AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MAY 11, 1999
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10
GENERAL FORM FOR REGISTRATION OF SECURITIES
PURSUANT TO SECTION 12(B) OR 12(G) OF
THE SECURITIES EXCHANGE ACT OF 1934
HUGHES ELECTRONICS CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 52-1106564
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
200 NORTH SEPULVEDA BOULEVARD
EL SEGUNDO, CALIFORNIA 90245
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(310) 662-9985
SECURITIES TO BE REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NONE.
SECURITIES TO BE REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
TITLE OF CLASS
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COMMON STOCK, PAR VALUE $1.00
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To the extent the items in this Form 10 are identical to items in a Form 10-K,
this Registration Statement on Form 10 has been prepared on the reduced
disclosure format specified in Instruction I to Form 10-K. Specifically, items 2
and 3 have been prepared in accordance with such Instruction I, and items 4, 5,
6 and 7 have been omitted in accordance with such Instruction I.
NY2:\456031\05\9RVJ05!.DOC\53356.0069
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HUGHES ELECTRONICS CORPORATION
FORWARD-LOOKING STATEMENTS
THIS REGISTRATION STATEMENT CONTAINS "FORWARD-LOOKING STATEMENTS"
WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 25E
OF THE SECURITIES EXCHANGE ACT OF 1934. THESE FORWARD-LOOKING STATEMENTS
GENERALLY CAN BE IDENTIFIED BY USE OF STATEMENTS THAT INCLUDE PHRASES SUCH AS WE
"BELIEVE," "EXPECT," ANTICIPATE," "INTEND," "PLAN," "FORESEE" OR OTHER SIMILAR
WORDS OR PHRASES. SIMILARLY, STATEMENTS THAT DESCRIBE OUR OBJECTIVES, PLANS OR
GOALS ALSO ARE FORWARD-LOOKING STATEMENTS. ALL OF THESE FORWARD-LOOKING
STATEMENTS ARE SUBJECT TO CERTAIN RISKS AND UNCERTAINTIES THAT COULD CAUSE OUR
ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE CONTEMPLATED BY THE RELEVANT
FORWARD-LOOKING STATEMENT. READERS ARE URGED TO CONSIDER THESE FACTORS CAREFULLY
IN EVALUATING THE FORWARD-LOOKING STATEMENTS. THE FORWARD-LOOKING STATEMENTS
INCLUDED IN THIS REGISTRATION STATEMENT ARE MADE ONLY AS OF THE DATE OF THIS
REGISTRATION STATEMENT AND WE UNDERTAKE NO OBLIGATION TO PUBLICLY UPDATE THESE
FORWARD-LOOKING STATEMENTS TO REFLECT SUBSEQUENT EVENTS OR CIRCUMSTANCES.
GENERAL
We are a wholly-owned subsidiary of General Motors Corporation. General
Motors is primarily engaged in the automotive and satellite and wireless
communications industries. General Motors has two classes of common stock, Class
H common stock and $1-2/3 common stock. The Class H common stock tracks the
performance of our company. Our financial performance determines the earnings
per share attributable to the Class H common stock and the amounts available for
the payment of dividends on the Class H common stock. This registration
statement, however, does not relate to registration of the Class H common stock
nor the $1-2/3 common stock. Rather, it relates to the registration of the
common stock of Hughes Electronics Corporation, all of which is owned by General
Motors.
This registration statement describes our planned acquisition of United
States Satellite Broadcasting Company, Inc. However, as of the date of the
filing of this registration statement, we have not yet consummated this
acquisition, and the acquisition is subject to certain contingencies that could
prevent its completion. These contingencies include the approval of the
shareholders of United States Satellite Broadcasting Company, Inc. We cannot
assure you that this approval will be obtained or that this acquisition will be
completed. See "Item 1. Business--Recent Acquisitions."
ITEM 1. BUSINESS
OVERVIEW
We are a leading global provider of digital direct broadcast satellite
entertainment services, satellite communications services and satellite-based
private business networks. We are also a leading global manufacturer of
satellite systems. Since our founding, we have been a pioneer in many aspects of
the satellite and wireless communications industry, and our technologies have
driven the creation of new services and markets. We believe that our ability to
identify, define and develop new markets early has provided us with a
significant competitive advantage in building sustainable market leadership
positions.(1)
Since our reorganization in 1997, we have focused on providing advanced
communications services on a global basis. By leveraging our technological
leadership in satellite and wireless communications systems, we have developed a
range of entertainment, information, and communications services for the home
and business markets, including video, data, voice, multimedia and Internet
services. These services provide the potential for higher margins and higher
growth than our traditional manufacturing businesses.
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(1) DIRECTV(R), Galaxy(R), Spaceway(TM), AIReach(TM), DirecDuo(TM), Turbo
Internet(TM), SPOTbytes(R), PRIMESTAR(R) and DirecPC(R) are trademarks of Hughes
Electronics Corporation or its subsidiaries. USSB(R) and U.S. Satellite
Broadcasting(R) are registered trademarks of United States Satellite
Broadcasting Company, Inc. All other trademarks are properties of their
respective owners.
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Our business includes:
o DIRECTV, which is the world's leading digital direct broadcast
satellite service based on number of subscribers. DIRECTV
includes businesses in the United States, Latin America and
Japan, and constitutes our Direct-to-Home Broadcast segment.
As referred to in this registration statement, the direct
broadcast satellite industry does not include providers and
subscriber data for the large satellite receiving dish, C-band
direct-to-home services market.
o PanAmSat, which owns and operates the largest commercial
satellite fleet in the world with 19 satellites that can
transmit signals to geographic areas covering 99% of the
world's population. PanAmSat, a publicly-held company of which
we own 81%, constitutes our Satellite Services segment.
o Spaceway, which is a planned satellite-based broadband
communications platform that is expected to provide customers
with high-speed two-way multimedia transmission on a more
cost-efficient basis than current systems beginning in 2002.
Spaceway currently is not a separately reported business
segment.
o Hughes Network Systems, which is a leading provider of
satellite and wireless communications ground equipment and
services with an estimated 55% to 60% share of the global
market for very small aperture terminal or "VSAT" private
business networks. Hughes Network Systems constitutes our
Network Systems segment.
o Hughes Space and Communications, which is a leading satellite
manufacturer that has won over 50% of its competitive bids
from 1991 through 1998. Hughes Space and Communications is the
principal component of our Satellite Systems segment.
INDUSTRY TRENDS AND OPPORTUNITIES
We seek to capitalize on several key trends that are revolutionizing
the communications industry, including:
o GROWING DEMAND FOR AN INCREASED VARIETY OF DIGITAL BROADCAST
ENTERTAINMENT SERVICES. We believe that satellite
direct-to-home entertainment will continue to be the fastest
growing sector of the multichannel entertainment industry both
in the United States and internationally. Since 1994, the
total number of direct broadcast satellite subscribers in the
United States has grown from 570,000 to 9.3 million as of
March 31, 1999. Direct broadcast satellite is now the largest
sector of the satellite communications services industry based
on revenues.
o INCREASING DEMAND FOR DIGITIZED DATA AND INTERNET SERVICES FOR
BOTH HOME AND BUSINESS USERS. We believe that the next wave of
demand for satellite-based communications services will be
fueled by the increasing need for digitized data, Internet and
broadband services. Drivers of this demand include the need
for cost-effective, high-speed data transmission and
increasing Internet traffic.
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o EMERGING DEMAND FOR MOBILE SATELLITE SERVICES, INCLUDING
TELEPHONY, PAGING AND INFORMATION SYSTEMS. Worldwide,
approximately 70% of the earth's land mass lacks cellular
coverage. Mobile satellite services are increasingly being
used to meet wireless telephony and other communications needs
of end users in these markets.
In meeting the demand created by these trends, satellite technology has
inherent competitive advantages over ground-based communications technologies
for many applications, including:
o the ability to broadcast hundreds of channels economically to millions
of recipients over very wide geographic areas;
o the potential for low cost two-way communications to areas of low
subscriber density;
o the ability to roll-out new infrastructure to a large number of
customers quickly; and
o the ability to deliver large amounts of information at high
transmission speeds.
COMPETITIVE ADVANTAGES
We believe that our satellite and wireless communications technological
capabilities, together with the inherent advantages of satellite technology over
ground-based technology for many applications, provide us with competitive
advantages. We believe these competitive advantages should enable us to achieve
sustainable market leadership positions and accelerate revenue and operating
cash flow growth. These competitive advantages include:
o DIRECTV BRAND AND FRANCHISE. The PRIMESTAR Inc. and U.S. Satellite
Broadcasting Company acquisitions solidify DIRECTV's leadership
position in the United States direct broadcast satellite market. In the
United States, DIRECTV has:
o the largest subscriber base--about 75% of direct broadcast
satellite subscribers, which provides greater opportunity to
obtain programming on favorable terms, secure exclusive
programming and introduce new services;
o substantial channel capacity--currently delivers about 225
channels and, following the successful launch of an additional
satellite scheduled for the third quarter of 1999 and the
completion of our pending acquisition of the in-orbit
satellite and related 11 satellite orbital frequencies of
Tempo Satellite, Inc., a wholly-owned subsidiary of TCI
Satellite Entertainment Inc., will have capacity for about 370
channels; and
o the largest distribution network--based on retail points of
sale, including national retailers such as Circuit City, Radio
Shack and Best Buy, several regional Bell operating companies
which provide installation, customer service and billing and
the PRIMESTAR dealer network in small urban and rural markets.
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In addition, there are currently only three licensed United
States orbital slots that provide the capability to deliver
high-power television signals throughout the contiguous United
States. Out of a total of 96 available frequencies at these
orbital slots, DIRECTV is authorized to use 35 frequencies
and, following our acquisition of the in-orbit satellite
assets of Tempo Satellite, will have authorization to use 46
frequencies.
We believe these factors, together with DIRECTV's brand name,
provide us with significant competitive advantages over other
U.S. multichannel service providers. We also believe that
DIRECTV's high quality digital picture and sound, its
increased variety of programming and its high quality customer
service provide competitive advantages over traditional cable
television. We are utilizing the DIRECTV brand name and U.S.
leadership position to accelerate growth in selected
international markets.
o DIRECT DIGITAL INTERACTIVE AND BROADBAND LINKS TO HOME AND
BUSINESS. We believe that our established customer
relationships in both the business and home segments will
become increasingly valuable as key portals to offer expanded
services. Consumers and businesses are increasingly demanding
the flow of greater amounts of data at higher speeds than can
be provided by traditional computer modems and phone lines. In
many cases, satellite-based systems are well suited to address
this need on a cost-effective basis. In meeting this demand,
we intend to capitalize on our existing customer
relationships. For example, through DIRECTV, we intend to
provide Internet-based services and interactive television
services in the United States and are already offering some of
these services in Japan. Also, beginning in North America in
2002, we plan to begin migrating existing corporate data
network clients and satellite Internet customers, many of whom
are Fortune 500 companies, to Spaceway.
o GLOBAL SPECTRUM AND ORBITAL SLOTS. We consider our regulatory
authorization to use desirable broadcast spectrum and orbital
slots for our current and planned global satellite fleet to be
a significant competitive advantage. Operation of an
international satellite fleet requires significant
international and national regulatory approvals. We and
PanAmSat have received regulatory approval for 27 licenses in
the C-band, the traditional network and cable television
distribution band, the Ku-band, the band used for many
telecommunications services and direct-to-home television, or
both bands. In addition, we and PanAmSat have obtained United
States Federal Communications Commission authorization for 17
licenses in the Ka-band, a high-power spectrum that will
enable new broadband, high-speed data and Internet service
offerings.
o GLOBAL MARKET LEADER. We believe that our global leadership
positions in our target markets--digital direct-to-home
entertainment, satellite transponder leasing, very small
aperture terminal business networks, and satellite systems
manufacturing--enable us to achieve economies of scale. The
satellite and wireless communications business is
characterized by high fixed costs with relatively lower
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variable costs. A market leadership position enables the cost
of developing expanded services, such as exclusive programming
for DIRECTV or specialized broadcasting services for PanAmSat,
to be spread across a larger customer base. Similarly,
economies of scale have enabled Hughes Space and
Communications to increase standardization of manufacturing
processes by developing a family of satellite structures,
electronics, and propulsion and power systems which can be
replicated at relatively low cost in a variety of commercial
and defense configurations. In addition, Hughes Network
Systems has benefited from economies of scale in manufacturing
VSATs.
o COMPREHENSIVE PORTFOLIO OF GLOBAL SATELLITE BUSINESSES. We
believe that our presence in several major segments of the
satellite communications industry affords significant
synergies, vertical integration benefits and the ability to
remain at the forefront of the latest industry growth trends.
We have leveraged our satellite manufacturing and systems
expertise to develop new service businesses such as DIRECTV,
satellite transponder leasing and Spaceway. In addition, our
vertically integrated structure has enabled us to respond
quickly to the growth needs of our services businesses. For
example, Hughes Network Systems' ability to increase
production of DIRECTV receiving equipment on short notice
enabled DIRECTV to achieve record subscriber growth in 1998.
In addition, our complete range of integrated satellite and
wireless communication services enables us to meet our
customers' needs for end-to-end communication solutions.
o TECHNOLOGY LEADERSHIP. We believe that our leadership
positions in our markets results in large part from our
technological capabilities, particularly in satellite design,
production and operation. Our technologies have significantly
enhanced the transmission capacity, power and efficiency of
satellites and improved their cost effectiveness. Because
these innovations have improved the economics of the
commercial satellite business, we believe that our
technological leadership has expanded, and will continue to
expand, the market for satellites, satellite equipment and
satellite services. We also believe that our technological
expertise provides us with an advantage in our other equipment
and services businesses. For example, our technologies enabled
DIRECTV to be first to market with digital direct broadcast
satellite services and these technologies will be critical to
the successful development of Spaceway broadband services.
STRATEGY
Our business objective is to maximize the creation of shareholder value
by leveraging our satellite and wireless communications systems expertise and
capitalizing on the competitive advantages discussed above in order to enhance
our position as a premier global communications company with an emphasis on
higher margin, higher growth services. Our core strategies for achieving our
business objective are to:
o ACHIEVE SUSTAINABLE MARKET LEADERSHIP POSITIONS THROUGH
INNOVATION. We have achieved market leadership positions
through our core competence in identifying, defining and
developing new markets and our ability to develop innovative
products and services to serve these markets. For example:
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o early development of satellite transponder leasing has allowed
us to capture a significant share of the world's limited
supply of both satellite orbital slots and broadcast spectrum;
o early entry into the digital high-powered direct-to-home
broadcast industry has provided us with direct relationships
with consumers to whom an expanded array of services can be
offered; and
o based on our commercial satellite systems manufacturing and
private business network services expertise, we announced our
intention to make a significant investment in an advanced
global broadband satellite network. We expect to be an early
entrant into the market, allowing Spaceway to attain a
leadership position in the high-speed transfer of digitized
data through broadband networks.
In addition, we have pursued and will continue to pursue acquisitions
and strategic alliances to extend our leadership in core markets and
divest or reposition businesses in those markets where leadership can
not be attained.
o LEAD MULTICHANNEL ENTERTAINMENT MARKET. We intend to capitalize on
favorable demand trends for multichannel entertainment in the United
States and selected international markets. We intend to maintain
DIRECTV's leadership in the United States by providing a premier
line-up of exclusive entertainment programming, high definition
television or "HDTV" programming, unique interactive services and
Internet based services. We are leveraging our United States
direct-to-home broadcast satellite expertise and brand name in selected
international markets.
o EXPLOIT GROWTH OPPORTUNITIES IN THE MARKETS FOR DIGITIZED DATA AND
INTERNET SERVICES. We believe that the digitized data and Internet
revolution will have a major impact on the satellite and wireless
communications industry. We have several initiatives in this area,
including:
o DIRECTV expects to integrate a range of web-based and
interactive technologies into its programming in the United
States and Latin America.
o Hughes Network Systems has developed an array of digitized
data, intranet and Internet services for the private business
systems and the consumer markets.
o PanAmSat has developed a range of Internet-related services,
including SPOTbytes(R), a bundled Internet service that offers
links from international locations to the United States
Internet backbone via PanAmSat teleports, and a new service
that provides the direct broadcast of web content to local
servers in the United States and internationally.
o We expect that, beginning in North America in 2002, the
Spaceway platform will enable service providers, including
Hughes Network Systems and PanAmSat, to offer customers a wide
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range of two-way, high-data-rate applications under their own
brands.
o INCREASE REVENUE-PER-USER THROUGH PROVISION OF ENHANCED SERVICES. A
core principle of our consumer and business service strategy is to
increase average revenue-per-user. Examples of this include:
o DIRECTV's monthly revenue per residential U.S. subscriber has
increased from about $39 in 1995 to about $47 as of March 1999
and, after implementing the conversion of PRIMESTAR and U.S.
Satellite Broadcasting Company subscribers, is expected to
increase to about $55 to $60.
o PanAmSat has increased its revenue from existing customers by
providing unique one-stop shopping for customers' national,
regional or global satellite transmissions, network design and
systems engineering, transmission of video channels and the
management of private business network traffic from PanAmSat
teleports.
o Hughes Network Systems has generated incremental revenue by
offering networking and other services to equipment customers.
o FOCUS ON CUSTOMER SATISFACTION AND QUALITY. We emphasize customer
satisfaction and quality in all of our manufacturing and services
businesses. For example:
o the cumulative channel availability of in-orbit satellites
that we manufacture is above 98%;
o DIRECTV's surveys show a customer satisfaction rating of over
90% in the United States; and
o Hughes Network Systems has shipped over 1 million DIRECTV
set-top boxes with a defect rate of less than two-tenths of
one percent.
We believe that a continued focus on customer satisfaction and quality
is key to our ability to expand our customer base and maintain
leadership positions in each of our businesses.
o FOCUS ON KEY PERFORMANCE MEASUREMENTS. We focus on performance
measurements that we believe will best help us achieve our goal of
maximizing long-term shareholder value. These include:
o Performance of Class H common stock. A portion of the
compensation of all of our full-time employees, excluding
employees of non-100% owned subsidiaries, is linked to the
Class H common stock price. In particular, more than half of
the compensation of our top executives is based on the Class H
common stock price.
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o Long-term EBITDA growth and EBITDA margin improvement. We
believe EBITDA serves as a good proxy for operating cash flow.
o Revenue growth, subscriber growth and growth in average
revenue-per-subscriber. We believe that these measurements are
especially relevant to DIRECTV, where the initial cost
incurred in acquiring a customer is offset by the long-term
profit potential of that customer.
We believe that these measurements are similar to those tracked by
other large communications, entertainment and media service providers,
such as cable and wireless communications companies, and are consistent
with its transformation from an aerospace, defense and automotive
electronics company to a satellite and wireless communications company.
DIRECTV
HIGHLIGHTS
o Over 7 million U.S. subscribers under the DIRECTV and
PRIMESTAR brand names
o Monthly revenue per residential U.S. subscriber of about $47
as of March 1999, which is expected to increase to $55 to $60
after implementing the conversion of PRIMESTAR and U.S.
Satellite Broadcasting Company subscribers
o Currently delivers about 225 video channels, and, following
successful launch of an additional satellite later in 1999 and
completion of the Tempo Satellite in-orbit satellite
acquisition, will have capacity of about 370 video channels in
the United States
o The broadest U.S. distribution network in its market based on
retail points of sale
o A leading multi-channel television provider in Latin America
and Japan
STRATEGIC GOALS
o Expand channel capacity and add new and exclusive programming
o Broaden and strengthen distribution channels
o Increase average revenue-per-subscriber
o Minimize subscriber churn
o Introduce new interactive and web-based services
o Leverage U.S. expertise to accelerate growth in selected
international markets
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Introduced in June 1994, DIRECTV was the first digital direct broadcast
satellite service in North America. Currently, DIRECTV provides programming in
the 48 contiguous United States, 25 countries in Latin America and Japan. We
recently acquired PRIMESTAR and U.S. Satellite Broadcasting Company. For a
further discussion of these acquisitions and DIRECTV's plans to integrate
PRIMESTAR and U.S. Satellite Broadcasting Company, see "--Recent Acquisitions."
UNITED STATES. DIRECTV, under the DIRECTV and PRIMESTAR brands,
currently has about 7.1 million of the 9.3 million direct broadcast satellite
subscribers in the U.S. This includes approximately 1.1 million subscribers
located primarily in rural areas of the continental United States who receive
DIRECTV services under an arrangement with the National Rural Telecommunications
Cooperative. Excluding National Rural Telecommunications Cooperative subscribers
and related revenues, average DIRECTV revenue per residential U.S. subscriber
was about $47 per month as of March 31, 1999. After implementing the conversion
of PRIMESTAR and U.S. Satellite Broadcasting Company subscribers, we expect
average revenue per residential U.S. subscriber to increase to $55 to $60 per
month, the highest in the United States direct broadcast satellite industry.
Currently, DIRECTV subscribers may receive about 225 channels of
television shows, premium movies, sports and pay-per-view events and 31 audio
channels. DIRECTV also provides premium sports and other premium programming
such as THE NFL SUNDAY TICKET(R), which allows subscribers, subject to local
restrictions, to view every National Football League game played each Sunday
during the regular season. DIRECTV is the exclusive small dish provider of THE
NFL SUNDAY TICKET through 2002. We believe that DIRECTV's increased channel
offerings, channel capacity and subscriber base resulting from the PRIMESTAR and
U.S. Satellite Broadcasting Company acquisitions provides DIRECTV with a
competitive advantage in acquiring subscribers, obtaining exclusive programming
from leading content providers on favorable terms and generating advertising
revenue. Also, we believe we have enhanced ability to provide consumers new and
innovative program offerings. For example, DIRECTV expects to introduce:
o data-enhanced programming, e-commerce, Internet-based services
and interactive advertising; and
o a series of products that are designed to allow subscribers to
control the programming they watch by being able to pause live
TV and create their own TV programming line-up based on
personal preferences.
We believe that the frequencies DIRECTV is authorized to use for
delivering digital television signals in the United States are significant
assets. There are currently only three licensed United States orbital slots that
provide the capability to deliver high-power television signals throughout the
contiguous United States. These orbital slots have a total of 96 available
frequencies. DIRECTV controls 35 of these frequencies, and, following the Tempo
Satellite in-orbit high-power satellite purchase, will control 46 of these
frequencies.
Currently, in the United States, DIRECTV is prohibited from providing
local television channels in local markets. DIRECTV believes this inability is a
disadvantage with respect to competing with cable television. Currently pending
legislation would authorize the delivery of local broadcast channels by
satellite. If adopted, this legislation would enhance the competitiveness of
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DIRECTV as compared to cable television. DIRECTV expects to begin offering local
channels in selected markets promptly after any adoption of the enabling
legislation.
There can be no assurance as to if or when this legislation will be adopted.
DIRECTV programming service and equipment are currently distributed
through consumer electronics stores such as Circuit City, Radio Shack and Best
Buy, and satellite television dealers. In addition, we have agreements with
several regional Bell operating companies to distribute DIRECTV programming and
service by bundling it with local phone services. The regional Bell operating
companies provide installation, customer service and billing. In addition, we
believe that DIRECTV's ability to reach rural and small urban areas has been
enhanced by the addition of PRIMESTAR's dealer network which primarily serves
these areas.
DIRECTV's net subscriber churn was about 1% per month in 1998. This
compares to an average churn rate of about 2.5% for the cable television
industry. Net subscriber churn is expected to increase, primarily as a result of
PRIMESTAR's and U.S. Satellite Broadcasting Company's higher historical churn
rates. DIRECTV's net subscriber churn for a given period is calculated by
dividing the number of subscribers canceling service during the period by the
total number of subscribers at the end of the period.
In 1999, DIRECTV's cost of acquiring new subscribers is expected to
increase due to, among other things, incentives granted by U.S. Satellite
Broadcasting Company to manufacturers of DIRECTV receiving equipment which were
assumed by DIRECTV in connection with its acquisition of U.S. Satellite
Broadcasting Company. In addition, depending on the competitive environment,
subscriber acquisition costs could increase further due to increased incentives
to dealers and consumers. Beyond 1999, subscriber acquisition costs will
continue to be largely determined by the competitive environment.
DIRECTV is currently broadcast from three Hughes Space and
Communications HS 601 satellites directly to 18-inch receiving antennae and
decoding boxes located in households and businesses. A fourth satellite under
construction and scheduled for launch in the third quarter of 1999 will provide
additional channels and allow for additional back-up capability to DIRECTV's
satellite fleet, including the satellite which experienced the failure of its
primary spacecraft control processor in 1998. See "--Other Business Risks--We
Are Vulnerable to Satellite Failure." In addition, DIRECTV has acquired a ground
satellite from Tempo Satellite and, subject to Federal Communications Commission
approval, has agreed to acquire an in-orbit satellite and 11 related satellite
orbital frequencies from Tempo Satellite that will provide additional channel
capacity. The acquisition of this satellite and related frequencies is subject
to Federal Communications Commission approval. DIRECTV's signal originates from
its 55,000 square foot broadcast facility in Castle Rock, Colorado. In mid-1999,
DIRECTV expects to complete a second broadcast center in Los Angeles which will
provide expanded capacity for additional channels, as well as back-up for the
Castle Rock facility.
DIRECTV receiving equipment is manufactured by a number of name brand
consumer electronics companies. Equipment prices have fallen steadily from the
initial $699-$899 range in June 1994 to approximately $99-$249 today. The
technology for the DIRECTV service is based, in part, on our satellite and
satellite-based services experience and in part, on the expertise of the
consumer electronics manufacturers which produce the equipment. DIRECTV has
outsourced many of the significant facets of consumer marketing, the operation
of the related infrastructure and support services to vendors experienced in the
respective fields.
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INTERNATIONAL. We believe we can leverage the DIRECTV brand name and
market leadership position in the United States in selected international
markets. We currently provide DIRECTV service in 25 countries in Latin America
and in Japan. Our direct-to-home broadcast business in Latin America is
conducted under the DIRECTV brand name by Galaxy Latin America, a partnership in
which we are the majority owner. The direct-to-home broadcast business in Japan
is conducted by DIRECTV Japan Management, Inc., a joint venture in which we hold
a 42.2% ownership interest. We evaluate, on an ongoing basis, opportunities to
expand DIRECTV to serve other international markets.
As a result of the competitive environment in its international
markets, DIRECTV may have to incur increased subscriber acquisition costs
through competitive offers in the future to maintain or improve its market
positions.
LATIN AMERICA. Introduced in 1996, Galaxy Latin America was the first
direct-to-home satellite television service available in Latin America and
currently offers over 197 video and 35 audio channels. We hold a 70% ownership
share in Galaxy Latin America. Cisneros Group of Venezuela holds 20% and TV
Abril of Brazil holds 10%.
Local operating companies in each country provide marketing, sales,
distribution, customer service and other infrastructure services. We believe
that having an equity stake, and in some situations a controlling interest, in
the local operating companies will help us to pursue a coordinated strategy
throughout Latin America. In furtherance of this strategy, we have recently
increased our ownership of the local operating company in Mexico and now manage
its day-to-day operations. Also, we have purchased or plan to purchase an
interest in each of the local operating companies operating in other large Latin
American markets, including Brazil, Venezuela, Colombia and Argentina.
As of March 31, 1999, there were approximately 550,000 subscribers in
Latin America. The local operating companies' average revenue per subscriber is
currently about $35 per month. Galaxy Latin America believes that approximately
one-half of television households in Latin America, or about 50 million
households, earn an income sufficient to afford multichannel pay television
services, but only a small fraction currently subscribe to such services.
JAPAN. We estimate that there are more than 40 million television
households in Japan, with very low cable penetration due to regulatory
restrictions. We believe that DIRECTV Japan's competitive strengths include its
programming line-up, which contains a number of unique local Japanese programs
and major U.S. programming channels, and its interactive services. The DIRECTV
Japan service commenced commercial operations in December 1997 with a partial
offering of channels. Full service began in April 1998 with 88 channels and
capacity was expanded to 190 channels in December 1998. DIRECTV Japan ended
March 1999 with approximately 250,000 subscribers and average monthly revenue
per subscriber of about $40.
PANAMSAT
HIGHLIGHTS
o A leading commercial provider of global satellite
communications services, based on sales volume
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o Global network of 19 satellites supported by seven teleport
operations facilities in the United States and more than 500
sales, marketing and engineering employees on five continents
o A unique one-stop provider of global satellite services
STRATEGIC GOALS
o Pursue a satellite fleet expansion plan designed to provide
unparalleled growth and back-up resources for customers
worldwide
o Continue to offer customers unique one-stop shopping for their
national, regional or global satellite transmission needs
o Expand innovative value-added services and applications such
as Internet distribution and HDTV
Through our 81% interest in PanAmSat Corporation, we offer
comprehensive end-to-end satellite services. PanAmSat, a publicly-held
corporation traded on the Nasdaq National Market System, was created through the
merger of our company's and PanAmSat's satellite services operations in May
1997. Today, the PanAmSat network:
o Distributes cable and broadcast television programming that
reaches more than 125 million households each day for clients
including: CNN, CBS, NBC, ABC, Disney, Fox, Sony, TCI, Viacom,
Turner Broadcasting, ESPN, the British Broadcasting
Corporation, NHK (Japan), Cisneros Group (Venezuela) and the
Australian Broadcasting Corporation.
o Operates platforms for current and planned direct-to-home
television services to Latin America, South Africa, Taiwan and
India that cumulatively will broadcast more than 500 channels.
o Provides live transmission services for news, sports and
special events coverage, and transmits news coverage for
virtually every major news gathering organization in the
world.
o Provides satellite services to more than 35 telecommunications
carriers worldwide, including MCI-WorldCom, Sprint, ImpSat,
Microspace and Telstra (Australia).
o Provides access to the U.S. Internet backbone in more than 50
countries to Internet Service Providers or "ISPs" and other
telecommunications providers.
o Relays digitized data via more than 125,000 VSATs to the
private networks of clients such as the Associated Press,
Citicorp, Hughes Network Systems, IBM, Reuters and the
University of Southern California.
We believe that PanAmSat's global transmission capability, especially
its ability to transmit signals among all of the world's major regions, provides
it with a significant advantage over commercial competitors who operate fleets
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limited to regional coverage. PanAmSat currently operates the largest commercial
network of communications satellites capable of remaining directly above a fixed
location on the earth, known as geosynchronous satellites, and possesses the
ability to transmit signals to a geographic area that includes 99% of the
world's population. PanAmSat is the only commercial entity that offers
geosynchronous satellite services on a global, one-stop-shopping basis.
To maintain this advantage, PanAmSat plans to expand its fleet from 19
satellites to 25 by the end of 2000, increasing transponder capacity by about
70%, from about 530 transponders in 1998 to about 910 transponders in 2000. This
will involve the launch of seven additional satellites and the retirement of one
existing satellite. These additional satellites are intended to meet the
expected demand for additional satellite capacity, replace capacity affected by
satellite anomalies and provide additional back-up to existing capacity. See
"--Other Business Risks--We Are Vulnerable to Satellite Failure." There can be
no assurance, however, that thE schedule for PanAmSat's future satellite
launches will be met. Delays in the production or successful launch of these
satellites could materially affect the ability of PanAmSat to deliver services
and benefit from the opportunities it is currently pursuing. In addition,
revenues attributable to satellites affected by anomalies could be at reduced
levels.
We consider PanAmSat's regulatory authorization to use various
broadcast spectrums and the desirable orbital locations of its satellite fleet
to be a significant competitive advantage. PanAmSat has regulatory approval to
operate its satellite fleet in the C-band, the traditional network and cable
television distribution band, the Ku-band, the band used for many
telecommunications services and direct-to-home television, or both bands. In
addition, PanAmSat has obtained Federal Communications Commission authorization
for 9 licenses in the Ka-band. The Ka-band is a high-powered frequency that will
be used primarily for broadband, high-speed data and Internet service offerings.
Like our other business units, PanAmSat seeks to obtain market
leadership positions by identifying, defining and developing new markets early.
In 1983, we revolutionized the television industry by launching Galaxy I, the
first cable television satellite for the United States. We pioneered the "cable
neighborhood" concept in the satellite services industry by securing key cable
programming for Galaxy I. Similar to the "anchor tenant" strategy pursued by
shopping mall operators, this strategy prompted a core group of cable operators
to focus their ground antennas on Galaxy I's orbital position. Because so many
cable head-end antennas were focused on Galaxy I, transmission capacity on the
satellite sold at a premium.
PanAmSat provides satellite services to its customers primarily through
long-term operating lease contracts for the use of full or partial transponder
capacity. PanAmSat also offers services to its customers through sales and
sales-type lease contracts. PanAmSat currently provides service to hundreds of
video distribution and telecommunications customers worldwide. As of March 31,
1999, PanAmSat had long-term arrangements for satellite services representing
future payments of approximately $6.3 billion, including amounts due from
affiliated companies, as well as approximately $400 million relating to
arrangements on satellites that are under construction and are expected to be
launched within 12 months.
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SPACEWAY
HIGHLIGHTS
o Approval for $1.4 billion investment in a broadband network
for North America
o Leverages our satellite industry leadership in manufacturing,
business networks, direct-to-home entertainment and services
o Expected to utilize innovative satellite technology such as
on-board digital processing, packet switching and spot beams
to offer high-speed bandwidth-on-demand broadband services
o Expected to seamlessly integrate and be compatible with
land-based systems
STRATEGIC GOALS
o Become the first satellite-based broadband service in North
America serving large businesses, telecommuters, small
office/home office users and consumers in 2002
o Migrate Hughes Network Systems' existing extensive blue-chip
business customer base to Spaceway and sell broadband services
to DIRECTV subscribers
o Work with global strategic partners to roll out additional
geosynchronous systems in other regions as the markets develop
o Further expand the network's global capacity by launching
complementary nongeosynchronous satellites
We intend to spend $1.4 billion to implement Spaceway, a broadband
communications platform, in North America. Spaceway will provide
"bandwidth-on-demand," the ability to transmit and receive data, video, audio,
and multimedia while offering customers the opportunity to use and pay for only
the amount of bandwidth they need for their specific application, from e-mail to
high-bandwidth, high-speed corporate networks. In addition, Spaceway is expected
to provide an overlay to current ground-based networks, providing network
operators with a wireless extension of their existing capabilities.
Offering space-based broadband services will be a key growth
opportunity for us in the 21st century, and we believe we will be among the
first to a market for which the demand has been forecast to increase
dramatically in the future. We expect that beginning in North America in 2002,
the Spaceway platform will supply service providers, including Hughes Network
Systems and PanAmSat, with the ability to offer customers a wide range of
two-way, high data-rate applications under their own brands. These include
desktop video conferencing, distance learning, teleimaging, corporate intranet
and extranet connectivity, and Internet access.
We are already a market leader in VSAT corporate data networking and
satellite broadband Internet businesses. See "--Hughes Network Systems." By
migrating these existing customers, many of which are Fortune 500 companies, to
Spaceway, we expect to provide expanded capabilities to these businesses while
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keeping end-user costs low enough to provide competitive advantages over
ground-based and other satellite offerings.
Our advanced technologies and networking services expertise will be the
key to Spaceway's success. The system will start with the construction and
launch of three HS 702 spacecraft to be built by Hughes Space and
Communications, and will utilize ground stations and very small satellite dishes
designed by Hughes Network Systems. PanAmSat will provide expertise in satellite
and network operations, and will resell capacity in certain markets. DIRECTV
will cross-sell the services to its extensive customer base.
We anticipate working with strategic global partners to roll out
Spaceway systems in other regions, including Europe, Latin America, Africa and
Asia. As these markets and the technology evolve, our strategy contemplates
making additional investments to add a fleet of spacecraft in lower earth orbits
that will support additional interactive broadband services, including services
without a transmission delay, in high-traffic markets.
Spaceway is still under development and is subject to a number of risks
and uncertainties. Thus, there can be no assurance that the introduction of the
Spaceway system will not be delayed or that the Spaceway system will ever be
implemented, or if implemented, that it will operate properly or be accepted by
the marketplace.
HUGHES NETWORK SYSTEMS
HIGHLIGHTS
o World's leading supplier of satellite-based private business
networks, based on an estimated worldwide market share of 55%
to 60%
o Has shipped over 300,000 one-way and two-way VSATs to
customers in 85 countries
o The second largest manufacturer of DIRECTV subscriber
equipment
o Provides satellite-based high-speed access to the Internet
through its DirecPC service
STRATEGIC GOALS
o Maintain leadership in core markets for private business
networks
o Significantly expand production of DIRECTV subscriber
equipment
o Leverage products and technologies into service business
opportunities
o Lead our development of the emerging market for broadband
communications services
Hughes Network Systems is the leading supplier, based on market share,
of very small aperture terminals or VSATs used in satellite-based private
business networks. Hughes Network Systems has delivered or received orders for
more than 300,000 of these terminals for use in the private networks of
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companies, government agencies, universities and research institutions. These
include more than 9,000 terminals installed in the GM Pulsar network, the
world's largest private business network. Since 1987, Hughes Network Systems has
sold private business networks to a variety of customers worldwide, including
DaimlerChrysler, Ford, Toyota, Chevron, Texaco, Mobil, Amoco, Wal-Mart, Toys "R"
Us, Jusco (Japan) and France Telecom.
Utilizing its expertise in private business networks,
satellite-delivered Internet services and advanced ground-based communications
infrastructure, Hughes Network Systems plans to focus on offering new broadband
services to a wide range of customers, including its existing blue-chip customer
base. Because of its early investments in broadband technology and its
networking expertise, Hughes Network Systems believes it will be a leader in
offering innovative broadband services to businesses, government agencies and
individuals.
Hughes Network Systems began manufacturing subscriber equipment for
DIRECTV in 1996 and is now the second leading supplier of this equipment in
terms of volume. Hughes Network Systems was able on short notice to increase its
production of DIRECTV receivers in 1998 to more than 650,000 units, enabling
DIRECTV to achieve record subscriber growth. Hughes Network Systems intends to
continue its production of DIRECTV units and expects its production to continue
to grow.
Hughes Network Systems developed DirecPC, a satellite-based information
delivery service that uses a small antenna and high-speed digital transmission
to make software, documents, desk-top video, games, news and other information
accessible through personal computers. For example, through DirecPC's Turbo
Internet(TM) servicE, a personal computer user can download data and video at
speeds up to 400 kilobits per second. Hughes Network Systems is working with
partners, including Compaq Computer Corporation, to establish DirecPC as the
global standard for high-speed multimedia transmission via satellite to personal
computers in homes and small offices.
We believe that significant opportunities exist for fixed wireless
telecommunications networks and mobile communications systems in areas with
deficient communications infrastructures. For example, in October 1998, Hughes
Ispat Limited, a limited liability company in which we have a minority ownership
interest, began providing basic telecommunications services within the Indian
state of Maharashtra.
We also believe that significant opportunities exist in utilizing
digital ground-based technologies to provide broadband fiber-quality wireless
access to businesses worldwide. For example, Hughes Network Systems has entered
into agreements to provide competitive local exchange carriers Winstar
Communications, Inc. and Teligent, Inc. with its AIReach(TM) Broadband system.
The AIReach Broadband system uses wireless technology to provide high-quality,
high-speed access to buildings not reached by fiber optic cables.
Hughes Network Systems believes that its technologies and other
capabilities position it to become a leading provider of satellite-based mobile
communications equipment and services. Several programs that have been awarded
in recent years to provide satellite ground telecommunications networking
equipment have established Hughes Network Systems' credentials in this sector.
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HUGHES SPACE AND COMMUNICATIONS
HIGHLIGHTS
o Manufactured the world's first communications satellite
capable of remaining directly above a fixed location on the
earth, known as a geosynchronous satellite
o 98% cumulative channel availability on Hughes built in-orbit
satellites
o Won over 50% of its competitive bids between 1991 and 1998
STRATEGIC GOALS
o Leverage technology leadership to gain a competitive advantage
and create new opportunities in our service businesses
o Provide customers with total satellite systems solutions
o Focus on quality in design and manufacturing
o Further improve productivity while decreasing the time it
takes to build a satellite
Hughes Space and Communications designs and builds satellite systems
for commercial customers worldwide and for the Department of Defense, NASA and
other government agencies. About 75% of Hughes Space and Communications revenues
in 1998 were from commercial customers.
As of March 31, 1999, Hughes Space and Communications had outstanding
orders to construct 34 communications satellites for companies and government
agencies in several countries, representing over $3.4 billion in backlog. In
1998, 11 satellites built by us were launched. In 1999, 19 satellites built by
Hughes Space and Communications are scheduled for launch. Launch schedules are
subject to a number of factors, some of which are beyond the control of Hughes
Space and Communications, including weather, availability of launch vehicles,
launch vehicle problems and governmental and political pressures. Launch
difficulties and delays, as well as construction delays, can result in increased
costs to Hughes Space and Communications.
We believe that Hughes Space and Communications' leadership position in
the competitive satellite manufacturing industry results from its technological
superiority in satellite design, production and operation. Since the launch of
Hughes Space and Communications' first satellite in 1963, its satellites have
accumulated over 1,000 years of in-orbit experience, with channel availability
of 98% on HS 376, HS 601 and other current generation in-orbit commercial
satellites. Approximately 95% of Hughes Space and Communications' satellites
have remained in service past their originally scheduled retirement dates.
Hughes Space and Communications' technological capabilities have
enhanced the power and capacity of its satellites and improved their cost
effectiveness. This enhances our competitiveness as a satellite manufacturer and
also results in increases in both revenue-per-satellite and the margin earned on
those revenues for satellite owners and operators. These improvements strengthen
our leadership position and expand the market for satellites as a whole. For
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example, Hughes Space and Communications has developed a family of satellite
structures, electronics, propulsion and power systems which can be replicated at
relatively low cost in a variety of commercial and government configurations. In
addition, Hughes Space and Communications has applied signal compression and
other methods to enhance the efficiency of transponders. The newest product in
this family is the HS 702 satellite, which will offer substantially higher power
levels than those previously achieved. Advances in digital electronics,
high-power amplifiers, antenna implementations and propulsion systems offer
improved performance capabilities of satellites built by Hughes Space and
Communications, which we expect will provide us with a competitive advantage
both as a manufacturer and as a service provider.
In order to enhance its competitive position in both the government and
commercial satellite manufacturing markets, Hughes Space and Communications
continues to work to lower its costs and improve productivity and quality. For
example, satellite manufacturing productivity has improved by approximately 64%,
measured by satellite sales dollars per employee, since 1992, and order to
delivery cycle times have been reduced to as low as 12 to 14 months for new HS
376 and HS 601 spacecraft. In addition, Hughes Space and Communications has
secured commitments for 45 launch vehicles over the next several years, which
will facilitate its access to space at competitive costs.
CORPORATE AND OTHER
We own equity interests in other businesses in addition to those
described above. These businesses are reported as part of the "corporate and
other" segment in our financial statements and the revenues of these businesses
are not, in the aggregate, material to us. For example, we are the largest
stockholder of American Mobile Satellite Corporation, with a current equity
interest of approximately 21%. American Mobile's common stock is publicly traded
and other stockholders include Motorola, Singapore Telecommunications, Ltd. and
AT&T Wireless Services. In addition, Spaceway is currently reported as part of
the "corporate and other" segment in our financial statements.
ACQUISITIONS, STRATEGIC ALLIANCES AND DIVESTITURES
Due to rapid growth in the telecommunications and space industry,
particularly internationally, and increasing competitive pressures, we review
our competitive position on an ongoing basis and from time to time consider
various acquisitions, strategic alliances and divestitures in order to continue
to compete effectively, grow our business and allocate our resources
efficiently. It is especially important for us to form strategic partnerships
with other firms to bring together the necessary expertise, such as
distribution, market knowledge and technology, to address competitive pressures
and meet new market demands. We have done this in our international DIRECTV
businesses as well as our network systems businesses. We also seek acquisitions
which will improve our position in these high growth and increasingly
competitive markets. The PRIMESTAR/Tempo Satellite and U.S. Satellite
Broadcasting Company transactions and the PanAmSat merger are significant recent
examples of this strategy. We continue to evaluate acquisitions, alliances and
divestitures, and from time to time engage in discussions regarding possible
transactions, which we believe will improve our competitive position and
financial results.
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REGULATION
Various aspects of our businesses are subject to federal and state
regulation. Noncompliance with these regulations may result in the suspension or
revocation of our licenses or registrations at issue, the termination or loss of
contracts at issue or the imposition of contractual damages, civil fines or
criminal penalties. In particular, our ability to sell satellites and other
technologies to businesses outside the United States is dependent on our
obtaining export licenses from the United States government. See "--Other
Business Risks."
U.S. GOVERNMENT CONTRACTS
We act as a prime contractor or major subcontractor with respect to
U.S. government programs. Principally, this business is performed by Hughes
Space and Communications. Sales to the U.S. government may be affected by:
o changes in acquisition policies;
o budget considerations;
o changing concepts of national defense;
o civilian space needs;
o spending priorities; and
o other factors that are outside our control.
U.S. government spacecraft acquisition programs generally follow a life
cycle of three phases. The first is the research and development phase, followed
by an engineering development phase which includes the first spacecraft, and
finally progressing into a production phase for the remaining spacecraft. The
production phase may continue with refinements and improvements for several
years. Large programs with significant start-up costs, which are usually
incurred in the research and development phase, do not become profitable until
the engineering development phase. The U.S. government typically uses multiple
sources during the research and development phase to intensify competition and
selects one source to perform the later phases of the program. Therefore, we may
not be selected for engineering development and production phases even when
considerable resources have been expended in the research and development phase
of a program.
We perform our U.S. government business under two general types of
contracts:
o Fixed-Price Contracts. Under fixed-price contracts, we realize
all the benefit or detriment caused by decreased or increased
costs of performing the contract.
o Cost Reimbursement Contracts. Under cost reimbursement
contracts, we receive reimbursement of our reasonable costs
that are allocable to the particular contract and allowable
under applicable regulations, plus a fee.
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Approximately 37% of our total sales to the U.S. government in 1998 were under
fixed-price contracts, and approximately 63% were under cost reimbursement
contracts. Net sales to the U.S. government in 1998 were approximately $700
million.
Most of our contracts with the U.S. government which are the basis of
our backlog are incrementally funded and therefore are subject to appropriations
decisions subsequent to award. Once awarded, contracts may be contested by other
bidders. In addition, our contracts with the U.S. government are subject to
termination by the U.S. government, either for its own convenience or because of
our default. In the event of a termination for convenience, we may not receive
full reimbursement for our costs, and the profit or fee we receive may be lower
than that which we had expected for the portion of the contract performed. In
the event of a termination for default, normal contract remedies generally
apply.
The U.S. government has broad discretion to suspend or prohibit
contractors from engaging in new government business, and often determines the
period of suspension or prohibition. A contractor may be prohibited based on a
conviction or civil judgment involving various offenses, including fraud in
connection with obtaining or performing a public contract or subcontract, and
may be suspended, if indicted for such an offense or if there is other adequate
evidence that such an offense has been committed. Like other government
contractors, we are subject to civil and criminal audits and investigations of
our contracting activity. This liability includes potential contract cost
reductions due to the defective pricing claims. See "--Other Business Risks."
COMPETITION
Although we have certain advantages which we believe help us compete in
our markets, each of our markets is highly competitive. Some of our competitors
in each of our markets have similar or better financial, technological and
personnel resources than us. As described elsewhere in this document, we believe
technological capabilities and innovation and the ability to invest in new and
developing businesses are critical to obtaining and maintaining leadership in
our markets and the communications industry in general. We cannot assure you as
to the effect that competition may have on our financial condition or results of
operations. See "--Other Business Risks."
o DIRECTV. DIRECTV faces stiff competition from local cable
operations as well as other direct-to-home satellite systems
in each of its regional markets. With respect to traditional
cable television, DIRECTV believes that it can compete
effectively because it provides higher quality picture and
sound and greater programming variety and believes it provides
higher quality customer service. DIRECTV expects to face
increasing competition from digital cable television over
time. Digital cable is capable of delivering high quality
picture and sound and a broader range of programming than
traditional cable. We believe that the current prohibition in
the United States on delivering by satellite local television
channels into local markets is a disadvantage with respect to
competing with cable television. Currently pending legislation
would remove this prohibition. See "--DIRECTV--United States."
With our acquisition of PRIMESTAR and U.S. Satellite
Broadcasting Company, Echostar Communications Corporation is
the only other direct-broadcast service company currently in
operation in the United States. Echostar has recently
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announced its acquisition of the satellites and orbital slots
owned by The News Corporation Limited and MCI WorldCom, Inc.
DIRECTV faces competition from other direct broadcast service
providers in major regions of Latin America and in Japan.
DIRECTV service also competes with telephone companies,
broadcast television and other entertainment services,
including video rentals. We believe that DIRECTV can compete
effectively through a combination of its broad range of
programming, including exclusive programming, and extensive
distribution.
As a result of this competitive environment, DIRECTV may have
to incur increased subscriber acquisition costs through
competitive offers in the future to maintain its market
leadership.
o PANAMSAT. PanAmSat primarily competes with companies and
organizations that own or utilize satellite or ground-based
transmission facilities. Satellite operators include global
competitors such as Intelsat, regional operators expanding
globally, such as Loral Space and Communications, GE Americom,
and Lockheed Martin, and numerous other regional operators and
governments. We believe PanAmSat can compete favorably in its
markets because of its large satellite fleet, global satellite
coverage and the location of its orbital positions.
o SPACEWAY. Spaceway will face competition from companies that
offer both ground-based and satellite-based broadband
services. Companies offering ground-based broadband services
include AT&T Corporation, Qwest Communications, Time Warner
and Bell Atlantic. Companies who may offer satellite-based
broadband services include Teledesic LLC, Skybridge LP and
Loral Space & Communication's Cyberstar. We believe we will
compete favorably because of our advanced technology for
satellites and the related ground equipment, and because of
Hughes Network Systems' and DIRECTV's existing customer bases.
o HUGHES NETWORK SYSTEMS. Hughes Network Systems business faces
global competition in the VSAT market from Gilat Satellite
Networks Ltd. and in its wireless communications markets from
firms such as Lucent Technologies Inc., Telefonaktiebolaget LM
Ericsson, AT&T Corporation, as well as other large
telecommunications companies and the various regional Bell
operating companies. Hughes Network Systems faces competition
from RCA/Thomson Consumer Electronics and Sony in the
manufacturing of DIRECTV subscriber equipment. We believe that
Hughes Network Systems' technologies and other capabilities
provide us with a competitive advantage in its markets.
o HUGHES SPACE AND COMMUNICATIONS. Hughes Space and
Communications faces competition in the United States from
companies such as TRW, Inc., Loral Space & Communications Ltd.
and Lockheed Martin and internationally from Matra Marconi,
Alcatel and DASA. We believe Hughes Space and Communications
can compete favorably because of its family of satellite
structures, electronics, propulsion and power systems and its
technological capabilities.
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In addition, our businesses compete generally with other communications
technologies and systems, such as telecommunications systems for fixed and
mobile applications, fiber optics networks, cable systems, wire telephony and
radio-based systems and other satellite-based systems.
RESEARCH AND INTELLECTUAL PROPERTY
The ability to continue to generate technological innovations is
critical to ensure our long-term success and the competitiveness of our
business. See "--Other Business Risks." The continued development of new
technologies may provide new and improved products which will continue to fuel
business opportunities and product improvements which, among other things, will
enable the extension of profitable production programs. Research and development
is carried on in each of our business units in connection with ongoing product
improvement efforts. In addition, HRL Laboratories LLC, a company of which we
own 50%, conducts long-range applied research in the specialized fields of
physics, chemistry, electronics and information sciences.
We utilize a large number of patents and trademarks which are held by
us or our affiliates. We believe that, in the aggregate, the rights existing
under such patents, trademarks and licenses are important. We believe that our
competitive position is dependent on research, engineering and production
capabilities. We actively pursue patent and trademark protections of our
technological and engineering innovations, and actively pursue enforcement of
our intellectual property rights.
