be completed during the
fourth quarter of 1997. TSAT currently believes that Tempo DBS-1 may
not fully comply with specifications, but has not yet determined the
extent of any such non-compliance. Tempo and Loral are currently
engaged in discussions regarding this matter and the terms of any
monetary settlement with respect thereto to which Tempo may be entitled
under the Satellite Construction Agreement. A launch defect or damage
affecting Tempo DBS-1 could cause a substantial monetary loss to TSAT
or, following consummation of the Restructuring Transaction, New
PRIMESTAR.
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 Tempo 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 launch through Delivery. Such risk insurance
is required to 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 fixed contract price for each undelivered Tempo
Satellite if Loral fails to deliver both Tempo 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.
Although TSAT is entitled to the benefit of such warranties and
insurance coverage relating to the Tempo Satellites pursuant to the
Satellite Construction Agreement, such warranties and insurance
coverage might not be sufficient to compensate TSAT for all of its
losses in the event of a partial or total satelite failure or casualty,
even if such failure or casualty were a covered loss.
(continued)
I-17
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Financial Statements
Tempo Option
In February 1990, Tempo entered into the Tempo Option Agreement with
PRIMESTAR Partners 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 FCC Permit. Under the Tempo Option Agreement, upon the
exercise of the Tempo Option, PRIMESTAR Partners was obligated to pay
Tempo $1,000,000 (the "Exercise Fee") and to 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 is in turn supported by letters of credit arranged for
by affiliates of all but one of the Partners. The aggregate funding
provided to Tempo by PRIMESTAR Partners ($463,133,000 at September 30,
1997) is reflected in "Due to PRIMESTAR Partners" in the accompanying
balance sheets. At September 30, 1997, the amount borrowed by PRIMESTAR
Partners under the PRIMESTAR Credit Facility was $555,000,000,
including amounts borrowed to pay interest charges. See notes 7 and 12.
During 1996, TCIC made intercompany advances to TSAT to fund the
majority of the construction and related costs associated with the
Tempo Satellites. Prior to 1996, PRIMESTAR Partners had funded
substantially all of the construction and related costs associated with
the Tempo Satellites. In connection with the TSAT Spin-off, a
determination was made that such 1996 advances from TCIC would be
repaid by TSAT to TCIC, to the extent (and only to the extent) that
Tempo received corresponding advances from PRIMESTAR Partners. As a
result of negotiations between TSAT and PRIMESTAR Partners to resolve a
disagreement concerning the Tempo Satellites, PRIMESTAR Partners
advanced $73,786,000 to Tempo in December 1996 to reimburse Tempo for
all of the 1996 costs which previously had been funded by TCIC. Upon
receipt, such advance was paid to TCIC by Tempo in repayment of such
1996 advances from TCIC.
(continued)
I-18
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Financial Statements
On February 7, 1997, the Partners Committee of PRIMESTAR Partners
adopted a resolution (i) affirming that PRIMESTAR Partners had
unconditionally exercised the Tempo Option, (ii) approving the proposed
launch of Tempo DBS-1 into the 119(degrees) W.L. orbital position and
the use of Tempo DBS-2 as a spare or back-up for Tempo DBS-1, pending
other deployment or disposition as determined by PRIMESTAR Partners,
and (iii) authorizing the payment by PRIMESTAR Partners to Tempo of the
Exercise Fee and other amounts in connection with the Tempo Option and
the Tempo Letter Agreements, including funding of substantially all
construction and related costs relating to the Tempo Satellites not
previously funded by PRIMESTAR Partners. Such amounts have been paid to
TSAT.
The Tempo Letter Agreements permit PRIMESTAR Partners to apply its
advances to Tempo against any payments (other than the Exercise Fee)
due under the Tempo Option with respect to its purchase or lease of
satellite capacity. Although TSAT and PRIMESTAR Partners have not
entered into an agreement with respect to the purchase or lease of 100%
of the capacity of the proposed Tempo DBS system pursuant to the Tempo
Option, TSAT believes that its obligations to PRIMESTAR Partners with
respect to such advances will be satisfied in connection with the
completion of such purchase or lease. However, if notwithstanding the
exercise of the Tempo Option such purchase or lease of satellite
capacity is not completed, TSAT believes that alternative courses of
action are available that would allow TSAT to recover its costs of
constructing the Tempo Satellites. See note 2.
(9) Other Assets
------------
The components of other assets are as follows (amounts in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
1997 1996
------------- ------------
<S> <C> <C>
Deferred financing costs, net of
accumulated amortization $ 22,979 7,000
Investment in, and advances to, ResNet
Communications, Inc. 5,500 5,827
----------- ---------
$ 28,479 12,827
=========== =========
</TABLE>
(continued)
I-19
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Financial Statements
(10) Debt
----
The components of debt are as follows (amounts in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
1997 1996
------------- ------------
<S> <C> <C>
Bank Credit Facility (a) $ -- 246,000
Senior Subordinated Notes (b) 200,000 --
Senior Subordinated Discount Notes (b) 163,634 --
Other 2,126 1,230
-------- -------
$365,760 247,230
======== =======
</TABLE>
(a) Bank Credit Facility
On December 31, 1996, TSAT entered into the Bank Credit Facility.
As a result of the February 1997 issuance of the Notes and the
March 1997 determination that GE-2 was commercially operational,
the maximum commitments under the Bank Credit Facility were
increased from $350,000,000 to $750,000,000. At September 30,
1997, $720,000,000 of such maximum commitments were unused. The
availability of such commitments for borrowing is subject to
TSAT's compliance with operating and financial covenants and other
customary conditions. Commencing March 31, 2001, aggregate
commitments will be reduced quarterly in accordance with a
schedule, until final maturity at June 30, 2005. TSAT's initial
borrowings under the Bank Credit Facility were used to repay in
full the principal amount of and accrued interest on the TSAT Note
and to fund financing costs associated with the arrangement of the
facility.
Borrowings under the Bank Credit Facility bear interest at
variable rates. In addition, TSAT is required to pay a commitment
fee equal to 0.375% on the average daily unused portion of the
available commitments, payable quarterly in arrears and at
maturity. Such commitment fees aggregated $1,749,000 during the
nine months ended September 30, 1997.
(continued)
I-20
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Financial Statements
Borrowings under the Bank Credit Facility are guaranteed by TSAT's
restricted subsidiaries (currently all of TSAT's subsidiaries
except Tempo) (the "Restricted Subsidiaries"), and secured by
collateral assignments or other security interests in (i) all
capital stock of certain of TSAT's Restricted Subsidiaries and
(ii) substantially all of TSAT's assets (other than the Tempo
Satellites). The Bank Credit Facility contains affirmative
covenants regarding minimum subscribers, revenue per subscriber
and debt service coverage, as well as negative covenants that
limit TSAT and its Restricted Subsidiaries from, among other
things, (i) incurring indebtedness, (ii) creating liens and other
encumbrances, (iii) entering into merger or consolidation
transactions, (iv) entering into transactions with affiliates, (v)
making investments, (vi) making capital expenditures, (vii) paying
dividends and making other distributions, (viii) redeeming stock,
(ix) redeeming or purchasing of subordinated debt (except under
certain limited circumstances) (x) paying interest on or principal
of subordinated debt during the continuation of (A) an event of
default under the Bank Credit Facility or (B) a default under the
Bank Credit Facility of which management of TSAT has actual or
constructive notice, (xi) entering into sale and leaseback
transactions and (xii) engaging in non-designated activities. The
Bank Credit Facility also contains customary events of default and
provisions for mandatory prepayments and commitment reductions in
the event of certain asset sales.
TSAT anticipates that it will be required to refinance and/or
amend the Bank Credit Facility prior to the consummation of the
Restructuring Transaction described in note 2. No assurance can be
given that any such refinancing and/or amendment will be completed
on terms acceptable to TSAT.
During the first quarter of 1997, two letters of credit with an
aggregate drawable amount of $30,000,000 were issued for the
account of TSAT pursuant to the Bank Credit Facility. See note 12.
(b) Notes
On February 20, 1997, TSAT issued 10-7/8% Senior Subordinated
Notes due 2007 having an aggregate principal amount of
$200,000,000 (the "Senior Subordinated Notes") and 12-1/4% Senior
Subordinated Discount Notes due 2007 having an aggregate principal
amount at maturity of $275,000,000 (the "Senior Subordinated
Discount Notes," and together with the Senior Subordinated Notes,
the "Notes"). The net proceeds from the issuance of the Notes
(approximately $340,500,000 after deducting offering expenses)
were initially held in escrow and were subsequently released to
TSAT on March 17, 1997. TSAT initially used $244,404,000 of such
net proceeds to repay amounts outstanding under the Bank Credit
Facility.
