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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______________ to ________________.
Commission File Number: 0-26176
ECHOSTAR COMMUNICATIONS CORPORATION
(Exact name of registrant as specified in its charter)
NEVADA 88-0336997
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
5701 S. SANTA FE DRIVE
LITTLETON, COLORADO 80120
(Address of principal executive offices) (Zip code)
(303) 723-1000
(Registrant's telephone number, including area code)
NOT APPLICABLE
(Former name, former address and former fiscal year,
if changed since last report)
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH
FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES X NO
--- ---
AS OF OCTOBER 19, 2001, THE REGISTRANT'S OUTSTANDING COMMON STOCK CONSISTED OF
240,770,601 SHARES OF CLASS A COMMON STOCK AND 238,435,208 SHARES OF CLASS B
COMMON STOCK.
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TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets -
December 31, 2000 and September 30, 2001 (Unaudited)............................................. 1
Condensed Consolidated Statements of Operations for the
three and nine months ended September 30, 2000 and 2001 (Unaudited).............................. 2
Condensed Consolidated Statements of Cash Flows for the
nine months ended September 30, 2000 and 2001 (Unaudited)........................................ 3
Notes to Condensed Consolidated Financial Statements (Unaudited)................................... 4
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.............. 17
Item 3. Quantitative and Qualitative Disclosures About Market Risk......................................... 30
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.................................................................................. 32
Item 2. Changes in Securities and Use of Proceeds.......................................................... None
Item 3. Defaults Upon Senior Securities.................................................................... None
Item 4. Submission of Matters to a Vote of Security Holders................................................ None
Item 5. Other Information.................................................................................. None
Item 6. Exhibits and Reports on Form 8-K................................................................... 38
ECHOSTAR COMMUNICATIONS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
(Unaudited)
DECEMBER 31, SEPTEMBER 30,
2000 2001
------------ -------------
AS ADJUSTED
(NOTE 3)
ASSETS
Current Assets:
Cash and cash equivalents .................................................................. $ 856,818 $ 1,203,629
Marketable investment securities ........................................................... 607,357 968,052
Trade accounts receivable, net of allowance for uncollectible accounts of
$31,241 and $26,270, respectively ........................................................ 278,614 290,366
Insurance receivable ....................................................................... 106,000 106,000
Inventories ................................................................................ 161,161 206,404
Other current assets ....................................................................... 50,827 75,791
----------- -----------
Total current assets .......................................................................... 2,060,777 2,850,242
Restricted cash and marketable investment securities .......................................... 3,000 1,288
Cash reserved for satellite insurance (Note 6) ................................................ 82,393 128,218
Property and equipment, net ................................................................... 1,511,303 1,833,052
FCC authorizations, net ....................................................................... 709,984 701,028
Other noncurrent assets ....................................................................... 269,378 245,026
----------- -----------
Total assets ............................................................................. $ 4,636,835 $ 5,758,854
=========== ===========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current Liabilities:
Trade accounts payable ..................................................................... $ 226,568 $ 315,394
Deferred revenue ........................................................................... 283,895 354,906
Accrued expenses ........................................................................... 691,482 759,427
Current portion of long-term debt .......................................................... 21,132 14,101
----------- -----------
Total current liabilities ..................................................................... 1,223,077 1,443,828
Long-term obligations, net of current portion:
9 1/4% Seven Year Notes .................................................................... 375,000 375,000
9 3/8% Ten Year Notes ...................................................................... 1,625,000 1,625,000
10 3/8% Seven Year Notes ................................................................... 1,000,000 1,000,000
4 7/8% Convertible Notes ................................................................... 1,000,000 1,000,000
5 3/4% Convertible Notes ................................................................... -- 1,000,000
Mortgages and other notes payable, net of current portion .................................. 14,812 12,133
Long-term deferred distribution and carriage revenue and other long-term liabilities ....... 56,329 84,008
----------- -----------
Total long-term obligations, net of current portion ........................................... 4,071,141 5,096,141
----------- -----------
Total liabilities ........................................................................ 5,294,218 6,539,969
Commitments and Contingencies (Note 7)
Stockholders' Deficit:
6 3/4% Series C Cumulative Convertible Preferred Stock, 218,951 and 0 shares
issued and outstanding, respectively ...................................................... 10,948 --
Class A Common Stock, $.01 par value, 1,600,000,000 shares authorized,
235,749,557 and 240,750,587 shares issued and outstanding, respectively ................... 2,357 2,408
Class B Common Stock, $.01 par value, 800,000,000 shares authorized,
238,435,208 shares issued and outstanding ................................................ 2,384 2,384
Class C common Stock, $.01 par value, 800,000,000 shares authorized, none
outstanding ................................................................................ -- --
Additional paid-in capital ................................................................. 1,700,367 1,716,906
Deferred stock-based compensation .......................................................... (58,193) (33,424)
Accumulated other comprehensive loss ....................................................... (60,580) (41,759)
Accumulated deficit ........................................................................ (2,254,666) (2,427,630)
----------- -----------
Total stockholders' deficit ................................................................... (657,383) (781,115)
----------- -----------
Total liabilities and stockholders' deficit .............................................. $ 4,636,835 $ 5,758,854
=========== ===========
See accompanying Notes to Condensed Consolidated Financial Statements.
1
ECHOSTAR COMMUNICATIONS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- ----------------------------
2000 2001 2000 2001
----------- ----------- ----------- -----------
AS ADJUSTED AS ADJUSTED
(NOTE 3) (NOTE 3)
REVENUE:
DISH Network:
Subscription television services ..................... $ 616,283 $ 920,970 $ 1,648,466 $ 2,598,473
Other ................................................ 998 3,672 4,480 9,400
----------- ----------- ----------- -----------
Total DISH Network ..................................... 617,281 924,642 1,652,946 2,607,873
DTH equipment sales and integration services ........... 54,496 73,238 177,234 161,416
Other .................................................. 26,195 24,626 79,642 81,419
----------- ----------- ----------- -----------
Total revenue ............................................. 697,972 1,022,506 1,909,822 2,850,708
COSTS AND EXPENSES:
DISH Network Operating Expenses:
Subscriber-related expenses .......................... 252,752 362,834 685,776 1,037,803
Customer service center and other .................... 60,293 72,790 184,713 207,486
Satellite and transmission ........................... 12,504 11,294 38,875 29,210
----------- ----------- ----------- -----------
Total DISH Network operating expenses .................. 325,549 446,918 909,364 1,274,499
Cost of sales - DTH equipment and integration services . 40,187 49,358 132,729 109,354
Cost of sales - other .................................. 7,126 15,684 22,362 54,185
Marketing:
Subscriber promotion subsidies - promotional DTH
equipment ......................................... 210,067 111,302 536,773 344,017
Subscriber promotion subsidies - other ............... 36,312 112,923 187,518 380,293
Advertising and other ................................ 41,449 45,375 89,090 99,179
----------- ----------- ----------- -----------
Total marketing expenses ............................... 287,828 269,600 813,381 823,489
General and administrative ............................. 63,285 85,772 177,038 249,121
Non-cash, stock-based compensation ..................... 11,568 6,831 38,599 21,298
Depreciation and amortization .......................... 44,511 72,871 126,679 194,560
----------- ----------- ----------- -----------
Total costs and expenses .................................. 780,054 947,034 2,220,152 2,726,506
----------- ----------- ----------- -----------
Operating income (loss) ................................... (82,082) 75,472 (310,330) 124,202
Other Income (Expense):
Interest income ........................................ 14,971 27,657 50,916 74,417
Interest expense, net of amounts capitalized ........... (62,633) (95,429) (185,648) (264,584)
Other .................................................. (12,251) (4,490) (20,935) (106,450)
----------- ----------- ----------- -----------
Total other expense ....................................... (59,913) (72,262) (155,667) (296,617)
----------- ----------- ----------- -----------
Income (loss) before income taxes ......................... (141,995) 3,210 (465,997) (172,415)
Income tax provision, net ................................. (54) (115) (145) (212)
----------- ----------- ----------- -----------
Net income (loss) ......................................... (142,049) 3,095 (466,142) (172,627)
6 3/4% Series C Cumulative Convertible Preferred Stock
dividends .............................................. (215) (1) (948) (337)
----------- ----------- ----------- -----------
Numerator for basic and diluted income (loss) per share -
income (loss) attributable to common shareholders ...... $ (142,264) $ 3,094 $ (467,090) $ (172,964)
=========== =========== =========== ===========
Denominator for basic income (loss) per share -
weighted-average common shares outstanding ............. 473,013 478,931 470,122 476,437
=========== =========== =========== ===========
Denominator for diluted income (loss) per share -
weighted-average common shares outstanding ............. 473,013 486,592 470,122 476,437
=========== =========== =========== ===========
----------- ----------- ----------- -----------
Basic and diluted net income (loss) per common share ... $ (0.30) $ 0.01 $ (0.99) $ (0.36)
=========== =========== =========== ===========
See accompanying Notes to Condensed Consolidated Financial Statements.
2
ECHOSTAR COMMUNICATIONS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------------
2000 2001
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ..................................................................... $ (466,142) $ (172,627)
Adjustments to reconcile net loss to net cash flows from operating activities:
Equity in losses of StarBand Communications ............................... 17,259 20,930
Deferred stock-based compensation recognized .............................. 38,599 21,298
Loss due to decline in the estimated fair value of strategic investments .. -- 85,264
Depreciation and amortization ............................................. 126,679 194,560
Amortization of debt discount and deferred financing costs ................ 4,624 6,592
Employee benefits funded by issuance of Class A Common Stock .............. 7,280 1,173
Change in long-term deferred distribution and carriage revenue and other
long-term liabilities ................................................... 5,586 27,679
Other, net ................................................................ 7,795 14,203
Changes in current assets and current liabilities, net .................... 34,792 133,464
----------- -----------
Net cash flows from operating activities ..................................... (223,528) 332,536
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of marketable investment securities ................................ (713,621) (1,854,264)
Sales of marketable investment securities .................................... 677,661 1,480,550
Purchases of property and equipment .......................................... (186,662) (493,415)
Cash reserved for satellite insurance (Note 6) ............................... (89,591) (59,488)
Change in cash reserved for satellite insurance due to depreciation on
related satellites (Note 6) ................................................ -- 13,663
Investment in Wildblue Communications ........................................ (50,000) --
Investment in SONICblue (fka Replay TV) ...................................... (10,000) --
Investment in StarBand Communications ........................................ (50,045) (50,000)
Other ........................................................................ (1,748) (664)
----------- -----------
Net cash flows from investing activities ..................................... (424,006) (963,618)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of 10 3/8% Seven Year Notes ....................... 989,375 --
Net proceeds from issuance of 5 3/4% Convertible Notes ....................... -- 980,000
Repayments of mortgage indebtedness and notes payable ........................ (11,783) (9,710)
Net proceeds from Class A Common Stock options exercised and Class A Common
Stock issued to Employee Stock Purchase Plan ............................... 10,422 7,943
Other ........................................................................ (3,568) (340)
----------- -----------
----------- -----------
Net cash flows from financing activities ..................................... 984,446 977,893
----------- -----------
Net (decrease) increase in cash and cash equivalents ......................... 336,912 346,811
Cash and cash equivalents, beginning of period ............................... 905,299 856,818
----------- -----------
Cash and cash equivalents, end of period ..................................... $ 1,242,211 $ 1,203,629
=========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Conversion and redemption of 6 3/4% Series C Cumulative Convertible
Preferred Stock to Class A common stock ................................. $ 33,005 $ 10,948
Forfeitures of deferred non-cash, stock-based compensation ................ 8,072 3,471
Class A Common Stock issued related to acquisition of Kelly Broadcasting
Systems, Inc. ........................................................... 31,556 --
See accompanying Notes to Condensed Consolidated Financial Statements.