RECENT DEVELOPMENTS
OUR FINANCIAL RESULTS FOR THE FIRST QUARTER OF 1999. Our revenues for
the first quarter of 1999 were $1,451.8 million, compared with $1,291.0 million
in the first quarter of 1998, a 12.5% increase. This increase was due primarily
to the Direct-to-Home Broadcast segment, where revenues increased 43.5% to
$556.6 million from $387.9 million in the first quarter of 1998. This increase
resulted from continued strong subscriber growth, as well as strong average
monthly revenue per subscriber in the United States.
Our earnings were $78.3 million, or $0.20 per share of Class H common
stock, in the first quarter of 1999 versus $44.5 million, or $0.11 per share of
Class H common stock, in the same period last year. First quarter earnings,
excluding one-time items, were $40.1 million in 1999 compared to $53.7 million
in the same period for 1998, resulting in earnings per share of Class H common
stock of $0.10 and $0.13 for the first quarter of 1999 and 1998, respectively.
Excluding one-time items, the declines in earnings and earnings per share of
Class H common stock were primarily due to lower interest income and higher
depreciation and amortization expenses.
One-time items in the first quarter of 1999 were a $94.3 million
after-tax, or $154.6 million pre-tax, gain related to the settlement of a patent
infringement case and a $56.1 million after-tax, or $92.0 million pre-tax,
charge related to the Asia-Pacific Mobile Telecommunications contract
termination. See "Item 2. Financial Information--Management's Discussion and
Analysis--General." The one-time item in the first quarter of 1998 was a $9.2
million after-tax charge for the cumulative effect of an accounting change
mandated by the American Institute of Certified Public Accountants for the
write-off of previously capitalized start-up costs.
With respect to our balance sheet, the cash balance declined $562.1
million in the quarter to $780.0 million as of March 31, 1999, primarily due to
working capital requirements, purchase of the Tempo ground spare satellite, and
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PanAmSat's early buy-out of satellite sale-leasebacks, which were partially
offset by proceeds from the settlement of the patent infringement case with the
United States government. See "Item 2. Financial Information--Management's
Discussion and Analysis--General." Long-term debt increased $77.9 million to
$856.6 million principally from an increase in PanAmSat's commercial paper
borrowings to fund its satellite fleet expansion and PanAmSat's early buy-out of
sale-leasebacks.
ISSUANCE OF DEBT AND EQUITY. We expect to file a shelf registration
statement with the Securities and Exchange Commission with respect to an
issuance of debt securities from time to time. We expect to issue between $500
million and $1 billion of these securities in the third and fourth quarters of
1999. General Motors filed on May 5, 1999, a registration statement on Form S-3
with the Commission with respect to a proposed issuance of Class H common stock
with a maximum aggregate offering price of $575 million. These registered
offerings will be made only by means of a prospectus and are expected to be
completed during the second and third quarters of 1999. General Motors will
contribute to our company the net proceeds from the Class H offering, together
with an additional $500 million on or about the closing of the equity offering.
We will use these funds principally to repay debt we incurred in connection with
the PRIMESTAR/Tempo Satellite and U.S. Satellite Broadcasting Company
transactions.
RECENT ACQUISITIONS
We have recently made the following acquisitions:
PRIMESTAR AND TEMPO SATELLITE
We acquired the direct-broadcast satellite medium-power business of
PRIMESTAR and agreed to acquire the related high-power satellite assets of Tempo
Satellite, a wholly owned subsidiary of TCI Satellite Entertainment, in related
transactions. PRIMESTAR operates a 160-channel medium-power direct broadcast
service using leased satellite capacity at 85(degree) west longitude. As of
March 31, 1999, PRIMESTAR had 2.3 million subscribers in tHe United States.
DIRECTV intends to operate the medium-power PRIMESTAR business for a period of
approximately two years, during which time PRIMESTAR subscribers will be offered
the opportunity to transition to the high-power DIRECTV service. During this
period, PRIMESTAR's distribution network will continue servicing PRIMESTAR
subscribers and begin offering the DIRECTV service to new subscribers.
The purchase price for the PRIMESTAR medium-power business was about
$1.1 billion in cash and about 4.9 million shares of Class H common stock. The
purchase price for the Tempo high-power satellite assets is $500 million in
cash. Of this purchase price, $150 million was paid in March 1999 for a
satellite that has not yet been launched. The remaining $350 million for an
in-orbit satellite and related satellite orbital frequencies is payable upon
Federal Communications Commission approval of the transfer of the 11 orbital
frequencies, which is expected in mid-1999. However, there can be no assurance
that this transfer will be approved or that this portion of the Tempo Satellite
transaction will be consummated.
The PRIMESTAR acquisition provides DIRECTV with an immediate increase
in revenues from the existing PRIMESTAR subscribers, and ongoing revenues from
those subscribers that transition to the DIRECTV service.
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The Tempo Satellite in-orbit satellite and related frequencies
acquisition, if completed, will provide DIRECTV with 11 high-power DBS
frequencies at 119(degree) west longitude, from which it can begin delivering
progrAmming to the contiguous United States at any time.
U.S. SATELLITE BROADCASTING COMPANY
We have acquired by merger all of the outstanding capital stock of U.S.
Satellite Broadcasting Company in exchange for cash and shares of Class H common
stock totaling $ billion. U.S. Satellite Broadcasting Company provides
subscription television programming to households throughout the continental
United States via the digital satellite broadcasting system that it shares with
DIRECTV. U.S. Satellite Broadcasting Company currently delivers 25 channels of
video programming, including premium networks such as HBO(R), Showtime(R),
CinemAx(R) and The Movie Channel(R). The programming delivered by U.S. Satellite
Broadcasting Company includes over 800 movies per month.
The total consideration payable in the merger is $ billion in cash and
shares of Class H common stock. The former shareholders of U.S. Satellite
Broadcasting Company, within a limited range, have the right to elect to receive
consideration in the form of Class H common stock or the cash equivalent. Not
more than 50% of the total consideration will be payable in cash and not more
than 70% of the total consideration will be in the form of Class H common stock.
Accordingly, the cash paid by us will be between $ and $ and between shares and
shares of Class H common stock will be issued.
As of March 31, 1999, U.S. Satellite Broadcasting Company had over 2.2
million subscribers. Over 90% of U.S. Satellite Broadcasting Company's
subscribers were also DIRECTV subscribers. DIRECTV plans to integrate the U.S.
Satellite Broadcasting Company business into its business as soon as possible
and to begin immediately offering more diverse programming packages to
subscribers, including the premium programming currently offered by U.S.
Satellite Broadcasting Company.
The acquisition of U.S. Satellite Broadcasting Company provides DIRECTV
with:
o the opportunity to achieve cost savings through the
consolidation of duplicate operations;
o the opportunity to increase its average revenue per
subscriber; and
o the ability to expand its channel offering from 185 to more
than 210 via the addition of U.S. Satellite Broadcasting
Company's premium channels.
OTHER BUSINESS RISKS
The following risks are related principally to our business. The risks
and uncertainties described below are not the only ones facing our business. You
should carefully review the information set forth elsewhere in this registration
statement. Additional risks and uncertainties not presently known to us or that
we currently believe to be immaterial may also adversely affect our business. If
any of the following risks and uncertainties develop into actual events, our
business, financial condition or results of operations could be materially
adversely affected.
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WE WILL BE ADVERSELY AFFECTED IF WE FAIL TO MAINTAIN LEADING
TECHNOLOGICAL CAPABILITIES
The rapid technological changes and innovation inherent in the
satellite and wireless communications industry could cause the products and
services offered by our company to become obsolete. If the new technologies on
which we are currently focusing our research and development investments fail to
achieve acceptance in the marketplace, we would suffer a material adverse effect
on our future competitive position and results of operations. For example, our
competitors could be the first to obtain proprietary technologies that are
perceived by the market as being superior. In addition, after substantial
research and development expenditures, one or more of the technologies under
development by us could become obsolete even prior to its introduction.
Our operating results will depend to a significant extent on our
ability to continue to introduce new products and services on a timely basis and
to reduce costs of existing products and services. We cannot assure you that we
will successfully identify new product or service opportunities and develop and
market these opportunities in a timely or cost-effective manner. The success of
new product development depends on many factors, including proper identification
of customer needs, cost, timely completion and introduction, differentiation
from offerings of competitors and market acceptance.
Technological innovation depends, to a significant degree, on the work
of technically skilled employees. Competition for the services of such employees
is vigorous. We cannot assure you that we will be able to attract and retain
these employees. If we were unable to attract and maintain technically skilled
employees, our competitive position could be adversely affected.
WE COULD HAVE INADEQUATE ACCESS TO CAPITAL FOR GROWTH
We may not be able to raise adequate capital to complete some or all of
our business strategies or to react rapidly to changes in technology, products,
services or the competitive landscape. We believe that key success factors in
the satellite and wireless communications industry include superior access to
capital and financial flexibility. Industry participants often face high capital
requirements in order to take advantage of new market opportunities, respond to
rigorous competitive pressures and react quickly to changes in technology. For
example, as a result of its competitive environment, DIRECTV may have to incur
increased subscriber acquisition costs through competitive offers in the future
to maintain its market leadership.
We expect the global satellite and wireless communications services
market to continue to grow due to the high demand for communications
infrastructure and the opportunities created by industry deregulation. Many of
our competitors are committing substantial capital and, in many instances, are
forming alliances to acquire or maintain market leadership. Our strategy is to
be a leader in providing satellite and wireless communications products and
services by building on our experience in satellite technology and by making
acquisitions and establishing, maintaining and restructuring strategic alliances
as appropriate. See "--Recent Acquisitions." This strategy will require
substantial investments of capital over the next several years. We may be unable
to satisfy our capital requirements in the future, whether through lack of
competitive access to capital markets, General Motors' overall financial
condition, restrictions imposed by General Motors or otherwise. General Motors'
ability to issue Class H common stock as a means of funding our capital
requirements may be limited in the event of the enactment of a proposal to amend
the Internal Revenue Code that is included in the Clinton administration's
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budget proposal for the fiscal year 2000. This amendment, which is proposed to
apply to tracking stock, including exercises of existing employee stock options,
issued on or after the date of enactment, would require General Motors to
recognize gain for federal income tax purposes when it issues Class H common
stock.
WE ARE VULNERABLE TO SATELLITE FAILURE
DIRECTV, including the operations of PRIMESTAR, PanAmSat and other
businesses of ours own or utilize satellites in their businesses. The complete
or partial loss of a satellite, in-orbit or during launch, could have a material
adverse impact on the operation of these businesses. Orbiting satellites are
subject to the risk of failing prematurely due to, among other things,
mechanical failure, a collision with objects in space or an inability to
maintain proper orbit. Satellites are subject to the risk of launch delay and
failure, destruction and damage while on the ground or during launch and failure
to become fully operational once launched. With respect to both in-orbit and
launch problems, insurance carried by PanAmSat and our company does not
compensate for business interruption or loss of future revenues or customers. In
addition, any future in-orbit failures involving satellites built by our company
could adversely impact satellite sales by Hughes Space and Communications.
These risks were highlighted during 1998, when four Hughes-built
satellites, three owned and operated by PanAmSat and the fourth owned by
DIRECTV, experienced the failure of a primary spacecraft control processor. With
the exception of the Galaxy IV satellite owned and operated by PanAmSat, control
of the satellites was automatically switched to a backup processor and the
spacecraft are operating normally. The backup processor on the Galaxy IV
satellite had previously failed, resulting in the loss of the satellite. An
extensive investigation by us revealed that electrical shorts involving
tin-plated relay switches were the most likely cause of the primary spacecraft
control processor failure. The failure of the backup control processor on Galaxy
IV appears to be unrelated and is being treated as an isolated anomaly. We
believe the probability of a primary and a backup processor failing in one
satellite is low, however we cannot assure you that additional spacecraft
control processor failures will not occur.
Battery anomalies have occurred in two other Hughes-built PanAmSat
satellites. In both cases, battery cells have failed, resulting in the need to
briefly shut off a number of transponders during twice-yearly eclipse periods.
It is possible that service to full-time customers could be interrupted for
brief periods during future eclipse periods, or that additional battery cell
failures will occur in the future. Such future service interruptions, depending
on their extent, could result in claims by affected customers for termination of
their transponder agreements.
In addition, following the launch of another PanAmSat satellite that
was not built by us, an error by the satellite's manufacturer was discovered
that affected the geographical coverage or flexibility of a number of the
transponders on the satellite. PanAmSat is evaluating the impact of the error
and currently believes that a portion of those transponders will not be
marketable for their intended purpose, although the affected transponders may be
capable of generating revenue at a reduced rate.
GRAND JURY INVESTIGATION/STATE DEPARTMENT REVIEW COULD RESULT IN
SANCTIONS
There is a pending grand jury investigation into whether we should be
indicted for criminal violations of the export control laws arising out of the
participation of two of our employees on a committee formed to review the
findings of Chinese engineers regarding the failure of a Long March rocket in
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China in 1996. We are also subject to the authority of the State Department to
impose sanctions for non-criminal violations of the Arms Export Control Act. The
possible criminal and/or civil sanctions could include fines as well as
debarment from various export privileges and participation in government
contracts. We do not expect the grand jury investigation or State Department
review to result in a material adverse effect upon our business. However, we
cannot assure you as to those conclusions. In addition, a congressional
committee chaired by Representative Cox has prepared a report that is expected
to be publicly released during May 1999. This report may contain negative
commentary about the compliance of U.S. satellite manufacturers, including our
company, with the export control laws.
THE U.S. GOVERNMENT COULD ADVERSELY IMPACT THE ABILITY OF THE U.S.
SATELLITE INDUSTRY TO COMPETE FOR FOREIGN SATELLITE COMMERCE
The U.S. government has broad discretion over the issuance of export
licenses for the sale to foreign customers and/or overseas launches of
commercial communication satellites. We sell a substantial number of satellites
to foreign customers and launch a substantial number of satellites overseas.
Effective March 1999, Congress directed that satellites and their components be
placed on the munitions list and made subject to the export licensing
jurisdiction of the State Department. Prior to March 1999, satellites were
classified as dual-use exports under the jurisdiction of the Department of
Commerce. It is anticipated that future licenses for satellite exports will not
be granted in the same manner and time frame as was previously the case, which
could adversely impact the ability of not only our company, but all other
domestic satellite manufacturers, to compete on equal footing with international
satellite manufacturers for foreign satellite sales.
In February 1999, the Department of Commerce notified us that it
intended to deny the export licenses required by us to fulfill our contractual
obligations to Asia-Pacific Mobile Telecommunications Satellite Pte. Ltd., a
Singapore-based company with a majority interest held by Chinese entities. As a
result, we and Asia-Pacific Mobile Telecommunications terminated the contract,
resulting in a pre-tax charge to our earnings of $92.0 million in the first
quarter of 1999. See "Item 2. Financial Information--Management's Discussion and
Analysis of Results of Operations and Financial Condition."
DISPUTES WITH RAYTHEON COMPANY REGARDING FORMER DEFENSE OPERATIONS
COULD RESULT IN A MATERIAL PAYMENT FROM OUR COMPANY TO RAYTHEON COMPANY
As part of the 1997 spin-off of the defense electronics business of our
predecessor and the subsequent merger of that business with Raytheon Company,
agreements entered into by our company and Raytheon provided processes for
resolving disputes that might arise in connection with post-closing financial
adjustments that were also called for by the terms of the merger agreement. Such
financial adjustments might require a cash payment from Raytheon to our company
or vice versa. A dispute currently exists regarding the post-closing adjustments
that we and Raytheon have proposed to one another and related issues regarding
the completeness and accuracy of disclosures made to Raytheon in the period
prior to consummation of the merger. In an attempt to resolve the dispute, we
gave notice to Raytheon to commence the arbitration process specified in the
merger agreement. Raytheon responded by filing an action in the Delaware
Chancery Court which seeks to enjoin the arbitration as premature. That
litigation is now inactive and we and Raytheon are now proceeding with the
dispute resolution process. It is possible that the ultimate resolution of the
post-closing financial adjustment and of related disclosure issues may result in
us making a payment to Raytheon that would be material to our company. However,
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the amount of any payment that either party might be required to make to the
other cannot be determined at this time. We intend to vigorously pursue
resolution of the disputes through the arbitration process, opposing the
adjustments proposed by Raytheon, and seeking the payment from Raytheon that it
has proposed.
WE MIGHT FAIL TO REALIZE THE BENEFITS OF RECENT ACQUISITIONS
We cannot assure you that the anticipated benefits of the
PRIMESTAR/Tempo Satellite and U.S. Satellite Broadcasting Company acquisitions
will be realized. We could experience difficulties integrating the operations of
these companies with our own operations, or could find that the anticipated cost
savings from such integration do not materialize.
EMPLOYEES
As of March 31, 1999, we employed approximately 15,500 persons.
As of March 31, 1999, approximately 13% of our work force in the United
States was represented by unions. We have not experienced any significant labor
problems in the past five years, and management considers its employee relations
to be good.
ITEM 2. FINANCIAL INFORMATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
CONDITION
As provided in General Motors' restated certificate of incorporation,
the earnings attributable to Class H common stock for purposes of determining
the amount available for the payment of dividends on Class H common stock
excludes purchase accounting adjustments related to General Motors' acquisition
of Hughes Aircraft Company, our predecessor, in 1985. Therefore, the following
discussion excludes such adjustments. You should review this section in
connection with our Unaudited Supplemental Pro Forma Financial Data, which
exclude these adjustments, and our audited financial statements, which reflect
these adjustments, both of which are included in this registration statement.
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GENERAL
On December 17, 1997, our predecessor, which was also known as Hughes
Electronics Corporation, and General Motors completed a series of transactions
designed to address strategic challenges facing its then-three principal
businesses and unlock stockholder value in General Motors. These transactions
included:
o the tax-free spin-off of its defense electronics business to
holders of General Motors $1-2/3 common stock and Class H
common stock;
o the transfer of Delco Electronics Corporation, its automotive
electronics business, to General Motors' Delphi Automotive
Systems unit, which is now a separate corporation; and
o the recapitalization of General Motors Class H common stock
into a new tracking stock of the same name, that is linked to
our telecommunications and space businesses.
These transactions were followed immediately by the merger of the
defense electronics business with Raytheon Company. In connection with this
recapitalization, the telecommunications and space business, consisting
principally of the direct-to-home broadcast, satellite services, network systems
and satellite systems businesses, were contributed to the recapitalized Hughes
by our predecessor. The following discussion and accompanying financial
statements pertain only to our company as it now exists, and do not pertain to
balances of our company for the period prior to our recapitalization, the
defense electronics business or Delco. For additional information on the basis
of presentation, see Note 1 to our financial statements included elsewhere in
this registration statement.
In May 1997, our company and PanAmSat Corporation merged their
respective satellite service operations into a new publicly-held company, which
retained the name PanAmSat Corporation. As a result of this merger, our 1997
financial information includes PanAmSat's results of operations from the date of
merger. For further information regarding this merger, see note 14 to our
financial statements included elsewhere in this registration statement.
During 1998, four satellites that we built experienced the failure of a
primary spacecraft control processor. Three of these satellites were owned and
operated by PanAmSat and the fourth was owned by DIRECTV. With the exception of
the Galaxy IV satellite, operated by PanAmSat, control of the satellites was
automatically switched to the spare control processor and the spacecraft are
operating normally. The spare control processor on the Galaxy IV satellite had
previously failed, resulting in the loss of the satellite.
An extensive investigation by us revealed that electrical shorts
involving tin-plated relay switches are the most likely cause of the primary
control processor failures. Although there exists the possibility of failure of
other currently operating spacecraft control processors, we believe the
probability of a primary and spare control processor failing in any one in-orbit
HS-601 satellite is low. We are confident that the phenomenon will not be
repeated on satellites currently being built and those ready for launch,
although there can be no assurance in this regard. The failure of the second
control processor on Galaxy IV appears to be unrelated and is being treated as
an isolated anomaly. However, no assurance can be given that additional
processor failures will not occur.
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Battery anomalies have occurred on two other PanAmSat satellites that
we built. In both cases, battery cells have failed resulting in the need to
shut-off a number of transponders for a brief time during twice-yearly eclipse
periods. To date, the impact on customers has been minimal. There can be no
assurance, however, that service to all full-time customers will not be
interrupted for brief periods during future eclipse periods or that additional
battery cell failures will not occur in the future. Such future service
interruptions, depending on their extent, could result in a claim by affected
customers for termination of their transponder agreements or the displacement of
other customers. PanAmSat is developing solutions for its customers that may
include transition of the affected services to other PanAmSat satellites or the
launch of replacement satellites.
In August 1998, Galaxy X, a PanAmSat satellite, was destroyed as a
result of the launch failure of a Boeing Delta III rocket. Galaxy X was fully
insured.
On February 24, 1999, the Department of Commerce notified us that it
intended to deny a U.S. government export license we were required to obtain in
connection with a contract with Asia-Pacific Mobile Telecommunications Satellite
Pte. Ltd. for the provision of a satellite-based mobile telecommunications
system. As a result, we and Asia-Pacific Mobile Telecommunications terminated
the contract on April 9, 1999, which led to us recording a pre-tax charge to
earnings of $92 million in the first quarter of 1999.
We have maintained a suit against the U.S. government since September
1973 regarding the U.S. government's infringement and use of one of our
satellite technology patents. On April 7, 1998, the U.S. Court of Appeals for
the Federal Circuit reaffirmed earlier decisions in this case, including
awarding $114.0 million in damages, plus interest. In March 1999, we received
and recognized, as other income, net, a $154.6 million payment from the U.S.
government as a final settlement of the suit.
RESULTS OF OPERATIONS
1998 compared to 1997
Revenues. 1998 revenues increased 16.3% to $5,963.9 million compared
with $5,128.3 million in 1997. Each of our four primary business segments
contributed to the growth in revenue, including continued strong subscriber
growth in the Direct-to-Home Broadcast segment, the effect of the PanAmSat
merger and increased operating lease revenues for video, data and
Internet-related services in the Satellite Services segment, increased sales of
DIRECTV receiver equipment in the Network Systems segment and increased sales of
commercial satellites in the Satellite Systems segment.
Direct-to-Home Broadcast segment revenues for 1998 increased 42.2% to
$1,816.1 million from $1,276.9 million in 1997. The large increase in revenues
resulted from record U.S. subscriber growth, increased average monthly revenue
per subscriber and low subscriber churn rates. Domestic DIRECTV was the biggest
contributor to this growth, with revenues of $1,604.1 million for 1998, a 45.4%
increase over prior year's revenues of $1,103.3 million. Our Latin American
DIRECTV subsidiary, Galaxy Latin America, LLC, had revenues of $141.3 million
compared with $70.0 million in 1997. Total DIRECTV subscribers as of December
31, 1998 were 4,458,000 in the United States and 484,000 in Latin America. In
addition, our unconsolidated affiliate, DIRECTV Japan, which initiated its
service in December 1997, had a total of 231,000 subscribers as of December 31,
1998.
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Revenues for the Satellite Services segment in 1998 increased 21.8% to
$767.3 million from $629.9 million in 1997. The increase in revenues was due to
the May 1997 PanAmSat merger and increased operating lease revenues from the
commencement of service agreements for full-time video distribution, as well as
short-term special events and an increase in data and Internet-related service
agreements. The increase was partially offset by a decrease in sales and
sales-type lease revenues.
Revenues in 1998 for the Network Systems segment were $1,076.7 million
compared with $1,011.3 million in 1997. The increase in revenues resulted from
the growth in sales of DIRECTV receiver equipment and the increased sales of
private business networks and satellite-based mobile telephony equipment offset
by lower international sales of wireless telephone systems and private business
networks, primarily in the Asia Pacific region.
Satellite Systems segment revenues increased 13.6% in 1998 to $2,831.1
million from $2,491.9 million in 1997, primarily due to higher commercial
satellite sales to customers such as Thuraya Satellite Telecommunications
Company, PanAmSat, ICO Global Communications and Orion Asia Pacific Corporation.
Operating Profit. Operating profit, excluding amortization of purchase
accounting adjustments related to General Motors' acquisition of our company,
was $270.1 million in 1998 compared with $306.4 million in 1997. Full-year 1998
operating profit margin on the same basis was 4.5% compared with 6.0% in 1997.
The lower 1998 operating profit and operating profit margin resulted principally
from lower sales of wireless telephone systems and private business networks in
the Asia Pacific region, as well as provisions for estimated losses at Hughes
Network Systems associated with uncollectible amounts due from certain wireless
customers. Also contributing to the decline was goodwill amortization associated
with the May 1997 PanAmSat merger and the additional May 1998 investment in
PanAmSat.
The operating loss in the Direct-to-Home Broadcast segment in 1998 was
$228.1 million compared with an operating loss of $254.6 million in 1997. The
full-year 1998 operating loss for domestic DIRECTV was $100.0 million compared
with $137.0 million in 1997. Galaxy Latin America's operating loss was $125.8
million in 1998 versus $116.0 million in 1997. The lower operating loss for
domestic DIRECTV in 1998 was principally due to increased subscriber revenues
which more than offset increased sales and marketing expenditures.
As a result of the increased revenues described above, the Satellite
Services segment operating profit increased 8.6% to $321.6 million in 1998,
compared with the prior year's operating profit of $296.2 million. Operating
profit margin in 1998 declined to 41.9% from 47.0% in the prior year principally
due to goodwill amortization associated with the PanAmSat merger, a provision
for losses relating to the May 1998 failure of PanAmSat's Galaxy IV satellite
and increased depreciation expense resulting from increased capital expenditures
by PanAmSat.
The Network Systems segment operating profit in 1998 was $10.9 million
versus $74.1 million in 1997 and operating profit margin declined to 1.0% from
7.3% last year. The decrease in operating profit and operating profit margin was
primarily due to a $26 million provision for estimated losses associated with
the bankruptcy filing by a customer, provision for uncollectible amounts due
from certain wireless customers and lower international sales of wireless
telephone systems and private business networks, primarily in the Asia Pacific
region.
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Operating profit for the Satellite Systems segment in 1998 was $246.3
million, an increase of 8.8% over $226.3 million in 1997. The increase was
primarily due to the higher commercial satellite sales noted above. The
operating profit margin for the year was 8.7% compared with the 9.1% margin
earned in the prior year.
Costs and Expenses. Selling, general and administrative expenses
increased to $1,457.0 million in 1998 from $1,119.9 million in 1997. The
increase in these expenses resulted primarily from increased marketing and
subscriber acquisition costs in the Direct-to-Home Broadcast segment and
increased expenditures to support the growth in the remaining business segments.
The increase in depreciation and amortization expense to $433.8 million in 1998
from $296.4 million in 1997 resulted from increased goodwill amortization
related to the May 1997 PanAmSat merger and the purchase of an additional 9.5%
interest in PanAmSat in May 1998, and increased capital expenditures in the
Direct-to-Home Broadcast and Satellite Services segments.
Interest Income and Expense. Interest income increased to $112.3
million in 1998 compared to $33.1 million in 1997, due primarily to higher cash
balances resulting from the recapitalization of our company. Interest expense
decreased $73.5 million to $17.5 million in 1998 versus $91.0 million in 1997,
resulting from the repayment at the end of 1997 of debt arising from the
PanAmSat merger.
Other, net. Other, net for 1998 relates primarily to losses from
unconsolidated subsidiaries of $128.3 million, attributable principally to
equity investments, including American Mobile Satellite Corporation and DIRECTV
Japan, and a provision for estimated losses associated with bankruptcy filings
by two customers. The amount for 1997 includes the $489.7 million pre-tax gain
recognized in connection with the May 1997 PanAmSat merger offset by losses from
unconsolidated subsidiaries of $72.2 million.
Income Taxes. The effective income tax rate was (21.1)% in 1998 and
37.0% in 1997. The effective income tax rate in 1998 benefited from the
favorable adjustment relating to an agreement with the Internal Revenue Service
regarding the treatment of research and experimentation costs for the years 1983
through 1995.
Discontinued Operations and Extraordinary Item. On December 15, 1997,
Hughes Avicom International, Inc. was sold to Rockwell Collins, Inc., resulting
in an after-tax gain of $62.8 million. We recorded an extraordinary after-tax
charge of $20.6 million in 1997 related to the refinancing of PanAmSat's debt.
For additional information see Note 6 to our financial statements included
elsewhere in this registration statement.
Accounting Changes. In 1998, we adopted American Institute of Certified
Public Accountants Statement of Position 98-5, Reporting on the Costs of
Start-Up Activities. Statement of Position 98-5 requires that all start-up costs
previously capitalized be written off and recognized as a cumulative effect of
accounting change, net of taxes, as of the beginning of the year of adoption. On
a prospective basis, these types of costs are required to be expensed as
incurred. The unfavorable cumulative effect of this accounting change at January
1, 1998 was $9.2 million after-tax, or $0.02 per share of Class H common stock.
Earnings. 1998 earnings were $271.7 million, or $0.68 per share of
Class H common stock, compared with 1997 earnings of $470.7 million, $1.18 per
share of Class H common stock on a pro forma basis. 1997 earnings per share are
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presented on a pro forma basis assuming the recapitalized Class H common stock
was outstanding for all of 1997. For further discussion see Note 13 to our
financial statements included elsewhere in this registration statement.
Backlog. The 1998 year-end backlog of $10,064.9 million decreased from
the $10,337.6 million reported at the end of 1997, primarily due to a decrease
in the Satellite Services segment.
1997 compared to 1996
Revenues. 1997 revenues increased 27.9% to $5,128.3 million compared
with $4,008.7 million in 1996. The increase reflects strong subscriber growth in
the Direct-to-Home Broadcast segment, increased revenues in the Satellite
Services segment resulting primarily from the PanAmSat merger and increased
sales on commercial satellite programs in the Satellite Systems segment.
Direct-to-Home Broadcast segment revenues more than doubled to $1,276.9
million from $621.0 million in 1996. This increase resulted from strong
subscriber growth and continued low subscriber churn rates. Domestic DIRECTV
fueled this growth with revenues of $1,103.3 million, a 78.5% increase over 1996
revenues of $618.2 million. Galaxy Latin America, LLC had revenues of $70.0
million compared with $2.7 million in 1996. Total DIRECTV subscribers as of
December 31, 1997 were 3,301,000 in the United States and 300,000 in Latin
America.
DIRECTV Japan initiated its service in December 1997.
Revenues for the Satellite Services segment in 1997 increased 30.5% to
$629.9 million from $482.8 million in 1996. The increased revenues were due to
the PanAmSat merger and increased operating lease revenues for both video
distribution and business communications services. PanAmSat's services were
expanded in 1997 with the successful launch of two dedicated direct-to-home
satellites and a new cable TV distribution satellite in Latin America, leading
to an increase in total transmission capability since the May merger.
Revenues in 1997 for the Network Systems segment were $1,011.3 million
compared with $1,070.0 million in 1996. The decline was primarily due to lower
domestic mobile cellular telephone equipment sales, which were partially offset
by higher satellite-based mobile telephony equipment sales.
Satellite Systems segment revenues increased 21.2% in 1997 to $2,491.9
million from $2,056.4 million in 1996, primarily due to higher commercial
satellite sales within the high-powered product line of satellites and on the
ICO Global Communications satellite contracts.
Operating Profit. Operating profit for our company increased to $306.4
million in 1997 from $210.1 million in 1996. The 45.8% increase reflects reduced
losses in the Direct-to-Home Broadcast segment, higher commercial satellite
sales and the completion of the PanAmSat merger.
The operating loss in the Direct-to-Home Broadcast segment in 1997 was
$254.6 million compared with an operating loss of $319.8 million in 1996. The
full-year 1997 operating loss for domestic DIRECTV was $137.0 million compared
with $192.0 million in 1996. Galaxy Latin America's operating loss was $116.0
million in 1997 versus $131.0 million in 1996. The lower operating losses in
1997 were principally due to increased subscriber revenues which more than
offset higher marketing and subscriber related expenditures.
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The Satellite Services segment operating profit was $296.2 million in
1997, an increase of 22.2% over the prior year's operating profit of $242.4
million. The increase resulted primarily from the PanAmSat merger and increased
operating lease revenues for both video distribution and business communications
services. Operating profit margin in 1997 declined to 47.0% from 50.2% in 1996,
principally due to goodwill amortization associated with the PanAmSat merger.
The Network Systems segment operating profit in 1997 was $74.1 million
versus $107.7 million in 1996 and operating profit margin declined to 7.3% from
10.1% in 1996. These decreases were primarily the result of lower domestic
mobile cellular telephone equipment sales, increased research and development
expenditures and higher marketing expenditures associated with the launch of the
DirecPC(R)/DirecDuo(TM) products.
Operating profit for the Satellite Systems segment in 1997 was $226.3
million, an increase of 23.5% over $183.3 million in 1996. The increase was
primarily due to the higher commercial program sales noted above. The operating
profit margin for the year was 9.1% compared with 8.9% in the prior year.
Costs and Expenses. Selling, general and administrative expenses
increased to $1,119.9 million in 1997 from $788.5 million in 1996. The increase
resulted principally from the PanAmSat merger, increased programming and
subscriber acquisition costs in the Direct-to-Home Broadcast segment and
increased research and development and marketing expenditures in the Network
Systems segment. The increase in depreciation and amortization expense to $296.4
million in 1997 from $194.6 million in 1996 resulted from increased goodwill
amortization related to the PanAmSat merger and additional satellite
depreciation in 1997.
Interest Income and Expense. Interest income increased $26.3 million in
1997 compared to 1996 due primarily to higher cash balances resulting from the
PanAmSat merger as well as increased cash resulting from the recapitalization of
our company. Interest expense increased $48.1 million in 1997 versus 1996 due to
the increased borrowings resulting from the PanAmSat merger.
Other, net. The 1997 amount included a $489.7 million pre-tax gain
related to the PanAmSat merger, partially offset by losses from unconsolidated
subsidiaries of $72.2 million attributable principally to equity investments in
American Mobile Satellite Corporation, DIRECTV Japan and SurFin Ltd. The 1996
amount included a $120.3 million pre-tax gain recognized from the sale of 2.5%
of DIRECTV to AT&T, partially offset by losses from unconsolidated subsidiaries
of $42.2 million, primarily related to American Mobile Satellite Corporation.
Income Taxes. The effective income tax rate was 37.0% in 1997 and 43.1%
in 1996. The decrease in the effective income tax rate in 1997 was due primarily
to an increase in research and development credits and favorable resolution of
certain tax contingencies in 1997.
Discontinued Operations and Extraordinary Item. On December 15, 1997,
Hughes Avicom was sold to Rockwell Collins, Inc., resulting in an after-tax gain
of $62.8 million. We recorded an extraordinary after-tax charge of $20.6 million
in 1997 related to premiums paid for the refinancing of PanAmSat's debt. For
additional information see Note 6 to our financial statements included elsewhere
in this registration statement.
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Earnings. 1997 earnings were $470.7 million, or $1.18 per share of
Class H common stock on a pro forma basis, compared with 1996 earnings of $183.5
million, or $0.46 per share of Class H common stock on a pro forma basis.
Earnings per share are presented on a pro forma basis assuming the recapitalized
Class H common stock was outstanding during all periods presented. For further
discussion in Note 13 to our financial statements included elsewhere in this
registration statement.
Backlog. The 1997 year-end backlog of $10,337.6 million increased from
the $6,780.5 million reported at the end of 1996, primarily due to the PanAmSat
merger.
LIQUIDITY AND CAPITAL RESOURCES
Cash and Cash Equivalents
Cash and cash equivalents were $1,342.1 million at December 31, 1998
compared to $2,783.8 million at December 31, 1997. The decrease in cash resulted
primarily from the purchase of an additional 9.5% interest in PanAmSat,
expenditures for PanAmSat and DIRECTV satellites, other equity investments and
cash paid to General Motors for a post-closing price adjustment related to the
transfer of Delco Electronics Corporation as part of the 1997 restructuring
transactions, offset in part by proceeds from insurance claims related to the
loss of the Galaxy IV and Galaxy X satellites.
Cash provided by continuing operations was $875.2 million in 1998,
compared to $10.5 million in 1997 and $367.4 million in 1996. The change in 1998
from 1997 resulted primarily from increased revenues and a decrease in working
capital, while the change in 1997 from 1996 resulted primarily from an increase
in working capital.
Net cash used in investing activities was $2,253.3 million in 1998,
$2,231.5 million in 1997 and $80.5 million in 1996. The increase in 1998
reflects the purchase of an additional 9.5% interest in PanAmSat, the early
buy-out of satellite sale-leasebacks at PanAmSat and an increase in expenditures
for satellites compared to 1997, offset in part by proceeds from insurance
claims related to the loss of the Galaxy IV and Galaxy X satellites. The
increase in 1997 reflects the repurchase of AT&T's 2.5% equity interest in
DIRECTV, the PanAmSat merger, and an increase in satellites and equity
investments compared to 1996, offset by proceeds received from the sale of
Hughes Avicom and the sale of investments.
Net cash used in financing activities was $63.6 million in 1998,
compared with net cash provided by financing activities of $5,014.0 million in
1997 and net cash used in financing activities of $279.8 million in 1996. 1998
financing activities include the payment to General Motors for the Delco
post-closing price adjustment, offset in part by net long-term borrowings. 1997
financing activities reflect the impact of the PanAmSat merger, the
recapitalization of our company and cash contributions from pre-recapitalization
Hughes, while the 1996 amount consisted of cash distributions to
pre-recapitalization Hughes.
Liquidity Measurement
As a measure of liquidity, the current ratio, which is the ratio of
current assets to current liabilities, at December 31, 1998 and 1997 was 1.91
and 3.29, respectively. Working capital decreased by $1,486.4 million to
$1,836.9 million at December 31, 1998 from $3,323.3 million at December 31,
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1997. The change in working capital resulted principally from the decrease in
cash discussed above.
Property and Satellites
Property, net of accumulated depreciation, increased $169.5 million to
$1,059.2 million in 1998 from $889.7 million in 1997. Satellites, net of
accumulated depreciation, increased $554.1 million to $3,197.5 million in 1998
from $2,643.4 million in 1997. The increase in property and satellites resulted
primarily from the construction of an additional broadcast center and increased
capital expenditures for satellites. Capital expenditures, including
expenditures related to satellites, increased to $1,428.5 million in 1998 from
$826.6 million in 1997. The increase reflects additions to property and
equipment to support revenue growth at various of our businesses, as well as
additional satellites to support future operations, the replacement of certain
satellites, including Galaxy X, and to provide spare satellites as part of our
satellite sparing strategy.
Dividend Policy and Use of Cash
As discussed in Note 13 to our financial statements included elsewhere
in this registration statement, since the completion of the recapitalization of
our company in late 1997, the General Motors board has not paid, and does not
currently intend to pay in the foreseeable future, cash dividends on its Class H
common stock. Similarly, since such time, we have not paid dividends to General
Motors and do not currently intend to do so in the foreseeable future. Future
Hughes earnings, if any, are expected to be retained for the development of our
businesses. Expected cash requirements in 1999 relate to capital expenditures
for property and equipment and expenditures for additional satellites of
approximately $1.9 billion, the early buy-out of satellite sale-leasebacks, the
funding of business acquisitions, including the acquisitions discussed below,
and additional equity investments. These cash requirements are expected to be
funded from a combination of existing cash balances, amounts available under
existing credit facilities, additional borrowings and equity offerings, as
needed, and this offering and the related equity contribution from General
Motors. Also, although we may be required to make a cash payment to or receive a
cash payment from Raytheon Company arising from the merger of our defense
electronics business with Raytheon, the amount of a cash payment to or from
Raytheon, if any, is not determinable at this time. See further discussion in
Note 18 to our financial statements included elsewhere in this registration
statement and in "Item 1. Business--Other Business Risks--Disputes With Raytheon
Company Regarding Former Defense Operations Could Result in a Material Payment
from Us to Raytheon Company."
Debt and Credit Facilities
In January 1998, PanAmSat issued five, seven, ten and thirty-year notes
totaling $750.0 million. The proceeds received were used by PanAmSat to repay a
revolving credit facility of $500.0 million and bridge loan of $100.0 million.
The outstanding principal balances and interest rates for the five, seven, ten
and thirty-year notes as of December 31, 1998 were $200.0 million at 6.00%,
$275.0 million at 6.13%, $150.0 million at 6.38% and $125.0 million at 6.88%,
respectively. Principal on the notes is payable at maturity, while interest is
payable semiannually.
At December 31, 1998, our 59.1% owned subsidiary, SurFin, had a total
of $155.9 million outstanding under two separate $150.0 million unsecured
revolving credit facilities. Borrowings under these credit facilities bear
interest at the Eurodollar rate plus 0.15%, and are subject to a facility fee of
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0.10% per annum. These facilities are expected to be replaced in May 1999 with a
single $400.0 million unsecured revolving credit facility.
At December 31, 1998, other long-term debt of $28.9 million, which
consisted of notes bearing fixed rates of interest of 9.61% to 11.11%, was
outstanding. Principal is payable at maturity in April 2007 while interest is
payable semiannually.
We have $1.0 billion of unused credit available under two unsecured
revolving credit facilities, consisting of a $750.0 million multi-year facility
and a $250.0 million 364-day facility. The multi-year credit facility provides
for a commitment of $750.0 million through December 5, 2002, subject to a
facility fee of 0.07% per annum. Borrowings bear interest at a rate which
approximates the London Interbank Offered Rate, or LIBOR, plus 0.155%. The
364-day credit facility provides for a commitment of $250.0 million through
December 1, 1999, subject to a facility fee of 0.05% per annum. Borrowings bear
interest at a rate which approximates LIBOR plus 0.25%, with an additional
0.125% utilization fee when borrowings exceed 50% of the commitment. No amounts
were outstanding under either facility at December 31, 1998. These facilities
provide back-up capacity for our $1.0 billion commercial paper program. No
amounts were outstanding under the commercial paper program at December 31,
1998. We expect to issue between $500 million and $1 billion of publicly
registered notes in the third and fourth quarters of 1999.
PanAmSat maintains a $500.0 million multi-year revolving credit
facility that provides for short-term and long-term borrowings and a $500.0
million commercial paper program that provides for short-term borrowings. The
multi-year revolving credit facility provides for a commitment through December
24, 2002, subject to a facility fee of 0.10% per annum. Borrowings bear interest
at a rate which approximates LIBOR plus 0.30%. Borrowings under the credit
facility and commercial paper program are limited to $500.0 million in the
aggregate. No amounts were outstanding under either agreement at December 31,
1998.
ACQUISITIONS AND DIVESTITURES
On ______, 1999, we acquired by merger all of the outstanding capital
stock of U.S. Satellite Broadcasting Company, a provider of subscription
television via the digital broadcasting system that it shares with DIRECTV, for
cash and shares of Class H common stock totaling $______ billion. The former
shareholders of U.S. Satellite Broadcasting Company, within a limited range,
have the right to elect to receive consideration in the form of Class H common
stock or the cash equivalent. Not more than 50% of the total consideration will
be payable in cash and not more than 70% of the total consideration will be in
the form of Class H common stock. Accordingly, the cash paid by us will be
between $_____ and $_____ and between ___ shares and shares of Class H common
stock will be issued. We will account for the U.S. Satellite Broadcasting
Company acquisition using the purchase method of accounting.
On April 28, 1999, we acquired PRIMESTAR's medium-power direct-to-home
business. In a related transaction, we also agreed on January 22, 1999 to
acquire the high-power satellite assets and direct-broadcast satellite orbital
frequencies of Tempo Satellite. The transactions will be accounted for using the
purchase method of accounting. The purchase price for the direct-to-home
business consisted of $1.1 billion in cash and 4,871,448 shares of GM Class H
common stock, for a total purchase price of $1.33 billion, based on the average
market price of $47.87 per share of Class H common stock at the time the
acquisition agreement was signed. The purchase price for the Tempo Satellite
assets consists of $500.0 million in cash. Of this purchase price, $150.0
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million was paid on March 10, 1999 for a satellite that has not yet been
launched. The remaining $350.0 million is for an in-orbit satellite and related
satellite orbital frequencies. Such amount is payable upon Federal
Communications Commission approval of the transfer of the 11 frequencies, which
is expected in mid-1999. There can be no assurance that the Federal
Communications Commission will approve this transfer or that this portion of the
Tempo Satellite transaction will be consummated.
In February 1999, we acquired an additional ownership interest in Grupo
Galaxy Mexicana, S.A. de C.V., a Galaxy Latin America local operating company
located in Mexico, from Grupo MVS, S.A. de C.V. Our equity ownership represents
49.0% of the voting equity and all of the non-voting equity of Grupo Galaxy
Mexicana. The transaction will be accounted for using the purchase method of
accounting. The increased ownership resulted in consolidation of Grupo Galaxy
Mexicana since the date of acquisition. As part of the transaction, in October
1998 we acquired from Grupo MVS an additional 10.0% interest in Galaxy Latin
America, increasing our ownership interest to 70.0%, as well as an additional
19.8% interest in SurFin, a company providing financing of subscriber receiver
equipment for certain local operating companies located in Latin America and
Mexico, increasing its ownership percentage from 39.3% to 59.1%. The Galaxy
Latin America and SurFin transactions were accounted for using the purchase
method of accounting. The increased ownership in SurFin resulted in its
consolidation since the date of acquisition. The aggregate purchase price for
the transactions was $197.0 million in cash.
In May 1998, we purchased an additional 9.5% interest in PanAmSat for
$851.4 million in cash, increasing our ownership interest in PanAmSat from 71.5%
to 81.0%.
In May 1997, Hughes and PanAmSat completed the merger of their
respective satellite service operations into a new publicly-held company, which
retained the name PanAmSat Corporation. We contributed our Galaxy(R) satellite
services business in exchange for a 71.5% interest in the new company. Existing
PanAmSat stockholders received a 28.5% interest in the new company and $1.5
billion in cash. Such cash consideration and other funds required to consummate
the merger were funded by new debt financing totaling $1,725.0 million borrowed
from General Motors, which was subsequently repaid in December 1997.
On December 15, 1997, we sold substantially all of the assets and
liabilities of the Hughes Avicom business to Rockwell Collins, Inc. for cash,
which resulted in an after-tax gain of $62.8 million. Hughes Avicom is treated
as a discontinued operation for all periods presented.
In March 1996, we sold a 2.5% equity interest in DIRECTV to AT&T for
$137.5 million, with options to increase AT&T's ownership interest under certain
conditions. The sale resulted in a $120.3 million pre-tax gain, which was
included in other income. In December 1997, we repurchased from AT&T the 2.5%
equity interest in DIRECTV for $161.8 million, ending AT&T's marketing agreement
to distribute the DIRECTV(R) direct-broadcast satellite television service and
DIRECTVTM receiver equipment and its options to increase its ownership in
DIRECTV.
ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS
AND HEDGING ACTIVITIES. This statement requires all derivatives to be recorded
as either assets or liabilities and the instruments to be measured at fair
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value. Gains or losses resulting from changes in the values of those derivatives
are to be recognized immediately or deferred depending on the use of the
derivative and whether or not it qualifies as a hedge. We plan to adopt this
statement by January 1, 2000, as required. We are currently assessing the impact
of this statement on our results of operations and financial position.
YEAR 2000
Many computer technologies made or used by us throughout our business
have the potential for operational problems if they lack the ability to handle
the transition to the Year 2000. Computer technologies include both information
technology in the form of hardware and software, as well as non-information
technology which includes embedded technology such as microprocessors.
Because of the potential disruption that this issue could cause to our
business operations and our customers, we initiated a comprehensive,
company-wide, Year 2000 program in 1996 to identify and remediate potential Year
2000 problems. The Year 2000 program addresses both information technology and
non-information technology systems related to internal systems and our products
and services.
Our Year 2000 program is being implemented in seven phases, some of
which are being conducted concurrently:
(1) Awareness--establish project teams made up of project leaders from
each of our operating companies, assign responsibilities and establish awareness
of Year 2000 issues. The awareness phase has been completed.
(2) Inventory--identify all systems within our company, determine if
they are critical and identify responsible personnel for compliance. The
inventory phase has been completed. Many of our systems are already Year 2000
compliant, or had already been scheduled for replacement as part of our ongoing
systems plans.
(3) Assessment--categorize all systems and determine activities that
are required to achieve compliance, including contacting and assessing the Year
2000 readiness of material third party vendors and suppliers of hardware and
software. The assessment phase is substantially complete. All critical systems
have been identified in this phase and are the primary focus of the project
teams. Critical systems identified requiring remediation include satellite
control and communication software, broadcast systems, systems utilized in
customer service/billing, engineering and manufacturing operations. We have also
identified the need to upgrade network control software for customers who have
maintenance agreements with us. Our in-orbit satellites do not have
date-dependent processing.
(4) Remediation--modify, repair or replace categorized systems.
Remediation has begun on many systems and is targeted for completion by the end
of the second quarter of 1999, with the exception of satellite control software
and teleport data router hardware and software, which are expected to be
completed early in the fourth quarter of 1999. The remediation tasks for the
satellite control software and ground stations delivered by us are being
coordinated with Raytheon, the supplier.
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(5) Testing--test remediated systems to assure normal function when
placed in their original operating environment and further test for Year 2000
compliance. Overall testing is completed at approximately the same time as
remediation due to the overlap of the remediation and testing phases. Testing is
currently underway and is expected to be a primary focus of the project teams
over the next several quarters. We expect to complete this phase shortly after
the remediation phase, with ongoing review and follow-up.
(6) Implementation--once a remediated system and its interfaces have
been successfully tested, the system will be put into its operating environment.
A number of remediated systems have already been put back into operations. The
remaining remediated systems will be put into operations during 1999.
(7) Contingency Planning--development and execution of plans that
narrow the focus on specific areas of significant concern and concentrate
resources to address them. All Year 2000 critical systems are expected to be
Year 2000 compliant by the end of 1999. However, we are in the process of
developing contingency plans to address the risk of any system not being Year
2000 compliant and expect to complete such plans in the third quarter of 1999.
We currently believe that the most reasonably likely worst case scenario is a
temporary loss of functionality in satellite control and communication software.
The loss of real-time satellite control software functionality would be
addressed through the use of back-dated processors or through manual procedures
but could result in slightly higher operating costs until the Year 2000 problems
are corrected.
We are utilizing both internal and external resources for the
remediation and testing of our systems that are undergoing Year 2000
modification. Our Year 2000 program is on schedule. We have incurred and
expensed approximately $2.0 million through 1997 and approximately $7.0 million
during 1998 related to the assessment of, and ongoing efforts in connection
with, our Year 2000 program. Future spending for system remediation and testing
subsequent to December 31, 1998 is currently estimated to be from $15 million to
$19 million, with the majority of the expense expected to be incurred during the
second quarter of 1999. Each of our operating companies is funding its
respective Year 2000 efforts with current and future operating cash flows.
We have mailed Year 2000 verification request letters to our suppliers
and other third parties and are coordinating efforts to assess and reduce the
risk that our operations could be adversely affected by the failure of these
third parties to adequately address the Year 2000 issue. A high percentage of
the third parties have replied and a large number of our third parties' systems
are Year 2000 compliant or are expected to be Year 2000 compliant in a timely
manner. For those third party systems that are not yet Year 2000 compliant, we
will continue to identify action plans or alternatives to meet our requirements.
In view of the foregoing, we do not currently anticipate that we will
experience a significant disruption of our business as a result of the Year 2000
issue. However, there is still uncertainty about the broader scope of the Year
2000 issue as it may affect us and third parties that are critical to our
operations. For example, lack of readiness by electrical and water utilities,
financial institutions, governmental agencies or other providers of general
infrastructure could pose significant impediments to our ability to carry on our
normal operations. If the modifications and conversions required to make us Year
2000 ready are not made or are not completed on a timely basis and in the event
that we are unable to implement adequate contingency plans in the event that
problems are encountered internally or externally by third parties, the
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resulting problems could have a material adverse effect on our results of
operations and financial condition.