(continued)
I-21
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Financial Statements
Cash interest on the Senior Subordinated Notes is payable semi-
annually in arrears on February 15 and August 15, commencing
August 15, 1997. Cash interest will not accrue or be payable on
the Senior Subordinated Discount Notes prior to February 15, 2002.
Thereafter cash interest will accrue at a rate of 12-1/4% per
annum and will be payable semi-annually in arrears on February 15
and August 15, commencing August 15, 2002; provided however, that
at any time prior to February 15, 2002, TSAT may make a Cash
Interest Election (as defined) on any interest payment date to
commence the accrual of cash interest from and after the Cash
Election Date (as defined). The Notes mature February 15, 2007.
The Notes will be redeemable at the option of TSAT, in whole or in
part, at any time after February 15, 2002 at specified redemption
prices. In addition, prior to February 15, 2000, TSAT may use the
net cash proceeds from certain specified equity transactions to
redeem up to 35% of the Notes at specified redemption prices.
The Notes were not originally registered under the Securities Act
of 1933, as amended (the "Securities Act"), but contained a
covenant requiring TSAT to file with the Securities and Exchange
Commission (the "SEC") a registration statement with respect to an
offer to exchange (the "Exchange Offer") the Notes for
substantially identical notes that are so registered ("Exchange
Notes") or, alternatively, to register the Notes under the
Securities Act. Although TSAT filed a registration statement in
connection with the Exchange Offer with the SEC on April 11, 1997,
such registration statement has not been declared effective, and
accordingly, the Exchange Offer has not been commenced. As a
result, effective July 5, 1997, TSAT began to incur additional
interest on the Notes. During the 90-day period ended October 3,
1997, additional interest on the Notes accrued at the rate of
$0.05 per $1000 principal amount per week. For each subsequent
90-day period in which the Notes are not registered under the
Securities Act or exchanged for registered Exchange Notes, the
additional interest on the notes will be increased by $0.05 per
$1000 principal amount per week up to a maximum of $0.50 per $1000
principal amount per week. Such additional interest aggregated
$252,000 through September 30, 1997. TSAT currently expects that,
due to the pendency of the Restructuring Transaction, it may not
be able to comply with the registration requirements under the
Notes, and accordingly, will not be able to cease the accrual of
additional interest, until the first quarter of 1998.
With the exception of the Notes, which had an aggregate fair value of
$388,903,000 at September 30, 1997, TSAT believes that the fair value and
the carrying value of TSAT's debt were approximately equal at September 30,
1997.
(continued)
I-22
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Financial Statements
(11) Transactions with Related Parties
---------------------------------
TCIC provides certain installation, maintenance, retrieval and other
customer fulfillment services to TSAT. During the nine months ended
September 30, 1997 and 1996, TSAT's capitalized installation costs included
amounts charged by TCIC to TSAT of $43,762,000 and $37,470,000,
respectively. Maintenance, retrieval and other operating expenses charged
by TCIC to TSAT aggregated $7,216,000 and $16,446,000 during the nine
months ended September 30, 1997 and 1996, respectively. Prior to the TSAT
Spin-off, the foregoing charges were allocated from TCIC to TSAT based upon
a standard charge for each of the customer fulfillment activities performed
by TCIC.
Pursuant to a fulfillment agreement (as amended, the "Fulfillment
Agreement"), TCIC has provided fulfillment services on an exclusive basis
to TSAT with respect to customers of the PRIMESTAR(R) medium power service.
Such services include installation, maintenance, retrieval, inventory
management and other customer fulfillment services. Among other matters,
the Fulfillment Agreement (i) sets forth the responsibilities of TCIC with
respect to fulfillment services, including performance standards, (ii)
provides for TCIC's fulfillment sites to be connected to the billing and
information systems used by TSAT, allowing for on-line scheduling and
dispatch of installation and other service calls, and (iii) provides
scheduled rates to be charged to TSAT for the various customer fulfillment
services provided by TCIC.
From January 1, 1997 through July 21, 1997, charges for customer
fulfillment services provided by TCIC were made pursuant to the Fulfillment
Agreement, as originally executed by TSAT and TCIC in connection with the
TSAT Spin-off (the "Original Fulfillment Agreement"). The cost to TSAT of
the services provided by TCIC under the Original Fulfillment Agreement
exceeded the standard charges allocated to TSAT for such services through
December 31, 1996. Effective July 22, 1997, the Original Fulfillment
Agreement was amended to, among other items, (i) change the termination
date to December 31, 1997 and, (ii) reduce the scheduled rates for the
customer fulfillment services provided by TCIC to rates that are comparable
to those that were used to allocate fulfillment charges to TSAT prior to
the TSAT Spin-off. In September and October, 1997, TSAT entered into
agreements with eight regional fulfillment companies (none of which is
affiliated with TSAT or any other party to the Restructuring Transaction)
to perform the services that will no longer be performed by TCIC following
the termination of the Fulfillment Agreement. TSAT's management believes
that the terms and conditions of such new third party fulfillment
agreements are in the aggregate no less favorable to TSAT than the terms
and conditions of the Original Fulfillment Agreement or the amended
Fulfillment Agreement. The transition from TCIC to the third party
fulfillment companies is currently in progress and is expected to be
completed in December 1997.
(continued)
I-23
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Financial Statements
TCIC also provides corporate administrative and certain telephony services to
TSAT. Prior to the TSAT Spin-off, the related administrative and telephony
expenses were allocated from TCIC to TSAT based on the estimated cost of
providing the service. Such charges aggregated $14,600,000 during the nine
months ended September 30, 1996.
Since the TSAT Spin-off Date, charges for administrative services provided by
TCIC have been made pursuant to a transition services agreement entered into by
TSAT and TCI in connection with the TSAT Spin-off (the "Transition Services
Agreement"). Pursuant to the Transition Services Agreement, TCI is obligated to
provide to TSAT certain services and other benefits, including certain
administrative and other services that were provided by TCI prior to the TSAT
Spin-off. Pursuant to the Transition Services Agreement, TCI has also agreed to
provide TSAT 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 HSDs,
satellite receivers and other equipment. As compensation for the services
rendered and for the benefits made available to TSAT pursuant to the Transition
Services Agreement, TSAT is required to 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), up to a
maximum of $3,000,000 per month, and to reimburse TCI quarterly for direct, out-
of-pocket expenses incurred by TCI to third parties in providing the services.
The Transition Services Agreement continues 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 TSAT following certain changes in control of TSAT, and (iii)
either party if the other party is the subject of certain bankruptcy or
insolvency-related events. Pursuant to the terms of the Transition Services
Agreement, TCI has the right to terminate the agreement upon the consummation of
the Restructuring Transaction. TSAT believes that TCI will exercise its right to
terminate the Transition Services Agreement concurrently with the consummation
of the Restructuring Transaction. TSAT does not believe that any such
termination will have a material adverse effect on TSAT. Charges under the
Transition Services Agreement aggregated $8,611,000 during the nine months ended
September 30, 1997.
During the nine months ended September 30, 1997, TSAT purchased from TCIC at
TCIC's cost certain telephony services aggregating $3,457,000.
Beginning in March 1997, TCIC began providing TSAT with customer support
services from its Boise, Idaho call center ( the "Boise Call Center"). The Boise
Call Center responds to calls that exceed the capacity of TSAT's National Call
Center. Amounts charged by TCIC to TSAT for such services aggregated $5,939,000
during the nine months ended September 30, 1997.
(continued)
I-24
<PAGE>
TCI SATELLITE ENTERTINMENT, INC.
(See note 1)
Notes to Financial Statements
Through the TSAT Spin-off Date, the effects of all transactions between
TSAT and TCI were reflected as adjustments to a non-interest bearing
intercompany account. As described in note 3, all but $250,000,000 of this
intercompany account was forgiven in connection with the TSAT Spin-off
(other than certain advances relating to construction of the Tempo
Satellites, which were repaid from advances subsequently received from
PRIMESTAR Partners - see note 8). Since the TSAT Spin-off Date, the effects
of transactions between TSAT and TCI have been reflected in a non-interest
bearing account that is settled periodically in cash. At September 30, 1997
and December 31, 1996, amounts owed to TCIC pursuant to such non-interest
bearing intercompany account aggregated $12,100,000 and $8,381,000,
respectively, and are included in "Other accrued expenses" in the
accompanying consolidated balance sheets.