3
ECHOSTAR COMMUNICATIONS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. ORGANIZATION AND BUSINESS ACTIVITIES
Principal Business
The operations of EchoStar Communications Corporation ("ECC," and together
with its subsidiaries, or referring to particular subsidiaries in certain
circumstances, "EchoStar" or the "Company") include two interrelated business
units (Note 8):
o The DISH Network - a direct broadcast satellite ("DBS") subscription
television service in the United States. As of September 30, 2001, we
had approximately 6.43 million DISH Network subscribers.
o EchoStar Technologies Corporation ("ETC") - engaged in the design,
development, distribution and sale of DBS set-top boxes, antennae and
other digital equipment for the DISH Network ("EchoStar receiver
systems"), the design, development and distribution of similar equipment
for international direct-to-home ("DTH") satellite and other systems and
the provision of uplink center design, construction oversight and other
project integration services for international DTH ventures.
Since 1994, EchoStar has deployed substantial resources to develop the
"EchoStar DBS System." The EchoStar DBS System consists of EchoStar's
FCC-allocated DBS spectrum, six DBS satellites ("EchoStar I," "EchoStar II,"
"EchoStar III," "EchoStar IV," "EchoStar V," and "EchoStar VI"), EchoStar
receiver systems, digital broadcast operations centers, customer service
facilities, and other assets utilized in its operations. EchoStar's principal
business strategy is to continue developing its subscription television service
in the United States to provide consumers with a fully competitive alternative
to cable television service.
Recent Developments
On August 5, 2001, EchoStar announced that it had made a proposal to
General Motors to combine Hughes Electronics Corporation with EchoStar in a
stock-for-stock transaction. The parties have been and continue to be engaged in
discussions regarding such a combination. There can be no assurance that any
agreement will result and discussions could terminate at any time.
2. SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting principles
and with the instructions to Form 10-Q and Article 10 of Regulation S-X for
interim financial information. Accordingly, these statements do not include all
of the information and footnotes required by generally accepted accounting
principles for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring adjustments) considered necessary
for a fair presentation have been included. All significant intercompany
accounts and transactions have been eliminated in consolidation. Operating
results for the nine months ended September 30, 2001 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2001. For further information, refer to the consolidated financial statements
and footnotes thereto included in EchoStar's Annual Report on Form 10-K for the
year ended December 31, 2000. Certain prior year amounts have been reclassified
to conform with the current year presentation.
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 for each reporting
period. Actual results could differ from those estimates.
4
ECHOSTAR COMMUNICATIONS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)
Comprehensive Income (Loss)
The components of comprehensive loss, net of tax, are as follows (in
thousands):
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------
2000 2001
--------- ---------
(Unaudited)
Net loss ................................................................. $(466,142) $(172,627)
Unrealized holding (losses) gains on available-for-sale securities arising
during period ......................................................... (6,829) (14,438)
Reclassification adjustment for impairment losses on available-for-sale
securities included in net loss ...................................... -- 33,259
--------- ---------
Comprehensive loss ....................................................... $(472,971) $(153,806)
========= =========
Accumulated other comprehensive loss presented on the accompanying
condensed consolidated balance sheets consists of the accumulated net unrealized
gains (losses) on available-for-sale securities, net of deferred taxes.
Basic and Diluted Loss Per Share
Statement of Financial Accounting Standards No. 128, "Earnings Per
Share" ("FAS No. 128") requires entities to present both basic earnings per
share ("EPS") and diluted EPS. Basic EPS excludes dilution and is computed by
dividing income (loss) available to common shareholders by the weighted-average
number of common shares outstanding for the period. Diluted EPS reflects the
potential dilution that could occur if stock options or warrants were exercised
or convertible securities were converted to common stock, resulting in the
issuance of common stock that then would share in any earnings of the Company.
EchoStar had net losses for the three month period ended September 30,
2000 and for the nine month periods ending September 30, 2000 and 2001.
Therefore, the effect of the common stock equivalents and convertible securities
is excluded from the computation of diluted earnings (loss) per share for these
periods since the effect is anti-dilutive. Since EchoStar had net income for the
three month period ended September 30, 2001, the potential dilution from stock
options exercisable into common stock for the three-month period ending
September 30, 2001 was computed using the treasury stock method based on the
average fair market value of the Class A common stock for the period. The
following table reflects the basic and diluted weighted-average shares (in
thousands).
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
2000 2001 2000 2001
------- ------- ------- -------
Denominator for basic income (loss) per share -
weighted-average common shares outstanding .... 473,013 478,931 470,122 476,437
Dilutive impact of options outstanding .......... -- 7,661 -- --
------- ------- ------- -------
Denominator for diluted income (loss) per share -
weighted-average common shares outstanding .... 473,013 486,592 470,122 476,437
======= ======= ======= =======
As of September 30, 2001, the 4 7/8% Convertible Subordinated Notes and
the 5 3/4% Convertible Subordinated Notes were convertible into approximately 22
million shares and approximately 23 million shares of Class A common stock,
respectively. The effect of the convertible securities is excluded from the
computation of diluted earning (loss) per share since the interest per common
share obtainable upon conversion of each security exceeds the basic earnings
(loss) per share and the effect is anti-dilutive.
5
ECHOSTAR COMMUNICATIONS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)
Effective July 6, 2001, EchoStar redeemed, for cash, all of its
remaining outstanding 6 3/4% Series C Cumulative Convertible Preferred Stock at
a total redemption price of approximately $2,400 or $51.929 per share.
New Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 141, "Business Combinations," ("FAS 141"),
which is required to be adopted July 1, 2001. FAS 141 requires the purchase
method of accounting for all business combinations initiated after June 30,
2001. The application of FAS 141 has not had a material impact on EchoStar's
financial position or results of operations.
In July 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 142, "Goodwill and Other Intangible
Assets" ("FAS 142"), which requires goodwill and intangible assets with
indefinite useful lives to no longer be amortized but to be tested for
impairment at least annually. Intangible assets that have finite lives will
continue to be amortized over their estimated useful lives. The amortization and
non-amortization provisions of FAS 142 will be applied to all goodwill and
intangible assets acquired after June 30, 2001. Effective January 1, 2002,
EchoStar is required to apply all other provisions of FAS 142. EchoStar is
currently evaluating the potential impact, if any, the adoption of FAS 142 will
have on our financial position and results of operations.
In August 2001, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("FAS 144"), which is effective for
fiscal periods beginning after December 15, 2001 and interim periods within
those fiscal years. FAS 144 establishes an accounting model for impairment or
disposal of long-lived assets to be disposed of by sale. EchoStar is currently
evaluating the potential impact, if any, the adoption of FAS 144 will have on
its financial position and results of operation.
3. RETROACTIVE APPLICATION OF EQUITY METHOD OF ACCOUNTING
Effective September 27, 2001, EchoStar invested an additional $50
million in StarBand, increasing its equity interest from approximately 19% to
approximately 32%. If and when construction is commenced for a next generation
satellite to be allocated for StarBand's service, EchoStar's equity interest
would increase to approximately 60%. EchoStar originally invested $50 million in
StarBand in April 2000. As a result of the increased equity stake, this
investment is now accounted for using the equity method of accounting. As
required by APB Opinion No. 18, the equity method accounting has been
retroactively applied back to April 2000, the date of EchoStar's original
investment in StarBand. This retroactive application resulted in an increase in
net loss and basic and diluted loss per share for the three and nine-month
periods ended September 30, 2000 as follows (in thousands):
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
2000 2000
------------- -------------
(Unaudited)
Net loss .................................. $ (11,156) $ (17,259)
============ ==========
Basic and diluted net loss per common share $ (0.02) $ (0.03)
============ ==========
6
ECHOSTAR COMMUNICATIONS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)
4. INVESTMENT SECURITIES
EchoStar currently classifies all marketable investment securities as
available-for-sale. The fair market value of marketable investment securities
approximates the carrying value and represents the quoted market prices at the
balance sheet dates. Related unrealized gains and losses are reported as a
separate component of stockholders' deficit, net of related deferred income
taxes, if applicable. The specific identification method is used to determine
cost in computing realized gains and losses. Such unrealized losses totaled
approximately $42 million as of September 30, 2001. Approximately $29 million of
these unrealized losses relate to a decline in the value of OpenTV. EchoStar
acquired that stock in connection with the establishment of a strategic
relationship with OpenTV which did not involve an investment of cash by
EchoStar.
In accordance with generally accepted accounting principles, declines
in the fair market value of a marketable investment security which are estimated
to be "other than temporary" must be recognized in the statement of operations,
thus establishing a new cost basis for such investment. EchoStar evaluates its
marketable investment securities portfolio on a quarterly basis to determine
whether declines in the market value of these securities are other than
temporary. This quarterly evaluation consists of reviewing, among other things,
the fair value of our marketable investment securities compared to the carrying
value of these securities, the historical volatility of the price of each
security and any market and company specific factors related to each security.
Generally, absent specific factors to the contrary, declines in the fair value
of investments below cost basis for a period of less than six months are
considered to be temporary. Declines in the fair value of investments for a
period of six to nine months are evaluated on a case by case basis to determine
whether any company or market-specific factors exist which would indicate that
such declines are other than temporary. Declines in the fair value of
investments below cost basis for greater than nine months are considered other
than temporary and are recorded as charges to earnings, absent specific factors
to the contrary. As a result of EchoStar's quarterly evaluations, through
September 30, 2001 EchoStar has recorded an aggregate charge to earnings for
other than temporary declines in the fair market value of its marketable
investment securities of approximately $33.3 million. If the fair market value
of EchoStar's marketable securities portfolio does not increase to cost basis or
if EchoStar becomes aware of any market or company specific factors that
indicate that the carrying value of certain of its securities is impaired,
EchoStar may be required to record an additional charge to earnings in future
periods equal to the amount of the decline in fair value.
EchoStar also has made strategic equity investments in certain
non-marketable investment securities including Wildblue Communications, StarBand
Communications, VisionStar, Inc. and Replay TV. Through September 30, 2001, the
original cost basis of EchoStar's investments in these non-marketable investment
securities totaled approximately $166 million. The securities of these companies
are not publicly traded. During August 2001, SONICblue, a publicly-traded
company, completed its acquisition of Replay TV. As such, during the quarter
ended September 30, 2001, EchoStar reclassified this investment as an
available-for-sale marketable investment security. EchoStar's ability to create
realizable value for its strategic investments in companies that are not public
is dependent on the success of their business plans and ability to obtain
sufficient capital to execute their business plans. StarBand and Wildblue
cancelled their planned initial public stock offerings. As a result of the
cancellation of those offerings and other factors, during the nine months ended
September 30, 2001, EchoStar recorded a non-recurring charge, net of the
retroactive StarBand equity method accounting adjustments (Note 3), of
approximately $52 million to reduce the carrying value of certain of these
non-marketable investment securities to their estimated fair values. As of
September 30, 2001, the carrying value of all non-marketable investment
securities totaled approximately $64 million, net of equity in losses of
StarBand. If EchoStar becomes aware of any factors that indicate that the
carrying value of certain of our non-marketable investment securities is
impaired, EchoStar may be required to record an additional charge to earnings in
future periods.