SECURITY RATINGS
In March 1999, Standard and Poor's Rating Services lowered the
long-term debt rating of our company from A- to BBB. The Standard and Poor's BBB
credit rating indicates the issuer has adequate capacity to pay interest and
repay principal. Additionally, Standard and Poor's affirmed its A-2 rating on
Hughes' commercial paper. The A-2 commercial paper rating is the third highest
category available and indicates a strong degree of safety regarding timely
payment. Standard and Poor's ratings outlook for our company remains developing.
In April 1999, Moody's Investors Service lowered the long-term credit
rating of our company from Baa1 to Baa2. The Baa2 rating for senior debt
indicates medium-grade obligations with adequate likelihood of interest and
principal payment and principal security. Moody's ratings for our commercial
paper remained unchanged at P-2. The rating is the second highest rating
available and indicates that the issuer has a strong ability for repayment
relative to other issuers. Moody's ratings outlook for our long-term and
short-term debt is stable.
Debt ratings by the various rating agencies reflect each agency's
opinion of the ability of issuers to repay debt obligations punctually. The
lowered ratings reflect increased financial leverage at our company resulting
from a significant acceleration of our growth initiatives, including the recent
PRIMESTAR/Tempo and U.S. Satellite Broadcasting Company transactions, PanAmSat's
satellite deployment and restoration plan, and the investment in Spaceway. Lower
ratings generally result in higher borrowing costs. A security rating is not a
recommendation to buy, sell, or hold securities and may be subject to revision
or withdrawal at any time by the assigning rating organization. Each rating
should be evaluated independently of any other rating.
MARKET RISK DISCLOSURE
The following discussion and the estimated amounts generated from the
sensitivity analyses referred to below include forward-looking statements of
market risk which assume for analytical purposes that certain adverse market
conditions may occur. Actual future market conditions may differ materially from
such assumptions because the amounts noted below are the result of analyses used
for the purpose of assessing possible risks and the mitigation thereof.
Accordingly, the forward-looking statements should not be considered projections
by us of future events or losses.
General
Our cash flows and earnings are subject to fluctuations resulting from
changes in foreign currency exchange rates, interest rates and changes in the
market value of our equity investments. We manage our exposure to these market
risks through internally established policies and procedures and, when deemed
appropriate, through the use of derivative financial instruments. Our policy
does not allow speculation in derivative instruments for profit or execution of
derivative instrument contracts for which there are no underlying exposures. We
do not use financial instruments for trading purposes and are not a party to any
leveraged derivatives.
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Foreign Currency Risk
We generally conduct our business in U.S. dollars with a small amount
of business conducted in a variety of foreign currencies and therefore are
exposed to fluctuations in foreign currency exchange rates. Our objective in
managing the exposure to foreign currency changes is to reduce earnings and cash
flow volatility associated with foreign exchange rate fluctuations to allow us
to focus our attention on our core business issues and challenges. Accordingly,
we primarily enter into foreign exchange-forward contracts to protect the value
of our existing assets, liabilities and firm commitments. Foreign
exchange-forward contracts are legal agreements between two parties to purchase
and sell a foreign currency, for a price specified at the contract date, with
delivery and settlement in the future. At December 31, 1998, the impact of a
hypothetical 10% adverse change in exchange rates on the fair values of foreign
exchange-forward contracts and foreign currency denominated assets and
liabilities would not be significant.
Investments
We maintain investments in publicly-traded common stock of unaffiliated
companies and are therefore subject to equity price risk. These investments are
classified as available-for-sale and, consequently, are reflected in the balance
sheet at fair value with unrealized gains or losses, net of tax, recorded as
part of accumulated other comprehensive income (loss), a separate component of
owner's equity. At December 31, 1998, the fair value of the investments in such
common stock was $8.0 million. The investments were valued at the market closing
price at December 31, 1998. We have not taken any actions to hedge this market
risk exposure. A 20% decline in the market price of both investments would cause
the fair value of the investments in common stock to decrease by $1.6 million.
Interest Rate Risk
We are subject to interest rate risk related to our $934.8 million of
debt outstanding at December 31, 1998. Debt, which is classified as
held-to-maturity, consisted of PanAmSat's fixed-rate borrowings of $750.0
million, SurFin's variable rate borrowings of $155.9 million and Hughes'
fixed-rate borrowings of $28.9 million. We are subject to fluctuating interest
rates which may adversely impact our results of operations and cash flows for
our variable rate bank borrowings. Fluctuations in interest rates may also
adversely affect the market value of our fixed-rate borrowings. At December 31,
1998, outstanding borrowings bore interest at rates ranging from 5.55% to
11.11%. The potential fair value loss resulting from a hypothetical 10% decrease
in interest rates related to our outstanding debt would be approximately $32.5
million.
In connection with debt refinancing activities by PanAmSat in 1997,
PanAmSat entered into certain U.S. Treasury rate lock contracts to reduce its
exposure to fluctuations in interest rates. The aggregate notional value of
these contracts was $375.0 million and these contracts were accounted for as
hedges. The cost to settle these instruments in 1998 was $9.1 million and is
being amortized to interest expense over the term of the related debt
securities.
Credit Risk
We are exposed to credit risk in the event of non-performance by the
counterparties to our foreign exchange-forward contracts. While we believe this
risk is remote, credit risk is managed through the periodic monitoring and
approval of financially sound counterparties.
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UNAUDITED PRO FORMA COMBINED CONDENSED
HUGHES ELECTRONICS CORPORATION FINANCIAL INFORMATION
The following unaudited pro forma combined condensed financial
statements have been prepared from the historical consolidated financial
statements of Hughes Electronics Corporation, U.S. Satellite Broadcasting
Company, PRIMESTAR and TCI Satellite Entertainment, the parent company of Tempo
Satellite, to give effect to:
o the merger of our company and U.S. Satellite Broadcasting
Company;
o our acquisition of PRIMESTAR's direct broadcast satellite
medium-power business and related high-power satellite assets
of Tempo Satellite;
o the equity offering of Class H common stock by General Motors
and the use of proceeds therefrom; and
o the $500 million contribution to us from General Motors to be
consummated substantially simultaneously with the equity
offering and our use of such funds.
The unaudited pro forma combined condensed statement of income (loss)
from continuing operations reflects adjustments as if these transactions had
each taken place on January 1, 1998. The unaudited pro forma combined condensed
balance sheet reflects adjustments as if these transactions had each occurred on
December 31, 1998. The pro forma adjustments described in the accompanying notes
are based on preliminary estimates and various assumptions that we believe are
reasonable in these circumstances.
The unaudited pro forma combined condensed statement of income (loss)
from continuing operations does not give effect to any cost savings that may be
realized from the PRIMESTAR/Tempo Satellite acquisition and the merger with U.S.
Satellite Broadcasting Company, which savings relate primarily to the reduction
of duplicative operating, general and administrative expenses.
The unaudited pro forma combined condensed financial statements should
be read in conjunction with the financial statements of Hughes Electronics
Corporation, PRIMESTAR, TCI Satellite Entertainment and U.S. Satellite
Broadcasting Company, including the respective notes thereto, which are included
elsewhere in this registration statement, each as of and for the period ended
December 31, 1998.
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HUGHES ELECTRONICS CORPORATION
UNAUDITED PRO FORMA COMBINED CONDENSED BALANCE SHEET
AS OF DECEMBER 31, 1998
<TABLE>
<CAPTION>
U.S. SATELLITE PRIMESTAR/ OFFERING AND
HISTORICAL BROADCASTING TEMPO GM
U.S. MERGER PRO PRO ACQUISITION PRO CONTRIBUTION PRO
HISTORICAL SATELLITE FORMA FORMA HISTORICAL PRO FORMA FORMA PRO FORMA FORMA
HUGHES BROADCASTING ADJUSTMENTS COMBINED PRIMESTAR/TEMPO ADJUSTMENTS COMBINED ADJUSTMENTS COMBINED
------ ------------ ----------- -------- --------------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
(DOLLARS IN MILLIONS)
ASSETS
CURRENT ASSETS
Cash and cash equivalents.. $1,342 $ 66 $ (646)(a) $ 762 $ 887 (i) $ 170 $ (887) (t) $ 268
(1,479)(j) 985 (u)
Accounts and notes
receivable, net......... 922 48 (19)(b) 951 $ 140 1,091 1,091
Contracts in process (less
advances and progress
payments)............... 784 784 784
784
Other current assets...... 798 9 807 4 811 811
------- ------ ------- ------- --------- --------- ------- ------ --------
Total Current Assets........ 3,846 123 (665) 3,304 144 (592) 2,856 98 2,954
Satellites, net............. 3,198 37 (c) 3,235 463 3,698 3,698
Property, net............... 1,059 59 (37)(c) 1,081 1,148 (15)(j) 2,214 2,214
Intangible assets, net...... 3,552 3,552 317 3,869 3,869
Investments and other assets 1,780 8 (42)(b) 1,746 34 (28)(j) 1,752 1,752
Excess of purchase price over
book value of net
liabilities
acquired.................. 1,670 (a) 1,670 122 (j) 1,792 1,792
------- ------ ------- ------- --------- --------- ------- ------ --------
Total Assets................ $ 13,435 $ 190 $ 963 $ 14,588 $ 2,106 $ (513) $ 16,181 $ 98 $ 16,279
======== ====== ======= ======= ========= ========= ======= ====== ========
LIABILITIES AND
OWNER'S EQUITY
CURRENT LIABILITIES
Accounts payable.......... $ 764 $ 66 $ 830 $ 196 $ 1,026 $ 1,026
Current portion of
long-term
debt.................... 156 156 575 $ (575)(j) 1,043 $ (887)(t) 156
887 (i)
Other current liabilities.. 1,089 91 $ (19)(b) 1,161 252 (50)(j) 1,363 1,363
------- ------ ------- ------- --------- --------- ------- ------ --------
Total Current Liabilities... 2,009 157 (19) 2,147 1,023 262 3,432 (887) 2,545
Long-term debt.............. 779 779 1,258 (1,258)(j) 779 779
Other liabilities and
deferred credits............ 1,139 87 (42)(b) 1,184 41 (41)(j) 1,184 1,184
Deferred income taxes....... 644 644 75 719 719
Minority interests.......... 482 482 482 482
Owner's Equity.............. 8,382 (54) 1,024 (a) 9,352 (291) 524 (j) 9,585 985 (u) 10,570
------- ------ ------- ------- --------- --------- ------- ------ --------
Total Liabilities and Owner's
Equity.................... $13,435 $ 190 $ 963 $14,588 $ 2,106 $ (513) $16,181 $ 98 $16,279
======== ====== ======= ======= ========= ========= ======= ====== ========
</TABLE>
The accompanying notes are an integral part of the unaudited pro forma
combined condensed financial statements.
45
<PAGE>
HUGHES ELECTRONICS CORPORATION
UNAUDITED PRO FORMA COMBINED CONDENSED
STATEMENT OF INCOME (LOSS) FROM CONTINUING OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1998
<TABLE>
<CAPTION>
U.S. SATELLITE PRIMESTAR/ OFFERING
HISTORICAL BROADCASTING TEMPO AND GM
U.S. MERGER PRO PRO HISTORICAL ACQUISITION PRO CONTRIBUTION PRO
HISTORICAL SATELLITE FORMA FORMA PRIMESTAR/ PRO FORMA FORMA PRO FORMA FORMA
HUGHES BROADCASTING ADJUSTMENTS COMBINED TEMPO ADJUSTMENTS COMBINED ADJUSTMENTS COMBINED
------ ------------------------ -------- ----- ----------- -------- ----------- --------
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues
Product sales................. $3,360 $ 3,360 $ 3,360 $ 3,360
Direct broadcast, leasing and 4,442
other services.............. 2,604 $ 551 $ (3)(b) 3,152 $ 1,290 4,442
------ ------- ----------- ------ -------- --------- --------
Total Revenues................ 5,964 551 (3) 6,512 1,290 7,802 7,802
------ ------- ----------- ------ -------- --------- --------
Operating Costs and Expenses
Cost of products sold......... 2,627 2,627 2,627 2,627
Broadcast programming and
other costs................. 1,176 328 75 (c) 1,579 655 $ 85 (k) 2,319 2,319
Selling, general, and
administrative expenses..... 1,457 267 (75)(c) 1,624 486 (85)(k) 2,025 2,025
(3)(b)
(22)(d)
Impairment of long-lived
assets...................... 950 (950)(l)
Depreciation and amortization. 455 17 42 (e) 514 543 6(m) 1,083 1,083
20(n)
------ ------- ----------- ------ -------- -------- --------- --------
Total operating costs and 8,054
expenses.................... 5,715 612 17 6,344 2,634 (924) 8,054
------ ------- ----------- ------ -------- -------- --------- --------
Operating Profit (Loss).......... 249 (61) (20) 168 (1,344) 924 (252) (252)
Interest income (expense), net... 95 4 (32)(f) 67 (146) (47)(o) 20 $ 47 (v) 67
146 (p)
Other, net....................... (153) (153) (8) (161) (161)
------ ------- ----------- ------ -------- -------- --------- --------- --------
Income (Loss) from Continuing
Operations Before Income
Taxes and Minority
Interests... 191 (57) (52) 82 (1,498) 1,023 (393) 47 (346)
Income tax benefit (expense)..... 45 27 (g) 72 148 (148)(q) 262 (19)(w) 243
190 (r)
Minority interests in net losses
of subsidiaries............... 24 24 24 24
------ ------- ----------- ------ -------- -------- --------- --------- --------
Income (Loss) from Continuing
Operations Before Cumulative
Effect of Accounting Change... 260 (57) (25) 178 (1,350) 1,065 (107) 28 (79)
Adjustments to exclude the
effect of GM purchase
accounting related to Hughes
Aircraft Company ............. 21 21 21 21
------ ------ --------- --------
Earnings (Loss) Used for
Computation of Available
Separate Consolidated Income
from Continuing Operations
Before Cumulative Effect of
Accounting Change............. $ 281 $ 199 $ (86) $ (58)
====== ====== ========= ========
Available Separate Consolidated
Income (Loss) from Continuing
Operations Before Cumulative
Effect of Accounting Change:
Average number of shares of
GM Class H Common Stock
outstanding (in millions)
(numerator)............... 105.3 18.3 (h) 123.6 4.9 (s) 128.5 9.0 (u) 137.5
Class H dividend base (in
millions) (denominator)(1) 399.9 18.3 (h) 418.2 4.9 (s) 423.1 18.0 (u) 441.1
Available Separate
Consolidated Income
(Loss) from Continuing
Operations Before
Cumulative Effect of
Accounting Change......... $ 74 $ 59 $ (26) $ (18)
------ ------ --------- --------
Earnings (Loss) Per Share from
Continuing Operations Before
Cumulative Effect of
Accounting Change............. $ 0.70 $ 0.48 $ (0.20) $ (0.13)
====== ====== ========= ========
</TABLE>
(1) See discussion of Class H dividend base in the Notes to the Hughes
Electronics Corporation Financial Statements.
The accompanying notes are an integral part of the unaudited pro forma
combined condensed financial statements.
46
<PAGE>
NOTES TO UNAUDITED PRO FORMA
COMBINED CONDENSED FINANCIAL STATEMENTS
BASIS OF PRESENTATION
The accompanying unaudited pro forma combined condensed financial
statements have been derived from the historical consolidated financial
statements of Hughes Electronics Corporation, U.S. Satellite Broadcasting
Company, PRIMESTAR and TCI Satellite Entertainment. The unaudited pro forma
combined condensed financial statements give effect to:
o the merger of our company and U.S. Satellite Broadcasting
Company;
o our acquisition of PRIMESTAR's direct broadcast satellite
medium-power business and related high-power satellite assets
of Tempo Satellite, Inc., a wholly owned subsidiary of TCI
Satellite Entertainment;
o the equity offering of Class H common stock by General Motors
and the use of proceeds therefrom; and
o the $500 million contribution to us from General Motors to be
consummated substantially simultaneously with the equity
offering.
The unaudited pro forma combined condensed statement of income (loss)
from continuing operations presents the historical results of operations of
Hughes, U.S. Satellite Broadcasting Company, PRIMESTAR and TCI Satellite
Entertainment for the year ended December 31, 1998, as if the above-mentioned
transactions had each occurred on January 1, 1998. The unaudited pro forma
combined condensed balance sheet presents the historical balance sheets of
Hughes, U.S. Satellite Broadcasting Company, PRIMESTAR and TCI Satellite
Entertainment as of December 31, 1998, as if the above-mentioned transactions
had each been consummated as of December 31, 1998. The pro forma adjustments
reflected in the accompanying unaudited pro forma combined condensed financial
statements were prepared using the purchase method of accounting.
The unaudited pro forma combined condensed financial statements do not
purport to present the financial position or results of operations of Hughes had
the transactions and events assumed therein occurred on the dates specified, nor
are they necessarily indicative of the results of operations that may be
achieved in the future. The unaudited pro forma combined condensed statement of
income (loss) from continuing operations does not give effect to any cost
savings that may be realized from the PRIMESTAR/Tempo Satellite acquisition and
the merger with U.S. Satellite Broadcasting Company, which savings relate
primarily to the reduction of duplicative operating, general and administrative
expenses.
The unaudited pro forma combined condensed financial statements should
be read in conjunction with the financial statements of Hughes Electronics
Corporation, PRIMESTAR, TCI Satellite Entertainment and U.S. Satellite
Broadcasting Company, including the respective notes thereto, which are included
elsewhere in this registration statement, each as of and for the period ended
December 31, 1998.
Various reclassifications have been made to the historical financial
statements of U.S. Satellite Broadcasting Company, PRIMESTAR and TCI Satellite
Entertainment to conform to the unaudited pro forma combined condensed financial
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<PAGE>
statement presentation. As more fully described in Note 3 to PRIMESTAR's 1998
consolidated financial statements, the historical operating results of PRIMESTAR
reflect the operations of its predecessor, TCI Satellite Entertainment, prior to
the restructuring transaction on April 5, 1998.
U.S. SATELLITE BROADCASTING COMPANY MERGER PRO FORMA ADJUSTMENTS
The following adjustments, which are set forth in millions, except per
share amounts, give pro forma effect to the U.S. Satellite Broadcasting Company
merger.
a. To record the exchange consideration at closing. The total purchase
price will be based on the average price of Class H common stock for
the 20 consecutive trading days ending on and including the second
trading day before the U.S. Satellite Broadcasting Company merger. For
purposes of the pro forma calculation, the share price is assumed to be
$53.05. Accordingly, based on this price, U.S. Satellite Broadcasting
Company shareholders would receive $18.00 for each share of U.S.
Satellite Broadcasting Company stock owned.
For purposes of the accompanying pro forma combined condensed financial
statements, the excess purchase price over book value of net
liabilities acquired has been estimated as follows:
<TABLE>
<S> <C>
Outstanding shares of U.S. Satellite Broadcasting Company stock........... 89.8
Consideration per share................................................... $18.00
------
Subtotal--purchase price............................................... 1,616
U.S. Satellite Broadcasting Company net liabilities....................... 54
------
Excess of purchase price over net book value of liabilities acquired...... $1,670
======
</TABLE>
Holders of U.S. Satellite Broadcasting Company stock may elect to
receive consideration in the form of Class H common stock or the cash
equivalent. However, not more than 50% of the total consideration will
be payable in cash, and not more than 70% of the total consideration
will be in the form of Class H common stock. For purposes of the
accompanying pro forma combined condensed financial statements, it is
assumed that 60% of the total consideration will be paid in Class H
common stock ($970) and 40% in cash ($646).
b. To eliminate intercompany transactions between our company and U.S. Satellite
Broadcasting Company.
c. To reclassify certain amounts in the historical financial statements of
U.S. Satellite Broadcasting Company to conform to our presentation.
d. To eliminate a non-recurring loss recorded by U.S. Satellite
Broadcasting Company during 1998 and to provide for the termination of
various contracts as specified in the U.S. Satellite Broadcasting
Company merger agreement.
e. We have not as yet completed an analysis of the relative fair market
value of U.S. Satellite Broadcasting Company's net liabilities in order
to determine a preliminary allocation of the purchase price to the net
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<PAGE>
liabilities acquired. Accordingly, the excess of the purchase price
over the carrying value of U.S. Satellite Broadcasting Company's net
liabilities has been presented as a single caption in the accompanying
pro forma combined condensed balance sheet. We believe the vast
majority of the excess will be allocated to U.S. Satellite Broadcasting
Company's FCC licenses and enterprise value goodwill. Both of these
intangible assets are considered to have indefinite lives and will be
amortized over 40 years.
f. To reduce interest income on cash required for the U.S. Satellite
Broadcasting Company merger assuming our historical interest rate of
5.0% on pro forma adjustment (a) above.
g. Income taxes associated with the pro forma adjustments discussed above
have been calculated at an assumed combined federal and state rate of
40%, excluding amortization associated with the excess purchase price
over book value of net liabilities acquired, which is not deductible
for tax purposes.
The unaudited pro forma combined condensed statement of income (loss)
from continuing operations has also been adjusted to recognize a tax
benefit, at an assumed combined federal and state rate of 40%, for U.S.
Satellite Broadcasting Company's historical losses from continuing
operations for the year ended December 31, 1998. This adjustment
recognizes that, if the U.S. Satellite Broadcasting Company merger had
taken place on January 1, 1998, the tax benefit of U.S. Satellite
Broadcasting Company's losses would have been realized in the
consolidated federal tax return of General Motors.
h. In connection with the U.S. Satellite Broadcasting Company merger,
General Motors will contribute to the capital of Hughes an amount of
cash at least sufficient to enable us to purchase from General Motors,
for fair value as determined by the General Motors board, the number of
shares of Class H common stock to be delivered to U.S. Satellite
Broadcasting Company shareholders in the merger. In connection
therewith, the General Motors board will increase the Class H dividend
base by the number of shares issued, which for purposes of this pro
forma presentation is assumed to be 18.3 million based on the
assumptions described in note (a) above, including that the Class H
common stock price is $53.05.
PRIMESTAR/TEMPO SATELLITE ACQUISITION PRO FORMA ADJUSTMENTS
The following adjustments, which are set forth in millions, except per
share amounts, give pro forma effect to the PRIMESTAR/Tempo Satellite
acquisition:
i. To record incremental debt incurred by us to finance the
PRIMESTAR/Tempo Satellite acquisition. For purposes of the accompanying
pro forma combined condensed financial statements, it is assumed that
$592 of the cash consideration was funded through our available cash
and $887 was financed through our commercial paper program and a
short-term bridge loan. The remaining consideration was settled through
the issuance of 4.9 million shares of Class H common stock.
j. To record the exchange consideration at closing. The total purchase
price of $1,833 will be adjusted upon consummation of the
PRIMESTAR/Tempo Satellite acquisition based upon the net working
capital of PRIMESTAR (as defined in the PRIMESTAR asset purchase
agreement) at closing. For purposes of this pro forma calculation, the
December 31, 1998 net working capital of PRIMESTAR, a liability of
49
<PAGE>
$121, was used to calculate the exchange consideration of the
PRIMESTAR/Tempo Satellite acquisition ($1,712).
For purposes of the accompanying pro forma combined condensed financial
statements, the excess purchase price over book value of net assets
acquired has been estimated as follows:
<TABLE>
<S> <C> <C>
Exchange consideration of PRIMESTAR/Tempo Satellite acquisition..... $1,712
Less book value of PRIMESTAR
Historical book value of PRIMESTAR............................. $(291)
Less: excluded assets.......................................... (43)
Plus: excluded liabilities..................................... 1,924
-------
Subtotal....................................................... 1,590
------
Preliminary excess purchase cost over net book value of assets
acquired (see note m, below)...................................... $ 122
======
</TABLE>
As defined in the PRIMESTAR asset purchase agreement, excluded assets
include high-power direct broadcast satellite inventory and deferred
loan costs. Excluded liabilities include debt and related interest
payable, restructuring accruals and employee-related liabilities.
k. To reclassify certain amounts in the historical financial statements of
PRIMESTAR to conform to our presentation.
l. To eliminate a non-recurring impairment loss and related income tax
benefit recorded by PRIMESTAR during 1998 to reduce the carrying amount
of certain assets to their net realizable values based upon the assumed
purchase price of the PRIMESTAR/Tempo Satellite acquisition.
m. We have not as yet completed an analysis of the relative fair market
value of the net assets acquired from PRIMESTAR and Tempo Satellite in
order to determine a preliminary allocation of the purchase price.
Accordingly, the excess of the purchase price over the carrying value
of the net assets acquired from PRIMESTAR and Tempo Satellite has been
presented as a single caption in the accompanying pro forma combined
condensed balance sheet. For purposes of the accompanying condensed
combined statement of income (loss) from continuing operations, such
excess is being amortized using an estimated weighted-average composite
life of 20 years.
n. To record depreciation on the in-orbit satellite acquired by us in
connection with the PRIMESTAR/Tempo Satellite acquisition over the
estimated remaining useful life of 12 years.
o. To reflect interest expense associated with the incremental debt
incurred by us to finance the PRIMESTAR/Tempo Satellite acquisition.
For purposes of pro forma calculation, our historical interest rate of
LIBOR + 0.25% (5.3% in total) was used to compute interest on the
incremental debt discussed in pro forma adjustment (i) above.
p. To reduce interest expense associated with PRIMESTAR debt not assumed
by us.
50
<PAGE>
q. To eliminate PRIMESTAR's historical income tax benefit recorded in
connection with PRIMESTAR's restructuring consummated during 1998.
r. Income taxes associated with the pro forma adjustments discussed above
have been calculated at an assumed combined federal and state rate of
40%. Since the PRIMESTAR/Tempo Satellite acquisition is a taxable
transaction, amortization of any goodwill generated is expected to be
deductible over 15 years for income tax purposes.
The unaudited pro forma combined condensed statement of income (loss)
from continuing operations has also been adjusted to recognize a tax
benefit, at an assumed combined federal and state rate of 40%, for
PRIMESTAR's historical losses from continuing operations for the year
ended December 31, 1998. This adjustment recognizes that, if the
PRIMESTAR/Tempo Satellite acquisition had taken place on January 1,
1998, the tax benefit of PRIMESTAR's and Tempo Satellite's losses would
have been realized in the consolidated federal tax return of General
Motors.
s. Based on the PRIMESTAR asset purchase agreement, 4.9 million shares of
Class H common stock were issued to effect the PRIMESTAR acquisition.
We acquired these shares from General Motors for a cash payment, which
was funded by us with a capital contribution from General Motors. In
connection therewith, the General Motors board increased the Class H
dividend base by 4.9 million.
OFFERING AND GENERAL MOTORS CONTRIBUTION ADJUSTMENTS
t. To reflect the pay down of short-term debt with proceeds from the
equity offering and the contribution of funds by General Motors.
u. To reflect the estimated net proceeds of the equity offering and the
contribution by General Motors.
The estimated net proceeds from the equity offering will be
approximately $485 million, assuming no exercise of the underwriters'
over-allotment option. General Motors will contribute these proceeds to
us. The average number of shares of Class H common stock outstanding
and the Class H dividend base will be increased by the number of shares
sold in the equity offering, which, based on an assumed share price of
$55.50, would be 9.0 million.
The Class H dividend base will be further increased to reflect the
contribution to us of an additional $500 million by General Motors. The
actual increase to the Class H dividend base as a result of this
contribution will be determined based on the price per share of Class H
common stock in the equity offering. For purposes of this pro forma
adjustment, the share price is assumed to be $55.50. Accordingly, the
contribution by General Motors will increase the Class H dividend base
by an additional 9.0 million.
v. To reduce interest expense for the result of the pay down of short-term
debt assuming our historical interest rate of 5.3%. See pro forma
adjustment (t) above.
w. To reflect the income tax effects of a reduction in interest expense
that resulted from the pay down of short-term debt at an assumed
combined federal and state tax rate of 40%.
51
<PAGE>
ITEM 3. PROPERTIES
As of March 31, 1999, we had approximately 152 locations operating in
20 states and 51 cities in the United States and approximately 28 additional
locations in 19 cities in approximately 17 countries outside the United States.
At such date, we owned approximately 2.8 million square feet of space and leased
an additional 2.8 million square feet of space.
ITEM 4. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Omitted.
ITEM 5. DIRECTORS AND EXECUTIVE OFFICERS
Omitted.
ITEM 6. EXECUTIVE COMPENSATION
Omitted.
ITEM 7. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Omitted.
ITEM 8. LEGAL PROCEEDINGS
SATELLITE CONTRACT DISPUTE. On or about October 25, 1996, an action was
commenced by Comsat Corporation against PanAmSat, News Corporation Limited and
Grupo Televisa, S.A., in the United States District Court for the Central
District of California. The complaint alleges that News Corporation wrongfully
terminated an agreement with Comsat for the lease of transponders on an Intelsat
satellite over the term of a five-year lease, breached certain alleged promises
related to such agreement, and breached its alleged obligations under a tariff
filed by Comsat with the Federal Communications Commission. As to PanAmSat, the
complaint alleges that PanAmSat, alone and in conspiracy with Grupo Televisa,
intentionally interfered with the alleged agreement and with Comsat's economic
relationship with News Corporation. Comsat had previously filed a similar action
in the United States District Court for the District of Maryland. By order dated
October 10, 1996, the Maryland District Court dismissed without prejudice the
complaint in that action on the ground that the court lacked personal
jurisdiction over all of the defendants. The complaint in the present action
seeks actual and consequential damages, and punitive or exemplary damages in an
amount to be determined at trial. PanAmSat believes this action is without
merit. It intends to vigorously contest this matter, although there can be no
assurance that PanAmSat will prevail. Following the completion of pretrial
discovery, all defendants moved for summary judgment dismissing the case. These
motions are awaiting action by the court. If PanAmSat were not to prevail, the
amounts involved could be material to PanAmSat.
FINANCING CONTRACT DISPUTE. General Electric Capital Corporation and
DIRECTV, Inc. entered into a contract on July 31, 1995, in which General
Electric Capital agreed to provide financing for consumer purchases of DIRECTV
programming and related hardware. Under the contract, General Electric Capital
also agreed to provide certain related services to DIRECTV, including credit
risk scoring, billing and collections services. DIRECTV agreed to act as a
surety for loans complying with the terms of the contract. We guaranteed
DIRECTV's performance under the contract. A complaint and counterclaim have been
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<PAGE>
filed by the parties in the U.S. District Court for the District of Connecticut
concerning General Electric Capital's performance and DIRECTV's obligation to
act as a surety. General Electric Capital claims damages from DIRECTV in excess
of $140 million. DIRECTV is seeking damages from General Electric Capital in
excess of $70 million. We intend to vigorously contest General Electric
Capital's allegations and pursue our own contractual right and remedies. We do
not believe that the litigation will have a material adverse impact on our
results of operations or financial position. Pretrial discovery is not yet
completed in the case and no trial date has been set.
RAYTHEON PURCHASE PRICE ADJUSTMENT DISPUTE. In connection with the 1997
spin-off of the defense electronics business of our predecessor and the
subsequent merger of that business with Raytheon Company, the terms of the
merger agreement provided processes for resolving disputes that might arise in
connection with post-closing financial adjustments that were also called for by
the terms of the merger agreement. Such financial adjustments might require a
cash payment from Raytheon to our company or vice versa. A dispute currently
exists regarding the post-closing adjustments which we and Raytheon have
proposed to one another and related issues regarding the adequacy of disclosures
made by us to Raytheon in the period prior to consummation of the merger. In an
attempt to resolve the dispute, we gave notice to Raytheon to commence an
arbitration process pursuant to the procedures under the merger agreement.
Raytheon responded by filing an action in Delaware Chancery Court which seeks to
enjoin the arbitration as premature. That litigation is now inactive and we and
Raytheon are now proceeding with the dispute resolution process. It is possible
that the ultimate resolution of the post-closing financial adjustment and of
related disclosure issues may result in our company making a payment to Raytheon
that would be material to us. However, the amount of any payment that either
party might be required to make to the other cannot be determined at this time.
We intend to vigorously pursue resolution of the disputes through the
arbitration processes, opposing the adjustments proposed by Raytheon, and
seeking the payment from Raytheon that it has proposed.
PERSONALIZED MEDIA PATENT DISPUTE. In November 1996, Personalized Media
Communications, Inc. brought an International Trade Commission proceeding
against DIRECTV, U.S. Satellite Broadcasting Company, Hughes Network Systems and
other manufacturers of receivers for the DIRECTV system. Personalized Media
sought to prevent importation of certain receivers manufactured in Mexico,
alleging infringement of one of its patents. During 1997, the International
Trade Commission held for DIRECTV and other respondents on all claims at issue,
finding each to be invalid. Personalized Media appealed these adverse rulings to
the Court of Appeals for the Federal Circuit. During 1998, the Court of Appeals
affirmed the lower holdings as to three of the claims, and remanded to the
International Trade Commission for further deliberation on a remaining claim.
Also in 1996, Personalized Media filed a related action in the U.S. District
Court for the Northern District of California. This case has been stayed pending
outcome of the International Trade Commission proceeding. The complaint alleges
infringement and willful infringement of three Personalized Media patents, and
seeks unspecified damages, trebling of damages, an injunction and attorneys'
fees. We deny that we engaged in acts of infringement of the asserted patents
and intend to vigorously contest these claims.
ENVIRONMENTAL. We are subject to the requirements of federal, state,
local and foreign environmental and occupational safety and health laws and
regulations. These include laws regulating air emissions, water discharge and
waste management. We have an environmental management structure designed to
facilitate and support our compliance with these requirements. We cannot assure
you, however, that we are at all times in complete compliance with all such
53
<PAGE>
requirements. Although we have made and will continue to make capital and other
expenditures to comply with environmental requirements, we do not expect capital
or other expenditures for environmental compliance to be material in 1999.
Environmental requirements are complex, change frequently and have tended to
become more stringent over time. Accordingly, there can be no assurance that
these requirements will not change or become more stringent in the future in a
manner that could have a material adverse effect on our business.
We are also subject to environmental laws requiring the investigation
and cleanup of environmental contamination. We believe our reserve is adequate
to cover environmental investigation and cleanup, although there can be no
assurance that our environmental cleanup costs and liabilities will not exceed
the current amount of our reserve.
In addition, we are involved in routine litigation incidental to the
conduct of our business. We do not believe that any of such litigation will have
a material adverse effect on our business.
ITEM 9. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS
All of our common stock, our sole class of common equity, is owned by
General Motors. Accordingly, there is no public trading market for our common
equity. Dividends on the common stock will be paid when and if declared by our
Board of Directors. At present, we have no plans to pay a dividend on our common
stock.
None of our common stock is subject to outstanding options or warrants
to purchase common stock. There are no securities convertible into our common
stock. None of our common stock currently can be sold under Rule 144. We are not
currently publicly offering any of our common stock.
ITEM 10. RECENT SALES OF UNREGISTERED SECURITIES
None.
ITEM 11. DESCRIPTION OF REGISTRANT'S SECURITIES TO BE REGISTERED
Our authorized capital stock consists of 1,000 shares of $1.00 par
value common stock. All of our outstanding capital stock is owned by General
Motors.
ITEM 12. INDEMNIFICATION OF DIRECTORS AND OFFICERS
We are a Delaware corporation. Subsection (b)(7) of Section 102 of the
Delaware General Corporation Law (the "DGCL") enables a corporation in its
original certificate of incorporation or an amendment thereto to eliminate or
limit the personal liability of a director to the corporation or its
stockholders for monetary damages for violations of the director's fiduciary
duty, except (i) for any breach of the director's duty of loyalty to the
corporation or its stockholders, (ii) for acts or omissions not in good faith or
which involve intentional misconduct or a knowing violation of law, (iii)
pursuant to Section 174 of the DGCL (providing for liability of directors for
unlawful payment of dividends or unlawful stock purchases or redemptions) or
(iv) for any transaction from which a director derived an improper personal
benefit. Article ___ of our Amended and Restated Certificate of Incorporation
and Article VI of our Bylaws provides that our directors and officers shall not
be personally liable to the corporation or its stockholders for monetary damages
54
<PAGE>
if a director or officer acts in good faith and in a manner he reasonably
believes to be in or not opposed to our best interests and provides for
indemnification of our officers and directors to the full extent permitted by
applicable law.
Subsection (a) of Section 145 of the DGCL empowers a corporation to
indemnify any director or officer, or former director or officer, who was or is
a party or is threatened to be made a party to any threatened, pending or
completed action, suit or proceeding, whether civil, criminal, administrative or
investigative (other than an action by or in the right of the corporation) by
reason of the fact that the person is or was a director or officer of the
corporation or is or was serving at the request of the corporation as a
director, officer, employee or agent of another corporation, partnership, joint
venture, trust or other enterprise, against expenses (including attorneys'
fees), judgments, fines and amounts paid in settlement actually and reasonably
incurred in connection with that action, suit or proceeding provided that the
director or officer acted in good faith in a manner reasonably believed to be
in, or not opposed to, the best interests of the corporation, and, with respect
to any criminal action or proceeding, provided further that the director or
officer has no reasonable cause to believe his conduct was unlawful.
Subsection (b) of Section 145 empowers a corporation to indemnify any
director or officer, or former director or officer, who was or is a party or is
threatened to be made a party to any threatened, pending or completed action or
suit by or in the right of the corporation to procure a judgment in its favor by
reason of the fact that the person acted in any of the capacities set forth
above, against expenses (including attorneys' fees) actually and reasonably
incurred in connection with the defense or settlement of that action or suit
provided that the director or officer acted in good faith and in a manner he
reasonably believed to be in, or not opposed to, the best interests of the
corporation, except that no indemnification may be made in respect of any claim,
issue or matter as to which the director or officer shall have been adjudged to
be liable to the corporation unless and only to the extent that the Court of
Chancery or the court in which the action or suit was brought shall determine
upon application that despite the adjudication of liability but in view of all
of the circumstances of the case, the director or officer is fairly and
reasonably entitled to indemnity for those expenses which the Court of Chancery
or other court shall deem proper.
Section 145 further provides that (i) to the extent a director or
officer of a corporation has been successful in the defense of any action, suit
or proceeding referred to in subsections (a) and (b) or in the defense of any
claim, issue or matter therein, he shall be indemnified against expenses
(including attorneys' fees) actually and reasonably incurred by him in
connection therewith; and (ii) indemnification and advancement of expenses
provided for, by, or granted pursuant to, Section 145 shall not be deemed
exclusive of any other rights to which the indemnified party may be entitled. In
addition, Section 145 empowers the corporation to purchase and maintain
insurance on behalf of any person who is or was a director or officer of the
corporation, or is or was serving at the request of the corporation as a
director, officer, employee or agent of another corporation, partnership, joint
venture, trust or other enterprise against any liability asserted against him or
incurred by him in any of those capacities, or arising out of his status as
such, whether or not the corporation would have the power to indemnify him
against those liabilities under Section 145.
Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to our directors, officers and controlling persons
pursuant to the foregoing provisions, or otherwise, we have been advised that in
the opinion of the Securities and Exchange Commission this indemnification is
against public policy as expressed in the Act and is, therefore, unenforceable.
55
<PAGE>
In the event that a claim for indemnification against those liabilities (other
than the payment by us of expenses incurred or paid by one of our directors,
officers or controlling persons in the successful defense of any action, suit or
proceeding) is asserted by any director, officer or controlling person in
connection with the securities being registered, we will, unless in the opinion
of our counsel the matter has been settled by controlling precedent, submit to a
court of appropriate jurisdiction the question whether indemnification by us is
against public policy as expressed in the Securities Act of 1933 and will be
governed by the final adjudication of that issue.
ITEM 13. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
This Registration Statement on Form 10 includes the financial
statements described in Item 15(a).
ITEM 14. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 15. FINANCIAL STATEMENTS AND EXHIBITS
(A) FINANCIAL INFORMATION
INDEX
Hughes Electronics Corporation Unaudited Supplemental Pro Forma Financial Data:
Introduction
Condensed Statement of Income
Condensed Balance Sheet
Selected Segment Data
Selected Financial Data
Hughes Electronics Corporation Financial Statements:
Independent Auditors' Report
Statement of Income and Available
Separate Consolidated Net Income
Balance Sheet
Statement of Changes in Owner's Equity
Statement of Cash Flows
Notes to Financial Statements
PRIMESTAR, Inc. Financial Statements:
Independent Auditors' Report
Consolidated Balance Sheet
Consolidated Statements of Operations
Consolidated Statements of Stockholders' Equity
Consolidated Statement of Cash Flows
Notes to Consolidated Financial Statements
56
<PAGE>
TCI Satellite Entertainment Inc. Financial Statements:
Independent Auditors' Report
Consolidated Balance Sheet
Consolidated Statements of Operations
Consolidated Statements of Stockholders' Equity
Consolidated Statement of Cash Flows
Notes to Consolidated Financial Statements
United States Satellite Broadcasting Company, Inc. Financial Statements:
Report of Independent Public Accountants
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Shareholders' Equity
Consolidated Statement of Cash Flows
Notes to Consolidated Financial Statements
(B) EXHIBITS
* 2.1 Agreement and Plan of Merger among General Motors
Corporation, Hughes Electronics Corporation and United States
Satellite Broadcasting Company, Inc. dated December 11, 1998
(incorporated by reference to Exhibit 2(a) to the Current
Report on Form 8-K of General Motors Corporation filed
December 17, 1998 (the "December 8-K")).
* 2.2 Shareholders Agreement dated December 11, 1998 among General
Motors Corporation, Hughes Electronics Corporation, Hubbard
Broadcasting, Inc., Stanley S. Hubbard, Stanley E. Hubbard and
Robert W. Hubbard (incorporated by reference to Exhibit 2(b)
to the December 8-K).
* 2.3 Asset Purchase Agreement among PRIMESTAR, Inc., PRIMESTAR
Partners L.P., PRIMESTAR MDU, Inc., the stockholders of
PRIMESTAR, Inc. and Hughes Electronics Corporation, dated as
of January 22, 1999 (incorporated by reference to Exhibit 99.1
to the Current Report on Form 8-K of General Motors
Corporation filed February 2, 1999 (the "February 8-K")).
- ------------------
* Incorporated by reference.
** To be filed by amendment
57
<PAGE>
* 2.4 Asset Purchase Agreement among PRIMESTAR, Inc., PRIMESTAR
Partners L.P., Tempo Satellite, Inc., the stockholders of
PRIMESTAR, Inc. and Hughes Electronics Corporation, dated as
of January 22, 1999 (incorporated by reference to Exhibit 99.2
to the February 8-K).
** 3.1 Amended and Restated Certificate of Incorporation of Hughes
Electronics Corporation
** 3.2 Bylaws of Hughes Electronics Corporation
** 4.1 Specimen form of certificate representing Common Stock of
Hughes Electronics Corporation
** 10.1 [Material Contracts]
** 11 Computation of Per Share Earnings
- ------------------
* Incorporated by reference.
** To be filed by amendment
58
<PAGE>
SIGNATURE
Pursuant to the requirements of Section 12 of the Securities Exchange
Act of 1934, the registrant has duly caused this Registration Statement to be
signed on its behalf by the undersigned, thereunto duly authorized.
HUGHES ELECTRONICS CORPORATION
By: /s/ Jan L. Williamson
--------------------------------------
Name: Jan L. Williamson
Title: Secretary
May 11, 1999
59
<PAGE>
<TABLE>
<CAPTION>
INDEX TO FINANCIAL INFORMATION
Page
<S> <C>
Hughes Electronics Corporation Unaudited Supplemental Pro Forma Financial
Data
Introduction...................................................................................
Condensed Balance Sheet........................................................................
Condensed Statement of Income..................................................................
Selected Segment Data..........................................................................
Selected Financial Data........................................................................
Hughes Electronics Corporation Financial Statements
Report of Independent Accountants..............................................................
Statement of Income and Available Separate Consolidated Net Income.............................
Balance Sheet..................................................................................
Statement of Changes in Owner's Equity.........................................................
Statement of Cash Flows........................................................................
Notes to Financial Statements..................................................................
PRIMESTAR, Inc. Financial Statements
Independent Auditors' Report...................................................................
Consolidated Balance Sheet.....................................................................
Consolidated Statements of Operations..........................................................
Consolidated Statements of Stockholders' Equity................................................
Consolidated Statement of Cash Flows...........................................................
Notes to Consolidated Financial Statements.....................................................
TCI Satellite Entertainment Inc. Financial Statements
Independent Auditors' Report...................................................................
Consolidated Balance Sheet.....................................................................
Consolidated Statements of Operations..........................................................
Consolidated Statements of Stockholders' Equity................................................
Consolidated Statement of Cash Flows...........................................................
Notes to Consolidated Financial Statements.....................................................
United States Satellite Broadcasting Company, Inc. Financial Statements
Report of Independent Public Accountants.......................................................
Consolidated Balance Sheets....................................................................
Consolidated Statements of Operations..........................................................
Consolidated Statements of Shareholders' Equity................................................
Consolidated Statement of Cash Flows...........................................................
Notes to Consolidated Financial Statements.....................................................
</TABLE>
F-1
<PAGE>
HUGHES UNAUDITED SUPPLEMENTAL PRO FORMA FINANCIAL DATA
Hughes' financial statements reflect the application of purchase
accounting adjustments as described in Note 1 to the financial statements, which
follow the unaudited supplemental pro forma financial data. However, as provided
in GM's restated certificate of incorporation, the earnings attributable to
Class H common stock for purposes of determining the amount available for the
payment of dividends on Class H common stock specifically excludes such
adjustments. More specifically, amortization of the intangible assets associated
with GM's 1985 purchase of Hughes Aircraft Company, a predecessor of Hughes,
amounted to $21.0 million in 1998, 1997 and 1996. Such amounts are excluded from
the earnings available for the payment of dividends on Class H common stock and
are charged against earnings available for the payment of dividends on GM's
$1-2/3 par value common stock. Unamortized purchase accounting adjustments
associated with GM's purchase of Hughes Aircraft Company were $426.6 million,
$447.6 million and $468.6 million at December 31, 1998, 1997 and 1996,
respectively.
In order to provide additional analytical data to the users of Hughes'
financial information, supplemental data in the form of unaudited summary pro
forma financial data are provided. Consistent with the basis on which earnings
of Hughes available for the payment of dividends on the GM Class H common stock
is determined, the pro forma data exclude purchase accounting adjustments
related to General Motors' acquisition of Hughes. Included in the supplemental
data are certain financial ratios which provide measures of financial returns
excluding the impact of purchase accounting adjustments. The pro forma data are
not presented as a measure of GM's total return on its investment in Hughes.
F-2
<PAGE>
HUGHES ELECTRONICS CORPORATION
UNAUDITED SUMMARY PRO FORMA FINANCIAL DATA*
PRO FORMA CONDENSED STATEMENT OF INCOME
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------
1998 1997 1996
---- ---- ----
(DOLLARS IN MILLIONS EXCEPT PER
SHARE AMOUNTS)
<S> <C> <C> <C>
Total revenues............................................................ $5,963.9 $5,128.3 $4,008.7
Total costs and expenses.................................................. 5,693.8 4,821.9 3,798.6
----------- --------- ----------
Operating profit.......................................................... 270.1 306.4 210.1
Non-operating (expense) income............................................ (58.3) 332.8 33.0
Income taxes.............................................................. (44.7) 236.7 104.8
Minority interests in net losses of subsidiaries.......................... 24.4 24.8 52.6
Income (loss) from discontinued operations................................ 64.0 (7.4)
Extraordinary item........................................................ (20.6)
Cumulative effect of accounting change.................................... (9.2)
----------- --------- ----------
Earnings Used for Computation of Available
Separate Consolidated Net Income..................................... $ 271.7 $470.7 $183.5
=========== ========= ==========
Earnings Attributable to General Motors Class H Common Stock on a Per Share
Basis:
Income from continuing operations before extraordinary item and
cumulative effect of accounting change............................... $ 0.70 $ 1.07 $ 0.48
Discontinued operations.............................................. 0.16 (0.02)
Extraordinary item................................................... (0.05)
Cumulative effect of accounting change............................... (0.02)
----------- --------- ----------
Earnings Attributable to General Motors
Class H Common Stock................................................. $ 0.68 $ 1.18 $ 0.46
=========== ========= ==========
</TABLE>
F-3
<PAGE>
PRO FORMA CONDENSED BALANCE SHEET
<TABLE>
<CAPTION>
DECEMBER 31,
------------
ASSETS 1998 1997
---- ----
(DOLLARS IN MILLIONS)
<S> <C> <C>
Total Current Assets............................................................ $3,846.4 $4,773.1
Satellites, net................................................................. 3,197.5 2,643.4
Property, net................................................................... 1,059.2 889.7
Net Investment in Sales-type Leases............................................. 173.4 337.6
Intangible Assets, Investments and Other Assets, net............................ 4,731.9 3,639.6
---------- ----------
Total Assets............................................................... $13,008.4 $12,283.4
========== ==========
LIABILITIES AND OWNER'S EQUITY
Total Current Liabilities....................................................... $2,009.5 $1,449.8
Long-Term Debt.................................................................. 778.7 637.6
Postretirement Benefits Other Than Pensions, Other Liabilities and Deferred
Credits....................................................................... 1,783.2 1,724.1
Minority Interests.............................................................. 481.7 607.8
Total Owner's Equity (1)........................................................ 7,955.3 7,864.1
---------- ----------
Total Liabilities and Owner's Equity (1)........................................ $13,008.4 $12,283.4
========== ==========
</TABLE>
Certain 1997 amounts have been reclassified to conform with the 1998
presentation.
* The summary excludes purchase accounting adjustments related to GM's
acquisition of Hughes.
(1) General Motors' equity in its wholly-owned subsidiary, Hughes. Holders of
GM Class H common stock have no direct rights in the equity or assets of
Hughes, but rather have rights in the equity and assets of GM (which
includes 100% of the stock of Hughes).
F-4
<PAGE>
HUGHES ELECTRONICS CORPORATION
UNAUDITED SUMMARY PRO FORMA FINANCIAL DATA*--CONTINUED
PRO FORMA SELECTED SEGMENT DATA
YEARS ENDED DECEMBER 31,
1998 1997 1996
----------- ----------- ------------
(DOLLARS IN MILLIONS)
DIRECT-TO-HOME BROADCAST
Total Revenues..................... $1,816.1 $1,276.9 $ 621.0
Operating Loss..................... (228.1) (254.6) (319.8)
Depreciation and Amortization...... 102.3 86.1 67.3
Segment Assets..................... 2,190.4 1,408.7 1,023.4
Capital Expenditures (1)........... 230.8 105.6 63.5
SATELLITE SERVICES
Total Revenues..................... $ 767.3 $ 629.9 $ 482.8
Operating Profit................... 321.6 296.2 242.4
Operating Profit Margin............ 41.9% 47.0% 50.2%
Depreciation and Amortization...... 231.7 141.9 55.2
Segment Assets..................... 5,824.2 5,612.8 1,202.6
Capital Expenditures (2)........... 921.7 625.7 308.7
SATELLITE SYSTEMS
Total Revenues..................... $2,831.1 $2,491.9 $2,056.4
Operating Profit................... 246.3 226.3 183.3
Operating Profit Margin............ 8.7% 9.1% 8.9%
Depreciation and Amortization...... 49.2 39.4 34.4
Segment Assets..................... 1,491.2 1,312.6 757.8
Capital Expenditures............... 99.7 113.9 87.8
NETWORK SYSTEMS
Total Revenues..................... $1,076.7 $1,011.3 $1,070.0
Operating Profit................... 10.9 74.1 107.7
Operating Profit Margin............ 1.0% 7.3% 10.1%
Depreciation and Amortization...... 41.7 32.0 28.3
Segment Assets..................... 1,299.0 1,215.6 964.0
Capital Expenditures............... 40.0 43.1 45.3
ELIMINATIONS AND OTHER
Total Revenues..................... $(527.3) $(281.7) $(221.5)
Operating (Loss)................... (80.6) (35.6) (3.5)
Depreciation and Amortization...... 8.9 (3.0) 9.4
Segment Assets..................... 2,203.6 2,733.7 (43.8)
Capital Expenditures............... 136.3 (61.7) (55.9)
TOTAL
Total Revenues..................... $5,963.9 $5,128.3 $4,008.7
Operating Profit................... 270.1 306.4 210.1
Operating Profit Margin............ 4.5% 6.0% 5.2%
Depreciation and Amortization...... 433.8 296.4 194.6
Segment Assets..................... 13,008.4 12,283.4 3,904.0
Capital Expenditures............... 1,428.5 826.6 449.4
Certain 1997 and 1996 amounts have been reclassified to conform with 1998
classifications.