Certain key employees of TSAT 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 TSAT have been recorded in the accompanying
financial statements, but are subject to future adjustment based upon the
market value of the underlying common stock of TCI and, ultimately, on the
final determination of market value when the rights are exercised. Non-
cash increases (decreases) to TSAT's share of TCI's estimated stock
compensation liability aggregated $3,039,000 and $(553,000) during the nine
months ended September 30, 1997 and 1996, respectively.
Through the TSAT Spin-off Date, TSAT's results of operations were included
in TCI's consolidated U.S. Federal income tax returns, in accordance with
the existing tax sharing arrangements among TCI and its consolidated
subsidiaries. Effective July 1, 1995, TCI, TCIC and certain other
subsidiaries of TCI entered into a tax sharing agreement (the "Tax Sharing
Agreement"), which formalized such pre-existing tax sharing arrangements
and implemented 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. In connection with the TSAT Spin-off, the Tax Sharing
Agreement was amended to provide that TSAT be treated as if it had been a
party to the Tax Sharing Agreement, effective July 1, 1995. TSAT's
intercompany income tax allocation for the nine months ended September 30,
1996 has been calculated in accordance with the Tax Sharing Agreement.
(continued)
I-25
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Financial Statements
In connection with the Restructuring Transaction, TSAT and TCI entered into
a tax sharing agreement dated June 1997, to confirm that pursuant to the
amended Tax Sharing Agreement (i) neither TSAT nor any of its subsidiaries
has any obligation to indemnify TCI or the TCI shareholders for any tax
resulting from the TSAT Spin-off failing to qualify as a tax-free
distribution pursuant to Section 355 of the Internal Revenue Code of 1986
(the "Code"); (ii) TCI is obligated to indemnify TSAT and its subsidiaries
for any taxes resulting from the TSAT Spin-off failing to qualify as a tax-
free distribution pursuant to Section 355 of the Code; (iii) to the best
knowledge of TCI, TSAT's total payment obligation under the Tax Sharing
Agreement could not reasonably be expected to exceed $5 million; and (iv)
the sole agreement between TCI, on the one hand, and TSAT or any of its
subsidiaries, on the other, relating to taxes is the Tax Sharing Agreement.
As of the date of the TSAT Spin-off, the sole agreement, if any, between
any of the TCI stockholders, on the one hand, and TSAT or any of its
subsidiaries, on the other, relating to taxes was the Tax Sharing
Agreement.
(12) Commitments and Contingencies
-----------------------------
At September 30, 1997, TSAT's future minimum commitments to purchase
satellite reception equipment aggregated approximately $20,000,000.
TSAT engages master sales agents to recruit, train and maintain a network
of sub-agents to sell services on behalf of TSAT and to install, service
and maintain equipment located at the premises of the subscribers. As part
of the compensation paid for such services, TSAT has agreed to pay certain
residual sales commissions equal to a percentage of the programming revenue
collected from a subscriber installed by a master sales agent during
specified periods following the initiation of service (generally five
years). During the nine months ended September 30, 1997 and 1996,
respectively, residual sales commissions to such master sales agents
aggregated $11,518,000 and $7,887,000, respectively, and were charged to
expense in the accompanying statements of operations.
On the TSAT Spin-off Date, TSAT entered into an Indemnification Agreement
with each of TCIC and TCI UA 1, Inc., ("TCI UA 1"), an indirect subsidiary
of TCIC, (collectively, the "Indemnification Agreements"). The
Indemnification Agreement with TCIC provides for TSAT to reimburse TCIC for
any amounts drawn under an irrevocable transferable letter of credit issued
for the account of TCIC to support TSAT's share of PRIMESTAR Partners'
obligations under the GE-2 Agreement. The drawable amount of such letter of
credit is $25,000,000. See note 7.
The Indemnification Agreement with TCI UA 1 provides for TSAT 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 the PRIMESTAR Credit Facility. The drawable amount
of the TCI UA 1 Letter of Credit was $141,250,000 at September 30, 1997.
See notes 7 and 8.
(continued)
I-26
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Financial Statements
During the first quarter of 1997, two additional irrevocable transferable
letters of credit were issued pursuant to the Bank Credit Facility for the
account of TSAT, one to support TSAT's share of PRIMESTAR Partners'
obligations under the GE-2 Agreement, and the second to support the
PRIMESTAR Credit Facility. The initial drawable amount of the first letter
of credit is $25,000,000, increasing to $50,000,000 if PRIMESTAR Partners
exercises the End-of-Life Option, and the initial drawable amount of the
second letter of credit is $5,000,000. See notes 7 and 10.
The Indemnification Agreements provide for TSAT 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 TSAT to TCIC
and TCI UA 1 under such Indemnification Agreements are subordinated in
right of payment with respect to the obligations of TSAT under the Bank
Credit Facility. See note 10.
During the first quarter of 1997, TCI agreed to cause TCI UA 1 to renew the
letter of credit arranged by it on TSAT's behalf, through December 31,
1997. During such period TSAT and/or PRIMESTAR Partners will seek to obtain
permanent financing for the Tempo Satellites (to the extent not sold to a
person other than PRIMESTAR Partners) on a basis that does not require TSAT
to post a letter of credit with respect thereto. If such permanent
financing is not available, under certain maintenance covenants contained
in the Bank Credit Facility, TSAT would be unable to provide or arrange for
such a letter of credit unless (i) the lenders under the Bank Credit
Facility were to agree to amend or waive such covenants to permit the
posting of such letter of credit by the TSAT, (ii) TCI were to agree to
renew the TCI UA 1 Letter of Credit for an additional period, or (iii) TSAT
were to achieve a greater than anticipated increase in operating income
before depreciation and stock compensation. If TSAT and/or PRIMESTAR
Partners are unable to refinance the Tempo Satellites (to the extent not
sold to a person other than PRIMESTAR Partners) without a letter of credit
and is unable to post (or arrange for the posting of) such a letter of
credit, TSAT could be adversely affected. See notes 7, 8 and 10.
The International Bureau of the FCC (the "International Bureau") has
granted EchoStar Satellite Corporation, a subsidiary of EchoStar
Communications Corp. (together with its consolidated subsidiaries,
"EchoStar") a conditional authorization to construct, launch and operate a
Ku-band domestic fixed satellite into the orbital position at 83(degrees)
W.L., immediately adjacent to that occupied by GE-2. Contrary to previous
FCC policy which would have permitted operation of a satellite at the
83(degrees) W.L. orbital position at a power level of only 60 to 90 watts
(subject to coordination requirements), EchoStar has been authorized to
operate at a power level of 130 watts. If EchoStar were to launch its high-
power satellite authorized to 83(degrees) W.L. and commence operations at
that location at a power level of 130 watts, it would likely cause harmful
interference to the reception of the PRIMESTAR(R) signal from GE-2 by
subscribers to the PRIMESTAR(R) medium power service.
(continued)
I-27
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1)
Notes to Financial Statements
GE Americom and PRIMESTAR Partners have each requested reconsideration of
the International Bureau's authorization for EchoStar to operate at
83(degrees) W.L. These requests, which were opposed by EchoStar and others,
are currently pending at the International Bureau. There can be no
assurance that the International Bureau will change slot assignments, or
power levels, in a fashion that eliminates the potential for harmful
interference. Accordingly, the ultimate outcome of this matter cannot
presently be predicted.
GE Americom and PRIMESTAR Partners have attempted to resolve potential
coordination problems directly with EchoStar. However, it is uncertain
whether any agreement in respect of such coordination between PRIMESTAR
Partners and EchoStar will be reached, or that even if such agreement is
reached, that coordination will resolve such interference.
TSAT has contingent liabilities related to legal proceedings and other
matters arising in the ordinary course of business. Although it is
reasonably possible TSAT may incur losses upon conclusion of such matters,
an estimate of any loss or range of loss cannot be made. 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 financial statements.
I-28
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1 to the accompanying 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 TSAT and should be read in
conjunction with (i) the accompanying financial statements of TSAT, and (ii) the
financial statements, and related notes thereto, of TSAT, and Management's
------------
Discussion and Analysis of Financial Condition and Results of Operations
- - ------------------------------------------------------------------------
included in TSAT's Annual Report on Form 10-K for the year ended December 31,
1996.