7
ECHOSTAR COMMUNICATIONS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)
5. INVENTORIES
Inventories consist of the following (in thousands):
DECEMBER 31, SEPTEMBER 30,
2000 2001
------------ -------------
Finished goods - DBS ........................................................... $ 96,362 $ 124,607
Raw materials .................................................................. 40,247 53,667
Finished goods - reconditioned and other ....................................... 23,101 22,334
Work-in-process ................................................................ 8,879 8,986
Consignment .................................................................... 2,478 2,260
Reserve for excess and obsolete inventory ...................................... (9,906) (5,450)
--------- ---------
$ 161,161 $ 206,404
========= =========
6. PROPERTY AND EQUIPMENT
EchoStar V
EchoStar V is equipped with a total of three momentum wheels, including
one spare. During July 2001, EchoStar V experienced an anomaly resulting in the
loss of one momentum wheel. The satellite was quickly restored to normal
operations mode. While no further momentum wheel losses are expected, until the
root cause of the anomaly is finally determined, there can be no assurance
future anomalies will not cause further losses which could impact commercial
operation of the satellite. The extent to which the loss of an additional
momentum wheel would impair commercial operation has not yet been finally
determined, but terms for in-orbit insurance, if procured, could be impacted.
During August 2001, one of the thrusters on EchoStar V experienced an anomalous
event resulting in a temporary interruption of service. The satellite was
quickly restored to normal operations mode. The satellite is equipped with a
substantial number of backup thrusters. EchoStar V is also equipped with a total
of 48 traveling-wave-tube amplifiers ("TWTAs"), including 16 spares. A total of
two TWTAs were taken out of service and replaced by spares between the launch of
the satellite and June 30, 2001. During the third quarter 2001, EchoStar V
experienced anomalous telemetry readings on two additional TWTAs. One of those
TWTAs experienced unusually high telemetry readings and as a precaution, during
September 2001 EchoStar substituted that TWTA with a spare. To the extent that
EchoStar V experiences anomalous telemetry readings on additional TWTAs it may
be necessary to utilize additional spare TWTAs. An investigation of the
anomalies, which have not impacted commercial operation of the satellite to
date, is continuing. Until the root cause of the anomalies is finally
determined, there can be no assurance future anomalies will not cause losses
which could impact commercial operation of the satellite.
EchoStar VI
EchoStar VI is equipped with a total of 48 transponders, including 16
spares. During April 2001, EchoStar VI experienced a series of anomalous events
resulting in a temporary interruption of service. The satellite was quickly
restored to normal operations mode. As a result of the anomaly, we believe that
one stationkeeping thruster and a pair of transponders are unusable. The
satellite is equipped with a substantial number of backup transponders and
thrusters. EchoStar VI has also experienced anomalies resulting in the loss of
two solar array strings. The satellite has a total of approximately 112 solar
array strings and approximately 106 are required to assure full power
availability for the 12-year design life of the satellite. The satellite
manufacturer, Space Systems Loral ("SS/L"), has advised EchoStar that it
believes that the thruster anomaly was isolated to one stationkeeping thruster,
and that while further failures are possible, SS/L does not believe it is likely
that additional thrusters will be impacted. An investigation of the solar array
anomalies, none of which have impacted commercial operation of the satellite to
date, is continuing. Until the root cause of these anomalies is finally
determined, there can be no assurance future anomalies will not cause further
losses which could impact commercial operation of the satellite.
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Satellite Insurance
As a result of the failure of EchoStar IV solar arrays to fully deploy
and the failure of 30 transponders to date, a maximum of approximately 14 of the
44 transponders on EchoStar IV are available for use at this time. In addition
to the transponder and solar array failures, EchoStar IV experienced anomalies
affecting its thermal systems and propulsion system. There can be no assurance
that further material degradation, or total loss of use, of EchoStar IV will not
occur in the immediate future.
In September 1998, EchoStar filed a $219.3 million insurance claim for
a constructive total loss under the launch insurance policies covering EchoStar
IV. The satellite insurance consists of separate identical policies with
different carriers for varying amounts which, in combination, create a total
insured amount of $219.3 million.
The insurance carriers offered EchoStar a total of approximately $88
million, or 40% of the total policy amount, in settlement of the EchoStar IV
insurance claim. The insurers allege that all other impairment to the satellite
occurred after expiration of the policy period and is not covered. EchoStar
strongly disagrees with the position of the insurers and has filed an
arbitration claim against them for breach of contract, failure to pay a valid
insurance claim and bad faith denial of a valid claim, among other things. There
can be no assurance that EchoStar will receive the amount claimed or, if
EchoStar does, that EchoStar will retain title to EchoStar IV with its reduced
capacity.
At the time EchoStar filed its claim in 1998, EchoStar recognized an
impairment loss of $106 million to write-down the carrying value of the
satellite and related costs, and simultaneously recorded an insurance claim
receivable for the same amount. EchoStar continues to believe it will ultimately
recover at least the amount originally recorded and does not intend to adjust
the amount of the receivable until there is greater certainty with respect to
the amount of the final settlement.
As a result of the thermal and propulsion system anomalies, EchoStar
reduced the estimated remaining useful life of EchoStar IV to approximately 4
years during January 2000. EchoStar will continue to evaluate the performance of
EchoStar IV and may modify its loss assessment as new events or circumstances
develop.
The in-orbit insurance policies for EchoStar I, EchoStar II, and
EchoStar III expired on July 25, 2000. The insurers refused to renew insurance
on EchoStar I, EchoStar II and EchoStar III on reasonable terms. Based on the
carriers' actions, EchoStar added causes of action in its EchoStar IV demand for
arbitration for breach of the duty of good faith and fair dealing, and unfair
claim practices. Additionally, EchoStar filed a lawsuit against the insurance
carriers in the United States District Court for the District of Colorado
asserting causes of action for violation of Federal and State antitrust laws.
While EchoStar believes it is entitled to the full amount claimed under the
EchoStar IV insurance policy and believes the insurance carriers' position is
wrongful, there can be no assurance as to the outcome of these proceedings.
During March 2001, EchoStar voluntarily dismissed the antitrust lawsuit without
prejudice. EchoStar has the right to re-file an antitrust action against the
insurers again in the future.
The indentures related to the outstanding senior notes of EchoStar
Broadband Corporation ("EBC") and EchoStar DBS Corporation ("EDBS") contain
restrictive covenants that require EchoStar to maintain satellite insurance with
respect to at least half of the satellites it owns. Insurance coverage is
therefore required for at least three of EchoStar's six satellites currently in
orbit. EchoStar had procured normal and customary launch insurance for EchoStar
VI, which expired on July 14, 2001. As a result, EchoStar is currently
self-insuring EchoStar I, EchoStar II, EchoStar III, EchoStar IV, EchoStar V and
EchoStar VI. To satisfy these insurance covenants, EchoStar reclassified an
amount equal to the depreciated cost of three of EchoStar's satellites from cash
and cash equivalents to cash reserved for satellite insurance on its balance
sheet. As of September 30, 2001, cash reserved for satellite insurance totaled
approximately $128 million. The reclassification will continue until such time,
if ever, as EchoStar can again insure its satellites on acceptable terms and for
acceptable amounts. EchoStar believes it has in-orbit satellite capacity
sufficient to expeditiously recover transmission of most programming in the
event one of its in-orbit satellites fails. However, the cash reserved for
satellite insurance is not adequate to fund the construction, launch and
insurance
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(Unaudited)
for a replacement satellite in the event of a complete loss of a satellite.
Programming continuity could not be assured in the event of multiple satellite
losses.
7. COMMITMENTS AND CONTINGENCIES
VisionStar
During November 2000, one of EchoStar's wholly-owned subsidiaries
purchased a 49.9% interest in VisionStar, Inc. VisionStar holds an FCC license
for, and is constructing a Ka-band satellite to launch into, the 113 degree
orbital location. Together with VisionStar, EchoStar has requested FCC approval
to acquire control over VisionStar by increasing its ownership of VisionStar to
90%, for a total purchase price of approximately $2.8 million. EchoStar has also
provided loans to VisionStar totaling less than $10 million to date for the
construction of their satellite and expects to provide additional funding to
VisionStar in the future. EchoStar is not obligated to finance the full
remaining cost to construct and launch the VisionStar satellite, but
VisionStar's FCC license currently requires construction of the satellite to be
completed by April 30, 2002 or the license could be revoked. EchoStar currently
expects to continue to fund loans and equity contributions for construction of
the satellite in the near term from cash on hand, and expects that it may spend
approximately $79.5 million during the fourth quarter 2001 for that purpose
subject to, among other things, FCC approval.
DirecTV
During February 2000, EchoStar filed suit against DirecTV and Thomson
Consumer Electronics/RCA in the Federal District Court of Colorado. The suit
alleges that DirecTV has utilized improper conduct in order to fend off
competition from the DISH Network, has demanded that certain retailers stop
displaying EchoStar's merchandise, has threatened to cause economic damage to
retailers if they continue to offer both product lines in head-to-head
competition, and has acted in violation of federal and state antitrust laws in
order to protect DirecTV's market share.
The DirecTV defendants filed a counterclaim against EchoStar. DirecTV
alleges that EchoStar tortiously interfered with a contract that DirecTV
allegedly had with Kelly Broadcasting Systems, Inc. ("KBS"). DirecTV alleges
that EchoStar "merged" with KBS in contravention of DirecTV's contract with KBS.
DirecTV also alleges that EchoStar has falsely advertised to consumers about its
right to offer network programming. DirecTV further alleges that EchoStar
improperly used certain trademarks owned by PrimeStar, which is now owned by
DirecTV. Finally, DirecTV alleges that EchoStar has been marketing National
Football League games in a misleading manner. Discovery has been stayed until
the next scheduling conference on November 2, 2001. In an arbitration proceeding
related to DirecTV's allegations with respect to KBS, DirecTV had claimed
damages totaling hundreds of millions of dollars. During September 2001, the
arbitration panel awarded DirecTV approximately $7.3 million, of which
approximately $4 million would be payable by EchoStar. EchoStar intends to
challenge the arbitration panel's decision.
Fee Dispute
EchoStar had a contingent fee arrangement with the attorneys who
represented EchoStar in prior litigation with News Corporation. The contingent
fee arrangement provides for the attorneys to be paid a percentage of any net
recovery obtained by us in the News Corporation litigation. The attorneys have
asserted that they may be entitled to receive payments totaling hundreds of
millions of dollars under this fee arrangement.
During mid-1999, EchoStar initiated litigation against the attorneys in
the Arapahoe County, Colorado, District Court arguing that the fee arrangement
is void and unenforceable. In December 1999, the attorneys initiated an
arbitration proceeding before the American Arbitration Association. The
litigation has been stayed while the arbitration is ongoing. The arbitration
hearing commenced April 2, 2001 and the presentation of evidence concluded on
August 17, 2001. The parties presented closing arguments to the arbitration
panel on October 11, 2001. During the four week arbitration hearing, the
attorneys presented a damage model for $56 million. However, during closing
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ECHOSTAR COMMUNICATIONS CORPORATION
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(Unaudited)
arguments, the attorneys presented a separate damage calculation for $111
million to the arbitration panel. EchoStar believes that even the $56 million
significantly overstates the amount the attorneys should be reasonably entitled
to receive under the fee agreement. It is not possible for EchoStar to predict
what the decision of the arbitration panel will be with any degree of certainty.
EchoStar anticipates that the panel will issue its ruling within the next 90
days.
WIC Premium Television Ltd.
During July 1998, a lawsuit was filed by WIC Premium Television Ltd.,
an Alberta corporation, in the Federal Court of Canada Trial Division, against
General Instrument Corporation, HBO, Warner Communications, Inc., John Doe,
Showtime, United States Satellite Broadcasting Company, Inc., EchoStar
Communications Corporation, and two of EchoStar's wholly-owned subsidiaries,
Echosphere Corporation and Dish, Ltd. EchoStar Satellite Corporation, EchoStar
DBS Corporation, EchoStar Technologies Corporation, and EchoStar Satellite
Broadcast Corporation were subsequently added as defendants. The lawsuit seeks,
among other things, interim and permanent injunctions prohibiting the defendants
from activating receivers in Canada and from infringing any copyrights held by
WIC.