* The summary excludes purchase accounting adjustments related to GM's
acquisition of Hughes.
(1) Includes expenditures related to satellites amounting to $70.2 million in
1998.
(2) Includes expenditures related to satellites amounting to $726.3 million,
$606.1 million and $259.2 million, respectively. Also included in the 1998
amount is $155.5 million related to the early buy-out of satellite
sale-leasebacks.
F-5
<PAGE>
HUGHES ELECTRONICS CORPORATION
UNAUDITED SUMMARY PRO FORMA FINANCIAL DATA*--CONCLUDED
PRO FORMA SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- -----------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C>
Operating profit............................................. $ 270 $ 306 $ 210 $ 172 $ 235
Income from continuing operations before income taxes,
minority interests, extraordinary item and cumulative
effect of accounting change............................... $ 212 $ 639 $ 243 $ 119 $ 174
Earnings used for computation of available separate
consolidated net income................................... $ 272 $ 471 $ 184 $ 27 $ 62
Average number of GM Class H dividend base shares (in
millions) (1)............................................. 399.9 399.9 399.9 399.9 399.9
Owner's equity............................................... $7,955 $7,864 $2,023 $2,119 $1,790
Working capital.............................................. $1,837 $3,323 $ 278 $ 312 $ 274
Operating profit as a percent of revenues.................... 4.5% 6.0% 5.2% 5.4% 8.7%
Income from continuing operations before income taxes,
minority interests, extraordinary item and cumulative
effect of accounting change as a percent of revenues...... 3.6% 12.5% 6.1% 3.8% 6.5%
Net income as a percent of revenues.......................... 4.6% 9.2% 4.6% 0.9% 2.3%
Return on equity (2)......................................... 3.4% 9.5% 8.9% 1.4% 3.8%
Income before interest expense and income taxes as a
percent of capitalization (3)............................. 3.2% 14.3% 16.3% 9.4% 14.0%
Pre-tax return on total assets (4)........................... 1.9% 8.2% 8.0% 3.8% 6.0%
</TABLE>
* The summary excludes purchase accounting adjustments related to GM's
acquisition of Hughes.
(1) Class H dividend base shares is used in calculating earnings attributable
to GM Class H common stock on a per share basis. This is not the same as
the average number of GM Class H shares outstanding, which was 105.3
million in 1998.
(2) Earnings used for computation of available separate consolidated net income
divided by average owner's equity (General Motors' equity in its
wholly-owned subsidiary, Hughes). Holders of GM Class H common stock have
no direct rights in the equity or assets of Hughes, but rather have rights
in the equity and assets of GM (which includes 100% of the stock of
Hughes).
(3) Income from continuing operations before interest expense, income taxes,
extraordinary item and cumulative effect of accounting change divided by
average owner's equity plus average total debt.
(4) Income from continuing operations before income taxes, extraordinary item
and cumulative effect of accounting change divided by average total assets.
F-6
<PAGE>
HUGHES ELECTRONICS CORPORATION
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of Hughes Electronics Corporation:
We have audited the accompanying Balance Sheet of Hughes Electronics
Corporation (as more fully described in Note 1 to the financial statements) as
of December 31, 1998 and 1997 and the related Statement of Income and Available
Separate Consolidated Net Income, Statement of Changes in Owner's Equity and
Statement of Cash Flows for each of the three years in the period ended December
31, 1998. These financial statements are the responsibility of Hughes
Electronics Corporation's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all
material respects, the financial position of Hughes Electronics Corporation at
December 31, 1998 and 1997 and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1998 in conformity
with generally accepted accounting principles.
As discussed in Note 2 to the accompanying financial statements,
effective January 1, 1998, Hughes Electronics Corporation changed its method of
accounting for costs of start-up activities by adopting American Institute of
Certified Public Accountants Statement of Position 98-5, Reporting on the Costs
of Start-Up Activities.
/S/ DELOITTE & TOUCHE LLP
DELOITTE & TOUCHE LLP
Los Angeles, California
January 20, 1999
(March 1, 1999 as to Note 19)
F-7
<PAGE>
HUGHES ELECTRONICS CORPORATION
STATEMENT OF INCOME AND
AVAILABLE SEPARATE CONSOLIDATED NET INCOME
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
1998 1997 1996
---- ---- ----
(DOLLARS IN MILLIONS EXCEPT
PER SHARE AMOUNTS)
<S> <C> <C> <C>
REVENUES
Product sales........................................................ $3,360.3 $3,143.6 $3,009.0
Direct broadcast, leasing and other services......................... 2,603.6 1,984.7 999.7
---------- ---------- ----------
TOTAL REVENUES............................................................ 5,963.9 5,128.3 4,008.7
---------- ---------- ----------
OPERATING COSTS AND EXPENSES
Cost of products sold................................................ 2,627.3 2,493.3 2,183.7
Broadcast programming and other costs................................ 1,175.7 912.3 631.8
Selling, general and administrative expenses......................... 1,457.0 1,119.9 788.5
Depreciation and amortization........................................ 433.8 296.4 194.6
Amortization of GM purchase accounting adjustments................... 21.0 21.0 21.0
---------- ---------- ----------
TOTAL OPERATING COSTS AND EXPENSES........................................ 5,714.8 4,842.9 3,819.6
---------- ---------- ----------
OPERATING PROFIT.......................................................... 249.1 285.4 189.1
Interest income........................................................... 112.3 33.1 6.8
Interest expense.......................................................... (17.5) (91.0) (42.9)
Other, net................................................................ (153.1) 390.7 69.1
---------- ---------- ----------
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES,
MINORITY INTERESTS, EXTRAORDINARY ITEM AND CUMULATIVE EFFECT OF
ACCOUNTING CHANGE...................................................... 190.8 618.2 222.1
Income taxes.............................................................. (44.7) 236.7 104.8
Minority interests in net losses of subsidiaries.......................... 24.4 24.8 52.6
---------- ---------- ----------
Income from continuing operations before extraordinary item and
cumulative effect of accounting change................................. 259.9 406.3 169.9
Income (Loss) from discontinued operations, net of taxes.................. -- 1.2 (7.4)
Gain on sale of discontinued operations, net of taxes..................... -- 62.8 --
---------- ---------- ----------
Income before extraordinary item and cumulative effect of accounting
change................................................................. 259.9 470.3 162.5
Extraordinary item, net of taxes.......................................... -- (20.6) --
Cumulative effect of accounting change, net of taxes...................... (9.2) -- --
---------- ---------- ----------
NET INCOME................................................................ 250.7 449.7 162.5
Adjustments to exclude the effect of GM purchase accounting
adjustments............................................................ 21.0 21.0 21.0
---------- ---------- ----------
EARNINGS USED FOR COMPUTATION OF AVAILABLE SEPARATE CONSOLIDATED
NET INCOME............................................................. $ 271.7 $ 470.7 $ 183.5
========== ========== ==========
AVAILABLE SEPARATE CONSOLIDATED NET INCOME
Average number of shares of General Motors Class H Common Stock
outstanding (in millions) (Numerator).................................. 105.3 101.5 98.4
Class H dividend base (in millions) (Denominator)......................... 399.9 399.9 399.9
Available Separate Consolidated Net Income................................ $ 71.5 $ 119.4 $ 45.2
========== ========== ==========
EARNINGS ATTRIBUTABLE TO GENERAL MOTORS CLASS H COMMON STOCK
ON A PER SHARE BASIS
Income from continuing operations before extraordinary item and
cumulative effect of accounting change................................. $ 0.70 $ 1.07 $ 0.48
Discontinued operations.............................................. -- 0.16 (0.02)
Extraordinary item................................................... -- (0.05) --
Cumulative effect of accounting change............................... (0.02) -- --
---------- ---------- ----------
Earnings Attributable to General Motors Class H Common Stock.............. $ 0.68 $ 1.18 $ 0.46
========== ========== ==========
</TABLE>
Reference should be made to the Notes to Financial Statements.
F-8
<PAGE>
HUGHES ELECTRONICS CORPORATION
BALANCE SHEET
<TABLE>
<CAPTION>
DECEMBER 31,
------------
ASSETS 1998 1997
---- ----
(DOLLARS IN MILLIONS)
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents.................................................... $1,342.1 $2,783.8
Accounts and notes receivable, net of allowances of $23.9 and $15.2.......... 922.4 630.0
Contracts in process, less advances and progress payments of $27.0 and
$50.2..................................................................... 783.5 575.6
Inventories.................................................................. 471.5 486.4
Prepaid expenses and other, including deferred income taxes of $33.6 and
$93.2..................................................................... 326.9 297.3
----------- -----------
TOTAL CURRENT ASSETS.............................................................. 3,846.4 4,773.1
SATELLITES, NET................................................................... 3,197.5 2,643.4
PROPERTY, NET..................................................................... 1,059.2 889.7
NET INVESTMENT IN SALES-TYPE LEASES............................................... 173.4 337.6
INTANGIBLE ASSETS, NET OF ACCUMULATED AMORTIZATION OF $413.2 AND $318.3........... 3,552.2 2,954.8
INVESTMENTS AND OTHER ASSETS...................................................... 1,606.3 1,132.4
----------- -----------
TOTAL ASSETS ..................................................................... $13,435.0 $12,731.0
=========== ===========
LIABILITIES AND OWNER'S EQUITY
CURRENT LIABILITIES
Accounts payable............................................................. $ 764.1 $ 472.8
Advances on contracts........................................................ 291.8 209.8
Deferred revenues............................................................ 43.8 77.8
Current portion of long-term debt............................................ 156.1 --
Accrued liabilities.......................................................... 753.7 689.4
----------- -----------
TOTAL CURRENT LIABILITIES......................................................... 2,009.5 1,449.8
----------- -----------
LONG-TERM DEBT.................................................................... 778.7 637.6
DEFERRED GAINS ON SALES AND LEASEBACKS............................................ 121.5 191.9
ACCRUED OPERATING LEASEBACK EXPENSE............................................... 56.0 100.2
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS....................................... 150.7 154.8
OTHER LIABILITIES AND DEFERRED CREDITS............................................ 811.1 706.4
DEFERRED INCOME TAXES............................................................. 643.9 570.8
COMMITMENTS AND CONTINGENCIES
MINORITY INTERESTS................................................................ 481.7 607.8
OWNER'S EQUITY
Capital stock and additional paid-in capital................................. 8,146.1 8,322.8
Net income retained for use in the business.................................. 257.8 7.1
----------- -----------
Subtotal Owner's Equity........................................................... 8,403.9 8,329.9
----------- -----------
Accumulated Other Comprehensive Income (Loss)
Minimum pension liability adjustment.................................... (37.1) (34.8)
Accumulated unrealized gains on securities.............................. 16.1 21.4
Accumulated foreign currency translation adjustments.................... (1.0) (4.8)
----------- -----------
Accumulated other comprehensive loss......................................... (22.0) (18.2)
----------- -----------
TOTAL OWNER'S EQUITY.............................................................. 8,381.9 8,311.7
----------- -----------
TOTAL LIABILITIES AND OWNER'S EQUITY.............................................. $13,435.0 $12,731.0
=========== ===========
</TABLE>
Certain 1997 amounts have been reclassified to conform with the 1998
presentation.
Reference should be made to the Notes to Financial Statements.
F-9
<PAGE>
HUGHES ELECTRONICS CORPORATION
STATEMENT OF CHANGES IN OWNER'S EQUITY
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
NET ACCUMULATED
CAPITAL INCOME OTHER
PARENT STOCK AND RETAINED COMPRE-
COMPANY'S ADDITIONAL FOR USE HENSIVE TOTAL COMPRE-
NET PAID-IN IN THE INCOME OWNER'S HENSIVE
INVESTMENT CAPITAL BUSINESS (LOSS) EQUITY INCOME
---------- ------- -------- ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT JANUARY 1, 1996............... $ 2,615.1 $ (6.2) $2,608.9
Net distribution to Parent Company....... (280.6) (280.6)
Net income............................... 162.5 162.5 $ 162.5
Foreign currency translation adjustments.. 0.8 0.8 0.8
-------
Comprehensive income..................... $ 163.3
---------- --------- -------- =======
BALANCE AT DECEMBER 31, 1996............. 2,497.0 (5.4) 2,491.6
Net contribution from Parent Company..... 1,124.2 1,124.2
Transfer of capital from Parent Company's
net investment........................... (4,063.8) $ 4,063.8 --
Capital contribution resulting from the
Hughes Transactions...................... 4,259.0 4,259.0
Minimum pension liability adjustment
resulting from the Hughes Transactions... (34.8) (34.8)
Unrealized gains on securities resulting
from the Hughes Transactions............. 21.4 21.4
Net income............................... 442.6 $ 7.1 449.7 $ 449.7
Foreign currency translation adjustments. 0.6 0.6 0.6
Comprehensive income..................... $ 450.3
---------- --------- ------- --------- -------- =======
BALANCE AT DECEMBER 31, 1997............. -- 8,322.8 7.1 (18.2) 8,311.7
Net income............................... 250.7 250.7 $ 250.7
Delco post-closing price adjustment...... (199.7) (199.7)
Tax benefit from exercise of GM Class H
common stock options................... 23.0 23.0
Minimum pension liability adjustment..... (2.3) (2.3) (2.3)
Foreign currency translation adjustments.. 3.8 3.8 3.8
Unrealized gains on securities:
Unrealized holding gains............. 1.8 1.8 1.8
Less: reclassification adjustment for
gains included in net income....... (7.1) (7.1) (7.1)
-------
Comprehensive income..................... $ 246.9
---------- --------- ------- --------- -------- =======
BALANCE AT DECEMBER 31, 1998............. $ -- $ 8,146.1 $ 257.8 $ (22.0) $8,381.9
========== ========= ======= ========= ========
</TABLE>
Reference should be made to the Notes to Financial Statements.
F-10
<PAGE>
HUGHES ELECTRONICS CORPORATION
STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
1998 1997 1996
--------- --------- -------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income..................................................................... $ 250.7 $ 449.7 $ 162.5
Adjustments to reconcile net income to net cash provided by continuing
operations
(Income) Loss from discontinued operations, net of taxes................... -- (1.2) 7.4
Gain on sale of discontinued operations, net of taxes...................... -- (62.8) --
Extraordinary item, net of taxes........................................... -- 20.6 --
Cumulative effect of accounting change, net of taxes....................... 9.2 -- --
Depreciation and amortization.............................................. 433.8 296.4 194.6
Amortization of GM purchase accounting adjustments......................... 21.0 21.0 21.0
Net gain on sale of investments and businesses sold........................ (13.7) (489.7) (120.3)
Gross profit on sales-type leases.......................................... -- (33.6) (51.8)
Deferred income taxes and other............................................ 153.2 285.5 91.9
Change in other operating assets and liabilities
Accounts and notes receivable.......................................... (97.5) (239.0) (87.0)
Contracts in process................................................... (230.9) (174.2) 54.1
Inventories............................................................ 20.2 (60.7) (121.5)
Collections of principal on net investment in sales-type leases........ 40.6 22.0 31.2
Accounts payable....................................................... 277.3 (184.1) 116.8
Advances on contracts.................................................. 82.0 (95.6) 97.6
Deferred revenues...................................................... (34.0) (21.2) 80.6
Accrued liabilities.................................................... 66.8 217.8 22.4
Deferred gains on sales and leasebacks................................. (36.2) (42.9) (41.6)
Other.................................................................. (67.3) 102.5 (90.5)
-------- -------- -------
Net Cash Provided by Continuing Operations................................. 875.2 10.5 367.4
Net cash used by discontinued operations................................... -- (15.9) (8.0)
Net Cash Provided by (Used in) Operating Activities........................ 875.2 (5.4) 359.4
-------- -------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in companies, net of cash acquired.................................. (1,240.3) (1,798.8) (32.2)
Expenditures for property...................................................... (343.6) (251.3) (261.5)
Increase in satellites......................................................... (945.2) (633.5) (191.6)
Proceeds from sale of investments.............................................. 12.4 242.0 --
Proceeds from the sale and leaseback of satellite transponders with General
Motors Acceptance -- -- 252.0
Corporation..................................................................
Proceeds from the sale of minority interest in subsidiary...................... -- -- 137.5
Early buy-out of satellite under sale and leaseback............................ (155.5) -- --
Proceeds from sale of discontinued operations.................................. -- 155.0 --
Proceeds from disposal of property............................................. 20.0 55.1 15.3
Proceeds from insurance claims................................................. 398.9 -- --
Net Cash Used in Investing Activities...................................... (2,253.3) (2,231.5) (80.5)
-------- -------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Long-term debt borrowings...................................................... 1,165.2 2,383.3 --
Repayment of long-term debt.................................................... (1,024.1) (2,851.9) --
Premium paid to retire debt.................................................... -- (34.4) --
Contributions from (distributions to) Parent Company........................... -- 1,124.2 (279.8)
Payment to General Motors for Delco post-closing price adjustment.............. (204.7) -- --
Capital infusion resulting from Hughes Transactions............................ -- 4,392.8 --
-------- -------- -------
Net Cash (Used in) Provided by Financing Activities........................ (63.6) 5,014.0 (279.8)
-------- -------- -------
Net (decrease) increase in cash and cash equivalents........................... (1,441.7) 2,777.1 (0.9)
Cash and cash equivalents at beginning of the year............................. 2,783.8 6.7 7.6
-------- -------- -------
Cash and cash equivalents at end of the year................................... $ 1,342.1 $ 2,783.8 $ 6.7
========= ========= =======
</TABLE>
Certain 1997 and 1996 amounts have been reclassified to conform with the 1998
presentation.
Reference should be made to the Notes to Financial Statements.
F-11
<PAGE>
HUGHES ELECTRONICS CORPORATION
NOTES TO FINANCIAL STATEMENTS
NOTE 1: BASIS OF PRESENTATION AND DESCRIPTION OF BUSINESS
On December 17, 1997, Hughes Electronics Corporation ("Hughes
Electronics") and General Motors Corporation ("GM"), the parent of Hughes
Electronics, completed a series of transactions (the "Hughes Transactions")
designed to address strategic challenges facing the three principal businesses
of Hughes Electronics and unlock stockholder value in GM. The Hughes
Transactions included the tax-free spin-off of the defense electronics business
("Hughes Defense") to holders of GM $1 2/3 par value and Class H common stocks,
the transfer of Delco Electronics Corporation ("Delco"), the automotive
electronics business, to GM's Delphi Automotive Systems unit and the
recapitalization of GM Class H common stock into a new tracking stock, GM Class
H common stock, that is linked to the remaining telecommunications and space
business. The Hughes Transactions were followed immediately by the merger of
Hughes Defense with Raytheon Company ("Raytheon"). For the periods prior to the
consummation of the Hughes Transactions on December 17, 1997, Hughes
Electronics, consisting of its defense electronics, automotive electronics and
telecommunications and space businesses, is hereinafter referred to as former
Hughes or Parent Company.
In connection with the recapitalization of Hughes Electronics on
December 17, 1997, the telecommunications and space business of former Hughes,
consisting principally of its direct-to-home broadcast, satellite services,
satellite systems and network systems businesses, was contributed to the
recapitalized Hughes Electronics. Such telecommunications and space business,
both before and after the recapitalization, is hereinafter referred to as
Hughes. The accompanying financial statements and footnotes pertain only to
Hughes and do not include balances of former Hughes related to Hughes Defense or
Delco.
Prior to the Hughes Transactions, the Hughes businesses were
effectively operated as divisions of former Hughes. For the period prior to
December 18, 1997, these financial statements include allocations of corporate
expenses from former Hughes, including research and development, general
management, human resources, financial, legal, tax, quality, communications,
marketing, international, employee benefits and other miscellaneous services.
These costs and expenses have been charged to Hughes based either on usage or
using allocation methodologies primarily based upon total revenues, certain
tangible assets and payroll expenses. Management believes the allocations were
made on a reasonable basis; however, they may not necessarily reflect the
financial position, results of operations or cash flows of Hughes on a
stand-alone basis in the future. Also, prior to December 18, 1997, interest
expense in the Statement of Income and Available Separate Consolidated Net
Income included an allocated share of total former Hughes' interest expense.
The Hughes Transactions had a significant impact on the Hughes balance
sheet. Prior to the consummation of the Hughes Transactions, Hughes participated
in the centralized cash management system of former Hughes, wherein cash
receipts were transferred to and cash disbursements were funded by former Hughes
on a daily basis. Accordingly, Hughes' balance sheet included only cash and cash
equivalents held directly by the telecommunications and space business. In
conjunction with the completion of the Hughes Transactions, certain assets and
liabilities were contributed by former Hughes to Hughes. The contributed assets
and liabilities consisted principally of cash, pension assets and liabilities,
liabilities for other postretirement benefits, deferred taxes, property and
equipment, and other miscellaneous items. In addition, Hughes received $4.0
F-12
<PAGE>
HUGHES ELECTRONICS CORPORATION
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
billion of cash proceeds from the borrowings incurred by Hughes Defense prior to
its spin-off to GM.
The accompanying financial statements include the applicable portion of
intangible assets, including goodwill, and related amortization resulting from
purchase accounting adjustments associated with GM's purchase of Hughes in 1985.
Hughes is a leading manufacturer of communications satellites and
provider of satellite-based services. It owns and operates one of the world's
largest private fleets of geostationary communications satellites and is the
world's leading supplier of satellite-based private business networks. Hughes is
also a leader in the direct broadcast satellite market with its programming
distribution service known as DIRECTV(R), which was introduced in the U.S. in
1994 and was the first high-powered, all digital, Direct-To-Home ("DTH")
television distribution service in North America. DIRECTV began service in Latin
America in 1996 and Japan in 1997. Hughes also provides communications equipment
and services in the mobile communications and packet switching markets. Its
equipment and services are applied in, among other things, data, video and audio
transmission, cable and network television distribution, private business
networks, digital cellular communications and DTH satellite broadcast
distribution of television programming.
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Combination and Consolidation
Prior to December 18, 1997, the financial statements present the
financial position, results of operations and cash flows of the
telecommunications and space business owned and operated by former Hughes on a
combined basis. Subsequent to the Hughes Transactions, the accompanying
financial statements are presented on a consolidated basis. The financial
statements include the accounts of Hughes and its domestic and foreign
subsidiaries that are more than 50% owned or controlled by Hughes, with
investments in associated companies in which Hughes owns at least 20% of the
voting securities or has significant influence accounted for under the equity
method of accounting.
Use of Estimates in the Preparation of the Financial Statements
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect amounts reported therein. Due to the inherent
uncertainty involved in making estimates, actual results reported in future
periods may be based upon amounts which differ from those estimates.
Revenue Recognition
Revenues are generated from sales of satellites and telecommunications
equipment, DTH broadcast subscriptions, and the sale of transponder capacity and
related services through outright sales, sales-type leases and operating lease
contracts.
Sales under long-term contracts are recognized primarily using the
percentage-of-completion (cost-to-cost) method of accounting. Under this method,
sales are recorded equivalent to costs incurred plus a portion of the profit
F-13
<PAGE>
HUGHES ELECTRONICS CORPORATION
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
expected to be realized, determined based on the ratio of costs incurred to
estimated total costs at completion. Profits expected to be realized on
long-term contracts are based on estimates of total sales value and costs at
completion. These estimates are reviewed and revised periodically throughout the
lives of the contracts, and adjustments to profits resulting from such revisions
are recorded in the accounting period in which the revisions are made. Estimated
losses on contracts are recorded in the period in which they are identified.
Certain contracts contain cost or performance incentives which provide
for increases in profits for surpassing stated objectives and decreases in
profits for failure to achieve such objectives. Amounts associated with
incentives are included in estimates of total sales values when there is
sufficient information to relate actual performance to the objectives.
Sales which are not pursuant to long-term contracts are generally
recognized as products are shipped or services are rendered. DTH subscription
revenues are recognized when programming is viewed by subscribers. Programming
payments received from subscribers in advance of viewing are recorded as
deferred revenue until earned.
Satellite transponder lease contracts qualifying for capital lease
treatment (typically based on the term of the lease) are accounted for as
sales-type leases, with revenues recognized equal to the net present value of
the future minimum lease payments. Upon entering into a sales-type lease, the
cost basis of the transponder is removed and charged to cost of products sold.
The portion of each periodic lease payment deemed to be attributable to interest
income is recognized in each respective period. Contracts for sales of
transponders typically include telemetry, tracking and control ("TT&C") service
agreements. Revenues related to TT&C service agreements are recognized as the
services are performed.
Transponder and other lease contracts that do not qualify as sales-type
leases are accounted for as operating leases. Operating lease revenues are
recognized on a straight-line basis over the respective lease term. Differences
between operating lease payments received and revenues recognized are deferred
and included in accounts and notes receivable or investments and other assets.
Hughes has entered into agreements for the sale and leaseback of
certain of its satellite transponders. The leaseback transactions have been
classified as operating leases and, therefore, the capitalized cost and
associated depreciation related to satellite transponders sold are not included
in the accompanying financial statements. Gains resulting from such transactions
are deferred and amortized over the leaseback period. Leaseback expense is
recorded using the straight-line method over the term of the lease, net of
amortization of the deferred gains. Differences between operating leaseback
payments made and expense recognized are deferred and included in accrued
operating leaseback expense.
Cash Flows
Cash equivalents consist of highly liquid investments purchased with
original maturities of 90 days or less.
F-14
<PAGE>
HUGHES ELECTRONICS CORPORATION
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
Net cash from operating activities includes cash payments made for
interest of $53.2 million, $156.8 million and $55.8 million in 1998, 1997 and
1996, respectively. Net cash refunds received by Hughes for prior year income
taxes amounted to $59.9 million in 1998. Cash payments for income taxes amounted
to $24.0 million and $36.5 million in 1997 and 1996, respectively.
Certain non-cash transactions occurred in connection with the
consummation of the Hughes Transactions on December 17, 1997, resulting in a
contribution of a net liability of $133.8 million.
In 1997, in a separate non-cash transaction, Hughes' subsidiary,
PanAmSat Corporation ("PanAmSat"), converted its outstanding preferred stock
into debt amounting to $438.5 million.
Contracts in Process
Contracts in process are stated at costs incurred plus estimated
profit, less amounts billed to customers and advances and progress payments
applied. Engineering, tooling, manufacturing, and applicable overhead costs,
including administrative, research and development and selling expenses, are
charged to costs and expenses when incurred. Contracts in process include
amounts relating to contracts with long production cycles, with $151.0 million
of the 1998 amount expected to be billed after one year. Amounts billed under
retainage provisions of contracts are not significant, and substantially all
amounts are collectible within one year. Under certain contracts with the U.S.
Government, progress payments are received based on costs incurred on the
respective contracts. Title to the inventories related to such contracts
(included in contracts in process) vests with the U.S. Government.
Inventories
Inventories are stated at the lower of cost or market principally using
the average cost method.
1998 1997
---- ----
(DOLLARS IN MILLIONS)
Major Classes of Inventories
Productive material and supplies..... $73.4 $57.5
Work in process...................... 285.1 328.5
Finished goods....................... 113.0 100.4
------ ------
Total........................... $471.5 $486.4
====== ======
Property, Satellites and Depreciation
Property and satellites are carried at cost. Satellite costs include
construction costs, launch costs, launch insurance and capitalized interest.
Capitalized satellite costs represent the costs of successful satellite
launches. Satellite costs related to unsuccessful launches, net of insurance
proceeds, are recognized in the period of failure. Depreciation is computed
generally using the straight-line method over the estimated useful lives of the
assets. Leasehold improvements are amortized over the lesser of the life of the
asset or term of the lease.
F-15
<PAGE>
HUGHES ELECTRONICS CORPORATION
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
Intangible Assets
Intangible assets, a majority of which is goodwill, are amortized using
the straight-line method over periods not exceeding 40 years.
Software Development Costs
Other assets include certain software development costs capitalized in
accordance with Statement of Financial Accounting Standards ("SFAS") No. 86,
Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise
Marketed. Capitalized software development costs at December 31, 1998 and 1997,
net of accumulated amortization of $70.6 million and $107.7 million,
respectively, totaled $104.1 million and $99.0 million. The software is
amortized using the greater of the units of revenue method or the straight-line
method over its useful life, not in excess of five years. Software program
reviews are conducted to ensure that capitalized software development costs are
properly treated and costs associated with programs that are not generating
revenues are appropriately written off.
Valuation of Long-Lived Assets
Hughes periodically evaluates the carrying value of long-lived assets
to be held and used, including goodwill and other intangible assets, when events
and circumstances warrant such a review. The carrying value of a long-lived
asset is considered impaired when the anticipated undiscounted cash flow from
such asset is separately identifiable and is less than its carrying value. In
that event, a loss is recognized based on the amount by which the carrying value
exceeds the fair market value of the long-lived asset. Fair market value is
determined primarily using the anticipated cash flows discounted at a rate
commensurate with the risk involved. Losses on long-lived assets to be disposed
of are determined in a similar manner, except that fair market values are
reduced for the cost of disposal.
Research and Development
Expenditures for research and development are charged to costs and
expenses as incurred and amounted to $121.4 million in 1998, $120.4 million in
1997 and $94.6 million in 1996.
Foreign Currency
Substantially all of Hughes' foreign operations have determined the
local currency to be their functional currency. Accordingly, these foreign
entities translate assets and liabilities from their local currencies to U.S.
dollars using year-end exchange rates while income and expense accounts are
translated at the average rates in effect during the year. The resulting
translation adjustment is recorded as part of accumulated other comprehensive
income (loss), a separate component of owner's equity. Gains and losses
resulting from remeasurement into the functional currency of transactions
denominated in non-functional currencies are recognized in earnings. Net foreign
currency transaction gains and losses included in the operating results were not
material for all years presented.
F-16
<PAGE>
HUGHES ELECTRONICS CORPORATION
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
Financial Instruments and Investments
Hughes maintains investments in equity securities of unaffiliated
companies. These investments are considered available-for-sale and carried at
current fair value with unrealized gains or losses, net of taxes, reported as
part of accumulated other comprehensive income (loss), a separate component of
owner's equity. Fair value is determined by market quotes, when available, or by
management estimate.
Market values of financial instruments, other than debt and derivative
instruments, are based upon management estimates. Market values of debt and
derivative instruments are determined by quotes from financial institutions.
The carrying value of cash and cash equivalents, accounts and notes
receivable, investments and other assets, accounts payable, amounts included in
accrued liabilities meeting the definition of a financial instrument and debt
approximated fair value at December 31, 1998.
Hughes' derivative contracts primarily consist of foreign
exchange-forward contracts. Hughes enters into these contracts to reduce its
exposure to fluctuations in foreign exchange rates. Foreign exchange-forward
contracts are accounted for as hedges to the extent they are designated as, and
are effective as, hedges of firm foreign currency commitments. Gains and losses
on foreign exchange-forward contracts designated as hedges of firm foreign
currency commitments are recognized in income in the same period as gains and
losses on the underlying transactions are recognized.
Stock Compensation
Hughes issues stock options to employees with grant prices equal to the
fair value of the underlying security at the date of grant. No compensation cost
has been recognized for options in accordance with the provisions of Accounting
Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to
Employees. See Note 10 for information regarding the pro forma effect on
earnings of recognizing compensation cost based on the estimated fair value of
the stock options granted, as required by SFAS No. 123, Accounting for
Stock-Based Compensation.
Compensation related to stock awards is recognized ratably over the
vesting period and, where required, periodically adjusted to reflect changes in
the stock price of the underlying security.
Market Concentrations and Credit Risk
Sales under U.S. Government contracts were 12.4%, 15.3% and 22.5% of
total revenues in 1998, 1997 and 1996, respectively. Hughes provides services
and extends credit to a large number of customers in the commercial satellite
communications market and to a large number of residential consumers. Management
monitors its exposure to credit losses and maintains allowances for anticipated
losses.
F-17
<PAGE>
HUGHES ELECTRONICS CORPORATION
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
Accounting Change
In 1998, Hughes adopted American Institute of Certified Pubic
Accountants Statement of Position ("SOP") 98-5, Reporting on the Costs of
Start-Up Activities. SOP 98-5 requires that all start-up costs previously
capitalized be written off and recognized as a cumulative effect of accounting
change, net of taxes, as of the beginning of the year of adoption. On a
prospective basis, these types of costs are required to be expensed as incurred.
The unfavorable cumulative effect of this accounting change at January 1, 1998
was $9.2 million after-tax, or $0.02 per share of GM Class H common stock.
New Accounting Standard
In June 1998, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS
No. 133 requires all derivatives to be recorded as either assets or liabilities
and the instruments to be measured at fair value. Gains or losses resulting from
changes in the values of those derivatives are to be recognized immediately or
deferred depending on the use of the derivative and whether or not it qualifies
as a hedge. Hughes plans to adopt SFAS No. 133 by January 1, 2000, as required.
Management is currently assessing the impact of this statement on Hughes'
results of operations and financial position.
NOTE 3: PROPERTY AND SATELLITES, NET
<TABLE>
<CAPTION>
ESTIMATED
USEFUL LIVES
(YEARS) 1998 1997
------- ---- ----
(DOLLARS IN MILLIONS)
<S> <C> <C> <C>
Land and improvements................................... 5-25 $ 51.7 $ 51.2
Buildings and unamortized leasehold
improvements......................................... 2-45 321.8 305.8
Machinery and equipment................................. 3-12 1,163.1 1,015.4
Furniture, fixtures and office machines................. 3-10 80.2 83.2
Construction in progress................................ -- 285.3 169.9
---------- ---------
Total................................................... 1,902.1 1,625.5
Less accumulated depreciation........................... 842.9 735.8
---------- ---------
Property, net........................................... $1,059.2 $ 889.7
========== =========
Satellites.............................................. 9-16 $3,783.2 $3,051.9
Less accumulated depreciation........................... 585.7 408.5
---------- ---------
Satellites, net......................................... $3,197.5 $2,643.4
========== =========
</TABLE>
Hughes capitalized interest of $55.3 million, $64.5 million and $12.9
million for 1998, 1997 and 1996, respectively, as part of the cost of its
satellites under construction.
NOTE 4: LEASING ACTIVITIES
Future minimum lease payments due from customers under noncancelable
satellite transponder operating leases, exclusive of amounts due from subleases
reported below, are $550.5 million in 1999, $498.9 million in 2000, $477.6
F-18
<PAGE>
HUGHES ELECTRONICS CORPORATION
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
million in 2001, $462.5 million in 2002, $440.7 million in 2003 and $2,031.7
million thereafter.
The components of the net investment in sales-type leases are as
follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
(DOLLARS IN MILLIONS)
<S> <C> <C>
Total minimum lease payments.................................... $301.9 $662.5
Less unearned interest income and allowance for doubtful accounts 106.0 297.1
------- -------
Total net investment in sales-type leases....................... 195.9 365.4
Less current portion............................................ 22.5 27.8
------- -------
Total..................................................... $173.4 $337.6
======= =======
</TABLE>
Future minimum payments due from customers under sales-type leases and
related service agreements as of December 31, 1998 are as follows:
MINIMUM SERVICE
LEASE AGREEMENT
PAYMENTS PAYMENTS
-------- --------
(DOLLARS IN MILLIONS)
1999.............. $ 46.1 $ 4.5
2000.............. 44.7 5.7
2001.............. 45.8 5.7
2002.............. 44.9 5.7
2003.............. 43.4 5.7
Thereafter........ 77.0 10.4
------ ------
Total........ $301.9 $ 37.7
====== ======
In February 1996, Hughes entered into a sale-leaseback agreement for
certain satellite transponders on Galaxy III-R with General Motors Acceptance
Corporation ("GMAC"), a subsidiary of GM. Proceeds from the sale were $252.0
million, and the sale resulted in a deferred gain of $108.8 million. In 1992 and
1991, Hughes entered into sale-leaseback agreements for certain transponders on
Galaxy VII and SBS-6, respectively, resulting in deferred gains of $180.0
million in 1992 and $96.1 million in 1991. Deferred gains from sale-leaseback
agreements are amortized over the expected term of leaseback period. In 1998,
PanAmSat exercised certain early buy-out options on the SBS-6 transaction and
repurchased the transponders for a total payment of $155.5 million. In January
1999, PanAmSat exercised early buy-out options for $141.3 million related to
certain transponders on Galaxy VII, and has remaining early buy-out options of
approximately $227.0 million on Galaxy III-R and Galaxy VII that can be
exercised later in 1999.
F-19
<PAGE>
HUGHES ELECTRONICS CORPORATION
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
As of December 31, 1998, the future minimum leaseback amounts payable
to lessors under the operating leasebacks and the future minimum sublease
amounts due from subleases under noncancelable subleases are as follows:
MINIMUM LEASEBACK
PAYMENTS SUBLEASE AMOUNTS
-------- ----------------
1999.............. $ 90.9 $ 57.5
2000.............. 120.3 58.2
2001.............. 71.9 53.2
2002.............. 110.9 49.5
2003.............. 26.6 34.2
-------- -------
Total........ $ 420.6 $ 252.6
======== =======
NOTE 5: ACCRUED LIABILITIES
1998 1997
---- ----
(DOLLARS IN
MILLIONS)
Payroll and other compensation......................... $196.5 $200.2
Contract-related provisions............................ 138.0 76.0
Reserve for consumer finance and rebate
programs............................................ 93.0 86.9
Other.................................................. 326.2 326.3
------ ------
Total........................................... $753.7 $689.4
====== ======
NOTE 6: LONG-TERM DEBT
1998 1997
---- ----
(DOLLARS IN
MILLIONS)
Notes payable.................. $750.0 $ --
Revolving credit facilities.... 155.9 500.0
Bridge loan.................... -- 100.0
Other.......................... 28.9 37.6
------- -------
Total debt..................... 934.8 637.6
Less current portion........... 156.1 --
------- -------
Total long-term debt...... $778.7 $637.6
======= =======
Notes payable consisted of five, seven, ten and thirty-year notes
totaling $750.0 million issued by PanAmSat in January 1998. The proceeds
received were used by PanAmSat to repay the revolving credit facility of $500.0
million and bridge loan of $100.0 million outstanding at December 31, 1997. The
outstanding principal balances and interest rates for the five, seven, ten and
thirty-year notes as of December 31, 1998 were $200.0 million at 6.00%, $275.0
million at 6.13%, $150.0 million at 6.38% and $125.0 million at 6.88%,
respectively. Principal on the notes is payable at maturity, while interest is
payable semi-annually.
At December 31, 1998, Hughes' 59.1% owned subsidiary, SurFin Ltd.
("SurFin"), had a total of $155.9 million outstanding under two separate $150.0
million unsecured revolving credit facilities. The first matures on April 30,
1999 and the second matures on July 31, 1999. Both credit facilities, which are
expected to be renewed, are subject to a facility fee of 0.10% per annum.
F-20
<PAGE>
HUGHES ELECTRONICS CORPORATION
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
Borrowings under these credit facilities bear interest at the Eurodollar Rate
plus 0.15% and were included in current portion of long-term debt.
Other long-term debt at December 31, 1998 and 1997 consisted primarily
of notes bearing fixed rates of interest of 9.61% to 11.11%. Principal is
payable at maturity in April 2007 while interest is payable semi-annually. Also
included in other long-term debt at December 31, 1997 was $9.1 million of
PanAmSat Senior Notes which were repaid in 1998.
As part of a debt refinancing program undertaken by PanAmSat in 1997,
an extraordinary charge of $20.6 million ($34.4 million before taxes) was
recorded, related to the excess of the price paid for the debt over its carrying
value, net of deferred financing costs.
The aggregate maturities of long-term debt for the five years
subsequent to December 31, 1998 are $156.1 million in 1999, $200.0 million in
2003 and $578.7 million thereafter.
Hughes has $1.0 billion of unused credit available under two unsecured
revolving credit facilities, consisting of a $750.0 million multi-year facility
and a $250.0 million 364-day facility. The multi-year credit facility provides
for a commitment of $750.0 million through December 5, 2002, subject to a
facility fee of 0.07% per annum. Borrowings bear interest at a rate which
approximates the London Interbank Offered Rate ("LIBOR") plus 0.155%. The
364-day credit facility provides for a commitment of $250.0 million through
December 1, 1999, subject to a facility fee of 0.05% per annum. Borrowings bear
interest at a rate which approximates LIBOR plus 0.25%, with an additional
0.125% utilization fee when borrowings exceed 50% of the commitment. No amounts
were outstanding under either facility at December 31, 1998. These facilities
provide backup capacity for Hughes' $1.0 billion commercial paper program. No
amounts were outstanding under the commercial paper program at December 31,
1998.
PanAmSat maintains a $500.0 million multi-year revolving credit
facility that provides for short-term and long-term borrowings and a $500.0
million commercial paper program that provides for short-term borrowings. The
multi-year revolving credit facility provides for a commitment through December
24, 2002, subject to a facility fee of 0.10% per annum. Borrowings bear interest
at a rate which approximates LIBOR plus 0.30%. Borrowings under the credit
facility and commercial paper program are limited to $500.0 million in the
aggregate.
No amounts were outstanding under either agreement at December 31, 1998.
NOTE 7: INCOME TAXES
The provision for income taxes is based on reported income from
continuing operations before income taxes, minority interests, extraordinary
item and cumulative effect of accounting change. Deferred income tax assets and
liabilities reflect the impact of temporary differences between the amounts of
assets and liabilities recognized for financial reporting purposes and such
amounts recognized for tax purposes, as measured by applying currently enacted
tax laws.
Hughes and former Hughes (prior to December 18, 1997), and their
domestic subsidiaries join with General Motors in filing a consolidated U.S.
Federal income tax return. The portion of the consolidated income tax liability
recorded by Hughes is generally equivalent to the liability it would have
incurred on a separate return basis.
F-21
<PAGE>
HUGHES ELECTRONICS CORPORATION
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
Prior to December 18, 1997, certain income tax assets and liabilities
were maintained by former Hughes. Income tax expense was allocated to Hughes as
if Hughes filed a separate income tax return. In connection with the Hughes
Transactions, certain income tax assets and liabilities were contributed to and
assumed by Hughes on December 17, 1997 and are included in the accompanying
balance sheet.
The income tax provision consisted of the following:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(DOLLARS IN MILLIONS)
<S> <C> <C> <C>
U.S. Federal, state and foreign taxes currently
(refundable) payable................................. $(177.3) $24.0 $36.5
U.S. Federal, state and foreign deferred tax
liabilities, net..................................... 132.6 212.7 68.3
-------- ------ ------
Total income tax (benefit) provision............... $(44.7) $236.7 $104.8
======== ====== ======
</TABLE>
Income from continuing operations before income taxes, minority
interests, extraordinary item and cumulative effect of accounting change
included the following components:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(DOLLARS IN MILLIONS)
<S> <C> <C> <C>
U.S. income............................................ $283.8 $ 659.4 $218.4
Foreign (loss) income.................................. (93.0) (41.2) 3.7
------- -------- ------
Total.............................................. $ 190.8 $618.2 $222.1
======= ======== ======
</TABLE>
The combined income tax provision was different than the amount
computed using the U.S. Federal statutory income tax rate for the reasons set
forth in the following table:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(DOLLARS IN MILLIONS)
<S> <C> <C> <C>
Expected tax at U.S. Federal statutory income tax
rate............................................. $ 66.8 $216.4 $77.7
Research and experimentation tax benefits.......... (183.6) (39.3) --
Foreign sales corporation tax benefit.............. (30.1) (25.5) (24.0)
U.S. state and local income taxes.................. 13.7 24.8 9.4
Purchase accounting adjustments.................... 7.3 7.3 7.3
Losses of equity method investees.................. 36.7 18.7 14.8
Minority interests in losses of partnership........ 19.3 17.5 17.7
Non-deductible goodwill amortization............... 20.1 9.7 --
Other.............................................. 5.1 7.1 1.9
-------- ------ ------
Total income tax (benefit) provision......... $(44.7) $236.7 $104.8
======== ====== ======
</TABLE>
F-22
<PAGE>
HUGHES ELECTRONICS CORPORATION
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
Temporary differences and carryforwards which gave rise to deferred tax
assets and liabilities at December 31 were as follows:
<TABLE>
<CAPTION>
1998 1997
-------------------- --------------------
DEFERRED DEFERRED DEFERRED DEFERRED
TAX TAX TAX TAX
ASSETS LIABILITIES ASSETS LIABILITIES
------ ----------- ------ -----------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C>
Profits on long-term contracts..................... $145.5 $ 155.5 $156.0 $ 142.8
Sales and leasebacks............................... 65.4 -- 85.8 --
Employee benefit programs.......................... 68.3 101.3 64.3 114.0
Postretirement benefits other than pensions........ 72.3 -- 72.9 --
Customer deposits and rebates...................... 52.9 -- 61.9 --
State taxes........................................ 38.8 -- 50.0 --
Gain on PanAmSat merger............................ -- 191.1 -- 195.0
Satellite launch insurance costs................... -- 103.1 -- 43.7
Depreciation....................................... -- 470.9 -- 438.6
Net operating loss and tax credit carryforwards.... 77.8 -- -- --
Sale of equity interest in DIRECTV................. -- 47.5 -- 48.7
Other.............................................. 32.8 30.5 63.9 35.4
-------- ------- ------- -------
Subtotal........................................... 553.8 1,099.9 554.8 1,018.2
Valuation allowance................................ (64.2) -- (14.2) --
-------- ------- ------- -------
Total deferred taxes............................... $489.6 $1,099.9 $540.6 $1,018.2
======== ======= ======= =======
</TABLE>
No income tax provision has been made for the portion of undistributed
earnings of foreign subsidiaries deemed permanently reinvested that amounted to
approximately $18.5 million and $18.2 million at December 31, 1998 and 1997,
respectively. Repatriation of all accumulated earnings would have resulted in
tax liabilities of $6.4 million in 1998 and $5.4 million in 1997.
At December 31, 1998, Hughes has $63.9 million of foreign operating
loss carryforwards expiring in varying amounts between 1999 and 2003. A
valuation allowance was provided for all of the foreign operating loss
carryforwards.
Hughes has an agreement with Raytheon which governs Hughes' rights and
obligations with respect to U.S. Federal and state income taxes for all periods
prior to the merger of Hughes Defense with Raytheon. Hughes is responsible for
any income taxes pertaining to those periods prior to the merger, including any
additional income taxes resulting from U.S. Federal and state tax audits. Hughes
is also entitled to any U.S. Federal and state income tax refunds relating to
those years.
The U.S. Federal income tax returns of former Hughes have been examined
through 1990. All years prior to 1983 are closed. Issues relating to the years
1983 through 1990 are being contested through various stages of administrative
appeal. The Internal Revenue Service ("IRS") is currently examining former
Hughes' U.S. Federal tax returns for years 1991 through 1994. Management
believes that adequate provision has been made for any adjustment which might be
assessed for open years.
F-23
<PAGE>
HUGHES ELECTRONICS CORPORATION
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
Hughes reached an agreement with the IRS regarding a claim for refund
of U.S. Federal income taxes related to the treatment of research and
experimentation costs for the years 1983 through 1995. Hughes recorded a total
of $183.6 million of research and experimentation tax benefits during 1998, a
substantial portion of which related to the above noted agreement with the IRS
and covered prior years.
NOTE 8: RETIREMENT PROGRAMS AND OTHER POSTRETIREMENT BENEFITS
Hughes adopted SFAS No. 132, Employers' Disclosures about Pensions and
Other Postretirement Benefits. SFAS No. 132 required changes in disclosure of
certain information about pensions and other postretirement benefits.
Substantially all of Hughes' employees participate in Hughes'
contributory and non-contributory defined benefit retirement plans. Benefits are
based on years of service and compensation earned during a specified period of
time before retirement. Additionally, an unfunded, nonqualified pension plan
covers certain employees. Hughes also maintains a program for eligible retirees
to participate in health care and life insurance benefits generally until they
reach age 65. Qualified employees who elected to participate in the Hughes
contributory defined benefit pension plans may become eligible for these health
care and life insurance benefits if they retire from Hughes between the ages of
55 and 65.
Prior to December 18, 1997, the pension-related assets and liabilities
and the postretirement benefit plans were maintained by former Hughes for its
non-automotive businesses and were not included in the Hughes balance sheet. A
portion of former Hughes' net pension expense or income and postretirement
benefit cost was allocated to Hughes and is included in the Statement of Income
and Available Separate Consolidated Net Income. The net pension expense
allocation was $12.3 million and $12.2 million for 1997 and 1996, respectively.
For 1997 and 1996, the pension expense components including benefits earned
during the year, interest accrued on benefits earned in prior years, actual
return on assets and net amortization and deferral, were not determined
separately for the Hughes participants. The postretirement benefit cost
allocated to Hughes was $11.2 million and $10.4 million for 1997 and 1996,
respectively. For 1997 and 1996, the postretirement benefit cost components,
including benefits earned during the year, interest accrued on benefits earned
in prior years and net amortization, were not determined separately for the
Hughes employees. The 1997 information presented below is based on pro rata
allocations from former Hughes for each pension and postretirement benefit
component.
F-24
<PAGE>
HUGHES ELECTRONICS CORPORATION
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
The components of the pension benefit obligation and the other
postretirement benefit obligation, as well as the net benefit obligation
recognized in the balance sheet, are shown below:
<TABLE>
<CAPTION>
OTHER
POSTRETIREMENT
PENSION BENEFITS BENEFITS
---------------- --------
1998 1997 1998 1997
---- ---- ---- ----
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C>
CHANGE IN BENEFIT OBLIGATION
Net benefit obligation at beginning of year............. $1,556.4 $1,490.5 $ 135.6 $ 132.3
Service cost............................................ 57.5 47.9 3.6 3.6
Interest cost........................................... 110.8 110.3 9.3 9.1
Plan participants' contributions........................ 14.1 13.7 -- --
Actuarial loss.......................................... 66.6 32.4 35.1 4.1
Acquisitions/divestitures............................... -- (17.6) -- --
Benefits paid........................................... (151.3) (120.8) (12.0) (13.5)
---------- ---------- -------- ---------
Net benefit obligation at end of year................... $1,654.1 $1,556.4 $ 171.6 $ 135.6
========== ========== ======== =========
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of year.......... $1,906.1 $1,716.4 $ -- $ --
Actual return on plan assets............................ 165.0 302.4 -- --
Employer contributions.................................. 20.3 12.0 12.0 13.5
Plan participants' contributions........................ 14.1 13.7 -- --
Acquisitions/divestitures............................... -- (17.6) -- --
Benefits paid........................................... (151.3) (120.8) (12.0) (13.5)
Transfers............................................... 4.7 -- -- --
---------- ---------- -------- ---------
Fair value of plan assets at end of year................ 1,958.9 1,906.1 -- --
---------- ---------- -------- ---------
Funded status at end of year........................ 304.8 349.7 (171.6) (135.6)
Unamortized asset at date of adoption............... -- (12.8) -- --
Unamortized amount resulting from changes in plan
provision......................................... 4.4 5.1 -- --
Unamortized net amount resulting from changes in plan
experience and actuarial assumptions.............. (80.8) (122.3) 4.9 (31.0)
---------- ---------- -------- ---------
Net amount recognized at end of year.................... $ 228.4 $ 219.7 $(166.7) $(166.6)
========== ========== ======== =========
Amounts recognized in the balance sheet consist of:
Prepaid benefit cost................................ $ 248.1 $ 227.0
Accrued benefit cost................................ (89.3) (83.8) $(166.7) $(166.6)
Intangible asset.................................... 7.4 18.0 N/A N/A
Deferred tax assets................................. 25.1 23.7 N/A N/A
Accumulated other comprehensive loss................ 37.1 34.8 N/A N/A
---------- ---------- -------- ---------
Net amount recognized at end of year.................... $ 228.4 $ 219.7 $(166.7) $(166.6)
========== ========== ======== =========
</TABLE>
F-25
<PAGE>
HUGHES ELECTRONICS CORPORATION
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
Included in the pension plan assets at December 31, 1998 are GM Class H
common stock of $2.3 million, GM $1 2/3 common stock of $7.1 million and GMAC
bonds of $3.3 million.