Certain statements in this Quarterly Report on Form 10-Q constitute "forward-
looking statements" within the meaning of the Private Securities Litigation
Reform Act of 1995. Such forward-looking statements involve known and unknown
risks, uncertainties and other important factors that could cause the actual
results, performance or achievements of TSAT, or industry results, to differ
materially from any future results, performance or achievements expressed or
implied by such forward-looking statements. Such risks, uncertainties and other
factors include, among others: general economic and business conditions and
industry trends; the continued strength of the multichannel video programming
distribution industry and the satellite services industry and the growth of
satellite delivered television programming; uncertainties inherent in proposed
business strategies, new product launches and development plans, including
uncertainties regarding the Restructuring Transaction, the ASkyB Transaction,
TSAT's high-power strategy, future financial performance, including
availability, terms and deployment of capital; the ability of vendors to deliver
required equipment, software and services; availability of qualified personnel;
changes in, or the failure or the inability to comply with, government
regulations, including, without limitation, regulations of the FCC, and adverse
outcomes from regulatory proceedings; changes in the nature of key strategic
relationships with partners and joint venturers; competitor responses to TSAT's
products and services, and the overall market acceptance of such products and
services, including acceptance of the pricing of such products and services;
possible interference by satellites in adjacent orbital positions with the
satellite currently being used for PRIMESTAR Partners' existing medium power
satellite television business; and other factors referenced in this Report.
These forward-looking statements speak only as of the date of this Report. TSAT
expressly disclaims any obligation or undertaking to disseminate any updates or
revisions to any forward-looking statement contained herein to reflect any
change in TSAT's expectations with regard thereto or any change in events,
conditions or circumstances on which any such statement is based.
I-29
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1 to the accompanying financial statements)
Material Changes in Results of Operations
- - -----------------------------------------
As described in note 2 to the accompanying financial statements of TSAT,
TSAT has entered into binding agreements with respect to the Restructuring
Transaction and the ASkyB Transaction. Upon consummation of the Restructuring
Transaction and the ASkyB Transaction, TSAT will be consolidated into New
PRIMESTAR and TSAT will no longer be a separate public company. New PRIMESTAR
will be a significantly larger entity than TSAT, and it is anticipated that New
PRIMESTAR will initially incur significantly greater losses than TSAT due
primarily to disproportionately higher levels of depreciation, amortization and
interest expense. In addition, it is anticipated that New PRIMESTAR will
develop a high-power DBS service, and that New PRIMESTAR may determine to
migrate some or all of the existing medium-power PRIMESTAR(R) customers to such
high-power service. Under such circumstances, New PRIMESTAR would necessarily
be operating under a different cost structure than that of TSAT's medium-power
business. No assurance can be given that the Restructuring Transaction and the
ASkyB Transaction will be consummated. The following discussion focuses on the
results of operations of TSAT as a stand-alone entity without giving effect to
the pending Restructuring Transaction and ASkyB Transaction.
As described in greater detail below, TSAT reported net losses of
$166,544,000 and $56,594,000 during the nine months ended September 30, 1997 and
1996, respectively. Improvements in TSAT'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 TSAT's
costs. No assurance can be given that any such improvements will occur. In
addition, TSAT incurs significant sales commissions and installation costs when
its customers initially subscribe to the service. Management expects that the
costs of acquiring subscribers will continue to be significant. The high cost
of obtaining new subscribers also magnifies the negative effects of subscriber
churn.
During the nine months ended September 30, 1997 and 1996, and the years
ended December 31, 1996, 1995 and 1994, (i) TSAT's annualized subscriber churn
rate (which represents the annualized number of subscriber terminations divided
by the weighted average number of subscribers during the period) was 32.2%,
38.9%, 38.5%, 24.7% and 16.1%, respectively, and (ii) the average subscriber
life implied by such subscriber churn rate was 3.1 years, 2.6 years, 2.6 years,
4.1 years and 6.2 years, respectively.
I-30
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1 to the accompanying financial statements)
Material Changes in Results of Operations (continued)
- - -----------------------------------------------------
As set forth above, TSAT experienced a higher rate of subscriber churn in
1996, as compared to the first nine months of 1997 and prior periods. TSAT
believes that the higher 1996 churn rate is primarily attributable to the fact
that subscribers were allowed to initiate service with no credit approval during
the fourth quarter of 1995 and the first six months of 1996. Service to a
significant number of such subscribers was terminated during 1996 after their
accounts became delinquent. Such delinquent accounts contributed to a
significant increase in TSAT's bad debt expense during 1996. TSAT has addressed
this issue by implementing more stringent credit policies. In this regard, TSAT
began to institute more selective credit policies during the third quarter of
1996 and further tightened such policies during the fourth quarter of 1996.
TSAT 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, TSAT expects that churn rates for the
remainder of 1997 and future periods will be lower than the levels experienced
in 1996. If TSAT's churn rates were to return to, or increase from, such 1996
levels, TSAT believes that its financial condition and results of operations
could be adversely affected.
TSAT currently offers a marketing program that allows subscribers to
purchase TSAT's proprietary satellite reception equipment at a price that is
less than TSAT's cost. Losses incurred by TSAT on such sales of satellite
reception equipment are charged to operations in the periods such sales are
consummated. To date, the number of customers selecting this marketing program
has been insignificant. TSAT cannot presently predict whether a significant
number of customers will take advantage of this marketing program in the future.
I-31
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1 to the accompanying financial statements)
Material Changes in Results of Operations (continued)
- - -----------------------------------------------------
Since July 1994, when PRIMESTAR Partners completed its conversion from an
analog to a digital signal, TSAT has experienced significant growth in the
number of customers and active authorized satellite receivers or integrated
receivers/decoders ("Authorized Units"). In this regard, the numbers of
customers and Authorized Units were as follows:
<TABLE>
<CAPTION>
September 30, December 31,
---------------- -------------------------
1997 1996 1996 1995 1994
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Customers 769,000 644,000 702,000 472,000 89,000
Authorized Units 888,000 735,000 805,000 535,000 100,000
</TABLE>
To the extent not otherwise described, increases in TSAT's revenue and
operating, selling, general and administrative expenses, as detailed below, are
primarily related to growth in customers and Authorized Units, as reflected in
the foregoing table. TSAT is operating in an increasingly competitive
environment. No assurance can be given that such increasing competition will
not adversely affect TSAT's ability to continue to achieve growth in Authorized
Units and revenue.
As further described in note 11 to the accompanying financial statements of
TSAT, TCIC has historically provided TSAT with certain fulfillment services with
respect to customers of the PRIMESTAR(R) programming service. From January 1,
1997 through July 21, 1997, charges for customer fulfillment services provided
by TCIC were made pursuant to the Original Fulfillment Agreement. The scheduled
rates for the services provided by TCIC under the Original Fulfillment Agreement
exceeded the scheduled rates upon which charges, historically, were allocated to
TSAT for such services. Effective July 22, 1997, the Original Fulfillment
Agreement was amended to, among other items, (i) change the termination date to
December 31, 1997 and, (ii) reduce the scheduled rates for the customer
fulfillment services provided by TCIC to rates that are comparable to those that
were used to allocate fulfillment charges to TSAT prior to the TSAT Spin-off.
In September and October, 1997, TSAT entered into agreements with eight regional
fulfillment companies (none of which is affiliated with TSAT or any other party
to the Restructuring Transaction) to perform the services that will no longer be
performed by TCIC following the termination of the Fulfillment Agreement.
TSAT's management believes that the terms and conditions of such new third party
fulfillment agreements are in the aggregate no less favorable to TSAT than the
terms and conditions of the Original Fulfillment Agreement or the amended
Fulfillment Agreement. The transition from TCIC to the third party contractors
is currently in progress and is expected to be completed in December 1997.
Installation charges from TCIC include direct and indirect costs of
performing installations. Through the TSAT Spin-off Date, TSAT capitalized a
portion of such charges as subscriber installation costs based upon amounts
charged by unaffiliated third parties to perform similar services. Subsequent
to the TSAT Spin-off Date, TSAT has capitalized the full amount of installation
fees paid to TCIC with respect to customers who have elected to lease satellite
reception equipment.