During September 1998, WIC filed another lawsuit in the Court of
Queen's Bench of Alberta Judicial District of Edmonton against certain
defendants, including EchoStar. WIC is a company authorized to broadcast certain
copyrighted work, such as movies and concerts, to residents of Canada. WIC
alleges that the defendants engaged in, promoted, and/or allowed satellite dish
equipment from the United States to be sold in Canada and to Canadian residents
and that some of the defendants allowed and profited from Canadian residents
purchasing and viewing subscription television programming that is only
authorized for viewing in the United States. The lawsuit seeks, among other
things, interim and permanent injunctions prohibiting the defendants from
importing hardware into Canada and from activating receivers in Canada, together
with damages in excess of $175 million.
The Court in the Alberta action recently denied EchoStar's Motion to
Dismiss, which EchoStar appealed. The Court in the Federal action has stayed
that case pending the outcome of the Alberta action. The case is now currently
in discovery. EchoStar intends to vigorously defend the suit. It is too early to
make an assessment of the probable outcome of the litigation or to determine the
extent of any potential liability or damages.
Broadcast network programming
Until July 1998, EchoStar obtained distant broadcast network channels
(ABC, NBC, CBS and FOX) for distribution to its customers through PrimeTime 24.
In December 1998, the United States District Court for the Southern District of
Florida entered a nationwide permanent injunction requiring PrimeTime 24 to shut
off distant network channels to many of its customers, and henceforth to sell
those channels to consumers in accordance with certain stipulations in the
injunction.
In October 1998, EchoStar filed a declaratory judgment action against
ABC, NBC, CBS and FOX in Denver Federal Court. EchoStar asked the court to enter
a judgment declaring that our method of providing distant network programming
did not violate the Satellite Home Viewer Act ("SHVA") and hence did not
infringe the networks' copyrights. In November 1998, the networks and their
affiliate groups filed a complaint against EchoStar in Miami Federal Court
alleging, among other things, copyright infringement. The court combined the
case that EchoStar filed in Colorado with the case in Miami and transferred it
to the Miami court. The case remains pending in Miami. While the networks have
not sought monetary damages, they have sought to recover attorney fees if they
prevail.
In February 1999, the networks filed a "Motion for Temporary
Restraining Order, Preliminary Injunction and Contempt Finding" against DirecTV,
Inc. in Miami related to the delivery of distant network channels to DirecTV
customers by satellite. DirecTV settled this lawsuit with the networks. Under
the terms of the settlement between DirecTV and the networks, some DirecTV
customers were scheduled to lose access to their satellite-provided distant
network channels by July 31, 1999, while other DirecTV customers were to be
disconnected by
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ECHOSTAR COMMUNICATIONS CORPORATION
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(Unaudited)
December 31, 1999. Subsequently, PrimeTime 24 and substantially all providers of
satellite-delivered network programming other than EchoStar agreed to this
cut-off schedule, although EchoStar does not know if they adhered to this
schedule.
In December 1998, the networks filed a Motion for Preliminary
Injunction against EchoStar in the Miami court, and asked the court to enjoin
EchoStar from providing network programming except under limited circumstances.
A preliminary injunction hearing was held on September 21, 1999. The court took
the issues under advisement to consider the networks' request for an injunction,
whether to hear live testimony before ruling upon the request, and whether to
hear argument on why the Satellite Home Viewer Act may be unconstitutional,
among other things.
In March 2000, the networks filed an emergency motion again asking the
court to issue an injunction requiring EchoStar to turn off network programming
to certain of its customers. At that time, the networks also argued that
EchoStar's compliance procedures violate the Satellite Home Viewer Improvement
Act. EchoStar opposed the networks' motion and again asked the court to hear
live testimony before ruling upon the networks' injunction request.
During September 2000, the Court granted the Networks' motion for
preliminary injunction, denied the Network's emergency motion and denied
EchoStar's request to present live testimony and evidence. The Court's original
order required EchoStar to terminate network programming to certain subscribers
"no later than February 15, 1999," and contained other dates with which it would
be physically impossible to comply. The order imposes restrictions on EchoStar's
past and future sale of distant ABC, NBC, CBS and Fox channels similar to those
imposed on PrimeTime 24 (and, we believe, on DirecTV and others). Some of those
restrictions go beyond the statutory requirements imposed by the Satellite Home
Viewer Act and the Satellite Home Viewer Improvement Act. For these and other
reasons EchoStar believes the Court's order is, among other things,
fundamentally flawed, unconstitutional and should be overturned. However, it is
very unusual for a Court of Appeals to overturn a lower court's order and there
can be no assurance whatsoever that it will be overturned.
On October 3, 2000, and again on October 25, 2000, the Court amended
its original preliminary injunction order in an effort to fix some of the errors
in the original order. The twice amended preliminary injunction order required
EchoStar to shut off, by February 15, 2001, all subscribers who are ineligible
to receive distant network programming under the court's order. EchoStar has
appealed the September 2000 preliminary injunction order and the October 3, 2000
amended preliminary injunction order. On November 22, 2000, the United States
Court of Appeals for the Eleventh Circuit stayed the Florida Court's preliminary
injunction order pending EchoStar's appeal. At that time, the Eleventh Circuit
also expedited its consideration of EchoStar's appeal.
During November 2000, EchoStar filed its appeal brief with the Eleventh
Circuit. Oral argument before the Eleventh Circuit was held on May 24, 2001. At
the oral argument, the parties agreed to participate in a court supervised
mediation and that the mediator was to report back to the Eleventh Circuit on
July 11, 2001. The Eleventh Circuit indicated that it would not rule on the
pending appeal until after July 11, 2001. Since May 24, 2001, the parties
participated in the court-supervised mediation. On July 11, 2001 the mediator
reported to the Eleventh Circuit the status of the parties' mediation efforts.
On July 16, 2001, the Eleventh Circuit issued an order for the parties to engage
in further mediation efforts until August 10, 2001. On August 8, 2001, the
parties participated in another court ordered mediation but were unable to reach
a resolution. On August 10, 2001, the mediator reported to the Eleventh Circuit
that despite the parties' extensive efforts, the parties were unable to resolve
their differences and that further efforts at mediation will not contribute to a
resolution of the dispute between the parties at this time. The mediator
therefore advised the Eleventh Circuit that it may rule upon EchoStar appeal.
On September 17, 2001, the Eleventh Circuit vacated the District
Court's nationwide preliminary injunction, which the Eleventh Circuit had stayed
in November 2000. The Eleventh Circuit also rejected EchoStar's First Amendment
challenge to the SHVA. EchoStar has filed a petition for rehearing asking the
Eleventh Circuit to
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ECHOSTAR COMMUNICATIONS CORPORATION
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(Unaudited)
reconsider its rejection of EchoStar's constitutional challenge. There can be no
assurance the Eleventh Circuit will reconsider or reverse its decision on
EchoStar's First Amendment challenge. However, the Eleventh Circuit found that
the District Court had made factual findings that were clearly erroneous and not
supported by the evidence, and that the District Court had misinterpreted and
misapplied the law. The Eleventh Circuit also found that the District Court came
to the wrong legal conclusion concerning the grandfathering provision found in
17 U.S.C. Section 119(d); the Eleventh Circuit reversed the District Court's
legal conclusion and instead found that this grandfathering provision allows
subscribers who switch satellite carriers to continue to receive the distant
network programming that they had been receiving. The Eleventh Circuit remanded
the matter to the District Court for an evidentiary hearing. EchoStar can not
predict when the evidentiary hearing will be set.
If, after an evidentiary hearing, the District Court enters a
preliminary injunction against EchoStar, the preliminary injunction could force
EchoStar to terminate delivery of distant network channels to a substantial
portion of its distant network subscriber base, which could also cause many of
these subscribers to cancel their subscription to EchoStar's other services.
Management has determined that such terminations would result in a small
reduction in EchoStar's reported average monthly revenue per subscriber and
could result in a temporary increase in churn. If EchoStar loses the case at
trial, the judge could, as one of many possible remedies, prohibit all future
sales of distant network programming by Echostar, which would have a material
adverse affect on EchoStar's business.
Gemstar
During October 2000, Starsight Telecast, Inc., a subsidiary of
Gemstar-TV Guide International, Inc., filed a suit for patent infringement
against EchoStar and certain of its subsidiaries in the United States District
Court for the Western District of North Carolina, Asheville Division. The suit
alleges infringement of United States Patent No. 4,706,121 (the "121 Patent")
which relates to certain electronic program guide functions. EchoStar has
examined this patent and believes that it is not infringed by any of its
products or services. EchoStar will vigorously defend against this suit.
In December 2000, EchoStar filed suit against Gemstar - TV Guide (and
certain of its subsidiaries) in the United States District Court for the
District of Colorado alleging violations by Gemstar of various federal and state
anti-trust laws and laws governing unfair competition. The lawsuit seeks an
injunction and monetary damages. Gemstar has also filed counterclaims in this
lawsuit alleging infringement of United States Patent Nos. 5,923,362 and
5,684,525 that relate to certain electronic program guide functions. EchoStar
has examined these patents and believes they are not infringed by any of
EchoStar's products or services. EchoStar will vigorously contest these
counterclaims. In August 2001, the Federal Multi-District Litigation panel
combined this suit, for discovery purposes, with other lawsuits asserting
antitrust claims against Gemstar, which had previously been filed by other
plaintiffs.
In February 2001, Gemstar filed patent infringement actions against
EchoStar in District Court in Atlanta, Georgia and in the International Trade
Commission (ITC). These suits allege infringement of United States Patent Nos.
5,252,066, 5,479,268 and 5,809,204 all of which relate to certain electronic
program guide functions. In addition, the ITC action alleges infringement of the
121 Patent which is asserted in the North Carolina case. In the Atlanta District
Court case, Gemstar seeks damages and an injunction. The North Carolina case has
been stayed pending resolution of the ITC action and EchoStar expects that the
Atlanta action will also be stayed pending resolution of the ITC action. ITC
actions typically proceed according to an expedited schedule. EchoStar expects
the ITC action to go to trial by the end of 2001. EchoStar further expects that
the ITC will issue an initial determination by March of 2002 and that a final
determination will be issued by April 2002. While the ITC cannot award damages,
it can issue exclusion orders that would prevent the importation of articles
that are found to infringe the asserted patents. Portions of EchoStar's
receivers are currently manufactured outside the United States. In addition, it
can issue cease and desist orders that would prohibit the sale of infringing
products that had been previously imported. EchoStar has examined these patents
and believes they are not infringed by any of EchoStar's
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ECHOSTAR COMMUNICATIONS CORPORATION
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(Unaudited)
products or services. EchoStar will vigorously contest the ITC, North Carolina
and Atlanta allegations of infringement and will, among other things, challenge
both the validity and enforceability of the asserted patents.
During 2000, Superguide Corp. also filed suit against EchoStar, DirecTV
and others in the United States District Court for the Western District of North
Carolina, Asheville Division, alleging infringement of United States Patent Nos.
5,038,211, 5,293,357 and 4,751,578 which relate to certain electronic program
guide functions, including the use of electronic program guides to control VCRs.
It is EchoStar's understanding that these patents may be licensed by Superguide
to Gemstar. Gemstar has been added as a party to this case and is now asserting
these patents against EchoStar. EchoStar has examined these patents and believes
that they are not infringed by any of its products or services. A Markman
hearing was held in July 2001 but no decision has been issued to date. The case
is not expected to go to trial before early 2002. EchoStar intends to vigorously
defend against this action and assert a variety of counterclaims.