<TABLE>
<CAPTION>
OTHER
POSTRETIREMENT
PENSION BENEFITS BENEFITS
---------------- --------
1998 1997 1998 1997
-------- -------- ------ ------
<S> <C> <C> <C> <C>
WEIGHTED-AVERAGE ASSUMPTIONS AS OF DECEMBER 31
Discount rate.......................................... 6.75% 7.25% 6.50% 6.75%
Expected return on plan assets......................... 9.50% 9.50% N/A N/A
Rate of compensation increase.......................... 5.00% 5.00% N/A N/A
</TABLE>
For measurement purposes, a 9.5% annual rate of increase per capita
cost of covered health care benefits was assumed for 1999. The rate was assumed
to decrease gradually 0.5% per year to 6.0% in 2006.
<TABLE>
<CAPTION>
OTHER
POSTRETIREMENT
PENSION BENEFITS BENEFITS
1998 1997 1998 1997
---- ---- ---- ----
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C>
COMPONENTS OF NET PERIODIC BENEFIT COST
Benefits earned during the year.............................. $ 57.5 $ 47.9 $ 3.6 $ 3.6
Interest accrued on benefits earned in prior years........... 110.8 110.3 9.3 9.1
Expected return on assets.................................... (144.5) (135.7) -- --
Amortization components
Unamortized asset at date of adoption................... (12.8) (14.2) -- --
Unamortized amount resulting from changes in plan
provisions........................................... 0.7 0.7 -- --
Unamortized net amount resulting from changes in
plan experience and actuarial assumptions............ 4.6 3.3 (0.8) (1.5)
-------- ------- ------- -------
Net periodic benefit cost.................................... $ 16.3 $ 12.3 $12.1 $11.2
======== ======= ======= =======
</TABLE>
The projected benefit obligation and accumulated benefit obligation for
the pension plans with accumulated benefit obligations in excess of plan assets
were $114.3 and $89.3, respectively, as of December 31, 1998, and $93.5 and
$83.8, respectively, as of December 31, 1997. The pension plans with accumulated
benefit obligations in excess of plan assets do not have any underlying assets.
Assumed health care cost trend rates have a significant effect on the
amounts reported for the health care plan. A one-percentage point change in
assumed health care cost trend rates would have the following effects:
<TABLE>
<CAPTION>
1-PERCENTAGE 1-PERCENTAGE
POINT POINT
INCREASE DECREASE
-------- --------
(DOLLARS IN MILLIONS)
<S> <C> <C>
Effect on total of service and interest cost
components.................................. $ 1.5 $ (1.2)
Effect on postretirement benefit obligation.... 14.0 (12.2)
</TABLE>
F-26
<PAGE>
HUGHES ELECTRONICS CORPORATION
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
Hughes maintains 401(k) plans for qualified employees. A portion of
employee contributions are matched by Hughes and amounted to $30.6 million,
$26.3 million and $16.7 million in 1998, 1997 and 1996, respectively.
Hughes has disclosed in the financial statements certain amounts
associated with estimated future postretirement benefits other than pensions and
characterized such amounts as "other postretirement benefit obligation."
Notwithstanding the recording of such amounts and the use of these terms, Hughes
does not admit or otherwise acknowledge that such amounts or existing
postretirement benefit plans of Hughes (other than pensions) represent legally
enforceable liabilities of Hughes.
NOTE 9: OWNER'S EQUITY
In connection with the Hughes Transactions, Hughes was recapitalized on
December 17, 1997 at which time 1,000 shares of $1.00 par value common stock,
representing all of the authorized and outstanding common stock of Hughes, were
issued to GM. Prior to December 17, 1997, the equity of Hughes was comprised of
Parent Company's net investment in its telecommunications and space business.
The following represents changes in the components of accumulated other
comprehensive income (loss), net of income taxes, as of December 31:
<TABLE>
<CAPTION>
1998 1997 1996
------------------------ ------------------------ ------------------------
TAX
PRE-TAX (CREDIT) NET PRE-TAX TAX NET PRE-TAX TAX NET
AMOUNT EXPENSE AMOUNT AMOUNT EXPENSE AMOUNT AMOUNT EXPENSE AMOUNT
------ ------- ------ ------ ------- ------ ------ ------- ------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Minimum pension liability
adjustments........... $ (3.9) $ (1.6) $ (2.3) -- -- -- -- -- --
Foreign currency
translation adjustments $ 6.4 $ 2.6 $ 3.8 $ 1.0 $ 0.4 $ 0.6 $ 1.3 $ 0.5 $ 0.8
Unrealized holding losses $ 3.0 $ 1.2 $ 1.8 -- -- -- -- -- --
Reclassification
adjustment for gains
included in net income. $(11.8) $ (4.7) $ (7.1) -- -- -- -- -- --
</TABLE>
NOTE 10: INCENTIVE PLANS
Under the Hughes Electronics Corporation Incentive Plan ("the Plan"),
as approved by the GM Board of Directors in 1998, shares, rights or options to
acquire up to 35.6 million shares of GM Class H common stock on a cumulative
basis were available for grant through December 31, 1998.
The GM Executive Compensation Committee may grant options and other
rights to acquire shares of GM Class H common stock under the provisions of the
Plan. The option price is equal to 100% of the fair market value of GM Class H
common stock on the date the options are granted. These nonqualified options
generally vest over two to four years, expire ten years from date of grant and
are subject to earlier termination under certain conditions.
F-27
<PAGE>
HUGHES ELECTRONICS CORPORATION
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
As part of the Hughes Transactions, the outstanding options of former
Hughes employees who continued as Hughes employees were converted on December
18, 1997 into options to purchase recapitalized GM Class H common stock.
Recognition of compensation expense was not required in connection with the
conversion.
Changes in the status of outstanding options were as follows:
SHARES UNDER WEIGHTED-AVERAGE
OPTION EXERCISE PRICE
------ --------------
GM CLASS H COMMON STOCK
Outstanding at December 31, 1997....... 13,961,615 $ 29.08
Granted................................ 4,180,525 51.02
Exercised.............................. (1,506,241) 23.22
Terminated............................. (937,179) 31.79
---------- ---------
Outstanding at December 31, 1998....... 15,698,720 $ 35.32
========== =========
The following table summarizes information about the Plan stock options
outstanding at December 31, 1998:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------- -------------------
WEIGHTED-
AVERAGE WEIGHTED- WEIGHTED-
REMAINING AVERAGE AVERAGE
RANGE OF EXERCISE NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
------ ----------- ---- ----- ----------- -----
(YEARS)
$9.86 to $20.00 833,203 3.7 $14.70 833,203 $14.70
20.01 to 30.00 1,056,354 5.9 22.18 1,056,354 22.18
30.01 to 40.00 9,800,388 8.2 32.08 3,344,007 32.64
40.01 to 50.00 1,372,700 9.6 43.71 -- --
50.01 to 54.79 2,636,075 9.3 54.79 -- --
----------- ------ ------- ---------- -------
$9.86 to $54.79 15,698,720 8.1 $35.32 5,233,564 $27.67
=========== ====== ======= ========== =======
At December 31, 1998, 5,373,522 shares were available for grant under
the Plan subject to GM Executive Compensation Committee approval.
On May 5, 1997, PanAmSat adopted a stock option incentive plan with
terms similar to the Plan. As of December 31, 1998, PanAmSat had issued
1,493,319 options to purchase its common stock with exercise prices ranging from
$29.00 per share to $59.75 per share. The options vest ratably over three years
and have a remaining life of approximately nine years on the 1998 options and
eight and one-half years on the 1997 options. At December 31, 1998, 113,590
options were exercisable. The PanAmSat options have been considered in the
following pro forma analysis.
F-28
<PAGE>
HUGHES ELECTRONICS CORPORATION
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
The following table presents pro forma information as if Hughes
recorded compensation cost using the fair value of issued options on their grant
date:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(DOLLARS IN MILLIONS EXCEPT
PER SHARE AMOUNTS)
<S> <C> <C> <C>
Reported earnings used for computation of available separate
consolidated net income.......................................... $ 271.7 $470.7 $183.5
Assumed stock compensation cost, net of tax........................ 85.0 43.5 8.8
-------- ------- -------
Adjusted earnings used for computation of available separate
consolidated net income.......................................... $ 186.7 $427.2 $174.7
======== ======= =======
Reported earnings per share attributable to GM Class H common stock.. $0.68 $1.18 $0.46
Adjusted earnings per share attributable to GM Class H common stock.. $0.47 $1.07 $0.44
======== ======= =======
</TABLE>
For stock options granted prior to the Hughes Transactions, the
estimated compensation cost was based upon an allocation from former Hughes
which was calculated using the Black-Scholes valuation model for estimation of
the fair value of its options. The following table presents the estimated
weighted-average fair value of options granted and the assumptions used for the
1998 and 1997 calculations (stock volatility has been estimated based upon a
three-year average derived from a study of a Hughes determined peer group and
may not be indicative of actual volatility for future periods):
1998 1997
---- ----
Estimated fair value per option granted....... $22.78 $26.90
Average exercise price per option granted..... 51.02 31.71
Stock volatility.............................. 32.8% 32.5%
Average risk-free interest rate............... 5.63% 5.87%
Average option life in years.................. 6.2 7.0
NOTE 11: OTHER INCOME AND EXPENSES
1998 1997 1996
--------- --------- --------
(DOLLARS IN MILLIONS)
Gain on PanAmSat merger.......................... $489.7
Gain on sale of DIRECTV interest to AT&T......... -- $120.3
Equity losses from unconsolidated affiliates..... $(128.3) (72.2) (42.2)
Other............................................ (24.8) (26.8) (9.0)
------- ------- -----
Total other, net............................ $(153.1) $390.7 $69.1
======= ======= =====
Equity losses from unconsolidated affiliates at December 31, 1998, are
primarily comprised of losses at DIRECTV Japan, of which Hughes owns 31.6%, and
American Mobile Satellite Corporation, of which Hughes owns 20.7%.
F-29
<PAGE>
HUGHES ELECTRONICS CORPORATION
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
NOTE 12: RELATED-PARTY TRANSACTIONS
In the ordinary course of its operations, Hughes provides
telecommunications services and sells electronic components to, and purchases
sub-components from, related parties. In addition, prior to December 18, 1997,
Hughes received allocations of corporate expenses and interest costs from former
Hughes and GM.
The following table summarizes significant related-party transactions:
1998 1997 1996
------- ------- --------
(DOLLARS IN MILLIONS)
Revenues.................................. $40.5 $45.2 $50.8
Costs and expenses Purchases......... 29.0 275.4 241.5
Allocation of corporate expenses..... -- 77.5 75.6
Allocated interest................... -- 55.6 53.2
NOTE 13: EARNINGS PER SHARE ATTRIBUTABLE TO GM CLASS H COMMON STOCK AND
AVAILABLE SEPARATE CONSOLIDATED NET INCOME
Earnings per share attributable to GM Class H common stock is
determined based on the relative amounts available for the payment of dividends
to holders of GM Class H common stock. Holders of GM Class H common stock have
no direct rights in the equity or assets of Hughes, but rather have rights in
the equity and assets of GM (which includes 100% of the stock of Hughes).
Amounts available for the payment of dividends on GM Class H common
stock are based on the Available Separate Consolidated Net Income ("ASCNI") of
Hughes. The ASCNI of Hughes is determined quarterly and is equal to the separate
consolidated net income of Hughes, excluding the effects of GM purchase
accounting adjustments arising from GM's acquisition of Hughes (earnings used
for computation of ASCNI), multiplied by a fraction, the numerator of which is a
number equal to the weighted-average number of shares of GM Class H common stock
outstanding during the period and the denominator of which was 399.9 million
during 1998, 1997 and 1996. The denominator used in determining the ASCNI of
Hughes may be adjusted from time-to-time as deemed appropriate by the GM Board
of Directors to reflect subdivisions or combinations of the GM Class H common
stock and to reflect certain transfers of capital to or from Hughes. The GM
Board's discretion to make such adjustments is limited by criteria set forth in
GM's Restated Certificate of Incorporation.
For 1997 and 1996, ASCNI and earnings attributable to GM Class H common
stock are presented on a pro forma basis. Prior to the Hughes Transactions, such
amounts were calculated based on the financial performance of former Hughes.
Since the 1997 and 1996 financial statements relate only to the
telecommunications and space business of former Hughes prior to the consummation
of the Hughes Transactions, they do not reflect the earnings attributable to the
GM Class H common stock on a historical basis. The pro forma presentation is
used, therefore, to present the financial results which would have been achieved
for 1997 and 1996 relative to the GM Class H common stock had they been
calculated based on the performance of the telecommunication and space business
of former Hughes.
F-30
<PAGE>
HUGHES ELECTRONICS CORPORATION
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
Earnings per share represent basic earnings per share. The assumed
exercise of stock options does not have a dilutive effect since such exercises
do not currently result in a change to the GM Class H dividend base
(denominator) used in calculating earnings per share. As Hughes has no other
common stock equivalents that may impact the calculation, diluted earnings per
share are not presented.
Dividends may be paid on the GM Class H common stock only when, as, and
if declared by GM's Board of Directors in its sole discretion. Dividends may be
paid on GM Class H common stock to the extent of the amount initially determined
to be available for the payment of dividends on Class H common stock, plus the
portion of earnings of GM after the closing of the Hughes Transactions
attributed to GM Class H common stock. The GM Board determined that the amount
initially available for the payment of dividends on shares of the recapitalized
GM Class H common stock was the cumulative amount available for the payment of
dividends on GM Class H common stock immediately prior to the closing of the
Hughes Transactions, reduced by a pro rata portion of the net reduction in GM's
total stockholders' equity resulting from the Hughes Transactions. As of
December 31, 1998, the amount available for the payment of dividends on GM Class
H common stock was $3.8 billion. The GM Board does not currently intend to pay
cash dividends on the recapitalized GM Class H common stock.
NOTE 14: ACQUISITIONS
In December 1998, Hughes agreed to acquire all of the outstanding
capital stock of United States Satellite Broadcasting Company, Inc. ("USSB").
USSB provides DTH premium satellite programming in conjunction with DIRECTV's
basic programming service. USSB launched its service in June 1994 and, as of
December 31, 1998, had more than two million subscribers nationwide. The
acquisition will be accounted for using the purchase method of accounting. The
purchase price, consisting of cash and GM Class H common stock, will be
determined at closing based upon an agreed-upon formula and will not exceed $1.6
billion in the aggregate. Subject to certain limitations in the merger
agreement, USSB shareholders will be entitled to elect to receive cash or shares
of GM Class H common stock. The amount of cash to be paid in the merger cannot
be less than 30% or greater than 50% of the aggregate purchase price with the
remaining consideration consisting of GM Class H common stock. The merger, which
is subject to USSB shareholder approval and the receipt of appropriate
regulatory approval, is expected to close in early to mid-1999.
In October 1998, Hughes agreed to acquire, pending regulatory approval
in Mexico, an additional ownership interest in Grupo Galaxy Mexicana, S.A. de
C.V. ("GGM"), a Galaxy Latin America, LLC ("GLA") local operating company
located in Mexico, from Grupo MVS, S.A. de C.V. ("MVS"). Hughes' equity
ownership will represent 49.0% of the voting equity and all of the non-voting
equity of GGM. The GGM transaction will be accounted for using the purchase
method of accounting. As part of the GGM transaction, in October 1998 Hughes
acquired from MVS an additional 10.0% interest in GLA, increasing its ownership
interest to 70.0%, as well as an additional 19.8% interest in SurFin, a company
providing financing of subscriber receiver equipment for certain GLA local
operating companies located in Latin America and Mexico, increasing its
ownership percentage from 39.3% to 59.1%. The GLA and SurFin transactions were
accounted for using the purchase method of accounting. The increased ownership
F-31
<PAGE>
HUGHES ELECTRONICS CORPORATION
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
in SurFin resulted in its consolidation since the date of acquisition. The
aggregate purchase price for the transactions was $197.0 million in cash.
In May 1998, Hughes purchased an additional 9.5% interest in PanAmSat
for $851.4 million in cash, increasing Hughes' ownership interest in PanAmSat
from 71.5% to 81.0%.
In December 1997, Hughes repurchased from AT&T, a 2.5% equity interest
in DIRECTV, ending AT&T's marketing agreement to distribute the DIRECTV direct
broadcast satellite television service and DIRECTVTM receiver equipment. The
$161.8 million repurchase resulted in goodwill of approximately $156.1 million.
In May 1997, Hughes and PanAmSat, a leading provider of international
satellite services, merged their respective satellite service operations into a
new publicly-held company, which retained the name PanAmSat Corporation. Hughes
contributed its Galaxy(R) satellite services business in exchange for a 71.5%
interest in the new company. PanAmSat stockholders received a 28.5% interest in
the new company and $1.5 billion in cash. Such cash consideration and other
funds required to consummate the merger were funded by new debt financing
totaling $1,725.0 million provided by Hughes, which borrowed such funds from GM.
For accounting purposes, the merger was treated by Hughes as an
acquisition of 71.5% of PanAmSat and was accounted for using the purchase
method. Accordingly, the purchase price was allocated to the net assets
acquired, including intangible assets, based on estimated fair values at the
date of acquisition. The purchase price exceeded the fair value of net assets
acquired by $2.4 billion. In addition, the merger was treated as a partial sale
of the Galaxy business by Hughes and resulted in a one-time pre-tax gain of
$489.7 million ($318.3 million after-tax).
As the Hughes 1997 financial statements include only PanAmSat's results
of operations since the date of acquisition, the following selected unaudited
pro forma information is being provided to present a summary of the combined
results of Hughes and PanAmSat as if the acquisition had occurred as of the
beginning of the respective periods, giving effect to purchase accounting
adjustments. The pro forma data is presented for informational purposes only and
may not necessarily reflect the results of operations of Hughes had PanAmSat
operated as part of Hughes for the years ended December 31, 1997 and 1996, nor
are they necessarily indicative of the results of future operations. The pro
forma information excludes the effect of non-recurring charges.
<TABLE>
<CAPTION>
1997 1996
---- ----
(DOLLARS IN MILLIONS
EXCEPT PER SHARE AMOUNTS)
<S> <C> <C>
Total Revenues.............................................. $5,247.9 $4,189.8
Income before extraordinary item............................ 164.1 42.1
Net income.................................................. 143.5 42.1
Pro forma available separate consolidated net income........ 41.8 15.5
Pro forma earnings per share attributable to GM Class H
common stock............................................. $ 0.41 $ 0.16
</TABLE>
F-32
<PAGE>
HUGHES ELECTRONICS CORPORATION
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
NOTE 15: DERIVATIVE FINANCIAL INSTRUMENTS AND RISK MANAGEMENT
In the normal course of business, Hughes enters into transactions that
expose it to risks associated with foreign exchange rates. Hughes utilizes
derivative instruments in an effort to mitigate these risks. Hughes' policy does
not allow speculation in derivative instruments for profit or execution of
derivative instrument contracts for which there are no underlying exposures.
Instruments used as hedges must be effective at reducing the risk associated
with the exposure being hedged and designated as a hedge at the inception of the
contract. Accordingly, changes in market values of hedge instruments are highly
correlated with changes in market values of the underlying transactions, both at
the inception of the hedge and over the life of the hedge contract.
Hughes primarily uses foreign exchange-forward contracts to hedge firm
commitments denominated in foreign currencies. Foreign exchange-forward
contracts are legal agreements between two parties to purchase and sell a
foreign currency, for a price specified at the contract date, with delivery and
settlement in the future. The total notional amounts of contracts afforded hedge
accounting treatment at December 31, 1998 and 1997 were not significant.
Hughes is exposed to credit risk in the event of non-performance by the
counterparties to its foreign exchange-forward contracts. While Hughes believes
this risk is remote, credit risk is managed through the periodic monitoring and
approval of financially sound counterparties.
In connection with debt refinancing activities by PanAmSat in 1997,
PanAmSat entered into certain U.S. Treasury rate lock contracts to reduce its
exposure to fluctuations in interest rates. The aggregate notional value of
these contracts was $375.0 million and these contracts were accounted for as
hedges. The cost to settle these instruments in 1998 was $9.1 million and is
being amortized to interest expense over the term of the related debt
securities.
NOTE 16: DISCONTINUED OPERATIONS
On December 15, 1997, Hughes sold substantially all of the assets and
liabilities of Hughes Avicom International, Inc. ("Hughes Avicom") to Rockwell
Collins, Inc. for cash. Hughes Avicom is a supplier of products and services to
the commercial airline market. Hughes recorded an after-tax gain of $62.8
million on the sale. The net operating results of Hughes Avicom have been
reported, net of applicable income taxes, as "Income (Loss) from discontinued
operations, net of taxes" and the net cash flows as "Net cash used by
discontinued operations."
Summarized financial information for Hughes Avicom follows:
1997 1996
---- ----
(DOLLARS IN MILLIONS)
Revenues......................... $102.5 $89.9
Net income (loss)................ 1.2 (7.4)
* Includes the results of Hughes Avicom through December 15, 1997.
F-33
<PAGE>
HUGHES ELECTRONICS CORPORATION
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
NOTE 17: SEGMENT REPORTING
Hughes' segments, which are differentiated by their products and
services, include Direct-To-Home Broadcast, Satellite Services, Satellite
Systems and Network Systems. Direct-To-Home Broadcast is engaged in acquiring,
promoting, selling and/or distributing digital programming via satellite to
residential and commercial customers. Satellite Services is engaged in the
selling, leasing and operating of satellite transponders and providing services
for cable television systems, news companies, Internet service providers and
private business networks. Satellite Systems designs, manufactures and markets
satellites and satellite components. Network Systems products include
satellite-based business networks and Internet access service, cellular-based
fixed wireless telephone systems and mobile cellular digital packet data
systems. Other includes the corporate office and other entities.
<TABLE>
<CAPTION>
DIRECT-
TO-HOME SATELLITE SATELLITE NETWORK
BROADCAST SERVICES SYSTEMS SYSTEMS OTHER ELIMINATIONS TOTAL
--------- -------- ------- ------- ----- ------------ -----
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C> <C>
1998
External Revenues............... $1,813.7 $643.8 $2,493.4 $1,000.6 $ 12.4 $5,963.9
Intersegment Revenues........... 2.4 123.5 337.7 76.1 0.8 $ (540.5) --
-------- ------ -------- -------- ------ ---------- --------
Total Revenues.................. $1,816.1 $767.3 $2,831.1 $1,076.7 $ 13.2 $ (540.5) $5,963.9
-------- ------ -------- -------- ------ ---------- --------
Operating Profit (1)............ $ (228.1) $318.3 $ 246.3 $ 10.9 $(68.2) $ (30.1) $ 249.1
Depreciation and Amortization (1) 102.3 235.0 49.2 41.7 31.6 (5.0) 454.8
Intangibles, net................ -- 2,433.5 -- 53.6 1,065.1 -- 3,552.2
Segment Assets (2).............. 2,190.4 5,890.5 1,491.2 1,299.0 2,856.8 (292.9) 13,435.0
Capital Expenditures (3)........ 230.8 921.7 99.7 40.0 3.3 133.0 1,428.5
-------- ------ -------- -------- ------ ---------- --------
1997
External Revenues............... $1,276.9 $537.3 $2,290.0 $ 998.3 $ 25.8 $5,128.3
Intersegment Revenues........... -- 92.6 201.9 13.0 2.7 $ (310.2) --
-------- ------ -------- -------- ------ ---------- --------
Total Revenues.................. $1,276.9 $629.9 $2,491.9 $1,011.3 $ 28.5 $ (310.2) $5,128.3
-------- ------ -------- -------- ------ ---------- --------
Operating Profit (1)............ $ (254.6) $292.9 $ 226.3 $ 74.1 $(47.9) $ (5.4) $ 285.4
Depreciation and Amortization (1) 86.1 145.2 39.4 32.0 14.7 -- 317.4
Intangibles, net................ -- 2,498.5 -- -- 456.3 -- 2,954.8
Segment Assets (2).............. 1,408.7 5,682.4 1,312.6 1,215.6 3,298.1 (186.4) 12,731.0
Capital Expenditures (3)........ 105.6 625.7 113.9 43.1 0.4 (62.1) 826.6
-------- ------ -------- -------- ------ ---------- --------
1996
External Revenues............... $ 621.0 $381.7 $1,950.4 $1,049.6 $ 6.0 $4,008.7
Intersegment Revenues........... -- 101.1 106.0 20.4 1.7 $ (229.2) --
-------- ------ -------- -------- ------ ---------- --------
Total Revenues.................. $ 621.0 $482.8 $2,056.4 $1,070.0 $ 7.7 $ (229.2) $4,008.7
-------- ------ -------- -------- ------ ---------- --------
Operating Profit (1)............ $ (319.8) $239.1 $ 183.3 $ 107.7 $(13.5) $ (7.7) $ 189.1
Depreciation and Amortization (1) 67.3 58.5 34.4 28.3 27.1 -- 215.6
Intangibles, net................ -- 72.9 -- -- 395.1 -- 468.0
Segment Assets (2).............. 1,023.4 1,275.5 757.8 964.0 457.1 (105.2) 4,372.6
Capital Expenditures (3)........ 63.5 308.7 87.8 45.3 - (55.9) 449.4
-------- ------ -------- -------- ------ ---------- --------
</TABLE>
See Notes on next page.
Certain 1997 and 1996 amounts have been reclassified to conform with the
1998 presentation.
F-34
<PAGE>
HUGHES ELECTRONICS CORPORATION
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
(1) Includes amortization arising from purchase accounting adjustments related
to GM's acquisition of Hughes amounting to $3.3 million in each of the
years for the Satellite Services segment and $17.7 million in each of the
years in Other.
(2) Assets of the Satellite Services segment and Other include the unamortized
purchase accounting adjustments associated with GM's acquisition of Hughes.
Satellite Services includes unamortized purchase accounting adjustments of
$66.3 million in 1998, $69.6 million in 1997 and $72.9 million in 1996.
Other includes unamortized purchase accounting adjustments of $360.3
million in 1998, $378.0 million in 1997 and $395.7 million in 1996.
(3) Includes expenditures related to satellites in segments as follows: $70.2
million in 1998 for Direct-To-Home Broadcast segment and $726.3 million,
$606.1 million and $259.2 million in 1998, 1997 and 1996, respectively, for
Satellite Services segment. Satellite Services segment also includes $155.5
million in 1998 related to the early buy-out of satellite sale-leasebacks.
A reconciliation of operating profit to income from continuing
operations before income taxes, minority interests, extraordinary item and
cumulative effect of accounting change, as shown in the Statement of Income and
Available Separate Consolidated Net Income, follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(DOLLARS IN MILLIONS)
<S> <C> <C> <C>
Operating profit.................................................... $249.1 $285.4 $189.1
Interest income..................................................... 112.3 33.1 6.8
Interest expense.................................................... (17.5) (91.0) (42.9)
Other, net.......................................................... (153.1) 390.7 69.1
------- -------- --------
Income from continuing operations before income taxes, minority
interests, extraordinary item and cumulative effect of accounting
change............................................................ $190.8 $618.2 $222.1
====== ====== ======
</TABLE>
F-35
<PAGE>
HUGHES ELECTRONICS CORPORATION
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
The following table presents revenues earned from customers located in different
geographic areas. Property and satellites are grouped by their physical
location. All satellites are reported as United States assets.
<TABLE>
<CAPTION>
1998 1997 1996
------------------- ------------------- -------------------
NET NET NET
TOTAL PROPERTY & TOTAL PROPERTY & TOTAL PROPERTY &
REVENUES SATELLITES REVENUES SATELLITES REVENUES SATELLITES
-------- ---------- -------- ---------- -------- ----------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
North America
United States....... $ 3,534.3 $ 4,206.3 $ 2,851.1 $ 3,507.1 $2,613.1 $ 1,725.1
Canada and Mexico... 136.7 2.0 101.3 -- 27.4 --
--------- --------- --------- --------- -------- ---------
Total North America..... 3,671.0 4,208.3 2,952.4 3,507.1 2,640.5 1,725.1
--------- --------- --------- --------- -------- ---------
Europe
United Kingdom...... 842.4 14.1 583.3 10.4 336.2 8.0
Other............... 275.5 0.6 419.0 0.4 290.0 0.3
--------- --------- --------- --------- -------- ---------
Total Europe............ 1,117.9 14.7 1,002.3 10.8 626.2 8.3
--------- --------- --------- --------- -------- ---------
Latin America
Brazil.............. 184.9 4.6 131.2 -- 48.6 --
Other............... 104.2 11.2 90.4 -- 23.1 --
--------- --------- --------- --------- -------- ---------
Total Latin America..... 289.1 15.8 221.6 -- 71.7 --
--------- --------- --------- --------- -------- ---------
Asia
Japan............... 185.9 0.6 147.9 0.5 119.7 0.4
India............... 83.4 14.7 46.5 12.7 8.0 11.7
China............... 63.4 1.7 154.5 1.5 125.2 1.4
Other............... 214.7 0.6 477.8 0.5 387.3 0.5
--------- --------- --------- --------- -------- ---------
Total Asia.............. 547.4 17.6 826.7 15.2 640.2 14.0
--------- --------- --------- --------- -------- ---------
Total Middle East....... 284.3 -- 77.7 -- 1.2 --
Total Africa............ 54.2 0.3 47.6 -- 28.9 --
--------- --------- --------- --------- -------- ---------
Total............... $ 5,963.9 $ 4,256.7 $ 5,128.3 $ 3,533.1 $4,008.7 $ 1,747.4
========= ========= ========= ========= ======== =========
</TABLE>
NOTE 18: COMMITMENTS AND CONTINGENCIES
In connection with the 1997 spin-off of Hughes Defense and its
subsequent merger with Raytheon, a process was agreed to among GM, Hughes and
Raytheon for resolving disputes that might arise in connection with post-closing
adjustments called for by the terms of the merger agreement. Such adjustments
might call for a cash payment between Hughes and Raytheon. A dispute currently
exists regarding the post-closing adjustments which Hughes and Raytheon have
proposed to one another. In an attempt to resolve the dispute, Hughes gave
notice to Raytheon to commence the arbitration process. Raytheon responded by
filing an action in Delaware Chancery Court which seeks to enjoin the
arbitration as premature. It is possible that the ultimate resolution of the
post-closing financial adjustment provision of the merger agreement may result
in Hughes making a payment to Raytheon that could be material to Hughes.
However, the amount of any payment that either party might be required to make
to the other is not determinable at this time. Hughes intends to vigorously
pursue resolution of the dispute through the arbitration process, opposing the
adjustments Raytheon seeks and seeking the payment from Raytheon that it has
proposed.
Hughes has entered into agreements to procure commercial satellite
launches, a significant number of which are expected to be used in connection
with satellites ordered by outside customers. The agreements provide for
launches beginning in 1999 and also contain options for additional launch
vehicles. The total amount of the commitments, which is dependent upon the
F-36
<PAGE>
HUGHES ELECTRONICS CORPORATION
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
number of options exercised, market conditions and other factors, could exceed
$2.0 billion.
Hughes has a long-term agreement for multiple launch services aboard
expendable launch vehicles using the Sea Launch ocean-based commercial launch
system. Hughes plans to use options under this agreement to deliver
communications satellites in-orbit. Sea Launch is scheduled to demonstrate the
capabilities of its ocean-based commercial launch system with its first launch
in March 1999. The first launch will carry a demonstration payload having the
same mission and physical characteristics (weight, size, etc.) as an HS 702
commercial communications satellite. If the first launch is not successful or
delayed, Hughes could be required by customers to procure other launch vehicles
to satisfy its contractual obligations, which may lead to higher operating
costs.
DIRECTV has an agreement with General Electric Capital Corporation
("GECC") under which GECC agreed to provide an open-end revolving credit program
for consumer purchases of DIRECTV receiver equipment, installations and
ancillary items at selected retail establishments. Funding under this program
was discontinued effective September 10, 1996. The aggregate outstanding balance
under this agreement at December 31, 1998 was approximately $190.0 million.
Hughes has certain rights regarding the administration of the program, and the
losses from qualifying accounts under this program accrue to Hughes, subject to
certain indemnity obligations of GECC. Hughes has established allowances to
provide for expected losses under the program. The allowances are subject to
periodic review based on information regarding the status of the program. A
complaint and counterclaim have been filed by the parties in the U.S. District
Court for the District of Connecticut concerning GECC's performance and
DIRECTV's obligation to act as a surety. GECC claims damages from DIRECTV in
excess of $140.0 million. DIRECTV seeks damages from GECC in excess of $70.0
million. Hughes intends to vigorously contest GECC's allegations and pursue its
own contractual rights and remedies. Hughes does not believe that the litigation
will have a material adverse impact on Hughes' results of operations or
financial position. Discovery is not yet completed in the case and no trial date
has been set.
In December 1994, former Hughes entered into an agreement with Computer
Sciences Corporation ("CSC") whereby CSC provides a significant amount of data
processing services required by the non-automotive businesses of former Hughes.
Baseline service payments to CSC are expected to aggregate approximately $1.5
billion over the term of the eight-year agreement for former Hughes. Based on
historical usage, approximately 17% of the costs incurred under the agreement
are attributable to Hughes. The contract is cancelable by Hughes with early
termination penalties.
At December 31, 1998, minimum future commitments under noncancelable
operating leases having lease terms in excess of one year, exclusive of
satellite transponders leaseback payments disclosed in Note 4, are primarily for
real property and aggregated $323.8 million, payable as follows: $56.6 million
in 1999, $53.3 million in 2000, $52.3 million in 2001, $50.3 million in 2002,
$29.4 million in 2003 and $81.9 million thereafter. Certain of these leases
contain escalation clauses and renewal or purchase options. Rental expenses
under operating leases were $62.0 million in 1998, $72.2 million in 1997 and
$52.7 million in 1996.
F-37
<PAGE>
HUGHES ELECTRONICS CORPORATION
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
In conjunction with its performance on long-term contracts, Hughes is
contingently liable under standby letters of credit and bonds in the amount of
$294.3 million at December 31, 1998. In Hughes' past experience, no material
claims have been made against these financial instruments. In addition, Hughes
has guaranteed up to $204.6 million of bank debt, including $150.0 million
related to American Mobile Satellite Corporation, and up to $22.1 million of
capital lease obligations. $150.0 million of bank debt matures in March 2003;
the remaining $54.6 million of bank debt matures in September 2007. The capital
lease obligations are due in variable amounts over the next five years.
In connection with the DTH broadcast businesses, Hughes has commitments
related to certain programming agreements which are variable based upon the
number of underlying subscribers and market penetration rates. Minimum payments
over the terms of applicable contracts are anticipated to be approximately
$700.0 million to $800.0 million.
Hughes is subject to potential liability under government regulations
and various claims and legal actions which are pending or may be asserted
against it. The aggregate ultimate liability of Hughes under these claims and
actions was not determinable at December 31, 1998. In the opinion of Hughes
management, such liability is not expected to have a material adverse effect on
Hughes' results of operations or financial position.
NOTE 19: SUBSEQUENT EVENTS
Hughes entered into a contract with Asia-Pacific Mobile
Telecommunications Satellite Pte. Ltd. ("APMT") effective May 15, 1998, whereby
Hughes was to provide to APMT a satellite-based mobile telecommunications system
consisting of two satellites, a ground segment, user terminals and associated
equipment and software. As part of the contract, Hughes was required to obtain
all necessary U.S. Government export licenses for the APMT system by February
15, 1999. On February 24, 1999, the Department of Commerce notified Hughes that
it intends to deny the export licenses required by Hughes to fulfill its
contractual obligation to APMT. Hughes has until March 16, 1999 to request
reconsideration of the decision. As a result of Hughes failing to obtain the
export licenses, APMT has the right to terminate the contract. At this time,
there are ongoing discussions between Hughes and APMT regarding the contract,
and between Hughes and the U.S. Government regarding the export licenses. If the
U.S. Government ultimately denies the required export licenses or APMT
terminates the contract, Hughes could be required to refund $45.0 million to
APMT and record a pre-tax charge to earnings of approximately $100 million in
1999.
On January 22, 1999, Hughes agreed to acquire Primestar, Inc.'s
("Primestar") 2.3 million-subscriber medium-power DTH business. In a related
transaction, Hughes also agreed to acquire the high-power satellite assets and
direct broadcast satellite ("DBS") orbital frequencies of Tempo, a wholly-owned
subsidiary of TCI Satellite Entertainment, Inc. The acquisitions will be
accounted for using the purchase method of accounting. The purchase price for
the DTH business will be comprised of $1.1 billion in cash and 4,871,448 shares
of GM Class H common stock, for a total purchase price of $1,325.0 million. The
DTH transaction, pending regulatory and Primestar lender approval, is expected
to close in early to mid-1999. The purchase price for the Tempo assets consists
of $500.0 million in cash, $150.0 million of which is expected to be paid in
F-38
<PAGE>
HUGHES ELECTRONICS CORPORATION
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
early to mid-1999 and $350.0 million of which is payable upon Federal
Communications Commission approval of the transfer of the DBS orbital
frequencies, which is expected in mid to late-1999.
Hughes has maintained a suit against the U.S. Government since
September 1973 regarding the Government's infringement and use of a Hughes
patent (the "Williams Patent") covering "Velocity Control and Orientation of a
Spin Stabilized Body," principally satellites. On April 7, 1998, the U.S. Court
of Appeals for the Federal Circuit ("CAFC") reaffirmed earlier decisions in the
Williams case including the award of $114.0 million in damages. The CAFC ruled
that the conclusions previously reached in the Williams case were consistent
with the U.S. Supreme Court's findings in the Warner-Jenkinson case. The U.S.
Government petitioned the CAFC for a rehearing, was denied the request, and
thereafter applied for certiorari to the U.S. Supreme Court.
On March 1, 1999, the U.S. Supreme Court denied the U.S. Government's
petition for certiorari. The case will be remanded back to the trial court
(Court of Claims) for entry of the final judgment. While no amount has been
recorded in the financial statements of Hughes to reflect the $114.0 million
award or the interest accumulating thereon as of December 31, 1998, it is
expected that resolution of this matter will result in the recognition of a
pre-tax gain of approximately $150 million during 1999.
The GGM transaction (discussed in Note 14) received regulatory approval
and closed in February 1999.
F-39
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
PRIMESTAR, Inc.:
We have audited the accompanying consolidated balance sheets of PRIMESTAR,
Inc. and subsidiaries (as defined in note 1) as of December 31, 1998 and 1997
and the related consolidated statements of operations, equity (deficit), and
cash flows for each of the years in the three-year period ended December 31,
1998. In connection with our audit of the consolidated financial statements, we
have also audited the financial statement schedule listed in the index at Item
14(a). These consolidated financial statements and the financial statement
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on these consolidated financial statements and the
financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of PRIMESTAR,
Inc. and subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 1998, in conformity with generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material respects, the information set forth therein.
KPMG LLP
Denver, Colorado
April 15, 1999
F-40
<PAGE>
PRIMESTAR INC. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 1998 and 1997
<TABLE>
<CAPTION>
1998 1997
------------------- -------------------
amounts in thousands
Assets
- - ------
<S> <C> <C>
Cash and cash equivalents $ -- 6,084
Trade accounts receivable 117,655 40,386
Other receivables 29,387 --
---------- ---------
147,042 40,386
Less allowance for doubtful accounts 7,442 5,307
---------- ---------
139,600 35,079
---------- ---------
Prepaid expenses 3,967 1,262
Investment in PRIMESTAR Partners L.P. (the "Partnership")
(note 3) -- 11,093
Property and equipment, at cost:
Satellites -- 463,133
Satellite reception equipment 1,198,376 674,387
Subscriber installation costs 270,384 227,131
Support equipment 93,698 34,389
---------- ---------
1,562,458 1,399,040
Less accumulated depreciation 413,868 277,103
---------- ---------
1,148,590 1,121,937
---------- ---------
Intangible assets, net of accumulated amortization (note 6) 786,373 --
Deferred financing costs and other assets, net of accumulated
amortization 33,557 29,401
---------- ---------
$2,112,087 1,204,856
========== =========
</TABLE>
(continued)
F-41
<PAGE>
PRIMESTAR INC. AND SUBSIDIARIES
Consolidated Balance Sheets, continued
December 31, 1998 and 1997
<TABLE>
<CAPTION>
1998 1997
--------------------- ---------------------
amounts in thousands
Liabilities and Stockholders' Equity (Deficit)
- - ----------------------------------------------
<S> <C> <C>
Accounts payable $ 195,873 50,755
Accrued charges from related parties (note 12) 14,792 62,816
Accrued commissions 16,296 10,435
Accrued interest payable 16,142 8,658
Other accrued expenses 104,463 17,712
Deferred revenue 100,948 29,675
Due to the Partnership (note 13) -- 463,133
Debt (note 8) 1,833,195 418,729
Deferred income taxes (note 11) 75,057 --
Other liabilities 40,095 6,674
----------- ---------
Total liabilities 2,396,861 1,068,587
----------- ---------
Stockholders' Equity (Deficit) (note 9):
PRIMESTAR, Inc. ("PRIMESTAR") preferred stock, $.01 par
value; authorized 350,000,000 shares; none issue -- --
PRIMESTAR Class A common stock, $.01 par value;
authorized 850,000,000 shares; issued 179,143,934 in
1998 1,791 --
PRIMESTAR Class B common stock, $.01 par value;
authorized 50,000,000 shares; issued 8,465,324 in 1998 85 --
PRIMESTAR Class C common stock, $.01 par value;
authorized 30,000,000 shares; issued 13,332,365 in 1998 133 --
PRIMESTAR Class D common stock, $.01 par value;
authorized 150,000,000 shares; none issued -- --
TCI Satellite Entertainment, Inc. ("TSAT") preferred
stock, $.01 per value; authorized 5,000,000 shares;
none issued -- --
TSAT Series A common stock; $1 par value; authorized
185,000,000 shares; issued 58,239,136 shares in 1997 -- 58,239
TSAT Series B common stock, $1 par value; authorized
10,000,000 shares; issued 8,465,324 shares in 1997 -- 8,465
Additional paid-in capital 1,511,041 523,685
Accumulated deficit (1,797,824) (454,120)
----------- ---------
Total stockholders' equity (deficit) (284,774) 136,269
----------- ---------
Commitments and contingencies (note 13) $ 2,112,087 1,204,856
=========== =========
</TABLE>
See accompanying notes to consolidated financial statements.
F-42
<PAGE>
PRIMESTAR INC. AND SUBSIDIARIES
Consolidated Statements of Operations
Years ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
1998 1997 1996
------------------- ------------------- -------------------
amounts in thousands,
except per share amounts
<S> <C> <C> <C>
Revenue:
Programming and equipment rental $ 1,227,270 512,894 351,548
Installation 62,396 49,096 65,913
----------- -------- --------
1,289,666 561,990 417,461
----------- -------- --------
Operating costs and expenses:
Charges from the Partnership
(note 12) 82,235 259,600 188,724
Operating (note 12) 565,510 23,992 28,546
Selling, general and administrative
(note 12) 438,795 198,263 193,566
Transition (note 12) 20,855 -- --
Restructuring charges (note 10) 26,025 -- --
Impairment of long-lived assets (note 2) 950,289 -- --
Stock compensation 414 8,092 (446)
Depreciation (note 5) 445,911 243,642 191,355
Amortization 97,176 -- --
----------- -------- --------
2,627,210 733,589 601,745
----------- -------- --------
Operating loss (1,337,544) (171,599) (184,284)
----------- -------- --------
Other income (expense):
Interest expense (145,939) (47,992) (2,023)
Share of losses of the Partnership (5,822) (20,473) (3,275)
Other, net (1,927) 1,723 3,641
----------- -------- --------
(153,688) (66,742) (1,657)
----------- -------- --------
Loss before income taxes (1,491,232) (238,341) (185,941)
Income tax benefit (note 11) 147,528 -- 45,937
----------- -------- --------
Net loss $(1,343,704) (238,341) (140,004)
=========== ======== ========
Basic and diluted loss per common share
(note 6) $ (8.02) (3.58) (2.11)
=========== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-43
<PAGE>
PRIMESTAR INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity (Deficit)
Years ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
PRIMESTAR Common Stock TSAT Common Stock
---------------------------------------------- -----------------------
Class A Class B Class C Series A Series B
------------------ ----------------- ------- ------------ ---------
amounts in thousands
<S> <C> <C> <C> <C> <C>
Balance at January 1, 1996 $ -- -- -- -- --
Net loss -- -- -- -- --
TCIC intercompany allocations -- -- -- -- --
Net cash transfers from TCIC -- -- -- -- --
Recognition of deferred tax assets
upon transfer of PRIMESTAR
Partners investment in connection
with Distribution (note 4) -- -- -- -- --
Adjustment to reflect consummation
of Distribution (note 4) -- -- -- 57,941 8,467
Issuance of TSAT Series A Common
Stock upon conversion of notes of
Tele-Communications, Inc. -- -- -- 5 --
------------------ ----------------- ------- ------- --------
Balance at December 31, 1996 -- -- -- 57,946 8,467
Net loss -- -- -- -- --
Recognition of stock compensation
related to stock options and
restricted stock awards -- -- -- -- --
Issuance of TSAT Series A Common
Stock related to restricted stock awards -- -- -- 33 --
Issuance of TSAT Series A Common
Stock upon conversion of convertible
securities of Tele-Communications, Inc. -- -- -- 258 --
Conversion of TSAT Series B to TSAT
Series A -- -- -- 2 (2)
------------------ ----------------- ------- ------- --------
Balance at December 31, 1997 -- -- -- 58,239 8,465
Net loss -- -- -- -- --
Recognition of stock compensation
related to stock options and
restricted stock awards -- -- -- -- --
Issuance of TSAT Series A Common
Stock related to restricted stock awards -- -- -- 50 --
Issuance of TSAT Series A Common
Stock upon conversion of convertible
securities of Tele-Communications, Inc. -- -- -- 989 --
Issuance of PRIMESTAR common stock
in Restructuring (note 3) 1,791 85 133 (59,278) (8,465)
Reimbursement of TSAT expenses (note
12) -- -- -- -- --
------------------ ----------------- ------- ------- --------
Balance at December 31, 1998 $1,791 85 133 -- --
================== ================= ======= ======= ========
<CAPTION>
Due to TCI
Additional Communications, Total
paid-in Accumulated Inc. stockholders'
capital deficit ("TCIC") equity (deficit)
-------------- ----------- ---------------- ----------------
amounts in thousands
<C> <C> <C> <C>
Balance at January 1, 1996 -- (75,775) 559,359 483,584
Net loss -- (140,004) -- (140,004)
TCIC intercompany allocations -- -- 21,009 21,009
Net cash transfers from TCIC -- -- 228,622 228,622
Recognition of deferred tax assets
upon transfer of PRIMESTAR
Partners investment in connection
with Distribution (note 4) -- -- 29,142 29,142
Adjustment to reflect consummation
of Distribution (note 4) 521,724 -- (838,132) (250,000)
Issuance of TSAT Series A Common
Stock upon conversion of notes of
Tele-Communications, Inc. -- -- -- 5
-------------- ----------- ---------------- ----------------
Balance at December 31, 1996 521,724 (215,779) -- 372,358
Net loss -- (238,341) -- (238,341)
Recognition of stock compensation
related to stock options and
restricted stock awards 1,781 -- -- 1,781
Issuance of TSAT Series A Common
Stock related to restricted stock awards 180 -- -- 213
Issuance of TSAT Series A Common
Stock upon conversion of convertible
securities of Tele-Communications, Inc. -- -- -- 258
Conversion of TSAT Series B to TSAT
Series A -- -- -- --
-------------- ----------- ---------------- ----------------
Balance at December 31, 1997 523,685 (454,120) -- 136,269
Net loss -- (1,343,704) -- (1,343,704)
Recognition of stock compensation
related to stock options and
restricted stock awards 2,596 -- -- 2,596
Issuance of TSAT Series A Common
Stock related to restricted stock awards (50) -- -- --
Issuance of TSAT Series A Common
Stock upon conversion of convertible
securities of Tele-Communications, Inc. -- -- -- 989
Issuance of PRIMESTAR common stock
in Restructuring (note 3) 984,962 -- -- 919,228
Reimbursement of TSAT expenses (note
12) (152) -- -- (152)
-------------- ----------- ---------------- ----------------
Balance at December 31, 1998 1,511,041 (1,797,824) -- (284,774)
============== =========== ================ ================
</TABLE>
See accompanying notes to consolidated financial statements.
F-44
<PAGE>
PRIMESTAR INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
1998 1997 1996
------------- --------- ---------
amounts in thousands
(see note 7)
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $(1,343,704) (238,341) (140,004)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Depreciation and amortization 543,087 243,642 191,355
Share of losses of the Partnership 5,822 20,473 3,275
Accretion of debt discount 20,941 16,719 --
Restructuring charges 26,025 -- --
Payments related to restructuring charges (6,388) -- --
Impairment of long-lived assets 950,289 -- --
Stock compensation 414 8,092 (446)
Payments related to stock appreciation rights (2,479) -- --
Deferred income tax expense (benefit) (147,528) -- 24,708
Other non-cash charges (credits) 3,940 6,919 (311)
Changes in operating assets and liabilities, net of the
effect of the Restructuring:
Change in receivables (79,838) (15,014) 4,364
Change in prepaids 3,417 (335) (841)
Change in accruals, payables and other
liabilities 132,375 42,056 24,096
Change in deferred revenue 30,802 7,426 9,005
----------- -------- --------
Net cash provided by operating activities 137,175 91,637 115,201
----------- -------- --------
Cash flows from investing activities:
Cash paid in Restructuring (54,894) -- --
Capital expended for property and equipment (563,334) (227,327) (326,621)
Capital expended for construction of satellites -- (5,448) (74,785)
Additional investments in, and related advances to, the
Partnership (75) (7,073) (17,552)
Repayments of advances to the Partnership -- 7,815 --
Other investing activities (6,365) (1,581) (5,458)
----------- -------- --------
Net cash used in investing activities (624,668) (233,614) (424,416)
----------- -------- --------
Cash flows from financing activities:
Borrowings of debt 959,761 498,061 259,000
Repayments of debt (469,858) (344,699) (263,000)
Payment of deferred financing costs (9,483) (17,780) (7,000)
Proceeds from issuance of common stock 989 471 --
Increase in due to the Partnership -- 5,448 74,785
Increase in due to TCIC -- -- 250,189
----------- -------- --------
Net cash provided by financing activities 481,409 141,501 313,974
----------- -------- --------
Net increase (decrease) in cash and cash
equivalents (6,084) (476) 4,759
Cash and cash equivalents:
Beginning of year 6,084 6,560 1,801
----------- -------- --------
End of year $ -- 6,084 6,560
============ ======== ========
</TABLE>
See accompanying notes to financial statements.
F-45
<PAGE>
PRIMESTAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
(1) Organization and Basis of Presentation
--------------------------------------
The accompanying consolidated financial statements of PRIMESTAR, Inc.