I-32
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1 to the accompanying financial statements)
Material Changes in Results of Operations (continued)
- - -----------------------------------------------------
Certain financial information concerning TSAT's operations is presented
below (dollar amounts in thousands):
<TABLE>
<CAPTION>
Nine months ended September 30,
-------------------------------------------------
1997 1996
------------------------ -----------------------
Percentage Percentage
of total of total
Amount revenue Amount revenue
----------- ----------- ---------- -----------
<S> <C> <C> <C> <C>
Revenue:
Programming and equipment rental $ 374,182 92% $ 249,439 83%
Installation 31,890 8 50,810 17
--------- ---- --------- ----
Total revenue 406,072 100 300,249 100
--------- ---- --------- ----
Operating costs and expenses:
Charges from PRIMESTAR Partners:
Programming (126,681) (31) (88,007) (29)
Satellite, national marketing and
distribution (61,568) (15) (46,781) (16)
--------- ---- --------- ----
(188,249) (46) (134,788) (45)
Other operating (18,992) (5) (23,909) (8)
--------- ---- --------- ----
(207,241) (51) (158,697) (53)
--------- ---- --------- ----
Selling, general and administrative:
Selling and regional marketing (80,844) (20) (87,073) (29)
Bad debt (14,929) (3) (14,179) (5)
Other general and administrative (43,784) (11) (34,914) (11)
--------- ---- --------- ----
(139,557) (34) (136,166) (45)
--------- ---- --------- ----
Operating Cash Flow (1) 59,274 15 5,386 2
Stock compensation (4,607) (1) 553 --
Depreciation (177,415) (44) (87,205) (29)
--------- ---- --------- ----
Operating loss $(122,748) (30)% $ (81,266) (27)%
========= ==== ========= ====
</TABLE>
____________________
(1) Operating Cash Flow, which represents operating income before depreciation
and stock compensation, is a commonly used measure of value and borrowing
capacity. Operating Cash Flow 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.
I-33
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1 to the accompanying financial statements)
Material Changes in Results of Operations (continued)
- - -----------------------------------------------------
Revenue increased $105,823,000 or 35% during the nine months ended
September 30, 1997, as compared to the corresponding prior year period. Such
increase represents the net effect of a $124,743,000 or 50% increase in
programming and equipment rental revenue and a $18,920,000 or 37% decrease in
installation revenue. The increase in programming and equipment rental revenue
is primarily the result of an increase from the 1996 period to the 1997 period
in the average number of Authorized Units. Additionally, TSAT's average monthly
programming and equipment rental revenue per Authorized Unit increased from $44
($50 per customer) during the 1996 period to $49 ($57 per customer) during the
1997 period. Such increase was primarily the result of rate increases
implemented in May 1997 as well as an increase in the average monthly revenue
derived from pay-per-view services. The decrease in installation revenue is
primarily attributable to a reduction from the 1996 period to the 1997 period in
the number of installations performed and a decrease from $132 during the 1996
period to $114 during the 1997 period in the average installation revenue from
each Authorized Unit installed.
PRIMESTAR Partners provides programming services to TSAT and other
authorized PRIMESTAR(R) distributors in exchange for a fee based upon the number
of customers receiving 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 authorized PRIMESTAR(R) distributor, including TSAT, based on such
distributor's total number of Authorized Units. The aggregate charges for such
services increased $53,461,000 or 40% during the nine months ended September 30,
1997, as compared to the corresponding prior year period. The average aggregate
monthly amount per Authorized Unit charged by PRIMESTAR Partners was $25 ($28
per customer) and $24 ($27 per customer) during each of the nine month periods
ended September 30, 1997 and 1996, respectively. 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, decreased $4,917,000 or 21%
during the nine months ended September 30, 1997, as compared to the
corresponding prior year period. Such decrease is primarily attributable to the
fact that TSAT's other operating costs and expenses for the nine months ended
September 30, 1996 included $7,844,000 of installation fees paid to TCIC that
were not capitalized. Other operating costs and expenses for the nine months
ended September 30, 1997 do not include a similar amount since TSAT has
capitalized the full amount of installation fees paid to TCIC since the TSAT
Spin-off Date for installations associated with customers who have elected to
lease satellite reception equipment. As described above, the charges for
installation and other customer fulfillment services provided by TCIC have been
made pursuant to the Original Fulfillment Agreement and the amended Fulfillment
Agreement since January 1, 1997.
I-34
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1 to the accompanying financial statements)
Material Changes in Results of Operations (continued)
- - -----------------------------------------------------
Selling, general and administrative expenses increased $3,391,000 or 2%
during the nine months ended September 30, 1997, as compared to the
corresponding prior year period. Selling and regional marketing expenses, which
represented 20% of revenue during the 1997 period, include sales commissions,
marketing and advertising expenses, and costs associated with the operation of
customer service call center and five regional sales offices. Bad debt expense
represented 3% of revenue during the 1997 period. In total, selling, general
and administrative expenses represented 34% and 45% of revenue during the nine
months ended September 30, 1997 and 1996, respectively. The decrease in such
percentage is primarily attributable to (i) lower sales commissions due to a 27%
decrease in installations in 1997 as compared to 1996, and (ii) the relatively
fixed nature of certain components of TSAT's selling, general and administrative
expenses.
Selling, general and administrative expenses during the nine months ended
September 30, 1997 include $8,611,000 that was charged to TSAT by TCIC pursuant
to the Transition Services Agreement, $3,457,000 that was charged to TSAT by
TCIC for certain telephony services, and $5,939,000 that was charged to TSAT
pursuant to a March 1997 agreement to use TCIC's Boise Call Center to respond to
calls that exceed the capacity of TSAT's National Call Center. Through the TSAT
Spin-off Date, general and administrative allocations from TCIC (including
telephony services) were based upon the estimated cost of such services provided
to TSAT. The amounts charged to TSAT pursuant to the Transition Services
Agreement are in excess of the amounts that would have been allocated by TCIC to
TSAT under the arrangement that was in effect through the TSAT Spin-off Date.
If the Transition Services Agreement had been effective as of January 1, 1996,
selling, general and administrative expenses would have been approximately
$139,995,000 for the nine months ended September 30, 1996. For additional
information, see note 11 to the accompanying financial statements of TSAT.
The $90,210,000 or 103% increase in depreciation expense during the nine
months ended September 30, 1997, as compared to the corresponding prior year
period, is the result of an increase in TSAT's depreciable assets due primarily
to capital expenditures with respect to TSAT's satellite reception equipment and
subscriber installation costs. Changes in TSAT's depreciation policies also
contributed to the increase. Effective October 1, 1996, TSAT (i) changed the
method used to depreciate its subscriber installation costs, and (ii) reduced
the estimated useful life of certain satellite reception equipment. The
inception-to-date effect on depreciation expense of the change in depreciation
method was recorded during the fourth quarter of 1996. The effect of the
reduction in estimated useful life was accounted for on a prospective basis.
For additional information concerning such accounting changes, see note 4 to the
accompanying financial statements of TSAT.
TSAT incurred interest expense of $33,965,000 during the nine months ended
September 30, 1997. Substantially all of such interest was attributable to the
December 31, 1996 completion of the Bank Credit Facility and the February 1997
issuance of the Notes. TSAT expects that it will continue to incur significant
levels of interest expense in future periods.
I-35
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1 to the accompanying financial statements)
Material Changes in Results of Operations (continued)
- - -----------------------------------------------------
TSAT's share of PRIMESTAR Partners' net losses increased $10,165,000 or
703% during the nine months ended September 30, 1997, as compared to the
corresponding prior year period. Such increase is primarily attributable to
increases in PRIMESTAR Partners' interest expense and operating loss. The
increase in interest expense is attributable to interest incurred on borrowings
under the PRIMESTAR Credit Facility that were used to fund the construction of
Tempo DBS-2. Prior to the January 1, 1997 determination that construction of
Tempo DBS-2 was substantially complete, interest incurred on the applicable
borrowings under the PRIMESTAR Credit Facility had been capitalized. The
increase in PRIMESTAR Partners' operating loss occurred as the increase in
PRIMESTAR Partners' revenue did not fully offset increases in selling, marketing
and certain other expenses. Historically, PRIMESTAR Partners' operating
deficits have been funded by capital contributions from TSAT and the other
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, TSAT anticipates that any such operating deficit would be
funded by PRIMESTAR Partners' then existing external sources of liquidity (which
may include capital contributions from TSAT and the other Partners), or by
increases in the above-described programming and authorization fees charged by
PRIMESTAR Partners to TSAT and other authorized PRIMESTAR(R) distributors.