In the event it is ultimately determined that EchoStar infringes on any
of the aforementioned patents EchoStar may be subject to substantial damages,
including the potential for treble damages, and/or an injunction that could
require EchoStar to materially modify certain user friendly electronic
programming guide and related features it currently offers to consumers. It is
too early to make an assessment of the probable outcome of the suits.
IPPV Enterprises
IPPV Enterprises, LLC and MAAST, Inc. filed a patent infringement suit
against EchoStar, and its conditional access vendor Nagra, in the United States
District Court for the District of Delaware. The suit alleged infringement of 5
patents. The patents disclose various systems for the implementation of features
such as impulse-pay-per view, parental control and category lock-out. One patent
relates to an encryption technique. One patent was subsequently dropped by
plaintiffs. The Court entered summary judgment in favor of EchoStar that the
encryption patent, with respect to which the plaintiffs claimed $80 million in
damages, was not infringed by EchoStar. On July 13, 2001, a jury found that the
remaining three patents were infringed and awarded damages of $15 million. The
jury also found that one of the patents was willfully infringed which means that
the judge is entitled to increase the award of damages. The parties recently
completed post-trial briefings in this action which are scheduled for oral
argument before the Court on October 24, 2001. EchoStar intends to appeal any
adverse decision and plaintiffs have indicated they will appeal as well. Any
final award of damages would be split between EchoStar and Nagra in percentages
to be agreed upon between EchoStar and Nagra.
California Actions
A purported class action was filed against EchoStar in the California
State Superior Court for Alameda County during May 2001 by Andrew A. Werby. The
complaint, relating to late fees, alleges unlawful, unfair and fraudulent
business practices in violation of California Business and Professions Code
Section 17200 et seq., false and misleading advertising in violation of
California Business and Professions Code Section 17500, and violation of the
California Consumer Legal Remedies Act. On September 24, 2001, EchoStar filed an
answer denying all material allegations of the Complaint. On September 27, 2001,
the Court entered an Order Pursuant to Stipulation for a provisional
certification of the class, for an orderly exchange of information and for
mediation. The provisional Order specifies that the class shall be de-certified
upon notice in the event mediation does not resolve the dispute. It is too early
in the litigation to make an assessment of the probable outcome of the
litigation or to determine the extent of any potential liability or damages.
EchoStar intends to deny all liability and intends to vigorously defend the
lawsuit.
A purported class action relating to the use of terms such as "crystal
clear digital video," "CD-quality audio," and "on-screen program guide", and
with respect to the number of channels available in various programming
packages, has also been filed against EchoStar in the California State Superior
Court for Los Angeles County by David Pritikin and by Consumer Advocates, a
nonprofit unincorporated association. The complaint alleges breach of express
warranty and violation of the California Consumer Legal Remedies Act, Civil Code
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(Unaudited)
Sections 1750, et. seq., and the California Business & Professions Code Sections
17500, 17200. EchoStar has filed an answer and the case is currently in
discovery. No motion for class certification has been filed to date. It is too
early in the litigation to make an assessment of the probable outcome of the
litigation or to determine the extent of any potential liability or damages.
EchoStar denies all liability and intends to vigorously defend the lawsuit.
Retailer Class Actions
EchoStar has been sued by retailers in three separate purported class
actions. In two separate lawsuits filed in the District Court, Arapahoe County,
State of Colorado and the United States District Court for the District of
Colorado, respectively, Air Communication & Satellite, Inc. and John DeJong, et.
al. filed lawsuits on October 6, 2000 on behalf of themselves and a class of
persons similarly situated. The plaintiffs are attempting to certify nationwide
classes allegedly brought on behalf of persons, primarily retail dealers, who
were alleged signatories to certain retailer agreements with EchoStar Satellite
Corporation. The plaintiffs are requesting the Court to declare certain
provisions of the alleged agreements invalid and unenforceable, to declare that
certain changes to the agreements are invalid and unenforceable, and to award
damages for lost commissions and payments, charge backs, and other compensation.
EchoStar intends to vigorously defend against the suits and to assert a variety
of counterclaims. It is too early to make an assessment of the probable outcome
of the litigation or to determine the extent of any potential liability or
damages.
Satellite Dealers Supply, Inc. filed a lawsuit in the United States
District Court for the Eastern District of Texas on September 25, 2000, on
behalf of itself and a class of persons similarly situated. The plaintiff is
attempting to certify a nationwide class on behalf of sellers, installers, and
servicers of satellite equipment who contract with EchoStar and claims the
alleged class has been "subject to improper chargebacks." The plaintiff alleges
that EchoStar: (1) charged back certain fees paid by members of the class to
professional installers in violation of contractual terms; (2) manipulated the
accounts of subscribers to deny payments to class members; and (3)
misrepresented to class members who own certain equipment related to the
provision of satellite television service. On September 18, 2001, the Court
granted EchoStar's Motion to Dismiss for lack of personal jurisdiction.
Plaintiff Satellite Dealers Supply has moved for reconsideration of the Court's
order dismissing the case.
EchoStar is subject to various other legal proceedings and claims which
arise in the ordinary course of business. In the opinion of management, the
amount of ultimate liability with respect to those actions will not materially
affect EchoStar's financial position or results of operations.
Meteoroid Events
Meteoroid events pose a potential threat to all in orbit geosynchronous
satellites including EchoStar's DBS satellites. While the probability that
EchoStar's satellites will be damaged by meteoroids is very small, that
probability increases significantly when the Earth passes through the
particulate stream left behind by various comets.
Occasionally, increased solar activity poses a potential threat to all
in-orbit geosynchronous satellites including EchoStar's DBS satellites. The
probability that the effects from this activity will damage our satellites or
cause service interruptions is generally very small.
Some decommissioned spacecraft are in uncontrolled orbits which pass
through the geostationary belt at various points, and present hazards to
operational spacecraft including EchoStar's DBS satellites. The locations of
these hazards are generally well known and may require EchoStar to perform
maneuvers to avoid collisions.
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ECHOSTAR COMMUNICATIONS CORPORATION
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(Unaudited)
8. SEGMENT REPORTING
Financial Data by Business Unit (in thousands)
Statement of Financial Accounting Standard No. 131, "Disclosures About
Segments of an Enterprise and Related Information" ("FAS No. 131") establishes
standards for reporting information about operating segments in annual financial
statements of public business enterprises and requires that those enterprises
report selected information about operating segments in interim financial
reports issued to shareholders. Operating segments are components of an
enterprise about which separate financial information is available and regularly
evaluated by the chief operating decision maker(s) of an enterprise. During
2000, under this definition, we were operating as three separate business units.
However, beginning 2001, it was determined that EchoStar's chief operating
decision maker regularly evaluates only the following two separate business
units. In addition, as previously stated, EchoStar has retroactively applied the
equity method of accounting to its StarBand investment. All prior year amounts
have been adjusted to conform to the current year presentation. The All Other
column consists of revenue and expenses from other operating segments for which
the disclosure requirements of FAS No. 131 do not apply.
ECHOSTAR
DISH TECHNOLOGIES CONSOLIDATED
NETWORK CORPORATION ALL OTHER ELIMINATIONS TOTAL
----------- ------------ ----------- ------------ ------------
THREE MONTHS ENDED SEPTEMBER 30, 2000
Revenue ........................... $ 641,381 $ 40,889 $ 16,309 $ (607) $ 697,972
Net income (loss) ................. (134,930) (2,580) (4,450) (89) (142,049)
THREE MONTHS ENDED SEPTEMBER 30, 2001
Revenue ........................... $ 944,274 $ 52,526 $ 27,066 $ (1,360) $ 1,022,506
Net income (loss) ................. 58,351 1,149 (11,075) (45,330) 3,095
NINE MONTHS ENDED SEPTEMBER 30, 2000
Revenue ........................... $ 1,714,596 $ 141,403 $ 55,906 $ (2,083) $ 1,909,822
Net income (loss) ................. (455,580) (2,935) (7,427) (200) (466,142)
NINE MONTHS ENDED SEPTEMBER 30, 2001
Revenue ........................... $ 2,668,855 $ 97,014 $ 87,908 $ (3,069) $ 2,850,708
Net income (loss) ................. (174,801) (14,108) (27,000) 43,282 (172,627)
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
All statements contained herein, as well as statements made in press
releases and oral statements that may be made by us or by officers, directors or
employees acting on our behalf, that are not statements of historical fact
constitute "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Such forward-looking statements
involve known and unknown risks, uncertainties and other factors that could
cause our actual results to be materially different from historical results or
from any future results expressed or implied by such forward-looking statements.
Among the factors that could cause our actual results to differ materially are
the following: a total or partial loss of one or more satellites due to
operational failures, space debris or otherwise; delays in the construction of
our seventh, eighth or ninth satellites; an unsuccessful deployment of future
satellites; inability to settle outstanding claims with insurers; a decrease in
sales of digital equipment and related services to international direct-to-home
service providers; a decrease in DISH Network subscriber growth; an increase in
subscriber turnover; an increase in subscriber acquisition costs; an inability
to obtain certain retransmission consents; our inability to retain necessary
authorizations from the FCC; an inability to obtain patent licenses from holders
of intellectual property or redesign our products to avoid patent infringement;
an increase in competition from cable as a result of digital cable or otherwise,
direct broadcast satellite, other satellite system operators, and other
providers of subscription television services; future acquisitions, business
combinations, strategic partnerships and divestitures; the introduction of new
technologies and competitors into the subscription television business; a change
in the regulations governing the subscription television service industry; the
outcome of any litigation in which we may be involved; general business and
economic conditions; and other risk factors described from time to time in our
reports and statements filed with the Securities and Exchange Commission. In
addition to statements that explicitly describe such risks and uncertainties,
readers are urged to consider statements that include the terms "believes,"
"belief," "expects," "plans," "anticipates," "intends" or the like to be
uncertain and forward-looking. All cautionary statements made herein should be
read as being applicable to all forward-looking statements wherever they appear.
In this connection, investors should consider the risks described herein and
should not place undue reliance on any forward-looking statements.
RESULTS OF OPERATIONS
Three Months Ended September 30, 2001 Compared to the Three Months Ended
September 30, 2000.
Revenue. Total revenue for the three months ended September 30, 2001
was $1.023 billion, an increase of $325 million compared to total revenue for
the three months ended September 30, 2000 of $698 million. The increase in total
revenue was primarily attributable to higher average revenue per subscriber and
continued DISH Network subscriber growth. We expect that our revenues will
continue to increase as the number of DISH Network subscribers increases.
DISH Network subscription television services revenue totaled $921
million for the three months ended September 30, 2001, an increase of $305
million compared to the same period in 2000. DISH Network subscription
television services revenue principally consists of revenue from basic, premium
and pay-per-view subscription television services. This increase was directly
attributable to higher average revenue per subscriber and continued DISH Network
subscriber growth. DISH Network added approximately 360,000 net new subscribers
for the three months ended September 30, 2001 compared to approximately 455,000
net subscriber additions during the same period in 2000. The reduction in net
new subscribers for the quarter ended September 30, 2001 primarily resulted from
increased churn due to the slowing economy, significant piracy of our
competitor's products, bounty programs offered by competitors, our maturing
subscriber base, and other factors. As of September 30, 2001, we had
approximately 6.43 million DISH Network subscribers compared to approximately
4.8 million at September 30, 2000, an increase of approximately 35%. DISH
Network subscription television services revenue will continue to increase to
the extent we are successful in increasing the number of DISH Network
subscribers and maintaining or increasing revenue per subscriber. While there
can be no assurance, assuming the U.S. economy continues to grow at a slow pace,
we expect to add approximately 1.5 to 1.75 million net new subscribers and to
obtain a majority of all net new DBS subscribers, during 2001.