("PRIMESTAR" or the "Company") include the historical financial information
of (i) certain satellite television assets (collectively, "TCI SATCO") of
TCIC, a subsidiary of Tele-Communications, Inc. ("TCI") for periods prior
to the December 4, 1996 consummation of the distribution transaction
described in note 4, (ii) TSAT and its consolidated subsidiaries for the
period from December 5, 1996 through March 31, 1998 and (iii) PRIMESTAR and
its consolidated subsidiaries for the period subsequent to March 31, 1998.
PRIMESTAR was incorporated on August 27, 1997, and subsequently, ten shares
of the Company's common stock were issued to TSAT for a capital
contribution of $10. All significant inter-entity and intercompany
transactions have been eliminated.
The Company owns and operates the PRIMESTAR(R) direct to home satellite
service throughout the continental U.S. The PRIMESTAR(R) service is
transmitted via a satellite ("GE-2") owned and operated by GE American
Communications ("GE Americom") at the 85 West Longitude ("W.L.") orbital
position.
(2) The Hughes Transactions
-----------------------
On January 22, 1999, PRIMESTAR announced that it had reached an agreement
with Hughes Electronics Corporation ("Hughes"), a subsidiary of General
Motors Corporation, to sell its medium-power direct broadcast satellite
("DBS") business and assets to Hughes for $1.1 billion in cash and 4.871
million shares of General Motors Class H common stock ("GMH Stock") valued
at approximately $225 million, based on the closing price of GMH Stock on
the date of the purchase agreement (the "Hughes Medium Power Transaction").
The foregoing purchase price is subject to adjustments for working capital
at the date of closing. The Company is responsible for the payment of
certain obligations not assumed by Hughes, satisfaction of its funded
indebtedness and the payment of costs, currently estimated to range from
$270 million to $340 million, associated with the termination of certain
vendor and service contracts and lease agreements related to the Company's
medium power business and proposed high power business strategy. The
consummation of the Hughes Medium Power Transaction is subject to various
consents from PRIMESTAR's lenders; restructuring of certain of the
Company's indebtedness, as described below; and other customary conditions.
On February 1, 1999 and in connection with the Hughes Medium Power
Transaction, the Company commenced tender offers (the "Tender Offers") to
purchase 100% of the outstanding principal amount of the Company's 10 7/8%
Senior Subordinated Notes due 2007 (the "Senior Subordinated Notes") at a
price of $670 per $1,000 principal amount and 100% of the outstanding
principal amount of the Company's 12 1/4% Senior Subordinated Discount
Notes due 2007 (the "Senior Subordinated Discount Notes", and together with
the Senior Subordinated Notes, the "Notes") at a price of 67% of the
accreted value of the Senior Subordinated Discount Notes as of February 15,
1999.
(continued)
F-46
<PAGE>
PRIMESTAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
In addition, PRIMESTAR made a separate offer to lenders under the
Company's Senior Subordinated Credit Agreement, dated as of April 1, 1998
(the "Interim Loan Agreement"), to purchase 100% of the outstanding
principal amount due thereunder at a price of $670 per $1,000 principal
amount (the "Offer to Purchase"). Each of the Tender Offers and the Offer
to Purchase was subject to a minimum tender condition of 90% of the
outstanding principal amount of such issue. In conjunction with the Tender
Offers, PRIMESTAR solicited consents to certain proposed amendments to the
indentures governing the Notes and the Interim Loan that would eliminate
substantially all of the restrictive covenants thereunder and would amend
certain other provisions. Consummation of both the Tender Offers and the
Offer to Purchase was conditioned upon the closing of the Hughes Medium
Power Transaction and other conditions.
Following several extensions, the Tender Offer and the Offer to Purchase
expired on March 25, 1999. The minimum tender conditions were not
satisfied under the Tender Offer and Offer to Purchase, and no securities
or loans were purchased thereunder.
Since the announcement of the Hughes Medium Power Agreement and of the
proposed restructuring of the Company's senior subordinated indebtedness
relating thereto (the "Proposed Debt Restructuring"), the Company has been
engaged in negotiations with the representatives of an informal committee
(the "Bondholders' Committee") of holders of Notes and with representatives
of an informal committee (the "Bridge Lenders' Committee" and, together
with the Bondholders' Committee, the "Committees") of holders of loans
under the Interim Loan Agreement, with respect to the possible terms and
conditions of the Proposed Debt Restructuring. In that connection, the
Company has entered into confidentiality agreements with certain
representatives of the Committees and has agreed to pay certain expenses of
the Committees, including certain fees and expenses of their legal counsel
and financial advisor. Based on the progress of such negotiations to date,
the Company believes that the Proposed Debt Restructuring will be
consummated on terms satisfactory to the Company and such Committees, by
means of privately negotiated transactions. However, the Company has not
entered into any agreements to date with respect to the terms and
conditions of any such restructuring, and there can be no assurance that
the Proposed Debt Restructuring will be consummated. In the event the
Company is unable to negotiate certain minimum tender conditions in
connection with the Proposed Debt Restructuring, the Company does not
intend to consummate the Hughes Medium Power Transaction.
In connection with their approval of the Hughes Medium Power Transaction,
the stockholders of PRIMESTAR also approved the payment to TSAT of
consideration (the "PRIMESTAR Payment") in the amount of $65 million,
payable in shares of GMH Stock, valued at $46.1875 (the closing price of
such stock on the date of the purchase agreements with Hughes), subject to
the terms and conditions set forth in an agreement dated as of January 22,
1999 (the "PRIMESTAR Payment Agreement"). In consideration of the PRIMESTAR
Payment, TSAT agreed to approve the Hughes Medium Power Transaction and
Hughes High Power Transaction as a stockholder of PRIMESTAR, to modify
certain agreements to facilitate the Hughes High Power Transaction, and to
issue the Company a share appreciation right with respect to the shares of
GMH Stock received as the PRIMESTAR Payment, granting the Company the right
to any appreciation in such GMH Stock over the one year period following
the date of issuance, over an agreed strike price of $47.00. Pursuant to
the PRIMESTAR Payment Agreement, TSAT has also agreed to forego any
liquidating distribution or other payment that may be made in respect of
the outstanding shares of PRIMESTAR upon any dissolution and winding-up of
PRIMESTAR, or otherwise in respect of PRIMESTAR'S existing equity. Such
payment is conditioned upon the closing of the Hughes Medium Power
Transaction.
(continued)
F-47
<PAGE>
PRIMESTAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
In connection with the Hughes Medium Power Transaction, the Company
concluded that it would be unable to recover the carrying value of its
assets over their expected remaining useful life. Accordingly, the Company
has recorded an impairment loss of $950,289,000 (the "Impairment Loss"),
which represents the difference between the carrying value of the Company's
assets and their estimated fair value. Such fair value was based upon the
estimated consideration to be received by the Company in the Hughes Medium
Power Transaction.
The reduction in carrying amount of assets included in the Impairment Loss
is as follows (amounts in thousands):
<TABLE>
<CAPTION>
<S> <C>
Property and equipment:
Satellite reception equipment $103,898
Subscriber installation costs 223,541
Intangible assets:
Excess purchase price over acquired net assets 401,475
Tradename 221,375
--------
$950,289
========
</TABLE>
In a separate transaction, the Company announced that TSAT and the Company
had reached an agreement with Hughes to sell (i) TSAT's authorizations
granted by the Federal Communications Commission (the "FCC") and other
assets and liabilities relating to a proposed DBS system being constructed
by Tempo Satellite, Inc. ("Tempo"), a subsidiary of TSAT, at 119 degrees
W.L. (collectively, the "Tempo DBS Assets") and (ii) PRIMESTAR's rights
relating to the Tempo DBS Assets (see note 13) to Hughes, for aggregate
consideration valued at $500 million (the "Hughes High Power Transaction").
Pursuant to the agreement, Hughes would assume $465 million of TSAT's
liability to the Partnership, pay TSAT $2.5 million in cash and pay
PRIMESTAR and the Partnership $32.5 million in cash. In addition, the
Partnership has agreed to forgive amounts due from TSAT in excess of the
$465 million to be assumed by Hughes ($4,498,000 at December 31, 1998). To
facilitate such transaction, the Partnership would terminate and relinquish
the Tempo Capacity Option, as defined in note 13.
Due to the fact that regulatory approval is required to transfer certain of
the Tempo DBS Assets to Hughes, the Hughes High Power Transaction will be
completed in two steps. Effective March 10, 1999, the first closing of the
Hughes High Power Transaction (the "First Closing") was consummated whereby
Hughes acquired one of Tempo's high power satellites ("Tempo DBS-2") and
PRIMESTAR's option to acquire Tempo DBS-2 (the "Tempo DBS-2 Option") for
aggregate consideration of $150 million. Such consideration was comprised of the
following: (i) $9,750,000 paid to PRIMESTAR and the Partnership for the Tempo
DBS-2 Option and the termination of the Partnership's rights under the Tempo
Capacity Option, (ii) $750,000 paid to TSAT to exercise the Tempo DBS-2 Option
and (iii) the assumption by Hughes of $139,500,000 due to the Partnership from
TSAT in exchange for Tempo DBS-2. Simultaneously with the First Closing, Hughes
repaid the liability to the Partnership that Hughes assumed.
With regard to the sale of the remaining assets contemplated by the Hughes High
Power Agreement (the "Second Closing"), Tempo has been notified that its
in-orbit satellite ("Tempo DBS-I") experienced power reductions which occurred
on March 29, 1999 and April 2, 1999. Although the Company does not believe the
extent of such power reductions is significant, a definitive assessment of the
impact on Tempo DBS-I is not yet complete. Notwithstanding the foregoing, the
Second Closing, which is subject to the receipt of appropriate regulatory
approvals and other customary closing conditions, is expected to be consummated
in the second quarter of 1999. In the event the Second Closing is not
consummated and the Hughes High Power Agreement is abandoned, there can be no
assurance that the Company will be able to recover the carrying amount of its
satellite rights.
In addition, consummation of the Hughes Medium Power Transaction is not
dependent on completion of the Hughes High Power Transaction, and completion of
the Hughes High Power Transaction is not dependent on consummation of the Hughes
Medium Power Transaction.
The Company has a history of operating losses and reported an accumulated
deficit at December 31, 1998. In connection with the Hughes Medium Power
Transaction, affiliates of the stockholders of the Company, other than TSAT, and
an affiliate of TCI have committed to make funds available to the Company,
either in the form of capital contributions or loans, up to an aggregate of
$1,013 million. Management of the Company believes, but cannot assure, that when
such funds are combined with the proceeds from the Hughes Medium Power and High
Power Transactions and the Company's existing sources of liquidity, that the
Company will be able to meet its obligations as they become due and payable.
In the event the Hughes Medium Power Transaction is not consummated and is
abandoned, the Company currently intends to continue operating its medium power
business. Under such scenario, the Company anticipates that it would curtail
marketing and sales activities, reduce the number of new installations and
otherwise reduce expenditures to the extent possible. The Company believes, but
cannot assure, that in such event, the Company's cash flow from continuing
operations, commitments from the Company's stockholders to make certain funds
available to the Company and proceeds from the Hughes High Power Transaction
would provide the necessary funds for the Company to meets its obligations as
they become due and payable through December 31, 1999. In the event the Company
is unable to meet its obligations as they become due and payable, the Company
may be required to restructure or refinance certain of its liabilities. There
can be no assurance that such restructuring or refinancing, if necessary, would
be accomplished on terms acceptable to the Company.
(continued)
F-48
<PAGE>
PRIMESTAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(3) The Restructuring and the TSAT Merger
-------------------------------------
The Restructuring
-----------------
Effective April 1, 1998 (the "Closing Date") and pursuant to (i) a Merger
and Contribution Agreement dated as of February 6, 1998 (the "Restructuring
Agreement"), among the Company, TSAT, Time Warner Entertainment Company,
L.P. ("TWE"), Advance/Newhouse Partnership ("Newhouse"), Comcast
Corporation ("Comcast"), Cox Communications, Inc. ("Cox"), MediaOne of
Delaware, Inc. ("MediaOne"), and GE Americom, and (ii) an Asset Transfer
Agreement dated as of February 6, 1998 (the "TSAT Asset Transfer
Agreement"), between the Company and TSAT, a business combination (the
"Restructuring") was consummated. In connection with the Restructuring,
TSAT contributed and transferred to the Company (the "TSAT Asset Transfer")
all of TSAT's assets and liabilities except (i) the capital stock of Tempo,
(ii) the consideration received by TSAT in the Restructuring and (iii) the
rights and obligations of TSAT under agreements with the Company and
others. In addition, (i) the business of the Partnership, (ii) the
business of distributing the PRIMESTAR(R) programming service
("PRIMESTAR(R)"), including certain related assets and liabilities of each
of TWE, Newhouse, Comcast, Cox and affiliates of MediaOne, and (iii) the
interest in the Partnership of each of TWE, Newhouse, Comcast, Cox,
affiliates of MediaOne and GE Americom (collectively, the "Non-TSAT
Parties") were consolidated into the Company.
In connection with the Restructuring, each of TSAT, Comcast, Cox, MediaOne,
Newhouse, TWE and GE Americom received from the Company (i) cash or an
assumption of indebtedness, (ii) shares of Class A Common Stock, $.01 par
value per share, of the Company, ("Class A Common Stock"), (iii) in the
case of TSAT only, shares of Class B Common Stock, $.01 par value per
share, of the Company ("Class B Common Stock"), and (iv) except in the case
of TSAT and GE Americom, shares of Class C Common Stock, $.01 par value per
share, of the Company ("Class C Common Stock"), in each case in an amount
determined pursuant to the Restructuring Agreement. The total
consideration paid by PRIMESTAR to the Non-TSAT Parties (including assumed
liabilities) aggregated approximately $2.2 billion comprising $1.3 billion
of cash and assumed liabilities and $900 million of common stock.
As of December 31, 1998, the approximate ownership of PRIMESTAR's common
stock was as follows:
<TABLE>
<CAPTION>
Ownership
Name of Beneficial Owner Percentage
------------------------ ----------
<S> <C>
TSAT 37.23%
TWE and Newhouse (collectively) 30.02%
Comcast 9.50%
MediaOne 9.69%
Cox 9.43%
GE Americom 4.13%
</TABLE>
(continued)
F-49
<PAGE>
PRIMESTAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The TSAT Asset Transfer has been recorded at TSAT's historical cost, and
the remaining elements of the Restructuring, as set forth above, have been
accounted for using the purchase method of accounting. The fair value of
the consideration issued to the Non-TSAT Parties has been allocated to the
assets and liabilities acquired based upon the estimated fair values of
such assets and liabilities.
TSAT has been identified as the acquirer for accounting purposes and the
predecessor for financial reporting purposes due to the fact that TSAT owns
the largest interest in the Company immediately following consummation of
the Restructuring.
The following pro forma operating results for the Company assume the
Restructuring had been consummated on January 1, 1997. Such unaudited pro
forma financial information is based upon historical results of operations
adjusted for acquisition costs and, in the opinion of management, is not
necessarily indicative of the results had the Restructuring been
consummated on January 1, 1997.
<TABLE>
<CAPTION>
Year ended
December 31,
----------------------------------------------------
1998 1997
------------------------- -------------------------
<S> <C> <C>
Revenue $ 1,493,729 1,272,274
Net loss $(1,434,214) (509,620)
Loss per common share $ (7.14) (2.54)
</TABLE>
The TSAT Merger
---------------
Effective February 6, 1998, PRIMESTAR and TSAT entered into an Agreement
and Plan of Merger (the "TSAT Merger Agreement"), providing for the merger
of TSAT with and into PRIMESTAR, with PRIMESTAR as the surviving
corporation (the "TSAT Merger"). In connection with the First Closing, the
Company and TSAT terminated the TSAT Merger Agreement.
(4) Distribution Transaction
------------------------
On December 4, 1996 (the "Distribution Date"), TCI distributed (the
"Distribution") all the capital stock of the Company to the holders of
Tele-Communications, Inc. Series A TCI Group Common Stock (the "Series A
TCI Group Stock") and Tele-Communications, Inc. Series B TCI Group Common
Stock (the "Series B TCI Group Stock" and, together with the Series A TCI
Group Stock, the "TCI Group Stock"). Holders of TCI Group Stock received
one share of TSAT Series A Common Stock for each ten shares of Series A TCI
Group Stock owned and one share of TSAT Series B Common Stock for each ten
shares of Series B TCI Group Stock owned.
In connection with the Distribution, the Company and TCI entered into
various agreements, including the "Reorganization Agreement" (see below),
the "Fulfillment Agreement" and the "Transition Services Agreement" (see
note 12), and an amendment to TCI's existing "Tax Sharing Agreement" (see
note 11).
(continued)
F-50
<PAGE>
PRIMESTAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Pursuant to the Reorganization Agreement, on the Distribution Date, the
Company issued to TCIC a promissory note (the "Company Note"), in the
principal amount of $250,000,000, representing a portion of the Company's
intercompany balance owed to TCIC on such date. The remainder of the
Company's intercompany balance owed to TCIC on the Distribution Date (other
than certain advances made to the Company by TCIC in 1996 to fund certain
construction and related costs associated with the Tempo Satellites, as
described in note 13) was assumed by TCI in the form of a capital
contribution to the Company. On December 31, 1996, the Company entered
into a bank credit agreement (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 Company Note.
(5) Changes in Accounting
---------------------
During the fourth quarter of 1996, the Company changed its depreciation
policy for subscriber installation costs. Such 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 the Company's
depreciation expense for the fourth quarter of 1996. Consequently, this
change in policy resulted in increases to the Company's depreciation
expense, net loss and net loss per share for the year ended December 31,
1996 of $55,304,000 ($8,754,000 of which relates to periods prior to
January 1, 1996), $41,478,000 ($6,566,000 of which relates to periods prior
to January 1, 1996) and $.62 ($.10 of which relates to periods prior to
January 1, 1996), respectively.
The Company also revised the estimated useful life of certain satellite
reception equipment on a prospective basis as of October 1, 1996. Such
change in estimate resulted in increases to the Company's depreciation
expense, net loss and net loss per share for the year ended December 31,
1996 of $7,796,000, $5,847,000 and $.09, respectively.
(6) Summary of Significant Accounting Policies
------------------------------------------
Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of
three months or less at the date of acquisition to be cash equivalents.
Investment in PRIMESTAR Partners L.P.
Prior to the Restructuring, the Company used the equity method to account
for its investment in the Partnership. Under this method, the investment,
originally recorded at cost, was adjusted to recognize the Company's share
of the net earnings or losses of the Partnership as they occurred, rather
than as dividends or other distributions were received, limited to the
extent of the Company's investment in, and advances and commitments to, the
Partnership. The Company's share of net earnings or losses of the
Partnership included the amortization of the difference between the
Company's investment and its share of the net assets of the Partnership.
As part of the Restructuring, the Partnership became a wholly-owned
subsidiary of the Company.
(continued)
F-51
<PAGE>
PRIMESTAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Property and Equipment
Property and equipment is stated at cost. Depreciation is computed on a
straight-line basis using estimated useful lives of 4 to 6 years (4 to 8
years through September 30, 1996) for satellite reception equipment and 3
to 10 years for support equipment. Subscriber installation costs are
depreciated over the estimated average life of a subscriber (4 years). Any
subscriber installation costs that have not been fully depreciated at the
time service to a subscriber is terminated are charged to depreciation
expense during the period in which such termination occurs.
Repairs and maintenance are charged to operations, and betterments and
additions are capitalized. At the time of ordinary retirements of satellite
reception equipment, sales or other dispositions of property, the original
cost and cost of removal of such property are charged to accumulated
depreciation, and salvage, if any, is credited thereto.
The Company periodically reviews the carrying amount of its long-lived
assets to determine whether current events or circumstances warrant
adjustments to such carrying amounts. The Company considers historical and
expected future net operating losses to be its primary indicators of
potential impairment. Assets are grouped and evaluated for impairment at
the lowest level for which there are identifiable cash flows that are
largely independent of the cash flows of other groups of assets ("Assets").
The Company deems Assets to be impaired if the Company is unable to recover
the carrying value of its Assets over their expected remaining useful life
through a forecast of undiscounted future operating cash flows directly
related to the Assets. If Assets are deemed to be impaired, the loss is
measured as the amount by which the carrying amount of the Assets exceeds
their fair values. PRIMESTAR generally measures fair value by considering
sales prices for similar assets or by discounting estimated future cash
flows. Considerable management judgment is necessary to estimate discounted
future cash flows. Accordingly, actual results could vary significantly
from such estimates.
Intangible Assets
Intangible assets at December 31, 1998 are comprised of the following
(amounts in thousands):
<TABLE>
<S> <C>
Customer relationships $390,000
Satellite rights 469,498
--------
859,498
Accumulated amortization (73,125)
--------
$786,373
========
</TABLE>
Customer relationships are amortized using the straight-line method over
their estimated useful life of 4 years. Satellite rights represent
PRIMESTAR's right to use Tempo's two high power communications satellites
(the "Tempo Satellites") as described in note 13. The Company is not
amortizing such rights as the Company has not launched a high power service
utilizing the Tempo Satellites.
(continued)
F-52
<PAGE>
PRIMESTAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
In connection with the Restructuring, the Company recorded tradenames of
$230,000,000 and excess cost over acquired net assets of $416,901,000.
Such intangible assets were amortized using the straight-line method over
20 years. As of December 31, 1998, such intangible assets were written
down to their estimated fair value of zero. Such writedown has been
included in the Impairment Loss described in note 2.
Deferred Financing Costs
Deferred financing costs are amortized over the term of the related loan
facility.
Revenue Recognition
Programming and equipment rental revenue is recognized in the period that
services are delivered. Installation revenue is recognized in the period
the installation services are provided to the extent of direct selling
costs. To date, direct selling costs have exceeded installation revenue.
Payments received from customers at the time of installation to reduce
future monthly rental fees are deferred and recognized as revenue over the
average life of a customer.
Programming Carriage Fees
Payments received from programmers at the time of launch for which future
carriage by the Company is required are deferred and recognized as a
reduction of programming expense over the term of the programming contract.
Advertising Costs
Advertising costs are generally expensed as incurred. Amounts expensed for
advertising aggregated $51,859,000, $23,062,000 and $25,622,000 during
1998, 1997 and 1996, respectively.
Marketing and Direct Selling Costs
Marketing and direct selling costs are expensed as incurred. The excess
cost of customer premises equipment over proceeds received upon sale of
such equipment is recognized at the time of sale and is included in selling
expense.
Residual Sales Commissions
Residual sales commissions, which become payable upon the collection of
programming revenue from certain subscribers, are expensed during the
period in which such commissions become payable.
Stock Based Compensation
The Company accounts for stock-based employee compensation using the
intrinsic value method pursuant to Accounting Principles Board Opinion No.
25.
(continued)
F-53
<PAGE>
PRIMESTAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Income Taxes
The Company accounts for its income taxes using the asset and liability
method. Under the asset and liability method, deferred tax assets and
liabilities are recognized for the estimated future tax consequences
attributable to differences between the financial statement carrying
amounts of existing assets and liabilities and their respective tax bases.
Deferred tax assets and liabilities are measured using enacted tax rates in
effect for the year in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of
a change in tax rates is recognized in income in the period that includes
the enactment date.
Loss Per Common Share
The loss per common share for the years ended December 31, 1998 and 1997 is
based on 167,615,000 and 66,658,000 weighted average shares outstanding
respectively. TSAT issued 66,408,000 shares of TSAT common stock pursuant
to the Distribution. The loss per share amounts set forth in the
accompanying consolidated statements of operations assume that the shares
issued pursuant to the Distribution were issued and outstanding since
January 1, 1996. Accordingly, the calculation of the loss per share
assumes weighted average shares outstanding of 66,408,000 for the year
ended December 31, 1996. Excluded from the computation of diluted EPS for
the years ended December 31, 1998, 1997 and 1996 are options to acquire
5,395,000, 7,894,000 and 591,000 weighted average shares of common stock,
respectively, because inclusion of such options would be anti-dilutive.
Comprehensive Income (Loss)
The Company's total comprehensive loss for all periods presented herein did
not differ from those amounts reported as net loss.
Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities 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.
(7) Supplemental Disclosures to Statements of Cash Flows
----------------------------------------------------
Cash paid for interest was $116,193,000, $20,224,000 and $1,946,000 during
the years ended December 31, 1998, 1997 and 1996, respectively. Cash paid
for income taxes was not material during the years ended December 31, 1998,
1997, and 1996.
(continued)
F-54
<PAGE>
PRIMESTAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Significant non-cash investing and financing activities for the year ended
December 31, 1998 are reflected in the following table (amounts in
thousands):
<TABLE>
<CAPTION>
<S> <C>
Cash paid in Restructuring:
Property and equipment acquired $ 716,821
Intangible assets 1,500,034
Current liabilities assumed, net of
current assets (116,849)
Debt assumed (903,299)
Deferred tax liability (222,585)
Common stock issued (919,228)
----------
$ 54,894
==========
</TABLE>
Transactions effected through the intercompany account with TCIC for
periods prior to the Distribution have been considered to be constructive
cash receipts and payments for purposes of the accompanying statements of
cash flows.
The non-cash effects of the Distribution are set forth in the accompanying
statements of equity.
Accounts payable includes accrued capital expenditures of $26,593,000,
$35,645,000 and $7,713,000 at December 31, 1998, 1997 and 1996,
respectively, which have been excluded from the accompanying statements of
cash flows.
(8) Debt
----
The components of debt are as follows:
<TABLE>
<CAPTION>
December 31,
1998 1997
---- ----
amounts in thousands
<S> <C> <C>
Bank Credit Facility (a) $ 513,200 48,000
Interim Loan Agreement (b) 350,000 --
Partnership Credit Facility (c) 575,000 --
Senior Subordinated Notes (d) 200,000 200,000
Senior Subordinated Discount Notes (d) 189,722 168,781
Other 5,273 1,948
---------- -------
$1,833,195 418,729
========== =======
</TABLE>
(continued)
F-55
<PAGE>
PRIMESTAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(a) In connection with the Restructuring, the Company amended and restated the
Bank Credit Facility. As amended, the Bank Credit Facility provides for
maximum commitments of up to $700 million, comprising $550 million of
revolving loan commitments and $150 million of term commitments, subject to
the Company's compliance with operating and financial covenants and other
customary conditions. In addition to the outstanding borrowings at December
31, 1998, $30 million of availability under the Bank Credit Facility had
been utilized to obtain two outstanding letters of credit. Commencing
March 31, 2001, the revolving loan commitments will be reduced quarterly,
and outstanding borrowings under the term loan commitments will be payable
in quarterly installments, in each case in accordance with a schedule,
until final maturity at June 30, 2005.
Borrowings under the Bank Credit Facility bear interest at variable rates
(6.7% at December 31, 1998). In addition, the Company must 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 were not significant during any of the years presented.
Borrowings under the Bank Credit Facility are guaranteed by all restricted
subsidiaries of the Company (defined under the Bank Credit Facility to mean
each of the Company's domestic subsidiaries of which the Company owns
directly or indirectly at least 80% of the outstanding capital stock), and
secured by collateral assignments or other security interests. The Bank
Credit Facility contains covenants regarding debt service coverage and
leverage, as well as negative covenants restricting, among other things
indebtedness, liens and other encumbrances, mergers or consolidation
transactions, transactions with affiliates, investments, capital
expenditures, and payment of dividends and other distributions.
At April 1, 1999, the Company was not in compliance with one of the
covenants in the Bank Credit Facility regarding the provision of audited
financial statements to the lenders under the Bank Credit Facility (the
"Banks") within 90 days of the Company's fiscal year-end. The Company will
remedy such event of noncompliance in accordance with the terms of the Bank
Credit Facility by providing its audited financial statements to the Banks
prior to April 30, 1999.
(b) On the Closing Date, the Company entered into the Interim Loan Agreement
with certain financial institutions (the "Lenders") with respect to a $350
million unsecured senior subordinated interim loan (the "Interim Loan").
The Interim Loan Agreement provided for commitments of $350 million. The
commitments were fully funded to the Company on the Closing Date.
The obligations under the Interim Loan Agreement were due in full one year
from the Closing Date. However, the Company had the option to convert any
outstanding principal amount of the Interim Loan on such date (the
"Conversion Date") into a term loan maturing on April 1, 2008. The
Company gave notice of such conversion on March 29, 1999, in accordance
with the terms of the Interim Loan Agreement.
In addition, on the Conversion Date, the Company became obligated to enter
into a stock warrant agreement with the Lenders providing for the issuance
of warrants to purchase common stock of the Company equal to 2% of the
Company's outstanding common stock on the Conversion Date. The warrants are
to be exercisable over a ten-year period at a nominal exercise price.
(continued)
F-56
<PAGE>
PRIMESTAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The outstanding principal under the Interim Loan Agreement bears
interest at a rate per annum equal to the greater of 10% or, at the
election of the Lenders, (i) a rate per annum that is equal to the
corporate base rate, as provided for in the Interim Loan Agreement,
(ii) the Federal Funds effective rate, plus 0.50%, or (iii) the London
interbank offered rate ("LIBOR") for such period, plus in each case
the Applicable Spread (as defined in the Interim Loan Agreement). The
interest rate on the Interim Loan in effect at December 31, 1998 was
11.5% which included the Applicable Spread of 650 basis points. The
Applicable Spread increases monthly thereafter, with a final increase
to 750 basis points from and after April 1, 1999.
At any time after the Conversion Date, the applicable spread is to be
850 basis points. In addition, at the request of any Lender, the
interest rate on all or any portion of the term loan owing to such
Lender will be converted to a fixed rate equal to the rate in effect
as of the date such Lender gave notice to the Company.
Interest was payable monthly in arrears on the last day of each month
until the Conversion Date. Thereafter, interest is payable quarterly
in arrears, except for any term loan converted to a fixed rate loan,
in which event interest is payable on March 31 and September 30 of
each year. If interest payable by the Company exceeds 15%, the
Company may elect to pay all or a portion of the interest in excess of
15% by issuance of notes in an aggregate principal amount equal to
such excess amount.
Prior to the Conversion Date, the Company could prepay the Interim
Loan without penalty. After the Conversion Date, certain limited
prepayments are permitted until April 1, 2001 out of the proceeds of
certain equity offerings. Otherwise, prepayment is not permitted until
on or after April 1, 2003. Prepayment penalties apply to any
prepayment prior to April 1, 2006, which penalties are calculated with
reference to the interest rate in effect at the time of prepayment.
The Interim Loan Agreement provides for mandatory prepayments of the
Interim Loan upon the occurrence of certain asset sales, capital
contributions, securities issuances and a change of control (as
defined in the Interim Loan Agreement) of the Company.
(continued)
F-57
<PAGE>
PRIMESTAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(c) The Partnership Credit Facility, as amended, allows for borrowings up to
$585 million, and borrowings thereunder are collateralized by letters of
credit (the "Partnership Letters of Credit"), which were arranged for by
affiliates of the partners of the Partnership (the "Partners") (or, in the
case of TSAT, affiliates of TCI) other than GE Americom. In connection
with the Restructuring, the Partnership became an indirect, wholly-owned
subsidiary of the Company. In addition, the Partners and TCI agreed to
maintain their respective Partnership Letters of Credit through June 1999,
and the Company entered into Reimbursement Agreements with respect to such
letters of credit, whereby the Company agreed to indemnify the parties
arranging for such letters of credit from and against all obligations
thereunder and/or other existing documentation relating thereto, including
all existing and future payment obligations. The obligations of the
Company under such Reimbursement Agreements are subordinated in right of
payment, in the manner set forth in the Reimbursement Agreement, to all
indebtedness of the Company under the Bank Credit Facility, the Interim
Loan Agreement and the Notes.
Borrowings under the Partnership Credit Facility bear interest at variable
rates (5.6% at December 31, 1998). In addition, the Company must pay
quarterly, in arrears, a commitment fee of 3/16% per annum on the daily
unused portion of the facility. Such commitment fees were not significant
during the year ended December 31, 1998.
The maturity date of the Partnership Credit Facility is June 30, 1999.
(d) On February 20, 1997, the Company issued the Senior Subordinated Notes
having an aggregate principal amount of $200,000,000 and the Senior
Subordinated Discount Notes having an aggregate principal amount at
maturity of $275,000,000.
Cash interest on the Senior Subordinated Notes is payable semi-annually in
arrears on February 15 and August 15. 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, the Company 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 will
be redeemable at the option of the Company, in whole or in part, at any
time after February 15, 2002 at specified redemption prices. In addition,
prior to February 15, 2000, the Company may use the net cash proceeds from
certain specified equity transactions to redeem up to 35% of the Notes at
specified redemption prices.
(continued)
F-58
<PAGE>
PRIMESTAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The fair value of the Company's debt is estimated based upon the quoted
market prices for the same or similar issuances or on the current rates
offered to the Company for debt of the same remaining maturities. With the
exception of the Notes, which had an aggregate fair value of $158,090,000
at December 31, 1998, PRIMESTAR believes that the fair value and the
carrying value of its debt were approximately equal at December 31, 1998.
As of December 31, 1998, annual maturities of the Company's debt for each
of the next five years were as follows (amounts in thousands):
<TABLE>
<S> <C>
1999 $575,921
2000 1,013
2001 15,342
2002 30,368
2003 153,596
</TABLE>
(9) Stockholders' Equity
-------------------------
PRIMESTAR Preferred Stock
-------------------------
The Restated Certificate of Incorporation of the Company authorizes the
PRIMESTAR Board of Directors (the "Board") to provide for the issuance of
all or any shares of preferred stock of the Company in one or more series
and to fix for each series the number of shares constituting such series
and such voting powers, full or limited, or no voting powers, and such
designations, preferences and relative, participating, optional or other
special rights and such qualifications, limitations or restrictions thereof
as shall be stated and expressed in the resolution or resolutions adopted
by the Board providing for the issuance of such series. As of December 31,
1998, no series of preferred stock have been designated.
PRIMESTAR Common Stock
----------------------
Holders of Class A Common Stock are entitled to one vote for each share of
such stock held, holders of Class B Common Stock are entitled to ten votes
for each share of such stock held and holders of Class C Common Stock are
entitled to ten votes for each share of such stock held. Holders of Class
D Common Stock are not entitled to any voting rights with respect to such
shares, except as may be required by law.
Each share of Class B Common Stock is convertible, at the option of the
holder, into one share of Class A Common Stock. Each share of Class C
Common Stock is convertible, at the option of the holder, into one share of
Class B Common Stock, and will be mandatorily and automatically so
converted upon the tenth anniversary of the Closing Date.
TSAT Preferred Stock
--------------------
Prior to the Restructuring, TSAT was authorized to issue 5,000,000 shares
of Preferred Stock.
(continued)
F-59
<PAGE>
PRIMESTAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
TSAT Common Stock
-----------------
Prior to the Restructuring, the TSAT Series A Common Stock had one vote per
share and the TSAT Series B Common Stock had ten votes per share. Each
share of TSAT Series B Common Stock was convertible, at the option of the
holder, into one share of TSAT Series A Common Stock.
Employee Retirement Plan
------------------------
Prior to the Restructuring, TSAT maintained an employee stock purchase plan
(the "TSAT Plan") pursuant to which employees could contribute up to 10% of
their compensation. TSAT, by annual resolution of the TSAT Board of
Directors (the "TSAT Board"), could elect to contribute up to 100% of the
amount contributed by employees. In connection with the Restructuring and
effective June 30, 1998, the TSAT Plan was merged with and into the
Partnership's amended and restated retirement plan, which has been renamed
the PRIMESTAR, Inc. 401(k) Savings Plan.
Stock Options
-------------
In June 1996, the Board of Directors of TCI (the "TCI Board") authorized
TCI to permit certain of its executive officers to acquire equity interests
in certain of TCI's subsidiaries. In connection therewith, the TCI Board
approved the acquisition by each of two executive officers of TCI who were
not employees of TSAT (the "TCI Officers"), of 1.0% of the net equity of
TSAT. The TCI Board also approved the acquisition by the chief executive
officer and a director of TSAT (the "TSAT Officer"), of 1.0% of the net
equity of TSAT and the acquisition by an executive officer of certain TCI
subsidiaries who is also a director, but not an employee, of TSAT (the "TCI
Subsidiary Officer"), of 0.5% of the net equity of TSAT. The TCI Board
determined to structure such transactions as grants by TSAT to such persons
of options to purchase shares of TSAT Series A Common Stock representing
1.0% (in the case of each of the TCI Officers and the TSAT Officer) and
0.5% (in the case of the TCI Subsidiary Officer) of the shares of TSAT
Series A Common Stock and TSAT Series B Common Stock issued and outstanding
on the Distribution Date, determined immediately after giving effect to the
Distribution, but before giving effect to any exercise of such options (the
"Distribution Date Options").
Pursuant to the Reorganization Agreement, and (in the case of the TCI
Officers and the TCI Subsidiary Officer) in partial consideration for the
capital contribution made by TCI to TSAT in connection with the
Distribution, TSAT agreed, effective as of the Distribution Date, to bear
all obligations under such options and to enter into stock option
agreements with respect to such options with each of the TCI Officers, the
TSAT Officer and the TCI Subsidiary Officer
Distribution Date Options to purchase 2,324,266 shares of TSAT Series A
Common Stock at a per share price of $8.86 were granted on the Distribution
Date. The market price of the TSAT Series A Common Stock on such date was
$12.63. As originally granted, the Distribution Date Options vest in 20%
cumulative increments on each of the first five anniversaries of February
1, 1996, and will be exercisable for up to ten years following February 1,
1996. Compensation expense with respect to the Distribution Date Options
held by the TSAT Officer aggregated $1,026,000, $1,101,000 and $95,000
during the years ended December 31, 1998, 1997 and 1996, respectively.
(continued)
F-60
<PAGE>
PRIMESTAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
On the Distribution Date, the TSAT Board adopted, and TCI as the sole
stockholder of TSAT prior to the Distribution, approved, the TCI Satellite
Entertainment, Inc. 1996 Stock Incentive Plan (the "TSAT 1996 Plan"). The
TSAT 1996 Plan provides for awards to be made in respect of a maximum of
3,200,000 shares of TSAT Series A Common Stock (subject to certain anti-
dilution adjustments). Awards may be made as grants of stock options,
stock appreciation rights ("SARs"), restricted shares, stock units,
performance awards or any combination thereof. As originally granted,
options granted pursuant to the TSAT 1996 Plan vest evenly over five years
from the date of grant and expire 10 years from the date of grant.
In March 1998, stockholders of TSAT approved the TCI Satellite
Entertainment, Inc. 1997 Nonemployee Director Stock Option Plan (the "TSAT
DSOP") including the grant, effective as of February 3, 1997, to each
person that as of that date was a member of the TSAT Board and was not an
employee of TSAT or any of its subsidiaries, of options to purchase 50,000
shares of TSAT Series A Common Stock. Pursuant to the TSAT DSOP, options
to purchase 200,000 shares of TSAT Series A Common Stock were granted at an
exercise price of $8.00 per share. As originally granted, options issued
pursuant to the TSAT DSOP vest and become exercisable over a five-year
period from the date of grant and expire 10 years from the date of grant.
In November 1997, the TSAT Board voted to increase the number of directors
by one, and the director named to fill such newly created directorship
received options to purchase 50,000 shares of TSAT Series A Common Stock at
an exercise price of $6.50.
In February 1997, certain key employees of TSAT were granted, pursuant to
the TSAT 1996 Plan, an aggregate of 325,000 restricted shares of TSAT
Series A Common Stock. Such restricted shares had a grant-date fair value
of $8.00. As originally granted, such restricted shares vest as to 50% on
January 1, 2001 and as to the remaining 50% on January 1, 2002.
Compensation expense with respect to the restricted shares aggregated
$1,570,000 and $585,000 during the years ended December 31, 1998 and 1997,
respectively.
In November 1997, the TSAT Board and the compensation committee of the TSAT
Board approved modifications to the vesting provisions of all options and
restricted stock awards issued pursuant to the TSAT 1996 Plan, (i)
accelerating the vesting schedules under such options, to provide for
vesting in three equal annual installments, commencing February 1998, and
(ii) accelerating the vesting schedules under such restricted stock awards
to provide for vesting of 50% on each of the second and third anniversaries
of the date of granting. Options granted prior to the Distribution, which
were 40% vested in February 1998, will become two-thirds vested in February
1999 and fully vested in February 2000.
On April 2, 1998, the PRIMESTAR Board of Directors approved the PRIMESTAR,
Inc. 1998 Incentive Plan (the "1998 PRIMESTAR Plan"). The 1998 PRIMESTAR
Plan provides for awards to be made in respect of a maximum of 7,000,000
shares of Class A Common Stock. Awards may be made as grants of stock
options, SARs, restricted shares, stock units, performance awards or any
combination thereof. Options granted pursuant to the 1998 PRIMESTAR Plan
vest evenly over three years from the date of grant and expire 10 years
from the date of grant.
(continued)
F-61
<PAGE>
PRIMESTAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The Company applies Accounting Principles Board Opinion No. 25 in
accounting for its stock options, and accordingly, compensation expense has
been recognized for its stock options in the accompanying financial
statements using the intrinsic value method. Had the Company determined
compensation expense based on the grant-date fair value method pursuant to
Statement of Financial Accounting Standards No. 123, the Company's net loss
and loss per share would have been $240,384,000 and $3.61 for 1997 and
would not have been significantly different than the amounts reported for
1998 or 1996.
The following table presents the number, weighted-average exercise price
and weighted-average grant-date fair value of options to buy TSAT Series A
Common Stock and Class A Common Stock.
<TABLE>
<CAPTION>
Number of options Weighted- Weighted-
--------------------------------------- average average
TSAT PRIMESTAR exercise grant-date
Series A Class A price fair value
------------------- ------------------ -------------- --------------
<S> <C> <C> <C> <C>
Granted in connection with ----------
Distribution 2,324,266 $8.86 $8.74
----------
Outstanding at December 31, 1996 2,324,266 8.86
Granted 1,070,000 7.93 4.77
----------
Outstanding at December 31, 1997 3,394,266 8.57
Options not assumed by
PRIMESTAR (1) (3,394,266)
Granted -- 4,934,993 7.69 5.95
Canceled -- (242,285) 7.69
---------- -----------------
Outstanding at December 31, 1998 -- 4,692,708 7.69
========== =================
Exercisable at December 31, 1996 --
==========
Exercisable at December 31, 1997 464,853 8.86
==========
Exercisable at December 31, 1998 --
=================
</TABLE>
________________
(1) At the time of the Restructuring, none of the outstanding options to
acquire TSAT common stock were converted into options to acquire
PRIMESTAR common stock. However, PRIMESTAR assumed TSAT's liability
with respect to any future cash payment to be made upon exercise by any
PRIMESTAR employee of an option or SAR issued by TSAT prior to the
Restructuring.
(continued)
F-62
<PAGE>
PRIMESTAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Options outstanding at December 31, 1998 have an exercise price of $7.69
and a weighted-average remaining contractual life of approximately nine
years.
The respective estimated grant-date fair values of the options noted above
are based on the Black-Scholes model and are stated in current annualized
dollars on a present value basis. The key assumptions used in the model for
purposes of these calculations include the following: (a) a discount rate
equal to the 10-year Treasury rate on the date of grant; (b) a 65%
volatility rate; (c) the 10-year option term; (d) the closing price of the
TSAT Series A Common Stock on the date of grant; and (e) an expected
dividend rate of zero.
Pursuant to the Reorganization Agreement, TSAT granted to TCI an option to
purchase up to 4,765,000 shares of TSAT 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 Distribution. During 1998, 1997 and 1996, TCI purchased 989,000 shares,
258,000 shares and 5,000 shares, respectively, of TSAT Series A Common
Stock pursuant to such option.
In connection with the Distribution, TCI and the Company also entered into
a "Share Purchase Agreement" to sell to each other from time to time, at
the then current market price, shares of Series A TCI Group Stock and TSAT
Series A Common Stock, respectively, as necessary to satisfy their
respective obligations after the Distribution Date under certain stock
options and SARs held by their respective employees and non-employee
directors.
Other
-----
At December 31, 1998, a total of 4,692,708 shares of Class A Common Stock
were reserved for issuance pursuant to the 1998 PRIMESTAR Plan. In
addition, one share of Class A Common Stock is reserved for each
outstanding share of Class B Common Stock and Class C Common Stock.
(10) Restructuring Charges
---------------------
During 1998, the Company reorganized its operations. In connection
therewith, the Company closed certain of its local offices and reduced its
corporate work force. As a result, the Company terminated approximately
700 employees. In connection with such reorganization, the Company
recognized restructuring charges of $26,025,000. Such restructuring
charges related to (i) severance costs for terminated employees
($18,828,000), (ii) lease cancellation fees and other office shutdown costs
($3,617,000) and (iii) the net book value of abandoned equipment
($3,580,000). As of December 31, 1998, the Company had paid approximately
$6,388,000 of the restructuring charges and has a remaining accrual of
$16,057,000.
(continued)
F-63
<PAGE>
PRIMESTAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(11) Income Taxes
------------
Through the Distribution 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. In
connection with the Distribution, 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 through the Distribution Date has been calculated in accordance
with the Tax Sharing Agreement. Subsequent to the Distribution Date, the
Company files separate U.S. Federal and state income tax returns.
Income tax benefit (expense) for the years ended December 31, 1998, 1997
and 1996 consists of:
<TABLE>
<CAPTION>
Current Deferred Total
---------------- ----------------- -----------------
amounts in thousands
<S> <C> <C> <C>
Year ended December 31, 1998:
Federal $ -- 128,243 128,243
State and local -- 19,285 19,285
---------------- ------- -------
$ -- 147,528 147,528
================ ======= =======
Year ended December 31, 1997:
Federal $ -- -- --
State and local -- -- --
---------------- ------- -------
$ -- -- --
================ ======= =======
Year ended December 31, 1996:
Intercompany allocation $70,645 -- 70,645
Federal -- (17,699) (17,699)
State and local -- (7,009) (7,009)
---------------- ------- -------
$70,645 (24,708) 45,937
================ ======= =======
</TABLE>
Income tax benefit (expense) differs from the amounts computed by applying
the Federal income tax rate of 35% as a result of the following:
<TABLE>
<CAPTION>
Years ended December 31
-------------------------------------------------------
1998 1997 1996
----------------- ----------------- -----------------
amounts in thousands
<S> <C> <C> <C>
Computed "expected" tax benefit $ 521,931 83,419 65,079
State and local income taxes, net
of Federal income tax benefit 12,535 13,009 (2,672)
Change in valuation allowance (238,739) (98,521) (16,371)
Amortization of goodwill (145,915) -- --
Other (2,284) 2,093 (99)
--------- ------- -------
$ 147,528 -- 45,937
========= ======= =======
</TABLE>
(continued)
F-64
<PAGE>
PRIMESTAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at
December 31, 1998 and 1997 are presented below:
<TABLE>
<CAPTION>
December 31,
------------------------------------------
1998 1997
-------------------- --------------------
amounts in thousands
<S> <C> <C>
Deferred tax assets:
Net operating loss carry forwards $ 226,823 133,024
Investment in the Partnership:
Due to an increase in tax basis upon transfer from
TCIC to the Company 29,305 29,305
Due principally to losses recognized for financial
statement purposes in excess of losses recognized
for tax purposes 57 2,671
Property and equipment principally due to impairment
write-offs for financial statement purposes 11,801 --
Future deductible amounts principally due to accruals
deductible in later periods 12,310 5,028
--------- --------
Total deferred tax assets 280,296 170,028
Less-valuation allowance (238,739) (114,892)
--------- --------
Net deferred tax assets 41,557 55,136
Deferred tax liabilities:
Intangible assets recorded in purchase accounting for
financial statement purposes 116,614 --
Property and equipment, principally due to differences
in depreciation -- 55,136
--------- --------
Net deferred tax liability $ 75,057 --
========= ========
</TABLE>
The valuation allowance for deferred tax assets as of December 31, 1998 was
$238,739,000. Such balance increased $123,847,000 from December 31, 1997.
The valuation allowance at December 31, 1997 related to TSAT's net
operating loss carryforwards which were not contributed to PRIMESTAR in the
Restructuring.
The Company has analyzed the sources and expected reversal periods of its
deferred tax assets. The Company believes that the tax benefits
attributable to deductible temporary differences will be realized to the
extent of future reversals of existing taxable temporary differences.
At December 31, 1998, the Company had net operating loss carry forwards for
income tax purposes aggregating approximately $593,001,000 of which, if not
utilized to reduce taxable income in future periods, $900,000 expire in
2005, $1,200,000 expire in 2006, $2,170,000 expire in 2008, $2,003,000
expire in 2011, $6,200,000 expire in 2012 and $580,528,000 expire in 2018.
(continued)
F-65
<PAGE>
PRIMESTAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(12) Transactions with Related Parties
---------------------------------
Pursuant to the terms of the TSAT Merger Agreement, PRIMESTAR reimbursed
TSAT for all reasonable costs and expenses incurred by TSAT (i) to comply
with its tax and financial reporting obligations, (ii) to maintain certain
insurance coverage and (iii) to maintain its status as a publicly traded
company. During the year ended December 31, 1998, such reimbursements
aggregated $152,000, and have been reflected as a reduction of PRIMESTAR's
equity.
In addition, PRIMESTAR makes advances to TSAT for the payment of certain
costs related to the Tempo Satellites and the proposed high power strategy.
Such advances aggregated $6,365,000 during 1998 and have been included in
intangible assets in the accompanying consolidated balance sheet. PRIMESTAR
anticipates that it will recover the advances upon the sale of the Tempo
Satellites to Hughes.
The Company is a party to a satellite transponder service agreement, as
amended (the "GE-2 Agreement") with an affiliate of GE Americom for
satellite service on GE-2. As originally executed, the GE-2 Agreement had
an initial term extending through February 2003 at an annual rate of
$86,340,000, with an option to extend the term through the end-of-life of
GE-2. The option to extend has expired without exercise. However, the
Company remains in discussions with GE Americom regarding other
alternatives for extension of the GE-2 Agreement, and the Company will
continue to assess other alternatives if the Hughes Medium Power
Transaction is not consummated. No assurance can be given that the parties
will agree to any such extension, if necessary, or that any other
alternatives will be confirmed. Charges to the Company for the use of GE-2
and other services provided by GE Americom aggregated $64,755,000 for the
period from April 1, 1998 through December 31, 1998, and are included in
operating expenses in the accompanying consolidated statement of
operations.
Pursuant to the GE-2 Agreement, GE Americom provides the Company with
service on 24 transponders on GE-2. The Company is currently entitled to
non-preemptible service on 18 of the transponders on GE-2 and preemptible
service on six transponders. Preemptible transponders are transponders
that may be reassigned to restore service to protected customers if such
protected customers experience transponder or satellite failure. The
Company does not believe that, during the early stages of GE-2's
operational life, the use of preemptible transponders is likely to
interfere in any material respect with the operation of the PRIMESTAR(R)
service. The Company currently receives "orbital location protected
service" on all 24 of its transponders, meaning that if there is a failure
of GE-2, the Company will be entitled to restore the lost service on
another GE Americom medium power satellite, GE-3, which was successfully
launched on September 4, 1997, into the same 85 W.L. orbital position used
by GE-2. Even in those circumstances, the six preemptible transponders,
although protected, would remain preemptible. Upon the successful launch
of another GE Americom medium power satellite, GE-4, the Company's six
preemptible transponders will become non-preemptible.
(continued)
F-66
<PAGE>
PRIMESTAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
TCI and the Non-TSAT Parties, other than GE Americom, have arranged for
letters of credit (the "GE-2 Letters of Credit") to support the Company's
obligations under the GE-2 Agreement. Pursuant to the Restructuring
Agreement, the Company reimburses TCI and the Non-TSAT Parties for fees
related to the Partnership Letters of Credit and the GE-2 Letters of
Credit. Such reimbursements aggregated $10,004,000 during the year ended
December 31, 1998 and are included in interest expense in the accompanying
consolidated statements of operations.