TSAT recognized no income tax benefit during the nine months ended
September 30, 1997 and an income tax benefit of $25,806,000 during the nine
months ended September 30, 1996. The effective tax rate associated with the
1996 benefit was 31%. TSAT's income tax benefit for the nine months ended
September 30, 1996 includes intercompany allocations from TCI of current income
tax benefits of $44,454,000. As a result of the TSAT Spin-off, TSAT is no
longer a part of the TCI consolidated tax group, and accordingly, is only able
to realize income tax benefits for financial reporting purposes to the extent
that such benefits offset TSAT's income tax liabilities or TSAT generates
taxable income. For financial reporting purposes, all of TSAT's income tax
liabilities had been fully offset by income tax benefits at December 31, 1996
and September 30, 1997. Additionally, during the first several years following
the TSAT Spin-off, TSAT 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. In connection with the TSAT Spin-off, TSAT became
a party to the Tax Sharing Agreement that currently exists among TCI, TCIC and
certain other subsidiaries of TCI. For additional information, see note 11 to
the accompanying financial statements of TSAT.
I-36
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1 to the accompanying financial statements)
Material Changes in Financial Position
- - --------------------------------------
As described in note 2 to the accompanying financial statements of TSAT,
TSAT has entered into binding agreements with respect to the Restructuring
Transaction and the ASkyB Transaction. Upon consummation of the Restructuring
Transaction and the ASkyB Transaction, TSAT will be consolidated into New
PRIMESTAR. New PRIMESTAR will be a significantly larger entity than TSAT and
will have significant financial obligations. In this regard, New PRIMESTAR will
incur significant indebtedness in connection with the Restructuring Transaction
and will issue approximately $600 million liquidation value of preferred stock
and approximately $516 million principal amount of subordinated convertible
notes in connection with the ASkyB Transaction. The debt to be assumed by New
PRIMESTAR in connection with the Restructuring Transaction will include the
Notes and any amounts outstanding under the Bank Credit Facility. In addition to
the foregoing obligations, New PRIMESTAR will be responsible for payments due
under the GE-2 Agreement and various other commitments and contingent
liabilities associated with the businesses and assets that will comprise New
PRIMESTAR following consummation of the Restructuring Transaction and the ASkyB
Transaction. To the extent not earlier refinanced by TSAT and/or PRIMESTAR
Partners, it is anticipated that New PRIMESTAR will also be required to
refinance the Bank Credit Facility and the PRIMESTAR Credit Facility. New
PRIMESTAR will also require significant capital in order to fund its business
strategies, including the development of a high-power DBS service, and any
possible migration of some or all of the existing medium-power PRIMESTAR(R)
customers to such high-power service. No assurance can be given that the
Restructuring Transaction and the ASkyB Transaction will be consummated or that,
if consummated, New PRIMESTAR will be able to obtain sufficient financial
resources in order to satisfy its short-term and long-term liquidity
requirements. The following discussion focuses on the liquidity and capital
resources of TSAT as a stand-alone entity without giving effect to the pending
Restructuring Transaction and the ASkyB Transaction.
Prior to the TSAT Spin-off Date, TSAT relied upon non-interest bearing
advances from TCIC in order to fund the majority of TSAT's working capital
requirements and capital expenditures. On the TSAT Spin-off Date, TSAT issued
the TSAT Note to TCIC and TCIC agreed to provide TSAT with financing pursuant to
the TCIC Credit Facility. The TCIC Credit Facility provided for TCIC's
commitment to make revolving loans to TSAT (the "TCIC Revolving Loans") and
TSAT's obligations with respect to the TCIC Revolving Loans and the TSAT Note,
including TSAT's best efforts obligations to refinance the TCIC Credit Facility.
On December 31, 1996, TSAT entered into the Bank Credit Facility and used
proceeds therefrom to repay the TSAT Note in full. In connection with the
February 1997 issuance of the Notes and the March 1997 determination that GE-2
was commercially operational, borrowing availability pursuant to the TCIC Credit
Facility was terminated. Accordingly, TCI is not expected to be a source of
financing for TSAT in future periods.
TSAT also has relied upon advances from PRIMESTAR Partners to finance the
cost of constructing the Tempo Satellites. Such advances, which aggregated
$463,133,000 at September 30, 1997, are reflected as a liability in the
consolidated balance sheets in the accompanying financial statements of TSAT.
See related discussion below.
I-37
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1 to the accompanying financial statements)
Material Changes in Financial Position (continued)
- - --------------------------------------------------
On February 20, 1997, TSAT issued the 10-7/8% Senior Subordinated Notes
having an aggregate principal amount of $200,000,000 and the 12-1/4% Senior
Subordinated Discount Notes having an aggregate principal amount at maturity of
$275,000,000. The net proceeds from the issuance of the Notes (approximately
$340,500,000 after deducting offering expenses) were initially held in escrow
and were subsequently released to TSAT on March 17, 1997. TSAT initially used
$244,404,000 of such net proceeds to repay amounts outstanding under the Bank
Credit Facility and expects to use the remaining net proceeds to fund capital
expenditures and operations and to provide for working capital and for other
general corporate purposes.
Cash interest on the Senior Subordinated Notes is payable semi-annually in
arrears on February 15 and August 15, commencing August 15, 1997. Cash interest
will not accrue or be payable on the Senior Subordinated Discount Notes prior to
February 15, 2002. Thereafter cash interest will accrue at a rate of 12-1/4%
per annum and will be payable semi-annually in arrears on February 15 and August
15, commencing August 15, 2002; provided however, that at any time prior to
February 15, 2002, TSAT may make a Cash Interest Election (as defined) on any
interest payment date to commence the accrual of cash interest from and after
the Cash Election Date (as defined). The Notes mature February 15, 2007. The
Notes will be redeemable at the option of TSAT, in whole or in part, at any time
after February 15, 2002 at specified redemption prices. In addition, prior to
February 15, 2000, TSAT may use the net cash proceeds from certain specified
equity transactions to redeem up to 35% of the Notes at specified redemption
prices.
The Notes were not originally registered under the Securities Act, but
contained a covenant requiring TSAT to file with the SEC a registration
statement with respect to the Exchange Offer, to exchange the Notes for Exchange
Notes, or, alternatively, to register the Notes under the Securities Act.
Although TSAT filed a registration statement in connection with the Exchange
Offer with the SEC on April 11, 1997, such registration statement has not been
declared effective, and accordingly, the Exchange Offer has not been commenced.
As a result, effective July 5, 1997, TSAT began to incur additional interest on
the Notes. During the 90-day period ended October 3, 1997, additional interest
on the Notes accrued at the rate of $0.05 per $1000 principal amount per week.
For each subsequent 90-day period in which the Notes are not registered under
the Securities Act, or exchanged for registered Exchange Notes, the additional
interest on the Notes will be increased by $0.05 per $1000 principal amount per
week up to a maximum of $0.50 per $1000 principal amount per week. Such
additional interest aggregated $252,000 through September 30, 1997. TSAT
currently expects that, due to the pendency of the Restructuring Transaction, it
may not be able to comply with the registration requirements under the Notes,
and accordingly, will not be able to cease the accrual of additional interest,
until the first quarter of 1998.
I-38
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1 to the accompanying financial statements)
Material Changes in Financial Position (continued)
- - --------------------------------------------------
At September 30, 1997, there were no outstanding borrowings under the Bank
Credit Facility. As a result of the February 1997 issuance of the Notes and the
March 1997 determination that GE-2 was commercially operational, the maximum
available commitments under the Bank Credit Facility were increased from
$350,000,000 to $750,000,000. At September 30, 1997, $720,000,000 of such
maximum commitments were unused. The availability of such commitments for
borrowing is subject to TSAT's compliance with operating and financial covenants
and other customary conditions. Commencing March 31, 2001, aggregate
commitments under the Bank Credit Facility will be reduced quarterly in
accordance with a schedule, until final maturity at June 30, 2005. TSAT
anticipates that it will be required to refinance and/or amend the Bank Credit
Facility prior to the consummation of the Restructuring Transaction described in
note 2. No assurance can be given that any such refinancing and/or amendment
will be completed on terms acceptable to TSAT. For additional information
concerning the Bank Credit Facility, see note 10 to the accompanying financial
statements of TSAT.