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - CONTINUED
Monthly average revenue per subscriber was approximately $49.26 during
the three months ended September 30, 2001 and approximately $45.36 during the
same period in 2000. For the nine months ended September 30, 2001, our monthly
average revenue per subscriber was approximately $49.19. The increase in monthly
average revenue per subscriber is primarily attributable to $1.00 price
increases in America's Top 100 CD, our most popular programming package, in both
May 2000 and February 2001, the increased availability of local channels by
satellite, the successful introduction of our $39.99 per month America's Top 150
programming package during April 2000 together with an increase in subscriber
penetration in our higher priced Digital Home Plans. As anticipated, in
connection with the introduction of our I Like 9 promotion in August 2001, as
discussed below, monthly average revenue per subscriber during the third quarter
of 2001 decreased slightly from monthly average revenue per subscriber of
approximately $50.00 during the second quarter of 2001. To the extent the I Like
9 promotion is successful, we expect monthly average revenue per subscriber to
decrease slightly from the third quarter levels for the remainder of 2001.
For the three months ended September 30, 2001, DTH equipment sales and
integration services revenue totaled $73 million, an increase of $19 million
compared to the same period during 2000. DTH equipment sales consist of sales of
digital set-top boxes and other digital satellite broadcasting equipment to
international DTH service operators and sales of DBS accessories. This increase
in DTH equipment sales and integration services revenue was primarily
attributable to an increase in demand for digital set-top boxes from our two
primary international customers as compared to the same period during 2000.
A significant portion of DTH equipment sales and integration services
revenues have resulted from sales to two international DTH providers. We
currently have agreements to provide equipment to DTH service operators in Spain
and Canada. Our future revenue from the sale of DTH equipment and integration
services in international markets depends largely on the success of these DTH
operators and continued demand for our digital set-top boxes. While we have
binding purchase orders from both providers for the remainder of 2001, we expect
overall demand for 2001 to be lower than the same period in 2000. As a result,
we expect total DTH equipment sales and integration services revenue to decrease
in 2001 compared to 2000. Although we continue to actively pursue additional
distribution and integration service opportunities internationally, no assurance
can be given that any such efforts will be successful.
In order, among other things, to plan for the potential
re-implementation of the injunction previously issued against us in our pending
litigation with the four major broadcast networks and their affiliate groups, we
may terminate the delivery of distant network channels to certain of our
subscribers. Additionally, during 2000, the FCC issued rules which impair our
ability to deliver certain superstation channels to our customers. Those rules
will increase the cost of our delivery of superstations, and could require that
we terminate the delivery of certain superstations to a material portion of our
subscriber base.
"Spot beam" technology on EchoStar VII and EchoStar VIII is expected to
increase our existing satellite capacity. The earliest scheduled launch of
EchoStar VII is late December 2001. Further postponement could result from
delays in delivery of the satellite, from difficulties procuring adequate launch
insurance, or from other factors. Insurance issues resulting from market
reticence with respect to Atlas III launches, particularly following the
September 11th tragedy, have prevented procurement of launch insurance to date.
We are evaluating alternative launch vehicles to potentially minimize the risk
of further delays. EchoStar VIII is currently expected to launch during the
first half of 2002. Commencing January 1, 2002, we will be required to comply
with the statutory requirement to carry substantially all over the air
television stations by satellite in any market where we carry any local network
channels by satellite. Any reduction in the number of markets we serve in order
to comply with "must carry" requirements for other markets, would adversely
effect our operations and could result in a temporary increase in churn. Failure
to comply with "must carry" requirements could result in substantial fines and
other sanctions. While there can be no assurance, based among other things on
the number of over the air television stations that have qualified for "must
carry" to date and on other available satellite capacity, we currently believe
we can meet statutory "must carry" requirements with few reductions in the
number of markets where we currently provide local channels by satellite.
However, until EchoStar VII and EchoStar VIII become operational we probably
will not be able to increase the number of markets where we provide local
network channels by satellite.
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - CONTINUED
DISH Network Operating Expenses. DISH Network operating expenses
totaled $447 million during the three months ended September 30, 2001, an
increase of $121 million or 37% compared to the same period in 2000. DISH
Network operating expenses represented 49% and 53% of subscription television
services revenue during the three months ended September 30, 2001 and 2000,
respectively. The increase in DISH Network operating expenses in total was
consistent with, and primarily attributable to, the increase in the number of
DISH Network subscribers. We expect to continue to control costs and create
operating efficiencies. We would expect operating expenses as a percentage of
subscription television services revenue to remain near current levels during
the remainder of 2001, however the I Like 9 promotion discussed below could
cause the percentage to increase.
Subscriber-related expenses totaled $363 million during the three
months ended September 30, 2001, an increase of $110 million compared to the
same period in 2000. The increase in total subscriber-related expenses is
primarily attributable to the increase in DISH Network subscribers. Such
expenses, which include programming expenses, copyright royalties, residuals
currently payable to retailers and distributors, and billing, lockbox and other
variable subscriber expenses, represented 39% and 41% of subscription television
services revenues during the three months ended September 30, 2001 and 2000,
respectively. The decrease in subscriber-related expenses as a percentage of
subscription television services revenue primarily resulted from our programming
package price increases during 2001. While there can be no assurance, we expect
subscriber-related expenses as a percentage of subscription television services
revenue to remain near current levels during the remainder of 2001.
Customer service center and other expenses principally consist of costs
incurred in the operation of our DISH Network customer service centers, such as
personnel and telephone expenses, as well as other operating expenses related to
our service and installation business. Customer service center and other
expenses totaled $73 million during the three months ended September 30, 2001,
an increase of $13 million as compared to the same period in 2000. The increase
in customer service center and other expenses primarily resulted from increased
personnel and telephone expenses to support the growth of the DISH Network and
from operating expenses related to the expansion of our installation and service
business. Customer service center and other expenses totaled 8% of subscription
television services revenue during the three months ended September 30, 2001, as
compared to 10% during the same period in 2000. The decrease in this expense to
revenue ratio primarily resulted from the on-going construction and start-up
costs of our fifth customer service center in Virginia and our sixth customer
service center in West Virginia during 2000. While there can be no assurance, we
expect these expenses in total, and as a percentage of subscription television
services revenue, to remain near current levels during the remainder of 2001.
These expenses and percentages could temporarily increase in the future as
additional infrastructure is added to meet future growth. We continue to work to
automate simple telephone responses, and intend to increase Internet-based
customer assistance in the future, in order to better manage customer service
costs.
Satellite and transmission expenses include expenses associated with
the operation of our digital broadcast center, contracted satellite telemetry,
tracking and control services, and commercial satellite in-orbit insurance
premiums. Satellite and transmission expenses totaled $11 million during the
three months ended September 30, 2001, a $2 million decrease compared to the
same period in 2000. Satellite and transmission expenses totaled 1% and 2% of
subscription television services revenue during the three months ended September
30, 2001 and 2000, respectively. We expect satellite and transmission expenses
in total and as a percentage of subscription television services revenue to
increase in the future as additional satellites or digital broadcast centers are
placed in service and to the extent we successfully place commercial in-orbit
insurance.
Cost of sales - DTH equipment and Integration Services. Cost of sales -
DTH equipment and integration services totaled $49 million during the three
months ended September 30, 2001, an increase of $9 million compared to the same
period in 2000. Cost of sales - DTH equipment and integration services
principally includes costs associated with digital set-top boxes and related
components sold to international DTH operators and DBS accessories. This
increase in cost of sales - DTH equipment and integration services is consistent
with the increase in DTH equipment sales and integration services revenue. Cost
of sales - DTH equipment and integration services represented 67% and 74% of DTH
equipment revenue, during the three months ended September 30, 2001 and 2000,
respectively.
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - CONTINUED
Marketing Expenses. Generally, under most promotions, we subsidize the
cost and installation of EchoStar receiver systems in order to attract new DISH
Network subscribers. Marketing expenses totaled $270 million during the three
months ended September 30, 2001 compared to $288 million for the same period in
2000. This decrease primarily resulted from a decrease in Subscriber promotion
subsidies - promotional DTH equipment as a result of higher penetration of our
Digital Home Plan promotion discussed below. This decrease was partially offset
by an increase in advertising related to our I Like 9 promotions. Subscriber
promotion subsidies - promotional DTH equipment includes the cost related to
EchoStar receiver systems distributed to retailers and other distributors of our
equipment. Subscriber promotion subsidies - other includes net costs related to
our free installation promotion and other promotional incentives. Advertising
and other expenses totaled $45 million and $41 million during the three months
ended September 30, 2001 and 2000, respectively.
During the three months ended September 30, 2001, our marketing
promotions included our Digital Home Plan, Free Now, I Like 9 and a free
installation program.
Our Digital Home Plan promotion, introduced during July 2000, offers
several choices to consumers, ranging from the use of one EchoStar receiver
system and our America's Top 100 CD programming package for $35.99 per month, to
providing consumers two or more EchoStar receiver systems and our America's Top
150 programming package for $49.99 to $59.99 per month. Consumers may also
choose from one of our DishPVR Plans which includes the use of two or more
EchoStar receiver systems, one of which includes a built-in hard drive that
allows viewers to pause and record live programming without the need for
videotape. The DishPVR Plans also included either America's Top 100 CD or DISH
Latino Dos programming package starting at $49.99 per month or America's Top 150
programming package starting at $59.99 per month. With each plan, consumers
receive in-home service, must agree to a one-year commitment and incur a
one-time set-up fee of $49.99, which includes the first month's programming
payment. Although there can be no assurance as to the ultimate duration of the
Digital Home Plan promotion, we intend to continue it through at least January
31, 2002.
From February through July 2001, we offered new subscribers a free
base-level EchoStar receiver system and free installation under our Free Now
promotion. To be eligible, a subscriber had to provide a valid major credit card
and make a one-year commitment to subscribe to either our America's Top 150
programming package or our America's Top 100 CD or DISH Latino Dos programming
package plus additional programming totaling at least $39.98 per month.
Subscriber acquisition costs were materially higher under this plan compared to
historical promotions. This promotion expired July 31, 2001.
During August 2001, we commenced our I Like 9 promotion. Under this
promotion, subscribers who purchase an EchoStar receiver system for $199 or
higher, receive free installation and either our America's Top 100 CD or our
DISH Latino Dos programming package for $9 a month for the first year.
Subscriber acquisition costs are materially lower under this plan compared to
historical promotions. Although there can be no assurance as to the ultimate
duration of the I Like 9 promotion, we intend to continue it through at least
January 31, 2002.
Generally, under most promotions, we subsidize the cost and
installation of EchoStar receiver systems in order to attract new DISH Network
subscribers. There is no clear industry standard used in the calculation of
subscriber acquisition costs. Our subscriber acquisition costs include
subscriber promotion subsidies - promotional DTH equipment, subscriber promotion
subsidies - other and DISH Network acquisition marketing expenses. During the
three months ended September 30, 2001, our subscriber acquisition costs totaled
approximately $268 million, or approximately $392 per new subscriber activation.
Since we retain ownership of the equipment, amounts capitalized under our
Digital Home Plan are not included in our calculation of these subscriber
acquisition costs. Comparatively, our subscriber acquisition costs during the
three months ended September 30, 2000 totaled $284 million, or approximately
$438 per new subscriber activation. The decrease in our per new subscriber
acquisition cost primarily resulted from the introduction of our I Like 9
promotion, an increase in direct sales and an increase in penetration of our
Digital Home Plans. While there can be no assurance, we expect total subscriber
acquisition costs for the year ended December 31, 2001 to be less than our prior
estimate of approximately $450 per subscriber.