Since April 1, 1998, a subsidiary of TCI has provided satellite uplink
services to the Company. Charges for such services aggregated $10,659,000
during 1998 and are included in operating expenses in the accompanying
consolidated statement of operations.
Since March 1997, TCI has provided the Company with customer support
services from TCI's Boise, Idaho call center. Amounts charged by TCI to
the Company for such services aggregated $24,938,000 and $12,173,000 during
the years ended December 31, 1998 and 1997, respectively, and are included
in selling, general and administrative expenses in the accompanying
consolidated statements of operations.
Subsequent to the Restructuring, the Non-TSAT Parties continued to operate
certain non-strategic local offices (the "Transition Offices") for
approximately three months (the "Transition Period") while the
responsibilities of such offices were transferred to other PRIMESTAR
offices. By the end of the Transition Period, all of the Transition
Offices had been closed. Transition expenses include costs incurred
through December 31, 1998 and charged to the Company by the Non-TSAT
Parties to operate the Transition Offices during the Transition Period.
Certain key employees of the Company hold stock options in tandem with
stock appreciation rights with respect to certain common stock of TCI.
Estimates of the compensation related to the options and/or stock
appreciation rights granted to employees of the Company have been recorded
in the accompanying consolidated 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. Stock compensation recognized by the
Company related to such options aggregated ($2,182,000), $6,134,000 and
$(541,000) during the years ended December 31, 1998, 1997 and 1996,
respectively.
Prior to the Restructuring, the Partnership provided programming services
to TSAT and other authorized distributors in exchange for a fee based upon
the number of subscribers receiving programming services. In addition, the
Partnership arranged for satellite capacity and uplink services, and
provided national marketing and administrative support services in exchange
for a separate authorization fee.
(continued)
F-67
<PAGE>
PRIMESTAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
TCI also provided corporate administrative services to the Company pursuant
to a transition services agreement (the "Transition Services Agreement").
Pursuant to the Transition Services Agreement, the Company was required to
pay TCI a monthly fee of $1.50 per qualified subscriber 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.
Charges under the Transition Services Agreement aggregated $3,174,000 and
$11,579,000 during the years ended December 31, 1998 and 1997,
respectively, and are included in selling, general and administrative
expenses in the accompanying consolidated statements of operations. The
Transition Services Agreement was terminated in connection with the
consummation of the Restructuring.
Through the Distribution Date, the effects of all transactions between the
Company and TCI were reflected as adjustments to a non-interest bearing
intercompany account. As described in note 4, all but $250,000,000 of this
intercompany account was forgiven in connection with the Distribution.
Subsequent to the Distribution Date, the effects of all transactions (other
than those related to the TCIC Credit Facility) have been reflected in a
non-interest bearing account between the Company and TCIC and are settled
periodically in cash.
Through December 31, 1996, TCI provided certain installation, maintenance,
retrieval and other customer fulfillment services to the Company. The costs
associated with such services were allocated to the Company based upon a
standard charge for each of the various customer fulfillment activities
performed by TCI. During the year ended December 31, 1996, the Company's
capitalized installation costs included amounts allocated from TCI of
$53,169,000. Maintenance, retrieval and other operating expenses allocated
from TCI to the Company aggregated $20,365,000 during the year ended
December 31, 1996.
Effective January 1, 1997, charges for customer fulfillment services
provided by TCI were made pursuant to the Fulfillment Agreement entered
into by the Company and TCI in connection with the Distribution. Pursuant
to the Fulfillment Agreement, TCI continued to provide fulfillment services
on an exclusive basis to the Company following the Distribution with
respect to customers of the PRIMESTAR(R) medium power service. Such
services were performed in accordance with specified performance standards.
Charges to TSAT pursuant to the Fulfillment Agreement aggregated
$54,823,000 during 1997, of which $46,498,000 were capitalized installation
costs. The Fulfillment Agreement terminated on December 31, 1997.
(13) Commitments and Contingencies
-----------------------------
At December 31, 1998, the Company's future minimum commitments to purchase
satellite reception equipment aggregated approximately $44 million The
Company currently purchases all of its integrated receiver/decoders
("IRDs") from one supplier and all of its home satellite dishes ("HSDs")
from a different supplier. Each supplier has certain disaster recovery
plans. However, a break in production of either IRDs or HSDs could result
in a slow down in the addition of new customers and a corresponding
reduction in the Company's revenue.
(continued)
F-68
<PAGE>
PRIMESTAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
As part of the compensation paid to the Company's various sales agents, the
Company has agreed to pay certain residual sales commissions during
specified periods following the initiation of service (generally five
years). Residual payments to sales agents aggregated $25,639,000,
$15,364,000, and $11,848,000 during 1998, 1997 and 1996, respectively and
were charged to expense in the accompanying consolidated statements of
operations.
In addition to leasing transponder capacity on GE-2, the Company leases
business offices and uses certain equipment under lease arrangements.
Rental expense under such arrangements amounted to $9,847,000, $2,237,000,
and $2,095,000 in 1998, 1997 and 1996, respectively. Included in the 1998
amount is $2,013,000 related to lease cancellation fees. It is expected
that, in the normal course of business, expiring leases will be renewed or
replaced by leases on other properties; thus, it is anticipated that future
minimum lease commitments will not be less than the rental expense incurred
during 1998, exclusive of the amounts for lease cancellations.
In February 1990, Tempo entered into an option agreement with the
Partnership granting the Partnership the right and option (the "Tempo
Capacity Option"), upon exercise, to purchase or lease 100% of the capacity
of the DBS system to be built, launched and operated by Tempo 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 Capacity Option and certain related matters,
Tempo and the Partnership subsequently entered into two letter agreements
(the "Tempo Letter Agreements") which provided for, among other things, the
funding by the Partnership of milestone and other payments due under a
satellite construction agreement, and certain related costs, through
advances by the Partnership to Tempo. The Tempo Letter Agreements permit
the Partnership to apply its advances to Tempo against any payments due
under the Tempo Capacity Option with respect to its purchase or lease of
satellite capacity. The aggregate funding provided to Tempo by the
Partnership ($469,498,000 at December 31, 1998) is reflected as satellite
rights in the accompanying consolidated balance sheet. On February 7, 1997,
the Partnership exercised the Tempo Capacity Option, but no capacity lease
or purchase agreement has been entered into in connection therewith. In
connection with the Hughes High Power Transaction, Hughes has agreed to
assume, and to satisfy and discharge, $465 million of Tempo's obligation to
the Partnership for such advances, and the Partnership has agreed to
forgive the remaining balance. In addition, the Partnership has agreed to
terminate and relinquish its rights under the Tempo Capacity Option.
Pursuant to the Restructuring Agreement, the Company has indemnified each
of the Non-TSAT Parties against (i) any and all losses and liabilities,
suffered or incurred by any such indemnified party resulting from any
liabilities of such party assumed by the Company in the Restructuring, (ii)
any and all losses and liabilities resulting from the operation by the
Company of the digital satellite business, whether before, on or after the
Closing Date and (iii) any and all losses and liabilities resulting from
the business, affairs, assets or liabilities of the Company whether arising
before, on or after the Closing Date.
(continued)
F-69
<PAGE>
PRIMESTAR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
In addition, the Company is required to indemnify each of the Non-TSAT
Parties against (i) all liability for taxes, other than transfer taxes,
incurred as a result of the Restructuring ("Covered Taxes") of PRIMESTAR
for the taxable period that begins after the Closing Date or the portion
that begins after the Closing Date of any taxable period that begins before
and ends after the Closing Date, (ii) all liability for Covered Taxes
failing to qualify under Section 368(a) of the Code if such failure is
attributable to any action taken after the Closing by the Company (other
than any such action expressly required or contemplated by the
Restructuring Agreement) and (iii) all liability for any reasonable legal,
accounting, appraisal, consulting or similar fees and expenses relating to
the foregoing.
The International Bureau of the FCC has granted a subsidiary of EchoStar
Communications Corporation ("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, the medium power satellite now used to provide the PRIMESTAR(R)
service. 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.
GE Americom and PRIMESTAR 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, currently
are 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 have attempted to resolve potential coordination
problems directly with EchoStar, and EchoStar has advanced a proposition to
resolve this matter. PRIMESTAR is currently evaluating such proposition.
It is uncertain whether any agreement in respect of such coordination
between the Partnership and EchoStar will be reached, or that if such
agreement is reached that coordination will resolve such interference.
The Company has contingent liabilities related to legal proceedings and
other matters arising in the ordinary course of business. Although it is
reasonably possible the Company 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.
F-70
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
TCI Satellite Entertainment, Inc.:
We have audited the accompanying consolidated balance sheets of TCI
Satellite Entertainment, Inc. and subsidiaries (as defined in note 1) as of
December 31, 1998 and 1997 and the related consolidated statements of
operations, equity (deficit), and cash flows for each of the years in the three-
year period ended December 31, 1998. In connection with our audit of the
consolidated financial statements, we have also audited the financial statement
schedule listed in the index at Item 14(a). These consolidated financial
statements and the financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and the financial statement schedule based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of TCI
Satellite Entertainment, Inc. and subsidiaries as of December 31, 1998 and 1997,
and the results of their operations and their cash flows for each of the years
in the three-year period ended December 31, 1998, in conformity with generally
accepted accounting principles. Also, in our opinion, the related financial
statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly, in all material respects, the
information set forth therein.
KPMG LLP
Denver, Colorado
April 15, 1999
F-71
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 1998 and 1997
<TABLE>
<CAPTION>
1998 1997
------------------- -------------------
amounts in thousands
Assets
- - ------
<S> <C> <C>
Cash and cash equivalents $ -- 6,084
Accounts receivable, net of allowance for doubtful accounts -- 35,079
Investment in PRIMESTAR, Inc. ("PRIMESTAR") (note 8) -- --
Investment in, and related advances to, PRIMESTAR Partners
L.P., ("PRIMESTAR Partners") -- 11,093
Property and equipment, at cost:
Satellites (note 9) 463,133 463,133
Satellite reception equipment -- 674,387
Subscriber installation costs -- 227,131
Support equipment -- 34,389
-------- ---------
463,133 1,399,040
Less accumulated depreciation -- 277,103
-------- ---------
463,133 1,121,937
-------- ---------
Deferred financing costs and other assets, net of accumulated
amortization -- 30,663
-------- ---------
$463,133 1,204,856
======== =========
</TABLE>
(continued)
F-72
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC. AND SUBSIDIARIES
Consolidated Balance Sheets, continued
December 31, 1998 and 1997
<TABLE>
<CAPTION>
1998 1997
-------------------- --------------------
amounts in thousands
Liabilities and Stockholders' Equity (Deficit)
- - ----------------------------------------------
<S> <C> <C>
Accounts payable $ -- 50,755
Accrued charges from PRIMESTAR Partners -- 48,591
Accrued charges from TCI Communications, Inc. ("TCIC") -- 14,225
Accrued commissions -- 10,435
Accrued interest payable -- 8,658
Other accrued expenses -- 24,386
Subscriber advance payments -- 29,675
Due to PRIMESTAR (note 9) 469,498 463,133
Debt -- 418,729
--------- ---------
Total liabilities 469,498 1,068,587
--------- ---------
Stockholders' Equity (Deficit) (note 10):
Preferred stock, $.01 par value; authorized 5,000,000
shares; none issued -- --
Series A common stock, $1 par value; authorized
185,000,000 shares; issued 59,280,466 in 1998 and
58,239,136 in 1997 59,280 58,239
Series B common stock, $1 par value; authorized
10,000,000 shares; issued 8,465,324 in 1998 and 1997 8,465 8,465
Additional paid-in capital 825,276 523,685
Accumulated deficit (899,386) (454,120)
--------- ---------
Total stockholders' equity (deficit) (6,365) 136,269
--------- ---------
Commitments (note 9)
$ 463,133 1,204,856
========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
F-73
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
Years ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
1998 1997 1996
------------------ ------------------- ------------------
amounts in thousands,
except per share amounts
Revenue:
<S> <C> <C> <C>
Programming and equipment rental $ 154,257 512,894 351,548
Installation 14,243 49,096 65,913
--------- --------- --------
168,500 561,990 417,461
--------- --------- --------
Operating costs and expenses:
Charges from PRIMESTAR Partners
(note 12) 82,235 259,600 188,724
Operating (note 12) 16,211 23,992 28,546
Selling, general and administrative (note
12) 55,495 198,263 193,566
Stock compensation 4,869 8,092 (446)
Depreciation (note 5) 65,105 243,642 191,355
--------- --------- --------
223,915 733,589 601,745
--------- --------- --------
Operating loss (55,415) (171,599) (184,284)
--------- --------- --------
Other income (expense):
Interest expense (14,177) (47,992) (2,023)
Share of losses of PRIMESTAR (note 8) (369,231) -- --
Share of losses of PRIMESTAR Partners (5,822) (20,473) (3,275)
Other, net (621) 1,723 3,641
--------- --------- --------
(389,851) (66,742) (1,657)
--------- --------- --------
Loss before income taxes (445,266) (238,341) (185,941)
Income tax benefit (note 11) -- -- 45,937
--------- --------- --------
Net loss $(445,266) (238,341) (140,004)
========= ========= ========
Basic and diluted loss per common share (note 6) $ (6.58) $ (3.58) (2.11)
========= ========= ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-74
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity (Deficit)
Years ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
Common Stock Additional
----------------------- paid-in Accumulated
Series A Series B capital deficit
------------ --------- ------------ ---------
amounts in thousands
<S> <C> <C> <C> <C>
Balance at January 1, 1996 $ -- -- -- (75,775)
Net loss -- -- -- (140,004)
TCIC intercompany allocations -- -- -- --
Net cash transfers from TCIC -- -- -- --
Recognition of deferred tax assets upon transfer
of PRIMESTAR Partners investment in connection
with Spin-off -- -- -- --
Adjustment to reflect consummation of Spin-off
(note 4) 57,941 8,467 521,724 --
Issuance of Series A Common Stock upon conversion
of notes of Tele-Communications, Inc. 5 -- -- --
------- -------- ------- --------
Balance at December 31, 1996 57,946 8,467 521,724 (215,779)
Net loss -- -- -- (238,341)
Recognition of stock compensation related to stock
options and restricted stock awards -- -- 1,781 --
Issuance of Series A Common Stock related to
restricted stock awards 33 -- 180 --
Issuance of Series A Common Stock upon conversion
of convertible securities of
Tele-Communications, Inc. 258 -- -- --
Conversion of Series B to Series A 2 (2) -- --
------- -------- ------- --------
Balance at December 31, 1997 58,239 8,465 523,685 (454,120)
Net loss -- -- -- (445,266)
Recognition of stock compensation related to stock
options and restricted stock awards -- -- 2,595 --
Issuance of Series A Common Stock related to
restricted stock awards 50 -- (50) --
Issuance of Series A Common Stock upon conversion
of convertible securities of
Tele-Communications, Inc. 991 -- -- --
Issuance of common stock by subsidiary (note 3) -- -- 299,046 --
------- -------- ------- --------
Balance at December 31, 1998 $59,280 8,465 825,276 (899,386)
======= ======== ======= ========
<CAPTION>
Total
Due to stockholders'
TCIC equity (deficit)
------------- ----------------
amounts in thousands
<S> <C> <C>
Balance at January 1, 1996 559,359 483,584
Net loss -- (140,004)
TCIC intercompany allocations 21,009 21,009
Net cash transfers from TCIC 228,622 228,622
Recognition of deferred tax assets upon transfer
of PRIMESTAR Partners investment in connection
with Spin-off 29,142 29,142
Adjustment to reflect consummation of Spin-off
(note 4) (838,132) (250,000)
Issuance of Series A Common Stock upon conversion
of notes of Tele-Communications, Inc. -- 5
------------- --------
Balance at December 31, 1996 -- 372,358
Net loss -- (238,341)
Recognition of stock compensation related to stock
options and restricted stock awards -- 1,781
Issuance of Series A Common Stock related to
restricted stock awards -- 213
Issuance of Series A Common Stock upon conversion
of convertible securities of
Tele-Communications, Inc. -- 258
Conversion of Series B to Series A -- --
------------- --------
Balance at December 31, 1997 136,269
Net loss -- (445,266)
Recognition of stock compensation related to stock
options and restricted stock awards -- 2,595
Issuance of Series A Common Stock related to
restricted stock awards -- --
Issuance of Series A Common Stock upon conversion
of convertible securities of
Tele-Communications, Inc. -- 991
Issuance of common stock by subsidiary (note 3) -- 299,046
------------- --------
Balance at December 31, 1998 -- (6,365)
============= ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-75
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
1998 1997 1996
----------------- ----------------- ----------------
amounts in thousands
(see note 7)
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $(445,266) (238,341) (140,004)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Depreciation 65,105 243,642 191,355
Share of losses of PRIMESTAR 369,231 -- --
Share of losses of PRIMESTAR Partners 5,822 20,473 3,275
Accretion of debt discount 4,682 16,719 --
Stock compensation 4,869 8,092 (446)
Deferred income tax expense -- -- 24,708
Other non-cash charges (credits) 8,108 6,919 (311)
Changes in operating assets and liabilities,
net of the effect of the Restructuring:
Change in receivables 10,845 (15,014) 4,364
Change in other assets (736) (335) (841)
Change in accruals and payables (10,210) 42,056 24,096
Change in subscriber advance payments (3,114) 7,426 9,005
--------- -------- --------
Net cash provided by operating activities 9,336 91,637 115,201
--------- -------- --------
Cash flows from investing activities:
Capital expended for property and equipment (73,966) (227,327) (326,621)
Capital expended for construction of satellites -- (5,448) (74,785)
Additional investments in, and related advances to,
PRIMESTAR Partners (75) (7,073) (17,552)
Repayments of advances to PRIMESTAR Partners -- 7,815 --
Other investing activities -- (1,581) (5,458)
--------- -------- --------
Net cash used in investing activities (74,041) (233,614) (424,416)
--------- -------- --------
Cash flows from financing activities:
Borrowings of debt 113,000 498,061 259,000
Repayments of debt (61,735) (344,699) (263,000)
Payment of deferred financing costs -- (17,780) (7,000)
Increase in due to PRIMESTAR 6,365 5,448 74,785
Proceeds from issuance of common stock 991 471 --
Increase in due to TCIC -- -- 250,189
--------- -------- --------
Net cash provided by financing activities 58,621 141,501 313,974
--------- -------- --------
Net increase (decrease) in cash and cash
equivalents (6,084) (476) 4,759
Cash and cash equivalents:
Beginning of year 6,084 6,560 1,801
--------- -------- --------
End of year $ -- 6,084 6,560
========= ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-76
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
(1) Basis of Presentation
- - --- ---------------------
The accompanying financial statements of TCI Satellite Entertainment, Inc.
("TSAT" or the "Company") include the historical financial information of
(i) certain satellite television assets (collectively, "TCI SATCO") of
TCIC, a subsidiary of Tele-Communications, Inc. ("TCI") for periods prior
to the December 4, 1996 consummation of the distribution transaction (the
"Spin-off") described in note 4, and (ii) TSAT and its consolidated
subsidiaries for the period following such date. Upon consummation of the
Spin-off, TSAT became the owner of the assets that comprise TCI SATCO,
which assets included (i) a 100% ownership interest in the TCIC business
that distributed the PRIMESTAR(R) programming service to subscribers within
specified areas of the continental United States, (ii) a 100% ownership
interest in Tempo Satellite, Inc. ("Tempo"), and (iii) a 20.86% aggregate
ownership interest in PRIMESTAR Partners, which owned and operated the
PRIMESTAR(R) service.
As a result of the TSAT Asset Transfer described in note 3, TSAT is
currently a holding company, with no substantial assets or liabilities
other than (i) 100% of the outstanding capital stock of Tempo, (ii) its
ownership interest in PRIMESTAR, and (iii) its rights and obligations under
certain agreements with PRIMESTAR and others.
In addition, the Company has no operations subsequent to the TSAT Asset
Transfer other than (i) expenses associated with the operation and
maintenance of the Tempo Satellites, as defined below and (ii) general and
administrative expenses incurred to maintain the Company's status as a
publicly traded company.
Tempo holds a permit (the "FCC Permit") issued by the Federal
Communications Commission ("FCC") authorizing the construction of a direct
broadcast satellite ("DBS") system in the 119 degrees West Longitude
("W.L.") orbital position. Tempo is also a party to a construction
agreement (the "Satellite Construction Agreement") with Space
Systems/Loral, Inc. ("Loral"), pursuant to which Tempo arranged for the
construction of two high power communications satellites (the "Tempo
Satellites"), one of which is currently in orbit at 119 degrees W.L.
("Tempo DBS-1") and one of which is currently used as a ground spare
("Tempo DBS-2").
All significant inter-entity and intercompany transactions have been
eliminated.
(continued)
F-77
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(2) Proposed Hughes Transactions
----------------------------
On January 22, 1999, the Company announced that the Company and PRIMESTAR
had reached an agreement with Hughes to sell (i) the Tempo Satellites, (ii)
Tempo's 119 degrees W.L. orbital location license and (iii) PRIMESTAR's
rights relating to Tempo's DBS system to Hughes, for aggregate
consideration valued at $500 million. Pursuant to the agreement, Hughes has
agreed to assume $465 million of TSAT's liability to PRIMESTAR Partners,
pay TSAT $2.5 million in cash and pay PRIMESTAR and PRIMESTAR Partners
$32.5 million in cash. In addition, PRIMESTAR Partners has agreed to
forgive amounts due from TSAT in excess of the $465 million to be assumed
by Hughes ($4,498,000 at December 31, 1998). Due to the fact that
regulatory approval is required to transfer Tempo DBS-1 and Tempo's FCC
authorization for 119 degrees W.L. to Hughes, the Hughes High Power
Transaction will be completed in two steps.
Effective March 10, 1999, the first closing of the Hughes High Power
Transaction (the "First Closing") was consummated whereby Hughes acquired
Tempo DBS-2 and PRIMESTAR's option to acquire Tempo DBS-2 (the "Tempo DBS-2
Option") for aggregate consideration of $150 million. Such consideration
was comprised of the following: (i) $9,750,000 paid to PRIMESTAR and
PRIMESTAR Partners for the Tempo DBS-2 Option and the termination of
PRIMESTAR Partners' rights with respect to the capacity of Tempo's high
power DBS assets, (ii) $750,000 paid to TSAT to exercise the Tempo DBS-2
Option and (iii) the assumption by Hughes of $139,500,000 due to PRIMESTAR
Partners from TSAT in exchange for Tempo DBS-2, which had a carrying value
of $224 million at December 31, 1998.
With regard to the sale of the remaining assets contemplated by the Hughes
High Power Agreement (the "Second Closing"), Tempo has been notified that
Tempo DBS-I experienced power reductions which occurred on March 29, 1999
and April 2, 1999. Although the Company does not believe the extent of such
power reductions is significant, a definitive assessment of the impact on
Tempo DBS-I is not yet complete. Notwithstanding the foregoing, the Second
Closing, which is subject to the receipt of appropriate regulatory
approvals and other customary closing conditions, is expected to be
consummated in the second quarter of 1999. Upon completion of the sale of
the Company's remaining high power assets, which had a carrying value of
$239 million at December 31, 1998, the Company will receive additional
consideration of $327 million in the form of cash and debt assumption. In
the event the Second Closing is not consummated and the Hughes High Power
Agreement is abandoned, there can be no assurance that the Company will be
able to recover the carrying amount of its satellites.
In a separate transaction (the "Hughes Medium Power Transaction"),
PRIMESTAR also announced that it had reached an agreement with Hughes to
sell PRIMESTAR's medium-power DBS business and assets for $1.1 billion in
cash and 4.871 million shares of General Motors Class H common stock ("GMH
Stock") valued at approximately $225 million, based on the closing price of
GMH Stock on the date of the purchase agreements. The foregoing purchase
price is subject to adjustments for working capital at the date of closing.
PRIMESTAR is responsible for the payment of certain obligations not assumed
by Hughes, satisfaction of its funded indebtedness and the payment of
costs, currently estimated to range from $270 million to $340 million,
associated with the termination of PRIMESTAR's high power business strategy
and sale of its medium power assets. The consummation of the Hughes Medium
Power Transaction is subject to various consents from PRIMESTAR's lenders,
restructuring of certain of PRIMESTAR's indebtedness, and other customary
conditions.
In addition, completion of the Hughes High Power Transaction is not
dependent on consummation of the Hughes Medium Power Transaction, and
consummation of the Hughes Medium Power Transaction is not dependent on
completion of the Hughes High Power Transaction.
In connection with their approval of the Hughes Medium Power Transaction,
the stockholders of PRIMESTAR approved the payment to TSAT of consideration
(the "PRIMESTAR Payment") in the amount of $65 million, payable in shares
of GMH Stock, valued at $46.1875 (the closing price of such stock on the
date of the purchase agreements with Hughes). Subject to the terms and
considerations set forth in an agreement (the "PRIMESTAR Payment
Agreement") dated as of January 22, 1999. In consideration of the PRIMESTAR
Payment, the Company agreed to approve the Hughes Medium Power Transaction
and Hughes High Power Transaction as a stockholder of PRIMESTAR, to modify
certain agreements to facilitate the Hughes High Power Transaction, and to
issue PRIMESTAR a share appreciation right (the "TSAT GMH SAR") with
respect to the shares of GMH Stock received as the PRIMESTAR Payment,
granting PRIMESTAR the right to any appreciation in such GMH Stock over the
one-year period following the date of issuance, over an agreed strike price
of $47.00.
The TSAT GMH SAR will be secured by a first priority pledge and security
interest in the underlying shares of GMH Stock, and both the TSAT GMH SAR
and such pledge and security interest will be pledged by PRIMESTAR for the
benefit of certain holders of share appreciation rights issued by PRIMESTAR
with respect to shares of GMH Stock (the "PRIMESTAR GMH SARs"). The shares
of GMH Stock issued to TSAT pursuant to the PRIMESTAR Payment Agreement
will be subject to certain restrictions on transfer during the first year
after the closing of the Hughes Medium Power Transaction, and TSAT will be
entitled (together with PRIMESTAR) to certain registration rights with
respect to such shares following the expiration of such one-year period.
Pursuant to the PRIMESTAR Payment Agreement, TSAT has also agreed to forego
any liquidating distribution or other payment that may be made in respect
of the outstanding shares of PRIMESTAR upon any dissolution and winding-up
of PRIMESTAR, or otherwise in respect of PRIMESTAR's existing equity. The
PRIMESTAR Payment is conditioned upon the closing of the Hughes Medium
Poser Transaction.
If the Hughes Medium Power Transaction is not consummated for any reason,
PRIMESTAR currently intends to continue operating its medium power
business, which may require the restructuring or refinancing of certain of
its liabilities. There can be no assurance that such restructuring or
refinancing, if necessary, could be accomplished on terms acceptable to
PRIMESTAR.
F-78
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(3) The Roll-up Plan
----------------
On March 6, 1998, the TSAT stockholders voted to approve a proposal to
adopt the provisions of certain agreements and the transactions
contemplated thereby, collectively, referred to herein as the "Roll-up
Plan". The Roll-up Plan is a two-step transaction comprising the
Restructuring and the proposed TSAT Merger, as described below.
Restructuring
Effective April 1, 1998 (the "Closing Date") and pursuant to (i) a Merger
and Contribution Agreement dated as of February 6, 1998, (the
"Restructuring Agreement"), among TSAT, PRIMESTAR, Time Warner
Entertainment Company, L.P. ("TWE"), Advance/Newhouse Partnership
("Newhouse"), Comcast Corporation ("Comcast"), Cox Communications, Inc.
("Cox"), MediaOne of Delaware, Inc., ("MediaOne"), US WEST Media Group,
Inc. and GE American Communications, Inc., and (ii) an Asset Transfer
Agreement dated as of February 6, 1998, (the "TSAT Asset Transfer
Agreement") between TSAT and PRIMESTAR, a business combination (the
"Restructuring") was consummated. In connection with the Restructuring,
TSAT contributed and transferred to PRIMESTAR (the "TSAT Asset Transfer")
all of TSAT's assets and liabilities except (i) the capital stock of Tempo,
(ii) the consideration received by TSAT in the Restructuring and (iii) the
rights and obligations of TSAT under certain agreements with PRIMESTAR and
others. In addition, the business of PRIMESTAR Partners and the business
of distributing the PRIMESTAR(R) programming service ("PRIMESTAR(R)") of
each of TWE, Newhouse, Comcast, Cox and affiliates of MediaOne were
consolidated into PRIMESTAR.
In connection with the TSAT Asset Transfer, PRIMESTAR assumed all of TSAT's
indebtedness on such date, and TSAT received from PRIMESTAR such number of
shares of Class A Common Stock of PRIMESTAR ("PRIMESTAR Class A Common
Stock") and Class B Common Stock of PRIMESTAR ("PRIMESTAR Class B Common
Stock" and together with the PRIMESTAR Class A Common Stock, "PRIMESTAR
Common Stock"), respectively, as equals the number of shares of Series A
Common Stock of TSAT ("Series A Common Stock") and Series B Common Stock of
TSAT ("Series B Common Stock"), respectively, issued and outstanding on the
Closing Date, in accordance with the Restructuring Agreement and the TSAT
Asset Transfer Agreement. In addition, TSAT received one share of
PRIMESTAR Class A Common Stock for each share of Series A Common Stock
issuable at the Closing Date ("Issuable TSAT Shares") pursuant to certain
TSAT stock options, restricted stock awards and other arrangements. TSAT
received 66.3 million shares of PRIMESTAR Class A Common Stock and 8.5
million shares of PRIMESTAR Class B Common Stock, and as a result, owns
approximately 37% of the outstanding shares of common equity of PRIMESTAR
at the closing of the Restructuring, representing approximately 38% of the
combined voting power of such common equity. As a result of the dilution
of TSAT's investment in PRIMESTAR from 100% to approximately 37%, TSAT
recognized an increase in its investment in PRIMESTAR and an increase in
additional paid-in capital of $299,046,000, net of income taxes. Such
increase represents the difference between TSAT's historical investment
basis in PRIMESTAR and TSAT's proportionate share of PRIMESTAR's equity
subsequent to the Restructuring.
(continued)
F-79
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
TSAT Merger
Effective February 6, 1998, TSAT and PRIMESTAR entered into an Agreement
and Plan of Merger (the "TSAT Merger Agreement"), providing for the merger
of TSAT with and into PRIMESTAR, with PRIMESTAR as the surviving
corporation (the "TSAT Merger"). In connection with the First Closing, the
Company and PRIMESTAR terminated the TSAT Merger Agreement.
(4) TSAT Spin-off Transaction
--------------------------
General
On December 4, 1996 (the "Spin-off Date"), TCI distributed (the "Spin-off")
all the capital stock of the Company to the holders of Tele-Communications,
Inc. Series A TCI Group Common Stock (the "Series A TCI Group Stock") and
Tele-Communications, Inc. Series B TCI Group Common Stock (the "Series B
TCI Group Stock" and, together with the Series A TCI Group Stock, the "TCI
Group Stock"). The Spin-off did not involve the payment of any
consideration by the holders of TCI Group Stock (such holders, the "TCI
Group Stockholders"), and was intended to qualify as a tax-free spinoff.
TCI Group Stockholders received one share of Series A Common Stock for each
ten shares of Series A TCI Group Stock owned and one share of Series B
Common Stock for each ten shares of Series B TCI Group Stock owned.
Since the Spin-off, the Company and TCI have operated independently. For
the purposes of governing certain of the ongoing relationships between the
Company and TCI after the Spin-off, and to provide mechanisms for an
orderly transition, the Company and TCI entered into various agreements,
including the "Reorganization Agreement" (see 10), the "Fulfillment
Agreement" and the "Transition Services Agreement" (see note 12), and an
amendment to TCI's existing "Tax Sharing Agreement" (see note 11).
(continued)
F-80
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(5) Changes in Accounting
---------------------
During the fourth quarter of 1996, the Company changed its depreciation
policy for subscriber installation costs. Such 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 the Company's
depreciation expense for the fourth quarter of 1996. Consequently, this
change in policy resulted in increases to the Company's depreciation
expense, net loss and net loss per share for the year ended December 31,
1996 of $55,304,000 ($8,754,000 of which relates to periods prior to
January 1, 1996), $41,478,000 ($6,566,000 of which relates to periods prior
to January 1, 1996) and $.62 ($.10 of which relates to periods prior to
January 1, 1996), respectively.
The Company also revised the estimated useful life of certain satellite
reception equipment on a prospective basis as of October 1, 1996. Such
change in estimate resulted in increases to the Company's depreciation
expense, net loss and net loss per share for the year ended December 31,
1996 of $7,796,000, $5,847,000 and $.09, respectively.
(6) Summary of Significant Accounting Policies
------------------------------------------
Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of
three months or less at the date of acquisition to be cash equivalents.
Equity Method Investments
The Company uses the equity method to account for its investment in
PRIMESTAR Partners and PRIMESTAR. Under this method, the investment,
originally recorded at cost, is adjusted to recognize the Company's share
of the net earnings or losses as they occur, rather than as dividends or
other distributions are received, limited to the extent of the Company's
investment in, and advances and commitments to, the investee.
Changes in the Company's proportionate share of the underlying equity of a
subsidiary or equity method investee, which result from the issuance of
additional securities by such subsidiary or equity investee, are recognized
as increases to or reductions of additional paid-in capital in the
consolidated statements of stockholders' equity.
Property and Equipment
Property and equipment is stated at cost. Upon acceptance by the Company
of delivery of a satellite, the satellite is depreciated using the
straight-line method over the estimated useful life of such satellite.
(continued)
F-81
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The Company periodically reviews the carrying amount of its long-lived
assets to determine whether current events or circumstances warrant
adjustments to such carrying amounts. The Company considers historical and
expected future net operating losses to be its primary indicators of
potential impairment. Assets are grouped and evaluated for impairment at
the lowest level for which there are identifiable cash flows that are
largely independent of the cash flows of other groups of assets ("Assets").
The Company deems Assets to be impaired if the Company is unable to recover
the carrying value of its Assets over their expected remaining useful life
through a forecast of undiscounted future operating cash flows directly
related to the Assets. If Assets are deemed to be impaired, the loss is
measured as the amount by which the carrying amount of the Assets exceeds
their fair values. TSAT generally measures fair value by considering sales
prices for similar assets or by discounting estimated future cash flows.
Considerable management judgment is necessary to estimate discounted future
cash flows. Accordingly, actual results could vary significantly from such
estimates.
Deferred Financing Costs
Deferred financing costs are amortized over the term of the related loan
facility.
Revenue Recognition
Programming and equipment rental revenue is recognized in the period that
services are delivered. Installation revenue is recognized in the period
the installation services are provided to the extent of direct selling
costs. To date, direct selling costs have exceeded installation revenue.
Advertising Costs
Advertising costs generally are expensed as incurred. Amounts expensed for
advertising aggregated $5,066,000, $23,062,000 and $25,622,000 during 1998,
1997 and 1996, respectively.
Marketing and Direct Selling Costs
Marketing and direct selling costs are expensed as incurred. The excess
cost of customer premises equipment over proceeds received upon sale of
such equipment is recognized at the time of sale and is included in selling
expense.
Residual Sales Commissions
Residual sales commissions, which become payable upon the collection of
programming revenue from certain subscribers, are expensed during the
period in which such commissions become payable.
Stock Based Compensation
The Company accounts for stock-based employee compensation using the
intrinsic value method pursuant to Accounting Principles Board Opinion No.
25.
(continued)
F-82
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Income Taxes
TSAT accounts for its income taxes using the asset and liability method.
Under the asset and liability method, deferred tax assets and liabilities
are recognized for the estimated future tax consequences attributable to
differences between the financial statement carrying amounts of existing
assets and liabilities and their respective tax bases. Deferred tax assets
and liabilities are measured using enacted tax rates in effect for the year
in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in
tax rates is recognized in income in the period that includes the enactment
date.
Loss Per Common Share
The loss per common share for the years ended December 31, 1998 and 1997 is
based on 67,718,000 and 66,658,000 weighted average shares outstanding
during the respective period. TSAT issued 66,408,000 shares of Company
Common Stock pursuant to the Spin-off. The loss per share amounts set
forth in the accompanying statements of operations assume that the shares
issued pursuant to the Spin-off were issued and outstanding since January
1, 1996. Accordingly, the calculation of the loss per share assumes
weighted average shares outstanding of 66,408,000 for the year ended
December 31, 1996. Excluded from the computation of diluted EPS for the
years ended December 31, 1998, 1997 and 1996 are options to acquire
6,929,000, 7,894,000 and 591,000 weighted average shares of Series A Common
Stock, respectively, because inclusion of such options would be anti-
dilutive.
Comprehensive Income (Loss)
The Company's total comprehensive loss for all periods presented herein did
not differ from those amounts reported as net loss in the consolidated
statements of operations.
Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities 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.
(7) Supplemental Disclosures to Statements of Cash Flows
----------------------------------------------------
Cash paid for interest was $13,844,000, $20,224,000 and $1,946,000 during
the years ended December 31, 1998, 1997 and 1996. Cash paid for income
taxes was not material during the years ended December 31, 1998, 1997 and
1996.
(continued)
F-83
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Significant non-cash investing and financing activities for the year ended
December 31 1998 are as follows (amounts in thousands):
<TABLE>
<S> <C>
Contribution of operating assets and liabilities to subsidiary in
Restructuring $ 68,796
========
Increase in equity due to issuance of stock by subsidiary in Restructuring
$299,046
========
</TABLE>
Transactions effected through the intercompany account with TCIC for periods
prior to the Spin-off have been considered to be constructive cash receipts and
payments for purposes of the accompanying statements of cash flows.
The non-cash effects of the Spin-off are set forth in the accompanying
statements of equity.
Accounts payable include accrued capital expenditures of $35,645,000 and
$7,713,000 at December 31, 1997 and 1996, respectively, which have been
excluded from the accompanying statements of cash flows .
(8) Investment in PRIMESTAR, Inc.
-----------------------------
As a result of the Restructuring, PRIMESTAR owns and operates the PRIMESTAR(R)
direct to home satellite service throughout the continental U.S.
Summarized unaudited financial information for PRIMESTAR is as follows:
<TABLE>
<CAPTION>
December 31,
-------------------------------------------------
1998 1997
------------------------ -----------------------
amounts in thousands
<S> <C> <C>
Financial Position
- - ------------------
Current assets $ 143,567 42,425
Property and equipment, net 1,148,590 1,121,937
Intangible assets, net 786,373 --
Other assets, net 33,557 40,494
---------- ---------
Total assets $2,112,087 1,204,856
========== =========
Current liabilities $ 448,514 180,051
Debt 1,833,195 418,729
Deferred income taxes 75,057 --
Other liabilities 40,095 469,807
Stockholders' equity (deficit) (284,774) 136,269
---------- ---------
Total liabilities and stockholders' equity (deficit) $2,112,087 1,204,856
========== =========
</TABLE>
(continued)
F-84
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
<TABLE>
<CAPTION>
Year ended December 31,
-------------------------------------------------------------
1998 1997 1996
------------------- ------------------- -------------------
amounts in thousands
<S> <C> <C> <C>
Results of Operations
- - ---------------------
Revenue $ 1,289,666 561,990 417,461
Operating, selling, general and administrative
expenses (1,133,834) (489,947) (410,390)
Impairment of long-lived assets (950,289) -- --
Depreciation and amortization (543,087) (243,642) (191,355)
----------- -------- --------
Operating loss (1,337,544) (171,599) (184,284)
Interest expense (145,939) (47,992) (2,023)
Other, net (7,749) (18,750) 366
Income tax benefit 147,528 -- 45,937
----------- -------- --------
Net loss $(1,343,704) (238,341) (140,004)
=========== ======== ========
</TABLE>
(9) Satellites
- - --- ----------
Tempo DBS System
The Company, 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.
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.
Tempo DBS-1 was launched into geosynchronous orbit on March 8, 1997. During
1997, Loral notified TSAT of nine separate occurrences of power reductions
on Tempo DBS-1. In addition, Loral notified TSAT of two additional, power
reductions that occurred on March 29, 1999 and April 2, 1999. 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. As a
result of such power reductions, in-orbit testing has been extended and
Tempo DBS-1 has not yet been accepted. Pursuant to the Satellite
Construction Agreement, Loral bears the risk of loss of the Tempo
Satellites until Tempo accepts delivery of the Tempo Satellites. 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 negotiations regarding
this matter, including the timing, extent and methodology of any further
tests to be conducted and the terms of any monetary settlement with respect
to the satellite to which Tempo may be entitled under the Satellite
Construction Agreement. Certain launch defects or damages affecting Tempo
DBS-1 could cause a substantial monetary loss to TSAT.
(continued)
F-85
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Under the FCC Permit, the time by which the Tempo Satellites must be
operational was due to expire in May 1998. On April 3, 1998, Tempo filed a
request with the FCC for an extension of that deadline pending FCC review
of TSAT's request for consent to the transfer of control of Tempo to
PRIMESTAR (the "Transfer Application") should the FCC determine that an
extension is necessary for Tempo to maintain its FCC authorizations at 119
degrees W.L. and 166 degrees W.L.
On April 30, 1998, the FCC determined that Tempo's satellite at 119 W.L.
was not operational. It did find, however, that an extension of time was
warranted for that orbital location and granted an extension to Tempo for
119 W.L. Such extension was granted until six months after the FCC
determination on the Transfer Application, with the condition that Tempo
not enter into a lease agreement with PRIMESTAR or any similar lease
arrangement prior to the FCC's decision on the Transfer Application. In
addition, Tempo voluntarily surrendered its permit for 166 W.L.
On November 25, 1998, Tempo and PRIMESTAR requested expedited action by the
FCC on the Transfer Application. Several parties filed responses to that
request, objecting to the proposed transfer. PRIMESTAR and Tempo filed a
joint reply to those objections. On January 27, 1999, Tempo filed a joint
application with DIRECTV Enterprises, Inc. seeking FCC approval to assign
Tempo's DBS authorization to DIRECTV ("DIRECTV Application"). In addition,
Tempo and PRIMESTAR jointly filed a letter seeking to maintain the status
quo with respect to the Transfer Application until the FCC decides the
DIRECTV Application. Therefore, Tempo and PRIMESTAR requested that the
Transfer Application be held in abeyance and, subject to and
contemporaneously with approval of the DIRECTV Application, that the FCC
dismiss the Transfer Application.
Upon delivery of each of the Tempo Satellites, Tempo is obligated to make a
$10 million incentive payment to Loral. Tempo is eligible to receive a pro
rata warranty payback of each such incentive payment to the extent that
transponder failures occur during the twelve-year period following
delivery. Satellite incentive payments and any related warranty paybacks
are treated as adjustments of the cost of the applicable Tempo Satellite.
(continued)
F-86
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Tempo Capacity Option
In February 1990, Tempo entered into an option agreement (the "Tempo Option
Agreement") with PRIMESTAR Partners granting PRIMESTAR Partners the right
and option (the "Tempo Capacity 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 Capacity 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 Capacity 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 (the "PRIMESTAR Advances"). The PRIMESTAR
Advances aggregated $469,498,000 at December 31, 1998 and are reflected in
due to PRIMESTAR, Inc. in the accompanying consolidated balance sheets.
On February 7, 1997, the Partners Committee of PRIMESTAR Partners adopted a
resolution (i) affirming that PRIMESTAR Partners had unconditionally
exercised the Tempo Capacity 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 Capacity 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.
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 Capacity 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 Capacity 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, including the Hughes High Power Transaction. However, if
notwithstanding the exercise of the Tempo Capacity 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.
In connection with the Hughes High Power Transaction, Hughes has agreed to
assume, and to satisfy and discharge, $465 million of Tempo's obligation to
PRIMESTAR Partners for the PRIMESTAR Advances, and PRIMESTAR
Partners has agreed to forgive the remaining balance. In addition,
PRIMESTAR has agreed to terminate its rights under the Tempo Capacity
Option.
(continued)
F-87
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(10) Stockholders' Equity
--------------------
Common Stock
The Series A Common Stock has one vote per share and the Series B Common
Stock has ten votes per share. Each share of Series B Common Stock is
convertible, at the option of the holder, into one share of Series A Common
Stock.
Preferred Stock
TSAT is authorized to issue 5,000,000 shares of Preferred Stock. The
Preferred Stock may be issued from time to time as determined by the Board
of Directors, without stockholder approval. Such Preferred Stock may be
issued in such series and with such designations, preferences, conversion
or other rights, voting powers, qualifications, limitations, or
restrictions as shall be stated or expressed in a resolution or resolutions
providing for the issue of such series adopted by the Company's Board of
Directors (the "TSAT Board"). The TSAT Board has not authorized the
issuance of any shares of Preferred Stock and has no current plans for the
issuance of any shares of Preferred Stock.
Employee Retirement Plan
TSAT's Employee Stock Purchase Plan (the "TSAT ESPP") became effective on
January 1, 1997 and was merged into PRIMESTAR Partners' retirement plan in
connection with the Restructuring. The TSAT Plan provided eligible
employees with an opportunity to invest in TSAT and to create a retirement
fund. Terms of the TSAT ESPP provided for eligible employees to contribute
up to 10% of their compensation to a trust for investment in TSAT common
stock. TSAT, by annual resolution of the TSAT Board, could elect to
contribute up to 100% of the amount contributed by employees. TSAT
contributions to the TSAT ESPP aggregated $317,000 and $1,200,000 for 1998
and 1997.
Stock Options
On the Spin-off Date, the TSAT Board adopted, and TCI as the sole
stockholder of the Company prior to the Spin-off, approved, the TCI
Satellite Entertainment, Inc. 1996 Stock Incentive Plan (the "TSAT 1996
Plan"). The TSAT 1996 Plan provides for awards to be made in respect of a
maximum of 3,200,000 shares of Series A Common Stock (subject to certain
anti-dilution adjustments). Awards may be made as grants of stock options,
stock appreciation rights ("SARs"), restricted shares, stock units,
performance awards or any combination thereof (collectively, "Awards").
Awards may be made to employees and to consultants and advisors to the
Company who are not employees. Shares of Series A Common Stock that are
subject to Awards that expire, terminate or are annulled for any reason
without having been exercised (or deemed exercised, by virtue of the
exercise of a related SAR), or are forfeited prior to becoming vested, will
return to the pool of such shares available for grant under the TSAT 1996
Plan. Options granted pursuant to the TSAT 1996 Plan vest evenly over five
years from the date of grant and expire 10 years from the date of grant.
(continued)
F-88
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
In June 1996, the Board of Directors of TCI (the "TCI Board") authorized
TCI to permit certain of its executive officers to acquire equity interests
in certain of TCI's subsidiaries. In connection therewith, the TCI Board
approved the acquisition by each of two executive officers of TCI who are
not employees of the Company (the "TCI Officers"), of 1.0% of the net
equity of the Company. The TCI Board also approved the acquisition by the
chief executive officer and a director of the Company (the "Company
Officer"), of 1.0% of the net equity of the Company and the acquisition by
an executive officer of certain TCI subsidiaries who is also a director,
but not an employee, of the Company (the "TCI Subsidiary Officer"), of 0.5%
of the net equity of the Company. The TCI Board determined to structure
such transactions as grants by the Company to such persons of options to
purchase shares of Series A Common Stock representing 1.0% (in the case of
each of the TCI Officers and the Company Officer) and 0.5% (in the case of
the TCI Subsidiary Officer) of the shares of Series A Common Stock and
Series B Common Stock issued and outstanding on the Spin-off Date,
determined immediately after giving effect to the Spin-off, but before
giving effect to any exercise of such options (the "Spin-off Date
Options").
Spin-off Date Options to purchase 2,324,266 shares of Series A Common Stock
at a per share price of $8.86 were granted on the Spin-off Date. As
originally granted, the Spin-off Date options were to vest in 20%
cumulative increments on each of the first five anniversaries of February
1, 1996, and were to be exercisable for up to ten years following February
1, 1996. In November 1997, the TSAT Board approved modifications to the
vesting provisions of the Spin-off Date Options accelerating the vesting
schedule such that the Spin-off Date Options will be two-thirds vested in
February 1999 and fully vested in February 2000. Compensation expense with
respect to the Spin-off Date Options held by the Company Officer aggregated
$621,000, $1,101,000 and $95,000 during the years ended December 31, 1998,
1997 and 1996, respectively.
Pursuant to the Reorganization Agreement, and (in the case of the TCI
Officers and the TCI Subsidiary Officer) in partial consideration for the
capital contribution made by TCI to the Company in connection with the
Spin-off, the Company agreed, effective as of the Spin-off Date, to bear
all obligations under such options and to enter into stock option
agreements with respect to such options with each of the TCI Officers, the
Company Officer and the TCI Subsidiary Officer
(continued)
F-89
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
On March 6, 1998, stockholders of the Company approved the TCI Satellite
Entertainment, Inc. 1997 Nonemployee Director Stock Option Plan (the "TSAT
DSOP") including the grant, effective as of February 3, 1997, to each
person that as of that date was a member of the TSAT Board and was not an
employee of the Company or any of its subsidiaries, of options to purchase
50,000 shares of Series A Common Stock. Pursuant to the TSAT DSOP, options
to purchase 200,000 shares of Series A Common Stock were granted at an
exercise price of $8.00 per share. As originally granted, options issued
pursuant to the TSAT DSOP vest and become exercisable over a five-year
period from the date of grant and expire 10 years from the date of grant.
In November 1997, the TSAT Board approved modifications to the vesting
provisions to provide for vesting in three annual installments, commencing
February 1998. In November 1997, the TSAT Board also voted to increase the
number of directors by one, and the director named to fill such newly
created directorship received options to purchase 50,000 shares of Series A
Common Stock at an exercise price of $6.50.
The Company applies Accounting Principles Board Opinion No. 25 in
accounting for its stock options, and accordingly, compensation expense has
been recognized for its stock options in the accompanying financial
statements using the intrinsic value method. Had the Company determined
compensation expense based on the grant-date fair value method pursuant to
Statement of Financial Accounting Standards No. 123, the Company's net loss
and loss per share would have been $447,012,000 and $6.60 for 1998,
$240,384,000 and $3.61 for 1997 and would not have been significantly
different than the amounts reported for 1996.
(continued)
F-90
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The following table presents the number, weighted-average exercise price
and weighted-average grant-date fair value of options to buy Series A
Common Stock.
<TABLE>
<CAPTION>
Weighted- Weighted-
average average
Number of exercise grant-date
options price fair value
------------------- ------------------- -------------------
<S> <C> <C> <C>
Granted in connection with Spin-off
2,324,266 $8.86 $8.74
---------
Outstanding at December 31, 1996 2,324,266
Granted in 1997 1,070,000 7.93 4.77
---------
Outstanding at December 31, 1997 and 1998 3,394,266 8.57
=========
Exercisable at December 31, 1996 --
=========
Exercisable at December 31, 1997 464,853 8.86
=========
Exercisable at December 31, 1998 1,241,706 8.64
=========
</TABLE>
As originally granted, options granted to employees vest evenly over five years
with such vesting period beginning January 1, 1997, first become exercisable on
January 1, 1998 and expire on December 31, 2006. In November 1997, the TSAT
Board approved modifications to the vesting provisions to provide for vesting in
three equal annual installments, commencing February 1998.
Options outstanding at December 31, 1998 have a range of exercise prices from
$6.50 to $8.86 and a weighted-average remaining contractual life of
approximately eight years.
The respective estimated grant-date fair values of the options noted above are
based on the Black-Scholes model and are stated in current annualized dollars on
a present value basis. The key assumptions used in the model for purposes of
these calculations include the following: (a) a discount rate equal to the 10-
year Treasure rate on the date of grant; (b) a 35% volatility rate; (c) the 10-
year option term; (d) the closing price of the Series A Common Stock on the date
of grant; and (e) an expected dividend rate of zero.