During the nine months ended September 30, 1997 and 1996, TSAT's operating
activities provided cash of $74,715,000 and $58,219,000, respectively. A
significant portion of the cash provided by TSAT's operating activities during
the 1996 period is attributable to the $44,454,000 intercompany allocation of
current income tax benefits from TCI. During the first several years following
the TSAT Spin-off, TSAT believes that it will not be in a position to realize
income tax benefits on a current basis. Additionally, changes in TSAT's
receivables, prepaids, accruals and payables and subscriber advance payments
("Operating Assets and Liabilities") accounted for $31,896,000 and $8,068,000 of
the cash provided by TSAT's operating activities during the nine months ended
September 30, 1997 and 1996, respectively. The timing and amount of changes in
the balances of TSAT'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, TSAT. Exclusive of the effects of intercompany allocations of
current income tax benefits, and changes in TSAT's Operating Assets and
Liabilities, TSAT's operating activities provided cash of $42,819,000 and
$5,697,000 during the nine months ended September 30, 1997 and 1996,
respectively.
During the nine months ended September 30, 1997 and 1996, TSAT used cash
of $5,448,000 and $69,930,000, respectively, to fund the cost of constructing
the Tempo Satellites and $151,062,000 and $258,907,000, respectively, to fund
(i) the acquisition and installation of satellite reception equipment, and (ii)
certain other capital expenditures. TSAT expects that the majority of future
capital expenditures with respect to TSAT's medium-power business will be used
to fund the acquisition and installation of satellite reception equipment. The
actual amount of capital to be required will be primarily a function of (i)
subscriber growth and churn rates, and (ii) the actual cost of purchasing and
installing satellite reception equipment.
I-39
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1 to the accompanying financial statements)
Material Changes in Financial Position (continued)
- - --------------------------------------------------
TSAT currently intends to operate Tempo DBS-1 as a platform to provide
high-power digital video and audio programming services to residential
customers, as well as multiple dwelling units, commercial customers and
resellers. TSAT presently is unable to reasonably estimate the amount of capital
expenditures that would be required in connection with any high-power strategy
that might be pursued by TSAT. As discussed above, TSAT's capital expenditure
requirements would be significantly impacted by the consummation of the
Restructuring Transaction and the ASkyB Transaction. In addition, TSAT's
capital expenditure requirements would be impacted if TSAT were to complete any
significant acquisitions or enter into any other significant business
activities.
At September 30, 1997, TSAT's future minimum commitments to purchase
satellite reception equipment aggregated approximately $20,000,000.
As part of the compensation paid to TSAT's four master sales agents, TSAT
has agreed to pay certain residual sales commissions equal to a percentage of
the programming collected from subscribers installed by such master sales agents
during specified periods following the initiation of service (generally five
years). During the nine months ended September 30, 1997 and 1996, residual sales
commissions to such master sales agents aggregated $11,518,000 and $7,887,000,
respectively, and were charged to expense in the accompanying statements of
operations of TSAT.
In connection with the TSAT Spin-off, TSAT entered into an Indemnification
Agreement with each of TCIC and TCI UA 1. The Indemnification Agreement with
TCIC provides for TSAT to reimburse TCIC for any amounts drawn under an
irrevocable transferable letter of credit for the account of TCIC to support
TSAT's share of PRIMESTAR Partners' obligations under the GE-2 Agreement. The
drawable amount of such letter of credit is $25,000,000.
The Indemnification Agreement with TCI UA 1 provides for TSAT to reimburse
TCI UA 1 for any amounts drawn under the TCI UA 1 Letter of Credit, which
supports the PRIMESTAR Credit Facility. At September 30, 1997, the drawable
amount of the TCI UA 1 Letter of Credit was $141,250,000.
During the first quarter of 1997, two additional irrevocable transferable
letters of credit were issued pursuant to the Bank Credit Facility for the
account of TSAT, one to support TSAT's share of PRIMESTAR Partners' obligations
under the GE-2 Agreement, and the second to support the PRIMESTAR Credit
Facility. The initial drawable amount of the first letter of credit is
$25,000,000, increasing to $50,000,000 if PRIMESTAR Partners exercises the End-
Of-Life Option, and the initial drawable amount of the second letter of credit
is $5,000,000.
I-40
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1 to the accompanying financial statements)
Material Changes in Financial Position (continued)
- - --------------------------------------------------
The Indemnification Agreements provide for TSAT 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 TSAT to TCIC and TCI UA
1, respectively, under such Indemnification Agreements are subordinated in right
of payment with respect to the obligations of TSAT under the Bank Credit
Facility.
The amounts advanced by PRIMESTAR Partners to TSAT to fund the cost of
constructing the Tempo Satellites ($463,133,000 at September 30, 1997) have been
financed by PRIMESTAR Partners' borrowings under the PRIMESTAR Credit Facility,
which is in turn supported by letters of credit arranged for by affiliates of
all but one of the Partners. At September 30, 1997, PRIMESTAR Partners'
indebtedness under the PRIMESTAR Credit Facility aggregated $555,000,000
including amounts borrowed to pay interest charges. The maturity date of the
PRIMESTAR Credit Facility has been extended to December 31, 1997, and long-term
financing alternatives with respect to the Tempo Satellites are currently being
evaluated. No assurance can be given that any such long-term financing will be
available on acceptable terms.
During the first quarter of 1997, TCI agreed to cause TCI UA 1 to renew the
letter of credit arranged by it on TSAT's behalf, through December 31, 1997.
TSAT believes (but cannot assure) that during such period TSAT and/or PRIMESTAR
Partners will be able to obtain permanent financing for the Tempo Satellites (to
the extent not sold to a person other than PRIMESTAR Partners) on a basis that
does not require TSAT to post a letter of credit with respect thereto. If such
permanent financing is not available, under certain maintenance covenants
contained in the Bank Credit Facility, TSAT would be unable to provide or
arrange for such a letter of credit unless (i) the lenders under the Bank Credit
Facility were to agree to amend or waive such covenants to permit the posting of
such letter of credit by TSAT, (ii) TCI were to agree to renew the TCI UA 1
Letter of Credit for an additional period, or (iii) TSAT were to achieve a
greater than anticipated increase in Operating Cash Flow. If TSAT and/or
PRIMESTAR Partners are unable to refinance the Tempo Satellites (to the extent
not sold to a person other than PRIMESTAR Partners) without a letter of credit
and is unable to post (or arrange for the posting of) such a letter of credit (a
"Letter of Credit Event"), TSAT could be adversely affected.
I-41
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1 to the accompanying financial statements)
Material Changes in Financial Position (continued)
- - --------------------------------------------------
Under PRIMESTAR Partners' Limited Partnership Agreement, as amended, TSAT
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.
Additionally, those subsidiaries of TSAT that are general partners of PRIMESTAR
Partners are 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. TSAT has additional contingent liabilities related to PRIMESTAR
Partners. See notes 7 and 12 to the accompanying financial statements of TSAT.
The International Bureau of the FCC has granted EchoStar a conditional
authorization to construct, launch and operate a Ku-band domestic fixed
satellite into the orbital position at 83(degrees) W.L., immediately adjacent to
that occupied by GE-2. Contrary to previous FCC policy which would have
permitted operation of a satellite at the 83(degrees) W.L. orbital position at a
power level of only 60 to 90 watts (subject to coordination requirements),
EchoStar has been authorized to operate at a power level of 130 watts. If
EchoStar were to launch its high-power satellite authorized to 83(degrees) W.L.
and commence operations at that location at a power level of 130 watts, it would
likely cause harmful interference to the reception of the PRIMESTAR(R) signal
from GE 2 by subscribers to the PRIMESTAR(R) medium power services.
GE Americom and PRIMESTAR Partners have each requested reconsideration of
the International Bureau's authorization for EchoStar to operate at 83(degrees)
W.L. These requests, which were opposed by EchoStar and others, are currently
pending at the International Bureau. There can be no assurance that the
International Bureau will change slot assignments, or power levels, in a fashion
that eliminates the potential for harmful interference. Accordingly, the
ultimate outcome of this matter cannot presently be predicted.
GE Americom and PRIMESTAR Partners have attempted to resolve potential
coordination problems directly with EchoStar. However, it is uncertain whether
any agreement in respect of such coordination between PRIMESTAR Partners and
EchoStar will be reached, or that even if such agreement is reached, that
coordination will resolve such interference.