20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - CONTINUED
Our subscriber acquisition costs, both in the aggregate and on a per
new subscriber activation basis, may materially increase further to the extent
that we introduce other more aggressive promotions if we determine that they are
necessary to respond to competition, or for other reasons.
General and Administrative Expenses. General and administrative
expenses totaled $86 million during the three months ended September 30, 2001,
an increase of $23 million as compared to the same period in 2000. The increase
in G&A expenses was principally attributable to increased personnel expenses to
support the growth of the DISH Network. G&A expenses represented 8% and 9% of
total revenue during the three months ended September 30, 2001 and 2000,
respectively. Although we expect G&A expenses as a percentage of total revenue
to remain near the current level or decline modestly in future periods, this
expense to revenue ratio could increase.
Non-cash, Stock-based Compensation. During 1999, we adopted an
incentive plan which provided certain key employees with incentives including
stock options. The payment of these incentives was contingent upon our
achievement of certain financial and other goals. We met certain of these goals
during 1999. Accordingly, during 1999 we recorded approximately $179 million of
deferred compensation related to post-grant appreciation of stock options
granted pursuant to the 1999 incentive plan. The related deferred compensation
will be recognized over the five-year vesting period. Accordingly, during the
three months ended September 30, 2001 and 2000 we recognized $7 million and $12
million, respectively, under this performance-based plan.
We report all non-cash compensation based on stock option appreciation
as a single expense category in our accompanying statements of operations. The
following table represents the other expense categories in our statements of
operations that would be affected if non-cash, stock-based compensation was
allocated to the same expense categories as the base compensation for key
employees who participate in the 1999 incentive plan:
THREE MONTHS ENDED
SEPTEMBER 30,
-------------------
2000 2001
------- -------
Customer service center and other ......... $ 107 $ 311
Satellite and transmission ................ 985 388
General and administrative ................ 10,476 6,132
------- -------
Total non-cash, stock-based compensation $11,568 $ 6,831
======= =======
Pre-Marketing Cash Flow. Pre-marketing cash flow is comprised of EBITDA
plus total marketing expenses. Pre-marketing cash flow was $425 million during
the three months ended September 30, 2001, an increase of 62% compared to the
same period in 2000. Our pre-marketing cash flow as a percentage of total
revenue was approximately 41.5% during the three months ended September 30, 2001
compared to 37.5% during the same period in 2000. We believe that pre-marketing
cash flow can be a helpful measure of operating efficiency for companies in the
DBS industry. While there can be no assurance, we expect pre-marketing cash flow
as a percentage of total revenue to remain near the current level during the
remainder of 2001.
Earnings Before Interest, Taxes, Depreciation and Amortization. EBITDA
represents earnings before interest, taxes, depreciation, amortization, and
non-cash, stock-based compensation. EBITDA was $155 million during the three
months ended September 30, 2001, compared to negative $26 million during the
same period in 2000. This improvement in EBITDA was directly attributable to the
increase in the number of DISH Network subscribers and higher average revenue
per subscriber, resulting in recurring revenue which was large enough to support
the cost of new and existing subscribers, together with the introduction of our
Digital Home Plan in July 2000. Our calculation of EBITDA for the three months
ended September 30, 2001 and 2000 does not include approximately $7 million and
$12 million, respectively, of non-cash compensation expense resulting from
post-grant appreciation of employee stock options. While there can be no
assurance, we expect to continue to have positive EBITDA for the year ended
December 31, 2001. As previously discussed, to the extent we introduce new
marketing promotions and our subscriber acquisition costs materially increase,
our EBITDA results will be negatively impacted because subscriber acquisition
costs are generally expensed as incurred.
21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - CONTINUED
It is important to note that EBITDA and pre-marketing cash flow do not
represent cash provided or used by operating activities. EBITDA and
pre-marketing cash flow should not be considered in isolation or as a substitute
for measures of performance prepared in accordance with generally accepted
accounting principles.
Depreciation and Amortization. Depreciation and amortization expenses
aggregated $73 million during the three months ended September 30, 2001, a $28
million increase compared to the same period in 2000. The increase in
depreciation and amortization expenses principally resulted from an increase in
depreciation related to the commencement of operation of EchoStar VI in October
2000 and other depreciable assets, including Digital Home Plan equipment, placed
in service during late 2000 and 2001.
Other Income and Expense. Other expense, net, totaled $72 million
during the three months ended September 30, 2001, an increase of $12 million
compared to the same period in 2000. This increase primarily resulted from an
increase in interest expense as a result of the issuance of our 10 3/8% Senior
Notes in September 2000 and the issuance of our 5 3/4% Convertible Subordinated
Notes in late May 2001. This increase in interest expense was partially offset
by an increase in interest income.
Nine Months Ended September 30, 2001 Compared to the Nine Months Ended September
30, 2000.
Revenue. Total revenue for the nine months ended September 30, 2001 was
$2.851 billion, an increase of $941 million compared to total revenue for the
nine months ended September 30, 2000 of $1.910 billion. The increase in total
revenue was primarily attributable to higher average revenue per subscriber and
continued DISH Network subscriber growth.
DISH Network subscription television services revenue totaled $2.598
billion for the nine months ended September 30, 2001, an increase of $950
million compared to the same period in 2000. This increase was directly
attributable to higher average revenue per subscriber and continued DISH Network
subscriber growth.
For the nine months ended September 30, 2001, DTH equipment sales and
integration services revenue totaled $161 million, a decrease of $16 million
compared to the same period during 2000. This decrease in DTH equipment sales
and integration services revenue was primarily attributable to a decrease in
demand for digital set-top boxes from our two primary international customers as
compared to the same period during 2000.
DISH Network Operating Expenses. DISH Network operating expenses
totaled $1.274 billion during the nine months ended September 30, 2001, an
increase of $365 million or 40% compared to the same period in 2000. DISH
Network operating expenses represented 49% and 55% of subscription television
services revenue during the nine months ended September 30, 2001 and 2000,
respectively. The increase in DISH Network operating expenses in total was
consistent with, and primarily attributable to, the increase in the number of
DISH Network subscribers.
Subscriber-related expenses totaled $1.038 billion during the nine
months ended September 30, 2001, an increase of $352 million compared to the
same period in 2000. Such expenses represented 40% and 42% of subscription
television services revenues during the nine months ended September 30, 2001 and
2000, respectively.
Customer service center and other expenses totaled $207 million during
the nine months ended September 30, 2001, an increase of $22 million as compared
to the same period in 2000. The increase in customer service center and other
expenses primarily resulted from increased personnel and telephone expenses to
support the growth of the DISH Network and from operating expenses related to
the expansion of our installation and service business. Customer service center
and other expenses totaled 8% of subscription television services revenue during
the nine months ended September 30, 2001, as compared to 11% during the same
period in 2000. The decrease in this expense to revenue ratio primarily resulted
from the on-going construction and start-up costs of our fifth customer service
center in Virginia and our sixth customer service center in West Virginia during
2000.
22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - CONTINUED
Satellite and transmission expenses totaled $29 million during the nine
months ended September 30, 2001, a $10 million decrease compared to the same
period in 2000. This decrease resulted from the expiration of the commercial
in-orbit satellite insurance policies for EchoStar I, EchoStar II and EchoStar
III during July 2000. As discussed below, we are currently self-insuring these
satellites. Satellite and transmission expenses totaled 1% and 2% of
subscription television services revenue during the nine months ended September
30, 2001 and 2000, respectively.
Cost of sales - DTH equipment and Integration Services. Cost of sales -
DTH equipment and integration services totaled $109 million during the nine
months ended September 30, 2001, a decrease of $24 million compared to the same
period in 2000. This decrease in cost of sales - DTH equipment and integration
services is consistent with the decrease in DTH equipment sales and integration
services revenue. Cost of sales - DTH equipment and integration services
represented 68% and 75% of DTH equipment revenue, during the nine months ended
September 30, 2001 and 2000, respectively.
Marketing Expenses. Marketing expenses totaled $823 million during the
nine months ended September 30, 2001, an increase of $10 million compared to the
same period in 2000. The increase in marketing expenses was attributable to an
increase in advertising and other. Advertising and other expenses totaled $99
million and $89 million during the nine months ended September 30, 2001 and
2000, respectively.
General and Administrative Expenses. General and administrative
expenses totaled $249 million during the nine months ended September 30, 2001,
an increase of $72 million as compared to the same period in 2000. The increase
in G&A expenses was principally attributable to increased personnel expenses to
support the growth of the DISH Network. G&A expenses represented 9% of total
revenue during each of the nine months ended September 30, 2001 and 2000.
Non-cash, Stock-based Compensation. As a result of substantial
post-grant appreciation of stock options, during the nine months ended September
30, 2001 and 2000 we recognized $21 million and $39 million, respectively, of
the total remaining deferred stock-based compensation under the 1999 incentive
plan. The remainder will be recognized over the remaining vesting period.
We report all non-cash compensation based on stock option appreciation
as a single expense category in our accompanying statements of operations. The
following table represents the other expense categories in our statements of
operations that would be affected if non-cash, stock-based compensation was
allocated to the same expense categories as the base compensation for key
employees who participate in the 1999 incentive plan:
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------
2000 2001
------- -------
Customer service center and other ......... $ 1,308 $ 932
Satellite and transmission ................ 2,296 1,165
General and administrative ................ 34,995 19,201
------- -------
Total non-cash, stock-based compensation $38,599 $21,298
======= =======
Pre-Marketing Cash Flow. Pre-marketing cash flow is comprised of EBITDA
plus total marketing expenses. Pre-marketing cash flow was $1.164 billion during
the nine months ended September 30, 2001, an increase of 74% compared to the
same period in 2000. Our pre-marketing cash flow as a percentage of total
revenue was approximately 41% during the nine months ended September 30, 2001
compared to 35% during the same period in 2000.
23
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - CONTINUED
Earnings Before Interest, Taxes, Depreciation and Amortization. EBITDA
represents earnings before interest, taxes, depreciation, amortization, and
non-cash, stock-based compensation. EBITDA was $340 million during the nine
months ended September 30, 2001, compared to negative $145 million during the
same period in 2000. This improvement in EBITDA was directly attributable to the
increase in the number of DISH Network subscribers and higher average revenue
per subscriber, resulting in recurring revenue which was large enough to support
the cost of new and existing subscribers, though not yet adequate to support
interest payments and other non-operating costs, together with the introduction
of our Digital Home Plan in July 2000. Our calculation of EBITDA for the nine
months ended September 30, 2001 and 2000 does not include approximately $21
million and $39 million, respectively, of non-cash compensation expense
resulting from post-grant appreciation of employee stock options.
It is important to note that EBITDA and pre-marketing cash flow do not
represent cash provided or used by operating activities. EBITDA and
pre-marketing cash flow should not be considered in isolation or as a substitute
for measures of performance prepared in accordance with generally accepted
accounting principles.
Depreciation and Amortization. Depreciation and amortization expenses
aggregated $195 million during the nine months ended September 30, 2001, a $68
million increase compared to the same period in 2000. The increase in
depreciation and amortization expenses principally resulted from an increase in
depreciation related to the commencement of operation of EchoStar VI in October
2000 and other depreciable assets, including Digital Home Plan equipment, placed
in service during late 2000 and 2001.
Other Income and Expense. Other expense, net, totaled $297 million
during the nine months ended September 30, 2001, an increase of $141 million
compared to the same period in 2000. This increase primarily resulted from
impairment losses on marketable and non-marketable investment securities of
approximately $85 million, as discussed below, and from an increase in interest
expense as a result of the issuance of our 10 3/8% Senior Notes in September
2000 and the issuance of our 5 3/4% Convertible Subordinated Notes in late May
2001. This increase in interest expense was partially offset by an increase in
interest income.