(continued)
F-91
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
In February 1997, certain key employees of the Company were granted,
pursuant to the TSAT 1996 Plan, an aggregate of 325,000 restricted shares
of Series A Common Stock. As originally granted, such restricted shares
vest as to 50% on January 1, 2001 and as to the remaining 50% on January 1,
2002. In November 1997, the TSAT Board approved modifications to the
vesting provisions accelerating the vesting schedules under such restricted
stock awards to provide for vesting of 50% on each of the second and third
anniversaries of the date of granting. Compensation expense with respect to
the restricted shares aggregated $434,000 and $585,000 during the years
ended December 31, 1998 and 1997, respectively.
Other
Pursuant to the Reorganization Agreement, the Company granted to TCI an
option to purchase up to 4,765,000 shares of Series A Common Stock, at an
exercise price of $1.00 per share, as required by TCI from time to time to
meet its obligations under the conversion features of certain convertible
securities of TCI as such conversion features were adjusted as a result of
the Spin-off. During 1998 and 1997, TCI purchased 991,000 shares and
258,000 shares, respectively, of Series A Common Stock pursuant to such
option.
In connection with the Spin-off, TCI and the Company also entered into a
"Share Purchase Agreement" to sell to each other from time to time, at the
then current market price, shares of Series A TCI Group Stock and Series A
Common Stock, respectively, as necessary to satisfy their respective
obligations after the Spin-off Date under certain stock options and SARs
held by their respective employees and non-employee directors.
At December 31, 1998, a total of 8,790,209 shares of Series A Common Stock
were reserved for issuance pursuant to the Spin-off Date Options, the Share
Purchase Agreements, the Reorganization Agreement, the TSAT 1996 Plan and
the TSAT DSOP. In addition, one share of Series A Common Stock is reserved
for each outstanding share of Series B Common Stock.
(11) Income Taxes
------------
Through the 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. In
connection with the 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 through the Spin-off Date has been calculated in accordance with
the Tax Sharing Agreement. Subsequent to the Spin-off Date, TSAT files
separate U.S. Federal and state income tax returns.
(continued)
F-92
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
In connection with the Restructuring, 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 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 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 and
TSAT or any of its subsidiaries relating to taxes is the Tax Sharing
Agreement.
TSAT recognized no income tax benefit during either of the years ended
December 31, 1998 and 1997. As a result of the 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,
1998 and 1997. Additionally, during the foreseeable future, 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.
Income tax benefit (expense) for the year ended December 31, 1996 consists
of:
<TABLE>
<CAPTION>
Current Deferred Total
---------------- ----------------- -----------------
amounts in thousands
<S> <C> <C> <C>
Year ended December 31, 1996:
Intercompany allocation $70,645 -- 70,645
Federal -- (17,699) (17,699)
State and local -- (7,009) (7,009)
------- ------- -------
$70,645 (24,708) 45,937
======= ======= =======
</TABLE>
Income tax benefit (expense) differs from the amounts computed by applying the
Federal income tax rate of 35% as a result of the following (amounts in
thousands):
<TABLE>
<CAPTION>
Years ended December 31
-------------------------------------------------------
1998 1997 1996
----------------- ----------------- -----------------
amounts in thousands
<S> <C> <C> <C>
Computed "expected" tax benefit $ 155,843 83,419 65,079
State and local income taxes, net
of Federal income tax benefit -- 13,009 (2,672)
Issuance of common stock by subsidiary (104,666) -- --
Change in valuation allowance (51,736) (98,521) (16,371)
Other 559 2,093 (99)
--------- ------- -------
$ -- -- 45,937
========= ======= =======
</TABLE>
(continued)
F-93
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities at December 31, 1998 and
1997 are presented below:
<TABLE>
<CAPTION>
December 31,
----------------------------------------
1998 1997
------------------- -------------------
amounts in thousands
<S> <C> <C>
Deferred tax assets:
Net operating loss carry forwards $ 152,468 133,024
Investment in PRIMESTAR, principally due to losses
recognized for financial statement purposes in excess of
losses recognized for tax purposes 15,827 --
Investment in PRIMESTAR Partners:
Due to an increase in tax basis upon transfer from
TCIC to the Company -- 29,305
Due principally to losses recognized for financial
statement purposes in excess of losses recognized for
tax purposes -- 2,671
Future deductible amounts principally due to accruals
deductible in later periods -- 5,028
--------- --------
Total deferred tax assets 168,295 170,028
Less-valuation allowance (166,628) (114,892)
--------- --------
Net deferred tax assets 1,667 55,136
Deferred tax liability-
Property and equipment, principally due to differences in
depreciation net of increase in tax basis resulting from
intercompany transfer -- 55,136
Other 1,667 --
--------- --------
Net deferred tax liability $ -- --
========= ========
</TABLE>
Immediately prior to the Spin-off, the investment in PRIMESTAR Partners was
transferred from TCIC to the Company. Such transfer, which resulted in an
increased tax basis for the investment in PRIMESTAR Partners, was recorded at
TCIC's carryover basis for financial reporting purposes. In connection with
such transfer, the Company recorded a $29,142,000 non-cash increase to the
intercompany account owed to TCIC and $29,142,000 non-cash decrease to the
Company's deferred tax liability.
The valuation allowance for deferred tax assets as of December 31, 1998 was
$166,628,000. Such balance increased $51,736,000 from December 31, 1997.
The Company has analyzed the sources and expected reversal periods of its
deferred tax assets. The Company believes that the tax benefits attributable to
deductible temporary differences will be realized to the extent of future
reversals of existing taxable temporary differences.
(continued)
F-94
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
At December 31, 1998, the Company had net operating loss carry forwards for
income tax purposes aggregating approximately $398,609,000 of which, if not
utilized to reduce taxable income in future periods, $526,000 expire in
2006, $13,967,000 expire in 2010, $55,145,000 expire in 2011, $258,347,000
expire in 2012 and $70,624,000 expire in 2018.
(12) Transactions with Related Parties
---------------------------------
Pursuant to the terms of the TSAT Merger Agreement, PRIMESTAR reimbursed
TSAT for all reasonable costs and expenses incurred by TSAT (i) to comply
with its tax and financial reporting obligations, (ii) to maintain certain
insurance coverage and (iii) to maintain its status as a publicly traded
company. During the year ended December 31, 1998, such reimbursements
aggregated $152,000. The effects of such reimbursements have been
reflected as a reduction of TSAT's investment in PRIMESTAR.
In addition, PRIMESTAR makes advances to TSAT for the payment of certain
costs related to the Tempo Satellite and the proposed high power strategy.
Such advances aggregated $6,365,000 during 1998, and are included in due to
PRIMESTAR in the accompanying consolidated balance sheets.
Certain former employees of TSAT, who are now employees of PRIMESTAR, hold
stock options, stock options with tandem stock appreciation rights, and
restricted shares of TSAT (collectively, the "TSAT Options"). Subsequent
to the Restructuring, compensation expense related to the TSAT Options
aggregated $1,541,000 and has been reflected as an increase in TSAT's
investment in PRIMESTAR in the accompanying consolidated financial
statements.
Prior to the Restructuring, PRIMESTAR Partners provided programming
services to the Company and other authorized distributors in exchange for a
fee based upon the number of subscribers receiving programming services.
In addition, PRIMESTAR Partners arranged for satellite capacity and uplink
services, and provided national marketing and administrative support
services in exchange for a separate authorization fee.
Through December 31, 1996, TCIC provided certain installation, maintenance,
retrieval and other customer fulfillment services to the Company. The costs
associated with such services were allocated to the Company based upon a
standard charge for each of the various customer fulfillment activities
performed by TCIC. During the year ended December 31, 1996, the Company's
capitalized installation costs included amounts allocated from TCIC of
$53,169,000. Maintenance, retrieval and other operating expenses allocated
from TCIC to the Company aggregated $20,365,000 during the year ended
December 31, 1996.
(continued)
F-95
<PAGE>
TCI SATELLITE ENTERTAINMENT, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Effective January 1, 1997, charges for customer fulfillment services
provided by TCI were made pursuant to the Fulfillment Agreement entered
into by the Company and TCIC in connection with the Spin-off. Pursuant to
the Fulfillment Agreement, TCIC continued to provide fulfillment services
on an exclusive basis to the Company following the Spin-off with respect to
customers of the PRIMESTAR(R) medium power service. Such services were
performed in accordance with specified performance standards. Charges to
TSAT pursuant to the Fulfillment Agreement aggregated $54,823,000 during
1997, of which $46,498,000 were capitalized installation costs. The
Fulfillment Agreement terminated on December 31, 1997.
TCIC also provided corporate administrative services to the Company.
Through the Spin-off Date, such administrative expenses, which were
allocated from TCIC to the Company based primarily on the estimated cost of
providing the service aggregated $18,120,000 during the year ended December
31, 1996.
Effective on the Spin-off Date, charges for administrative services
provided by TCIC were made pursuant to the Transition Services Agreement.
Pursuant to the Transition Services Agreement, TCI was obligated to provide
to the Company certain services and other benefits. As compensation for
the services rendered and for the benefits made available to the Company
pursuant to the Transition Services Agreement, the Company was 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. Amounts charged to TSAT
pursuant to the Transition Services Agreement aggregated $3,174,000 and
$11,579,000 for the years ended December 31, 1998 and 1997, respectively,
and are included in selling, general and administrative expenses in the
accompanying consolidated statements of operations. Upon consummation of
the Restructuring, TSAT and TCI agreed to terminate the Transition Services
Agreement.
Beginning in March 1997, and through the Closing Date, TCIC provided TSAT
with customer support services from TCIC's Boise, Idaho call center.
Amounts charged by TCIC to TSAT for such services aggregated $5,026,000 and
$12,173,000 during the years ended December 31, 1998 and 1997,
respectively, and are included in selling, general and administrative
expenses in the accompanying consolidated statements of operations.
Certain key employees of the Company hold stock options in tandem with SARs
with respect to certain common stock of TCI. In connection with the Spin-
off, the Company assumed the stock compensation liability with respect to
such TCI options and SARs. Estimates of the compensation related to the
options and/or SARs granted to employees of the Company have been recorded
in the accompanying financial statements, but are subject to future
adjustment based upon the market value of the underlying TCI common stock
and, ultimately, on the final determination of market value when the rights
are exercised. Non-cash increases (decreases) to such estimated stock
compensation liability, which are included in the above-described TCIC
administrative expense allocations, aggregated $(541,000) during the year
ended December 31, 1996. In 1998 and 1997, the Company recognized
$3,814,000 and $6,134,000, respectively, of stock compensation expense
related to the aforementioned options with tandem SARs.
F-96
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To United States Satellite Broadcasting Company, Inc.
We have audited the consolidated balance sheets of United States Satellite
Broadcasting Company, Inc. (a Minnesota corporation) and Subsidiaries as of
December 31, 1998 and 1997, and the related consolidated statements of
operations, shareholders' equity (deficit) and cash flows for each of the three
years in the period ended December 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of United States
Satellite Broadcasting Company, Inc. and Subsidiaries as of December 31, 1998
and 1997, and the results of their operations and their cash flows for each
of the three years in the period ended December 31, 1998 in conformity with
generally accepted accounting principles.
/s/ Arthur Andersen LLP
Minneapolis, Minnesota,
January 22, 1999
F-97
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
United States Satellite Broadcasting Company, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
As of December 31,
- - ------------------------------------------------------------------------------------------------------------------
(In thousands, except share and per share data) 1998 1997
- - ------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 66,297 $ 68,646
Trade accounts receivable, less allowance of $5,986 and $6,074
at December 31, 1998 and 1997, respectively 47,843 44,992
Prepaid expenses and other 8,856 11,832
- - ------------------------------------------------------------------------------------------------------------------
Total current assets 122,996 125,470
- - ------------------------------------------------------------------------------------------------------------------
PROPERTY AND EQUIPMENT
Land 351 351
Buildings and improvements 5,106 5,075
Equipment 150,249 138,264
- - ------------------------------------------------------------------------------------------------------------------
155,706 143,690
Less - Accumulated depreciation (96,548) (79,235)
- - ------------------------------------------------------------------------------------------------------------------
Total property and equipment, net 59,158 64,455
- - ------------------------------------------------------------------------------------------------------------------
OTHER ASSETS
Satellite deposits - 8,380
Long-term investments 4,501 3,970
Other 3,456 4,035
- - ------------------------------------------------------------------------------------------------------------------
Total other assets 7,957 16,385
- - ------------------------------------------------------------------------------------------------------------------
$ 190,111 $ 206,310
- - ------------------------------------------------------------------------------------------------------------------
Liabilities and Shareholders' Equity (Deficit)
CURRENT LIABILITIES
Accounts payable and accrued expenses $ 65,743 $ 60,599
Deferred revenue 52,956 56,156
Manufacturer Incentive obligation 25,579 17,023
Contract cancellation payable 13,200 -
- - ------------------------------------------------------------------------------------------------------------------
Total current liabilities 157,478 133,778
- - ------------------------------------------------------------------------------------------------------------------
MANUFACTURER INCENTIVE OBLIGATION 77,103 60,433
DUE TO HBI 10,000 10,000
COMMITMENTS AND CONTINGENCIES (NOTE 4)
SHAREHOLDERS' EQUITY (DEFICIT)
Preferred Stock, $.01 par value, 50 million shares authorized; none issued
or outstanding - -
Class A Common Stock -
Participating, voting, $.0001 par value, 500 million shares authorized,
29,390,450 and 16,172,601 shares issued and outstanding at December 31, 1998
and 1997, respectively 2 2
Common Stock -
Participating, voting, $.0001 par value, 100 million shares authorized,
60,422,825 and 73,638,174 shares issued and outstanding at December 31, 1998
and 1997, respectively 7 7
Additional paid-in capital 374,896 374,877
Accumulated deficit (429,380) (372,777)
Accumulated other comprehensive income (deficit) 5 (10)
- - ------------------------------------------------------------------------------------------------------------------
Total shareholders' equity (deficit) (54,470) 2,099
- - ------------------------------------------------------------------------------------------------------------------
$ 190,111 $ 206,310
- - ------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
F-98
<PAGE>
United States Satellite Broadcasting Company, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Years Ended December 31,
(In thousands, except per share data) 1998 1997 1996
- - -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
REVENUES $ 550,801 $ 456,619 $ 292,624
COST OF SALES 327,676 292,917 193,356
- - -----------------------------------------------------------------------------------------------------------
GROSS MARGIN 223,125 163,702 99,268
OPERATING EXPENSES
Selling and marketing 114,983 99,399 102,715
Manufacturer Incentive 44,778 66,726 18,387
General and administrative 57,571 46,935 31,992
Commissions to retailers 13,232 14,537 13,909
Engineering and operations 13,834 9,801 11,644
Depreciation and amortization 17,316 18,426 19,687
Early cancellation of contracts due to merger (Note 2) 22,130 - -
- - -----------------------------------------------------------------------------------------------------------
Net operating loss (60,719) (92,122) (99,066)
- - -----------------------------------------------------------------------------------------------------------
OTHER (INCOME) EXPENSE
Interest expense - - 2,326
Interest (income) (4,067) (4,919) (6,244)
Cost to terminate Credit Agreement - - 9,504
Other (49) 103 307
- - -----------------------------------------------------------------------------------------------------------
Net loss ($ 56,603) ($ 87,306) ($104,959)
- - -----------------------------------------------------------------------------------------------------------
Net loss per share - basic and diluted ($ 0.63) ($ 0.97) ($ 1.17)
- - -----------------------------------------------------------------------------------------------------------
Weighted average shares outstanding - basic and diluted 89,811 89,811 89,811
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-99
<PAGE>
United States Satellite Broadcasting Company, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
Class A
-------
Common Stock Common Stock
------------ ------------
(In thousands, except per share data) Shares Amount Shares Amount
<S> <C> <C> <C> <C>
- - -----------------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY (DEFICIT) AT DECEMBER 31, 1995 16,876 $ 2 72,935 $ 7
Conversion of shares pursuant to
Recapitalization (16,876) (2) 16,876 2
Conversion of notes and cancellation of
warrants - - 7,412 1
Conversion of shares available for
overallotment 1,245 - (1,245) -
Transfer of common stock from HBI - - (15,712) (2)
Sale of Class A common stock for
$27 per share, net 8,300 1 - -
Conversion of shares pursuant to
certain shareholder rights 5,570 1 (5,570) (1)
Media credits utilized - - - -
Unrealized loss on investments - - - -
Net loss - - - -
- - -----------------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY (DEFICIT) AT DECEMBER 31, 1996 15,115 2 74,696 7
Conversion of shares pursuant to
certain shareholder rights 1,058 - (1,058) -
Media credits utilized - - - -
Media credits cancelled - - - -
Unrealized gain on investments - - - -
Net loss - - - -
- - -----------------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY (DEFICIT) AT DECEMBER 31, 1997 16,173 2 73,638 7
Conversion of shares pursuant to
certain shareholder rights 13,215 - (13,215) -
Issuance of Class A Common stock 2 - - -
Unrealized gain on investments - - - -
Net loss - - - -
- - -----------------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY (DEFICIT) AT DECEMBER 31, 1998 29,390 $ 2 60,423 $ 7
- - -----------------------------------------------------------------------------------------------------------------------
- - -----------------------------------------------------------------------------------------------------------------------
<CAPTION>
Additional Accumulated
Paid-In Accumulated Other
(In thousands, except per share data) Warrants Capital Deficit Comprehensive
Income (Deficit)
- - --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
SHAREHOLDERS' EQUITY (DEFICIT) AT DECEMBER 31, 1995 $ 7,350 $ 127,423 ($180,512) $ 154
Conversion of shares pursuant to
Recapitalization - - - -
Conversion of notes and cancellation of
warrants (7,350) 44,491 - -
Conversion of shares available for
overallotment - - - -
Transfer of common stock from HBI - - - -
Sale of Class A common stock for
$27 per share, net - 206,200 - -
Conversion of shares pursuant to
certain shareholder rights - - - -
Media credits utilized - - - -
Unrealized loss on investments - - - (176)
Net loss - - (104,959) -
- - --------------------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY (DEFICIT) AT DECEMBER 31, 1996 - 378,114 (285,471) (22)
Conversion of shares pursuant to
certain shareholder rights - - - -
Media credits utilized - - - -
Media credits cancelled - (3,237) - -
Unrealized gain on investments - - - 12
Net loss - - (87,306) -
- - --------------------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY (DEFICIT) AT DECEMBER 31, 1997 - 374,877 (372,777) (10)
Conversion of shares pursuant to
certain shareholder rights - - - -
Issuance of Class A Common stock - 19 - -
Unrealized gain on investments - - - 15
Net loss - - (56,603) -
- - --------------------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY (DEFICIT) AT DECEMBER 31, 1998 - $ 374,896 ($429,380) $ 5
- - --------------------------------------------------------------------------------------------------------------------------
- - --------------------------------------------------------------------------------------------------------------------------
<CAPTION>
Unused
Media
(In thousands, except per share data) Credits Total
- - ------------------------------------------------------------------------------------
<S> <C> <C>
SHAREHOLDERS' EQUITY (DEFICIT) AT DECEMBER 31, 1995 ($3,396) ($ 48,972)
Conversion of shares pursuant to
Recapitalization - -
Conversion of notes and cancellation of
warrants - 37,142
Conversion of shares available for
overallotment - -
Transfer of common stock from HBI - (2)
Sale of Class A common stock for
$27 per share, net - 206,201
Conversion of shares pursuant to
certain shareholder rights - -
Media credits utilized 243 243
Unrealized loss on investments - (176)
Net loss - (104,959)
- - ------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY (DEFICIT) AT DECEMBER 31, 1996 (3,153) 89,477
Conversion of shares pursuant to
certain shareholder rights - -
Media credits utilized (84) (84)
Media credits cancelled 3,237 -
Unrealized gain on investments - 12
Net loss - (87,306)
- - ------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY (DEFICIT) AT DECEMBER 31, 1997 - 2,099
Conversion of shares pursuant to
certain shareholder rights - -
Issuance of Class A Common stock - 19
Unrealized gain on investments - 15
Net loss - (56,603)
- - ------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY (DEFICIT) AT DECEMBER 31, 1998 - ($ 54,470)
- - ------------------------------------------------------------------------------------
- - ------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-100
<PAGE>
United States Satellite Broadcasting Company, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the Years Ended December 31
(In thousands) 1998 1997 1996
- - --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net Loss ($ 56,603) ($ 87,306) ($104,959)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities -
Depreciation and amortization 17,316 18,426 19,687
Deferred loan origination fees charged to expense in
connection with termination of Credit Agreement -- -- 5,465
Early cancellation of contracts due to merger 9,030 -- --
Media credits utilized -- (84) 243
Change in operating items:
Trade accounts receivable (2,850) (2,590) (25,532)
Prepaid expenses and other current assets 2,975 (6,969) (278)
Accounts payable and accrued expenses 5,144 8,679 19,851
Contract cancellation payable 13,200 -- --
Deferred revenue (3,200) 9,036 23,943
Manufacturer Incentive 25,225 59,146 14,632
Other 563 (3,829) (852)
- - --------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities 10,800 (5,491) (47,800)
- - --------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Purchase of and deposits on equipment (12,668) (14,854) (5,487)
Purchase of investments (500) -- --
Proceeds from sale of investments -- 3,000 5,996
- - --------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities (13,168) (11,854) 509
- - --------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Advances from (repayments to) affiliated companies -- (527) (637)
Proceeds from debt borrowings -- -- 485
Repayment of debt -- -- (91,922)
Proceeds from sale of common stock 19 -- 206,200
- - --------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities 19 (527) 114,126
- - --------------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents (2,349) (17,872) 66,835
CASH AND CASH EQUIVALENTS, beginning of period 68,646 86,518 19,683
- - --------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, end of period $ 66,297 $ 68,646 $ 86,518
- - --------------------------------------------------------------------------------------------------------------------
NONCASH TRANSACTIONS
Conversion of notes and cancellation of warrants $ -- $ -- $ 44,491
- - --------------------------------------------------------------------------------------------------------------------
Expiration of unused media credits $ -- $ 3,237 $ --
- - --------------------------------------------------------------------------------------------------------------------
SUPPLEMENTARY CASH FLOW INFORMATION
Cash paid during the period for -
Interest $ -- $ -- $ --
Income taxes $ -- $ -- $ --
- - --------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-101
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES
United States Satellite Broadcasting Company, Inc. and Subsidiaries
("USSB" or the "Company") provide subscription television programming via a
high-power direct broadcast satellite ("DBS") to households throughout the
continental United States. The Company broadcasts a high quality digital
television signal using a digital satellite system ("DIRECTV/USSB System").
The Company's programming is available to customers who have a DIRECTV/USSB
unit, which consists of an 18-inch satellite dish, a receiver/decoder and a
remote control. All of the Company's gross revenues and identifiable assets
relate to the Company's activities in this industry.
Hubbard Broadcasting, Inc. ("HBI") beneficially owned 51.8% of the
Company as of December 31, 1998 and 1997, and had approximately 73.4% of the
total voting power at December 31, 1998.
Until July 1, 1994, the Company was a development stage company. The
Company has incurred losses since its inception and had an accumulated
deficit of approximately $429.4 million as of December 31, 1998. Management
anticipates that losses will continue into 1999.
The Company has entered into an Agreement and Plan of Merger dated as of
December 11, 1998 (the "Merger Agreement") with General Motors Corporation, a
Delaware corporation ("GM"), and its subsidiary Hughes Electronics
Corporation, a Delaware corporation ("Hughes"), pursuant to which, if certain
conditions are satisfied, the Company will be merged with and into Hughes
(the "Merger") (See Note 2).
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the
Company and its wholly owned Subsidiaries, including USSB II, Inc. ("USSB
II"). USSB II owns the Company's satellite transponders and holds the
Company's FCC licenses and permits (see Note 4). All significant intercompany
accounts and transactions have been eliminated in consolidation.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Ultimate results could differ from those estimates.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents, which consist primarily of short-term United
States Treasury-backed securities with original maturities of less than 90
days, are stated at cost, which approximates fair value.
INVESTMENTS
Long-term investments at December 31, 1998, consist primarily of a U.S.
Treasury security maturing in 1999, which the Company classifies as
available-for-sale. The Treasury security bears interest at 5.5% and its
aggregate amortized cost approximated its market value of
F-102
<PAGE>
$4,001,000 at December 31, 1998. Unrealized gains and losses are reported as
other comprehensive income.
MANUFACTURER INCENTIVE PROGRAM
The Company's costs under its financial incentive arrangements with
manufacturers of DIRECTV/USSB System equipment are charged to expense as
incurred. See Note 4 for additional disclosure regarding these arrangements.
RETAILER COMMISSIONS
The Company generally pays commissions to eligible retailers for their
customers who are current USSB subscribers. Commissions paid are charged to
expense over the related subscription period. Accrued retailer commissions
totaled $5,262,000 at December 31, 1998 and $5,996,000 at December 31, 1997.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Depreciation is provided
using accelerated and straight-line methods based on estimated useful lives
as follows:
<TABLE>
<S> <C>
Satellite Transponders 10 years
Other Equipment 5-10 years
Buildings & Improvements 31 years
</TABLE>
FINANCIAL INSTRUMENTS
Unless otherwise indicated, the recorded value of the Company's
financial instruments approximates their fair value.
REVENUE RECOGNITION
Programming revenues are recorded when the respective services are
rendered. Subscriptions received in advance of the delivery of the related
programming are recorded as deferred revenue.
ADVERTISING AND PROMOTIONS
Costs for advertising and promotional materials and activities
(including the cost, if any, of programming provided to current or
prospective customers free of charge) are charged to expense as incurred.
RESEARCH AND DEVELOPMENT
Costs related to the Company's research and development efforts are
charged to expense as incurred.
INCOME TAXES
Deferred income tax assets and liabilities are computed annually for
differences between the financial statement and tax bases of assets and
liabilities. These differences will result in taxable or
F-103
<PAGE>
deductible amounts in the future based on enacted tax laws and are applicable
to the periods in which the differences are expected to affect taxable
income.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
The Company adopted FASB Statement No. 130, "Reporting Comprehensive
Income" (SFAS No. 130), effective January 1, 1998. SFAS No. 130 establishes
standards for reporting and display of comprehensive earnings and its
components in financial statements. Comprehensive income is defined as
changes in equity of a business enterprise during a period except those
resulting from investment by owners and distributions to owners. The
adoption of SFAS No. 130 had no impact on the Company's statements of
operations or shareholders' equity as of December 31, 1998.
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133 "Accounting for Derivative
Instruments and Hedging Activities" (SFAS No. 133). SFAS No. 133 establishes
accounting and reporting standards requiring that every derivative financial
instrument (including certain derivative instruments embedded in other
contracts) be recorded in the balance sheet either as an asset or liability
measured at its fair value. SFAS No. 133 requires that changes in the
derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. Special accounting for qualifying hedges
allows a derivative's gains and losses to offset related results on the
hedged item in the income statement, and requires that a company must
formally document, designate, and assess the effectiveness of transactions
that receive hedge accounting. The Company will be required to adopt SFAS
No. 133 no later than January 1, 2000. The Company has not entered into any
derivative financial instruments as of December 31, 1998. As a result,
adoption of SFAS No. 133 would currently have no impact on the Company. In
the future, if the Company were to enter into derivative financial
instruments which are covered by SFAS No. 133, volatility in earnings and
other comprehensive income could be increased.
2. AGREEMENT AND PLAN OF MERGER
The Company has entered into an Agreement and Plan of Merger dated as of
December 11, 1998 (the "Merger Agreement") with General Motors Corporation, a
Delaware corporation ("GM"), and its subsidiary Hughes Electronics
Corporation, a Delaware corporation ("Hughes"), pursuant to which, if certain
conditions are satisfied, the Company will be merged with and into Hughes
(the "Merger"). The Merger, which is subject to regulatory and shareholder
approval, and to the satisfaction of other conditions contained in the Merger
Agreement, is expected to take place in the first half of 1999. If the
Merger is completed, each share of USSB stock will be converted, subject to
certain limitations, into either (i) a fraction of a share of Class H Common
Stock of GM equal to the exchange ratio provided in the Merger Agreement or
(ii) cash equal to that exchange ratio multiplied by the 20-day
volume-weighted average price of the GM Class H Common Stock (the "Merger
Consideration"). The Merger Consideration is dependent upon the GM Class H
Common Stock price and will not exceed $18.00 per share.
As required by the Merger Agreement, the Company has canceled contracts
with Lockheed Martin and Convergys Information Management Group Inc. In
connection with the cancellation of these contracts, the Company recorded a
special one-time charge in the fourth quarter of 1998 of $20.7 million. This
charge represents the total amount of the charge associated with such
contract cancellations. The fourth quarter charge includes non-cash
write-offs of satellite deposits of $7.6 million and development costs for
subscriber management and billing systems of $1.3 million. The remainder of
the fourth quarter charge consists of net contract termination fees, which
were paid in January 1999. The charge of $22.1 million included in the
statement of operations for the year ended December 31, 1998 also includes a
write-off of satellite deposits of $1.43 million recorded in June 1998.
F-104
<PAGE>
3. SHAREHOLDERS' EQUITY
RECAPITALIZATION AND INITIAL PUBLIC OFFERING
In the third quarter of 1995, the Company decided to proceed with an
initial public offering of its Class A Common Stock. In connection with the
offering, on January 31, 1996, the Company effected a recapitalization of the
Company's capital structure.
Prior to the recapitalization, the Company's capitalization consisted of
two classes of common stock (referred to herein as "old common stock" and
"old class A common stock"). Terms of the recapitalization included (i) a
change in the authorized capital of the Company to consist of 100,000,000
shares of Common Stock, 500,000,000 shares of Class A Common Stock and
50,000,000 shares of undesignated Preferred Stock; (ii) the conversion of the
Company's old common stock and old class A common stock into shares of Common
Stock; (iii) the conversion of certain convertible subordinated promissory
notes into shares of Common Stock and the cancellation of warrants issued to
the holders of those notes; (iv) a 75-for-one split of the new capital stock;
and (v) the contribution by HBI of 8,300,000 shares of Common Stock in
connection with the public offering and 7,411,950 shares of Common Stock in
connection with conversion of the convertible subordinated promissory notes,
pursuant to HBI's agreements with certain current shareholders, in order to
prevent those shareholders from experiencing dilution in their ownership of
the Company. The Company's consolidated financial statements are presented as
if the above changes in authorized capital and the 75-for-one split of new
capital stock had been effective for all periods presented.
The offering (which closed on February 6, 1996) consisted of the sale by
the Company of 8,300,000 shares of Class A Common Stock at $27.00 per share,
generating proceeds of approximately $206.2 million, net of underwriting
commissions and other expenses incurred in connection with the offering.
Pursuant to the over-allotment provisions in the underwriting agreement,
certain shareholders who had purchased shares of the Company's capital stock
in previous private placements sold 1,245,000 shares of newly converted Class
A Common Stock in connection with the offering. The Company did not receive
any of the proceeds of such sales.
CONVERSION RIGHTS
On May 1, 1996, approximately 3.1 million shares of the Company's Common
Stock, with 10 votes per share, automatically converted into Class A Common
Stock, with one vote per share, at a conversion ratio of 1:1. On July 30,
1996, the remainder of the Company's Common Stock, with 10 votes per share,
became eligible, at the option of the holders thereof, to convert into Class
A Common Stock, with one vote per share, at a conversion ratio of 1:1.
In accordance with certain shareholder agreements, prior to the
Company's initial public offering, the ownership percentages of certain
shareholders, other than HBI, were protected from dilution, based on total
outstanding shares of 89,810,775, until the ownership of HBI was reduced to
51%. In connection with the Company's initial public offering, 15,711,950
shares of old common stock were contributed by HBI to the Company for no
consideration in 1996. In addition, certain shareholders holding 22,645,350
shares of Common Stock have certain "piggy-back" rights to participate in
certain public offerings of the Company's stock and certain "co-sale" rights
to include all or a portion of their shares in certain sales by HBI of its
stock of the Company.
F-105
<PAGE>
UNUSED MEDIA CREDITS
In connection with a sale of old class A common stock in 1994, the
Company received a $5.0 million media credit. The unused balance of the
media credit at December 31, 1997 ($3.2 million) was canceled by the Company.
Such cancellation was recorded as a reduction of additional paid-in capital
to reflect the actual net proceeds realized from the original stock sale.
CONVERTIBLE SUBORDINATED PROMISSORY NOTES
During 1994, the Company issued and sold unsecured convertible
subordinated promissory notes (the "Notes") for $34.5 million. The Notes
were subject to mandatory conversion into shares of old class A common stock
equal to the face amount of the Notes divided by $5.66 if the gross proceeds
of an initial public offering of the Company were to exceed $50 million at an
offering price of at least $7.00 per share. Such conversion occurred as part
of the recapitalization at which time the Notes (including cumulative
accretion) had a recorded balance of $37.1 million. Issued with the
convertible subordinated promissory notes were warrants valued at $7.5
million, which were canceled as a part of the recapitalization.
STOCK-BASED COMPENSATION
In December 1995, the Company's shareholders approved a stock option
plan (the "1995 Plan") and, in November 1996, the Company's shareholders
approved a Non-Employee Director Stock Option Plan (the "1996 Non-Employee
Director Plan") (together, the "Option Plans"). The Option Plans authorize
the granting of options to purchase up to an aggregate of 2,150,000 shares of
Class A Common Stock. The 1995 Plan provides for employees, officers and
consultants of the Company to be granted options to purchase Class A Common
Stock of two types: (i) those that qualify as incentive stock options
("Incentive Options") within the meaning of Section 422 of the Internal
Revenue Code of 1986, as amended, and (ii) those that do not qualify as
Incentive Options ("Nonstatutory Options"). All options granted under the
1996 Non-Employee Director Plan are Nonstatutory Options. The Option Plans
are administered by the Compensation Committee. Under the 1995 Plan, the
Compensation Committee determines the persons who are to receive options, the
terms and the number of shares subject to each option and whether the option
is to be an Incentive Option or a Nonstatutory Option. The options vest
equally over a four or five year period, and are exercisable over ten years
from the date of grant. The 1996 Non-Employee Director Plan provides for the
automatic, non-discretionary, grant of options. Information regarding the
Option Plans is as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------------------------------------------------------------------------------------
1998 1997 1996
----------------------------------- --------------------------------- ---------------------------------
Shares Weighted Shares Weighted Shares Weighted
Under Average Under Average Under Average
Option Exercise Option Exercise Option Exercise
Plan Exercise Price Price Plan Exercise Price Price Plan Exercise Price Price
- - ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Outstanding
at beginning of year 690,000 $7.75 - $36.00 $19.58 439,700 $11.50 - $36.00 $26.55 -- -- --
Granted 60,000 $6.19 - $10.00 $8.20 260,300 $7.75 - $12.00 $8.04 475,300 $11.50 - $36.00 $26.62
Exercised (2,500) $13.75 $13.75 - - - -- -- --
Forfeited (42,600) $7.75 - $27.00 $17.12 (10,000) $11.50 - $27.00 $24.45 (35,600) $27.00 - $28.50 $27.45
-------- -------------- ------ ------- --------------- ------ ------- --------------- ------
Outstanding 704,900 $6.19 - $36.00 $18.82 690,000 $7.75 - $36.00 $19.58 439,700 $11.50 - $36.00 $26.55
at end of year
Exercisable 217,547 $7.75 - $36.00 $21.87 103,946 $7.75 - $36.00 $23.64 11,000 $11.50 $11.50
at end of year
Weighted average $5.92 $5.24 $17.72
fair value of options
granted
</TABLE>
As of December 31, 1998, the outstanding stock options granted in 1996
have a remaining contractual life of approximately seven years and the
outstanding stock options granted in 1997 have a remaining contractual life
of approximately eight years.
F-106
<PAGE>
The Company accounts for the Option Plans under APB Opinion No. 25,
under which no compensation cost has been recognized. Had compensation cost
for the Option Plans been determined consistent with Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS
No. 123), the Company's pro forma net loss and pro forma loss per share would
have been as follows (in thousands):
<TABLE>
<CAPTION>
Years Ended December 31
1998 1997 1996
---- ---- ----
<S> <C> <C> <C> <C>
Net loss As Reported $(56,603) $(87,306) $(104,959)
Pro Forma $(58,418) $(88,670) $(112,750)
Net loss per share - basic and diluted As Reported $(.63) $(.97) $(1.17)
Pro Forma $(.65) $(.99) $(1.26)
</TABLE>
The fair value of each option grant is estimated on the date of the
grant using the Black-Scholes option pricing model with the following
weighted average assumptions: risk-free interest rates of 5.1% in 1998 and
6.3% in 1997; expected life of 10 years for 1998 and 1997; expected
volatility of 57.3% in 1998 and 39.5% in 1997.
4. COMMITMENTS AND CONTINGENCIES
REGULATORY MATTERS
USSB II, Inc. (a wholly owned subsidiary of the Company) holds a license
from the Federal Communications Commission (the "FCC") to broadcast from five
transponders at 101DEG. west longitude (the "License"). The Company must
continue to maintain the License to operate its business. The License
expires in June 2004 and is renewable at ten-year intervals. Although the
Company expects to obtain such renewals in the ordinary course, there can be
no assurance that such renewals will be granted.
The construction and launch of broadcasting satellites and the operation
of satellite broadcasting systems are subject to substantial regulation by
the FCC. Under the License, the Company is subject to FCC review primarily
for the following: (i) standards regarding individual satellites (e.g.,
meeting minimum financial, legal and technical standards); (ii) avoiding
interference with other satellites; and (iii) complying with rules the FCC
has established specifically for high-power DBS satellite licenses. In
addition, uplink facilities are separately licensed by the FCC. The
Company's National Broadcast Center and the Auxiliary Broadcast Center have
each received its FCC license. FCC rules are subject to change in response to
industry developments, new technology and political considerations.
The FCC granted the Company a Construction Permit and Launch Authority
(the "Permit"), held by USSB II, for satellites with three transponders at
110DEG. west longitude and eight transponders at 148DEG. west longitude. On
June 24, 1998, the Company voluntarily returned to the FCC its authorization
for eight transponders at 148DEG. west longitude. The return of the
authorization at 148DEG. west longitude had no effect on the status of the
Company's Permit for the 110DEG. orbital location.
The Permit requires the Company to comply with specified construction
and launch schedules. The FCC has the authority to revoke the Permit for the
110DEG. orbital location if the Company fails to comply with the FCC
schedule for construction and launch. Under the Merger Agreement, the
Company and Hughes have agreed to cooperate and use their reasonable best
efforts to maintain the Permit at the 110DEG. orbital location. In
connection therewith, the Company and Hughes have jointly filed an
application for modification of authorization to move
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the DBS-1 satellite, which presently operates at the 101DEG. orbital
location, to the 110DEG. orbital location to satisfy the FCC's due diligence
requirements. On April 1, 1999, the FCC staff issued an order approving the
transfer of control of the FCC authorization for construction at the 110DEG.
orbital location to DIRECTV, conditioned upon DIRECTV initiating service on
the three transponders authorized at the 110DEG. orbital location by December
31, 1999.
Under the Merger Agreement, on December 17, 1998, Hughes, DIRECTV
Enterprises, Inc., a wholly-owned subsidiary of Hughes, and the Company also
filed applications with the FCC requesting consent to the transfer of control
of all of the FCC authorizations held by USSB II, Inc. to Hughes. The FCC
staff's April 1, 1999 order also approved the transfer of control of the FCC
license for five transponders at the 101DEG. orbital location and related
earth station licenses to DIRECTV.
Any petition requesting reconsideration by the FCC staff, or application
for review of the April 1, 1999 order by the full Commission, must be filed
by May 3, 1999. In addition, the FCC may determine to review the order on
its own motion until May 11, 1999. Absent any of the foregoing, the April 1,
1999 order will become final on May 12, 1999.
While the Company has generally been successful to date with respect to
compliance with regulatory matters, there can be no assurance that the
Company will succeed in obtaining and maintaining all requisite regulatory
approvals for its operations.
LOCKHEED MARTIN ASTRO SPACE AGREEMENT
The Company originally entered into contracts with Lockheed Martin for
the construction of direct broadcast satellites at the 110DEG. orbital
location (the "110DEG. Contract") and at the 148DEG. orbital location (the
"148DEG. Contract"). As required by the Merger Agreement, the Company has
canceled the 110DEG. Contract and has allowed the 148DEG. Contract to
expire in accordance with its terms. Both actions were effective December
31, 1998. The Company has recorded charges related to these cancellations,
which represent the total amount of the charges associated with such
cancellations (See Note 2).
ADVERTISING AND PROMOTIONS
The Company has entered into commitments to purchase or participate in
joint purchases of broadcast, print and other media for advertising and
promotional purposes. At December 31, 1998, such commitments totaled $4.0
million due through June 30, 1999, with the non-cancelable portion of such
commitments totaling $3.0 million.
INSURANCE
The Company maintains business interruption and in-orbit insurance
coverages at levels management considers necessary to address the normal
risks of operating via communications satellite, including damage,
destruction or failure of the satellite or its transponders. Additionally,
the Company maintains general liability and directors' and officers'
insurance coverages.
SATELLITE
All of the Company's programming is carried on a single satellite,
DBS-1, which the Company co-owns with DIRECTV, a subsidiary of Hughes
Electronics Corporation. As previously reported, a spacecraft control
processor ("SCP") aboard the DBS-1 satellite failed on July 4, 1998, and
control of DBS-1 was automatically switched to the spare SCP without
interruption of service. In connection with the execution of the Merger
Agreement, DIRECTV and
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the Company entered into a Channel Services Provision Agreement which
provides that, subject to the terms of that Agreement, DIRECTV will provide
to USSB, on a full time basis, channel capacity and related services on two
other satellites owned by Hughes at the 101DEG. orbital location sufficient
to transmit and deliver a limited number of premium movie services to USSB
subscribers. At the same time, the Company and Hughes also entered into a
Replacement Payload Option Agreement which clarifies USSB's right to
transponder capacity on a replacement satellite , in the event the Merger
Agreement is terminated due to the failure of the transponders on DBS-1. The
Replacement Payload Option Agreement provides that USSB may elect to purchase
five transponders at a fixed price on DIRECTV 1-R, a satellite under
construction by Hughes.
LITIGATION
In November 1996, Personalized Media Communications, L.L.C. ("PMC")
initiated legal proceedings against the Company and others before the United
States International Trade Commission ("ITC"), and in the United States
District Court for the Northern District of California. The Company does not
believe that PMC is entitled to damages or any remedies from the Company, and
management intends to vigorously defend both actions.
In June 1997, IPPV Enterprises, a Georgia partnership ("IPPV") initiated
a legal proceeding against the Company and others in the United States
District Court for the District of Delaware. The Company does not believe
that IPPV is entitled to damages or any remedies from the Company, and
management intends to vigorously defend the action.
In September 1998, WIC Premium Television, Ltd., an Edmonton, Alberta,
Canada corporation, ("WIC") initiated two separate legal proceedings in the
Federal Court of Canada Trial Division and in the Judicial District of
Edmonton against numerous retailers, programming providers, and programming
distributors, including the Company. This action is in the preliminary
stages of discovery and management has not reached a judgment regarding
whether WIC may be entitled to damages or any remedies from the Company.
Item 3 of this Report on Form 10-K contains additional information on
these matters.
The Company is also exposed to other litigation encountered in the
normal course of business. In the opinion of management, the resolution of
these other litigation matters of which the Company is aware will not have a
material adverse effect on the Company's financial position, results of
operations or cash flows.
MANUFACTURER INCENTIVE PROGRAM
On August 26, 1996, the Company, together with DIRECTV, entered into
financial incentive arrangements with certain manufacturers of DIRECTV/USSB
System equipment to assist these manufacturers in lowering the price of
DIRECTV/USSB Systems. Such arrangements, which run for up to four years
depending on manufacturer, commit the Company to pay the manufacturers over a
five-year period from the date new DIRECTV/USSB System households are
authorized to receive programming. The expense and liability for such future
commitments are established and recorded upon activation of the related
DIRECTV/USSB System. For the years ended December 31, 1998 and 1997, the
Company charged to expense $44.8 and $66.7 million, respectively,
representing the full amount of those future obligations for the Manufacturer
Incentive program incurred for the sale of DIRECTV/USSB Systems to new
households. Cash paid in 1998 related to the Manufacturers Incentive program
was $21.8 million.. Future obligations totaled $102.7 million at December
31, 1998, payable in the following years:
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<PAGE>
<TABLE>
<CAPTION>
In Thousands
<S> <C>
1999 $25,579
2000 25,417
2001 25,196
2002 18,250
2003 8,240
</TABLE>
While the amounts to be incurred in the future by the Company under
these arrangements cannot be precisely estimated, the Company expects that as
the level of retail DIRECTV/USSB system unit sales increase, the cash flow
related to these arrangements will increase accordingly.
The fair value of the future obligation at December 31, 1998 is
approximately $86.0 million and has been calculated by discounting the future
cash flows at the Company's estimated incremental borrowing rate.
5. RELATED-PARTY TRANSACTIONS
Certain officers and directors of the Company are also employed by, and spend
a significant portion of their time on, the businesses of HBI and its
affiliates other than the Company. Each person who is a director has
indicated to the Company that, should a conflict of interest arise, he will
promptly disclose such conflict to the Company's Board of Directors and
refrain from voting on such matter as a director.
DUE TO HBI
Debt due to HBI consists principally of amounts accrued for management
services valued at $10.0 million provided to the Company by HBI during the
years 1992 through 1994 under an agreement which expired June 30, 1994. The
balance does not bear interest. The Company was contingently obligated to
pay these amounts and they will not become due until, in the board of
director's opinion, adequate resources exist. As a result of certain
significant financial performance thresholds, USSB management discontinued
accruing the $3.3 million annual charge after 1992 and did not intend to
accrue any additional charges until and unless it was determined payment
could be considered probable. When the Company decided to proceed with its
initial public stock offering, the board of directors determined that it
became likely that certain preconditions would ultimately be satisfied, and
therefore made payment of this obligation probable. Accordingly, during the
quarter ended September 30, 1995, the Company accrued as an operating expense
the remaining $6.7 million of its management fee obligation. In connection
with the execution of the Merger Agreement, Hughes has agreed to pay the
accrued management fee of $10 million to HBI on the first anniversary of the
closing date of the Merger, but not later than April 1, 2000.
HBI provides certain general and administrative services to the Company
under an agreement that is renewed annually. The Company incurred a charge of
$1,252,000 for such services for the year ended December 31, 1998, $1,124,000
for 1997, and $978,000 for 1996. The Company also purchases programming,
engineering services and other services from other entities affiliated with
HBI. Amounts included in the accompanying consolidated statements of
operations which were purchased from these affiliated entities were $4.6
million in 1998, $5.4 million in 1997, and $3.8 million in 1996. The Company
believes that the services provided between the Company and HBI and its
subsidiaries and affiliates, and by entities with which certain directors are
affiliated, are on terms comparable to those available from third parties and
that such terms are reasonable.
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OTHER
The Company's employees participate in a 401(k) plan sponsored by HBI.
Under the terms of the plan, the Company may make annual base contributions
and can match participant contributions for each year. HBI made
contributions to the plan on behalf of the Company's employees (which amounts
were reimbursed by the Company) of $237,000 for the year ended December 31,
1998, $157,000 during 1997 and $116,000 during 1996.
6. INCOME TAXES
The Company's deferred tax assets and liabilities, all of which are
long-term, are summarized as follows (in thousands):
<TABLE>
<CAPTION>
Deferred Tax Asset (Liability)
-----------------------------------------------------------------------------
As of December 31
-----------------------------------------------------------------------------
1998 1997
-----------------------------------------------------------------------------
<S> <C> <C>
Deferred tax assets:
Manufacturer Incentive 41,073 $ 30,983
Preoperating capitalized costs 314 2,201
Capitalized interest - 181
Management services 4,000 4,337
Other 3,800 3,995
Net operating loss carryforward 137,738 121,825
------- -------
Total deferred tax assets 186,925 163,522
Deferred tax liabilities:
Depreciation (15,951) (15,149)
-------- --------
Total deferred tax liability (15,951) (15,149)
-----------------------------------------------------------------------------
Valuation allowance 170,974 (148,373)
-----------------------------------------------------------------------------
Net deferred tax balance $ - $ -
-----------------------------------------------------------------------------
</TABLE>
The Company has net operating losses for federal tax reporting purposes
totaling $344.3 million available for carryover to subsequent years as of
December 31, 1998, expiring in years 2000 through 2014. The valuation
allowance applied against the Company's net deferred tax assets increased by
$22.6 million for the year ended December 31, 1998, $37.5 million for 1997,
and $39.3 million for 1996.
The Company and HBI file separate federal tax returns and a combined
state tax return in Minnesota and New Mexico. HBI has benefited from this
unitary relationship as it has utilized USSB losses to reduce its combined
income subject to apportionment in Minnesota and New Mexico through December
31, 1996. The benefit that HBI realized was approximately $0.1 million for
the year ended December 31, 1998, $0.2 million for 1997, and $1.4 million for
1996. This unitary relationship has reduced the Company's Minnesota net
operating loss carryforward. Benefits realized by HBI in years preceding
1994 were not significant. Under a tax sharing agreement dated November 30,
1995, HBI has agreed to reimburse the Company for such benefits in the year
they would otherwise have been realized by the Company. In connection with
the execution of the Merger Agreement, HBI has agreed to pay Hughes, as the
successor to the Company, an amount sufficient to satisfy this obligation on
the first anniversary of the closing date of the Merger, but not later than
April 1, 2000.
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<PAGE>
7. QUARTERLY CONDENSED FINANCIAL INFORMATION (UNAUDITED)
Summarized unaudited quarterly data for 1998 and 1997 is as follows (in
thousands, except per share amounts):
<TABLE>
<CAPTION>
First Quarter Second Quarter Third Quarter Fourth Quarter Full Year
- - -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1998
Revenues $136,839 $132,710 $136,567 $144,685 $550,801
Cost of Sales 84,656 78,742 80,225 84,053 327,676
------ ------ ------ ------ -------
Gross Margin 52,183 53,968 56,342 60,632 223,125
Operating Expenses 62,316 62,899 66,204 92,425 283,844
------ ------ ------ ------ -------
Net Operating Loss (10,133) (8,931) (9,862) (31,793) (60,719)
Other (income) expense, net (1,004) (1,041) (1,132) (939) (4,116)
------- ------- ------- ----- -------
Net Loss (9,129) (7,890) (8,730) (30,854) (56,603)
------ ------ ------ ------ -------
------ ------ ------ ------ -------
Weighted Average Shares Outstanding 89,811 89,811 89,811 89,811 89,811
------ ------ ------ ------ -------
------ ------ ------ ------ -------
Net loss per share - basic and diluted $(0.10) $(0.09) $(0.10) $(0.34) $(0.63)
------ ------ ------ ------ -------
------ ------ ------ ------ -------
1997
Revenues $99,231 $114,236 $114,383 $128,769 $456,619
Cost of Sales 64,930 73,223 73,557 81,207 292,917
------ ------ ------ ------ -------
Gross Margin 34,301 41,013 40,826 47,562 163,702
Operating Expenses 57,925 51,620 70,082 76,197 255,824
------ ------ ------ ------ -------
Net Operating Loss (23,624) (10,607) (29,256) (28,635) (92,122)
Other (income) expense, net (1,174) (1,324) (1,109) (1,209) (4,816)
------- ------- ------- ------- -------
Net Loss (22,450) (9,283) (28,147) (27,426) (87,306)
------ ------ ------ ------ -------
------ ------ ------ ------ -------
Weighted Average Shares Outstanding 89,812 89,811 89,811 89,821 89,811
------ ------ ------ ------ -------
------ ------ ------ ------ -------
Net loss per share - basic and diluted $(0.25) $(0.10) $(0.31) $(0.31) $(0.97)
------ ------ ------ ------ -------
------ ------ ------ ------ -------
</TABLE>
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