At September 30, 1997, approximately 9,813,000 shares of Series A Common
Stock were reserved for issuance pursuant to certain option and restricted stock
agreements, and certain arrangements with TCIC.
I-42
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1 to the accompanying financial statements)
Material Changes in Financial Position (continued)
- - --------------------------------------------------
Effective as of June 4, 1997, TCI Satellite MDU, Inc. ("TSAT-MDU"), a
wholly-owned subsidiary of TSAT, and ResNet Communications, Inc. ("ResNet
Corp."), a wholly-owned subsidiary of LodgeNet Entertainment Corporation
("LodgeNet"), formed ResNet Communications, LLC ("ResNet LLC"). TSAT-MDU
acquired a 4.99% ownership interest in ResNet LLC, and ResNet Corp. acquired a
95.01% ownership interest in ResNet LLC. ResNet LLC was formed to own and
operate the business owned and operated by ResNet Corp. prior to the formation
of ResNet LLC. ResNet Corp. was formed by LodgeNet in February 1996 to engage
in the business of operating as a "private cable operator" under applicable
federal law, providing video on demand, basic and premium cable television
programming, and other interactive multi-media entertainment and information
services to subscribers in multiple dwelling units with facilities that do not
use any public right-of-way (the "ResNet Business"). Effective as of October
21, 1996, TSAT-MDU had acquired 4.99% of the issued and outstanding capital
stock of ResNet Corp. In connection with the formation of ResNet LLC, ResNet
Corp. redeemed all of its capital stock previously issued to TSAT-MDU. ResNet
LLC agreed to purchase from TSAT-MDU, at a price that approximates TSAT-MDU's
cost, up to $40,000,000 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 LLC if ResNet LLC has not
purchased the full $40,000,000 in equipment during the five-year initial term).
TSAT-MDU also agreed to make a subordinated convertible term loan to ResNet
LLC, in the principal amount of $34,604,000, the proceeds of which can be used
only to purchase such equipment from TSAT-MDU. The term of the loan is five
years with an option by ResNet LLC 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 ownership interests in ResNet LLC,
representing 32% of the total ownership interests in ResNet LLC. TSAT-MDU's
only recourse with respect to repayment of the loan is conversion into ownership
interests in ResNet LLC stock or warrants. 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, TSAT-MDU could be
prohibited from holding 5% or more of the ownership interests in ResNet LLC and
consequently could not exercise the conversion rights under the convertible loan
agreement. TSAT-MDU is required to convert the convertible loan at such time as
conversion would not violate such currently applicable regulatory restrictions.
The above-described transactions between TSAT-MDU and ResNet LLC supercede
in their entirety substantially similar transactions entered into between TSAT-
MDU and ResNet Corp. effective as of October 21, 1996.
I-43
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
(See note 1 to the accompanying financial statements)
Material Changes in Financial Position (continued)
- - --------------------------------------------------
At September 30, 1997, TSAT held aggregate cash and cash equivalents of
$19,279,000. TSAT believes that such cash and cash equivalents, together with
borrowing availability pursuant to the Bank Credit Facility and any funds
generated by TSAT's operating activities will be sufficient through December 31,
1998, to fund TSAT's working capital, debt service and currently projected
capital expenditure requirements associated with its medium-power satellite
distribution business. However, to the extent that TSAT (i) funds all or any
significant portion of the cost of the Tempo Satellites, (ii) pursues a strategy
with respect to the high-power segment of the digital satellite industry that
requires significant capital expenditures, (iii) completes any significant
acquisitions, (iv) enters into any other business activities that require
significant capital investments, (v) suffers a Letter of Credit Event or is
required to meet other significant future liquidity requirements in addition to
those described above, TSAT anticipates that it would be required to obtain
additional debt or equity financing. No assurance can be given, however, that
TSAT would be able to obtain additional financing on terms acceptable to it, or
at all. As described above, TSAT's liquidity and capital resources would be
significantly impacted by the consummation of the pending Restructuring
Transaction and ASkyB Transaction. See also note 2 of the accompanying
financial statements of TSAT.
TSAT is highly leveraged. The degree to which TSAT is leveraged may
adversely affect TSAT'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 TSAT and its stockholders. TSAT's ability to
repay or refinance its debt will require TSAT to increase its Operating Cash
Flow or to obtain additional debt or equity financing. There can be no assurance
that TSAT will be successful in increasing its Operating Cash Flow by a
sufficient magnitude or in a timely manner or in raising sufficient additional
debt or equity financing to enable it to repay or refinance its debt. See
related discussion above and note 2 to the accompanying financial statements of
TSAT.
I-44
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
- - ------- -----------------
On September 30, 1997, a civil action entitled Croce Advertising, Inc.
-----------------------
v. TCI Digital Satellite Entertainment, Inc. d/b/a PRIMESTAR By TCI and
-----------------------------------------------------------------------
The Hibbert Company d/b/a The Hibbert Group was filed in the U.S.
-------------------------------------------
District Court for the District of Colorado, Civil Action No. 97-S-
2130. On October 20, 1997, Croce; the plaintiff filed an amended
Complaint naming TSAT as a defendant and dropping TCI Digital Satellite
Entertainment, Inc. d/b/a PRIMESTAR By TCI from the action. Service was
made upon TSAT on October 20, 1997. Croce alleges copyright
infringement based on its allegations that after the parties
relationship was terminated, TSAT reprinted certain marketing materials
created by Croce. TSAT is investigating the merits of the claim and
believes it has legitimate defense which it will assert in its answer.
Croce's claim for damages includes alleged profits related to the
printing of the materials at issue and TSAT's profits from the use of
these materials. Croce also named The Hibbert Company as a defendant on
the copyright infringement claim because The Hibbert Company printed
certain TSAT marketing materials. TSAT has agreed to indemnify The
Hibbert Company for costs and damages arising out of the copyright
claim. Croce's remaining claims arise out of the parties ongoing
dispute concerning unpaid invoices. Croce alleges TSAT owes
$4,962,550.05 on these invoices, plus interest from March 7, 1997,
until final resolution. TSAT expects to obtain an extension of time to
December 1, 1997, within which to file its answer. Management of TSAT
believes that, although no assurance can be given as to the outcome of
this action, the ultimate disposition should not have a material
adverse effect upon the financial condition of TSAT.
Item 2. Changes in Securities.
- - ------- ----------------------
During the three months ended September 30, 1997, TSAT issued 31,868
shares of Series A Common Stock to TCI for aggregate consideration of
$31,868. Such shares were issued pursuant to a "Share Purchase
Agreement" between TSAT and TCI to allow TCI to meet its obligations
under the conversion features of certain convertible securities of TCI.
The issuance was made in reliance on the exemption from registration
afforded by Section 4(2) of the Securities Act.
During the three months ended September 30, 1997, TSAT, issued 31,500
shares of Series A Common Stock to TCI for an aggregate consideration
of $212,625, which was equal to the market price of such shares on the
date of issuance. Such shares were issued so that TCI would be able to
issue restricted shares of Series A Common Stock to certain TCI
employees pursuant to certain previously granted restricted stock
awards. In addition, during the three months ended September 30, 1997,
TSAT also issued 1,500 shares of Series A Common Stock to an officer of
TSAT pursuant to a restricted stock award previously granted to such
officer by TCI and assumed by TSAT in connection with the TSAT Spin-
off. The above-described issuances were made in reliance on the
exemption from registration afforded by Section 4(2) of the Securities
Act.
The Bank Credit Facility contains a negative covenant that restricts
TSAT and its Restricted Subsidiaries from paying dividends and making
other distributions.
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,
1997 -
<TABLE>
<CAPTION>
Financial
Date of Items Statements
Report Reported Filed
------- -------- -----
<S> <C> <C>
July 1, 1997 Item 5 None
</TABLE>
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 10, 1997 By: /s/ Gary S. Howard
----------------------------------
Gary S. Howard
Chief Executive Officer
Date: November 10, 1997 By: /s/ Kenneth G. Carroll
----------------------------------
Kenneth G. Carroll
Senior Vice President and
Chief Financial Officer
(Principal Financial Officer)
Date: November 10, 1997 By: /s/ Scott D. Macdonald
-----------------------------------
Scott D. Macdonald
Vice President and Controller
(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, 1997 AND IS QUALIFIED IN ITS ENTIRETY
BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
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<S> <C>
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0
0
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</TABLE>