LIQUIDITY AND CAPITAL RESOURCES
Cash Sources
As of September 30, 2001, our cash, cash equivalents and marketable
investment securities totaled $2.301 billion, including $128 million of cash
reserved for satellite insurance and approximately $1 million of restricted
cash, compared to $1.550 billion, including $82 million of cash reserved for
satellite insurance and $3 million of restricted cash, as of December 31, 2000.
For the nine months ended September 30, 2001 and 2000, we reported net cash
flows from operating activities of $333 million and negative $224 million,
respectively. The $557 million increase in net cash flow from operating
activities reflects, among other things, an increase in the number of DISH
Network subscribers, increased penetration of our Digital Home Plan promotions,
changes in working capital and higher average revenue per subscriber, resulting
in recurring revenue which is large enough to support the cost of new and
existing subscribers, though not yet adequate to support interest payments and
other non-operating costs.
We expect that our future working capital, capital expenditure and debt
service requirements will be satisfied primarily from existing cash and
investment balances and cash generated from operations. Our ability to generate
positive future operating and net cash flows is dependent upon our ability to
continue to expand our DISH Network subscriber base, retain existing DISH
Network subscribers, and our ability to grow our ETC and Satellite Services
businesses. There can be no assurance that we will be successful in achieving
our goals. The amount of capital required to fund our remaining 2001 working
capital and capital expenditure needs will vary, depending, among other things,
on the rate at which we acquire new subscribers and the cost of subscriber
acquisition. Our working capital and capital expenditure requirements could
increase materially in the event of increased competition for subscription
television customers, significant satellite failures, or in the event of a
general economic downturn, among other factors. These factors could require that
we raise additional capital in the future.
From time to time we evaluate opportunities for strategic investments
or acquisitions that would complement our current services and products,
enhance our technical capabilities or otherwise offer growth opportunities. As
a result, acquisition discussions and offers, and in some cases, negotiations
may take place and future material investments or acquisitions involving cash,
debt or equity securities or a combination thereof may result.
24
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - CONTINUED
Investment Securities
We currently classify all marketable investment securities as
available-for-sale. In accordance with generally accepted accounting principles,
we adjust the carrying value of our available-for-sale marketable investment
securities to fair market value and report the related temporary unrealized
gains and losses as a separate component of stockholders' deficit. Declines in
the fair market value of a marketable investment security which are estimated to
be "other than temporary" must be recognized in the statement of operations,
thus establishing a new cost basis for such investment. We evaluate our
marketable investment securities portfolio on a quarterly basis to determine
whether declines in the market value of these securities are other than
temporary. This quarterly evaluation consists of reviewing, among other things,
the fair value of our marketable investment securities compared to the carrying
value of these securities, the historical volatility of the price of each
security and any market and company specific factors related to each security.
Generally, absent specific factors to the contrary, declines in the fair value
of investments below cost basis for a period of less than six months are
considered to be temporary. Declines in the fair value of investments for a
period of six to nine months are evaluated on a case by case basis to determine
whether any company or market-specific factors exist which would indicate that
such declines are other than temporary. Declines in the fair value of
investments below cost basis for greater than nine months are considered other
than temporary and are recorded as charges to earnings, absent specific factors
to the contrary.
As of December 31, 2000, we had declines in the fair market value of
our marketable securities portfolio of approximately $61 million. Approximately
$29 million and $17 million of the decline in fair market value related to two
separate securities, neither of which had traded below their cost basis for a
period of more than six to nine months. In addition, our evaluation of the
marketable securities portfolio as of December 31, 2000 did not result in any
market or company specific findings for any of the individual securities that
lead us to believe that these declines were other than temporary in nature. As
such, as of December 31, 2000 we recorded unrealized losses of approximately $61
million as a separate component of stockholders' deficit.
During the nine months ended September 30, 2001, we recorded an
aggregate charge to earnings for other than temporary declines in the fair
market value of certain of our marketable investment securities of approximately
$33.3 million, and established a new cost basis for these securities. All of
these charges were recorded during the first half of 2001. In addition, we have
recorded unrealized losses totaling approximately $42 million as of September
30, 2001. If the fair market value of our marketable securities portfolio does
not increase to cost basis or if we become aware of any market or company
specific factors that indicate that the carrying value of certain of our
securities is impaired, we may be required to record additional charges to
earnings in future periods equal to the amount of the decline in fair value.
We have made strategic equity investments in certain non-marketable
investment securities, which we also evaluate on a quarterly basis to determine
whether the carrying value of each investment is impaired. The securities of
these companies are not publicly traded. As such, this quarterly evaluation
consists of reviewing, among other things, company business plans and current
financial statements, if available, for factors which may indicate an impairment
in our investment. Such factors may include, but are not limited to, cash flow
concerns, material litigation, violations of debt covenants and changes in
business strategy. As of December 30, 2000, we reviewed our non-marketable
investment securities, and determined that the carrying value of each investment
was not impaired. During 2001, certain of the companies in which we have
investments cancelled their planned initial public offerings. As a result of the
cancellation of those offerings and other factors, we have recorded cumulative
non-recurring charges to earnings totaling approximately $52 million as of
September 30, 2001 to reduce the carrying value of certain of these
non-marketable investment securities to their estimated fair values. If we
become aware of any factors that indicate that the carrying value of certain of
our non-marketable investment securities is impaired, we may be required to
record additional charges to earnings in future periods.
25
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - CONTINUED
Subscriber Turnover
Our percentage churn for the nine months ended September 30, 2001
increased compared to the same period during 2000. The increase resulted from
the slowing economy, significant piracy of our competitor's products, bounty
programs offered by competitors, our maturing subscriber base, and other
factors. As a result of these factors we also expect our percentage churn for
the remainder of 2001 to be higher than our historical average, but that it will
continue to be lower than satellite and cable industry averages. While there
can be no assurance, we also expect that our percentage churn during the fourth
quarter will be lower than it was during the third quarter.
Further, impacts from our litigation with the networks in Miami, new
FCC rules governing the delivery of superstations and other factors, could cause
us to terminate delivery of distant network channels and superstations to a
material portion of our subscriber base, which could cause many of those
customers to cancel their subscription to our other services. Any such
terminations could result in a small reduction in average monthly revenue per
subscriber and could result in an increase in our percentage churn.
"Spot beam" technology on EchoStar VII and EchoStar VIII is expected to
increase our existing satellite capacity. The earliest scheduled launch of
EchoStar VII is late December 2001. Further postponement could result from
delays in delivery of the satellite, from difficulties procuring adequate launch
insurance, or from other factors. Insurance issues resulting from market
reticence with respect to Atlas III launches, particularly following the
September 11th tragedy, have prevented procurement of launch insurance to date.
We are evaluating alternative launch vehicles to potentially minimize the risk
of further delays. EchoStar VIII is currently expected to launch during the
first half of 2002. Commencing January 1, 2002, we will be required to comply
with the statutory requirement to carry substantially all over the air
television stations by satellite in any market where we carry any local network
channels by satellite. Any reduction in the number of markets we serve in order
to comply with "must carry" requirements for other markets, would adversely
effect our operations and could result in a temporary increase in churn.
Failure to comply with "must carry" requirements could result in substantial
fines and other sanctions. While there can be no assurance, based among other
things on the number of over the air television stations that have qualified for
"must carry" to date and on other available satellite capacity, we currently
believe we can meet statutory "must carry" requirements with few reductions, in
the number of markets where we currently provide local channels by satellite.
However, until EchoStar VII and EchoStar VIII become operational we probably
will not be able to increase the number of markets where we provide local
network channels by satellite.
In combination, these terminations would result in a small reduction in
average monthly revenue per subscriber and could increase subscriber churn.
Subscriber Acquisition Costs
As previously described, we generally subsidize the cost and
installation of EchoStar receiver systems in order to attract new DISH Network
subscribers. Our average subscriber acquisition costs were $403 per new
subscriber activation during the nine months ended September 30, 2001. Since we
retain ownership of the equipment, amounts capitalized under our Digital Home
Plan are not included in our calculation of these subscriber acquisition costs.
While there can be no assurance, we expect total subscriber acquisition costs
for the year ended December 31, 2001 to be less than our prior estimate of
approximately $450 per subscriber. Our subscriber acquisition costs, both in the
aggregate and on a per new subscriber activation basis, may materially increase
to the extent that we introduce other more aggressive promotions if we determine
that they are necessary to respond to competition, or for other reasons.
Funds necessary to meet subscriber acquisition costs will be satisfied
from existing cash and investment balances to the extent available. We may,
however, be required to raise additional capital in the future to meet these
requirements. If we were required to raise capital today, a variety of debt and
equity funding sources would likely be available to us. However, there can be no
assurance that additional financing will be available on acceptable terms, or at
all, if needed in the future.
Digital Home Plan
Our Digital Home Plan promotion, introduced during July 2001, offers
four choices to consumers, ranging from the use of one EchoStar receiver system
and our America's Top 100 CD programming package for $35.99 per month, to
providing consumers two or more EchoStar receiver systems and our America's Top
150 programming package for $49.99 to $59.99 per month. Consumers may also
choose from one of our DishPVR Plans which includes the use of two or more
EchoStar receiver systems, one of which includes a built-in hard disk drive that
allows viewers to pause and record live programming without the need for video
tape. The DishPVR Plans also included either America's Top 100 CD or DISH Latino
Dos programming package starting at $49.99 per month or America's Top 150
programming package starting at $59.99 per month. With each plan, consumers
receive in-home-service, must agree to a one-year commitment and incur a
one-time set-up fee of $49.99, which includes the first month's programming
payment. Our Digital Home Plan promotion allows us to capitalize and depreciate
over 4 years equipment costs that would otherwise be expensed at the time of
sale, but also results in increased capital expenditures. Capital expenditures
under our Digital Home Plan promotion totaled approximately $258 million for the
nine months ended September 30, 2001.
26
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - CONTINUED
Conditional Access System
The access control system is central to the security network that
prevents unauthorized viewing of programming. Theft of cable and satellite
programming has been widely reported and our signal encryption has been pirated
and could be further compromised in the future. Theft of our programming reduces
future potential revenue and increases our net subscriber acquisition costs. If
other measures are not successful, it could be necessary to replace the credit
card size smart card that controls the security of each consumer set top box at
a material cost to us. In order to combat piracy and to generate additional
future revenue opportunities, we may decide to replace smart cards at any time
in the future. The cost of replacing these smart cards will not have a material
adverse effect on our results of operations.
Intellectual Property
Many entities, including some of our competitors, now have and may in
the future obtain patents and other intellectual property rights that cover or
affect products or services directly or indirectly related to those that we
offer. In general, if a court determines that one or more of our products
infringes on intellectual property held by others, we would be required to cease
developing or marketing those products, to obtain licenses to develop and market
those products from the holders of the intellectual property, or to redesign
those products in such a way as to avoid infringing the patent claims. Material
damage awards, including the potential for triple damages under patent laws,
could also result. Various parties have asserted patent and other intellectual
property rights with respect to components within our direct broadcast satellite
system. Certain of these parties have filed suit against us, including Starsight
and Superguide, as previously described. We cannot be certain that these persons
do not own the rights they claim, that our products do not infringe on these
rights, that we would be able to obtain licenses from these persons on
commercially reasonable terms or, if we were unable to obtain such licenses,
that we would be able to redesign our products to avoid infringement.
Obligations and Future Capital Requirements
Semi-annual cash debt service of approximately $94 million related to
our 9 1/4% Senior Notes due 2006 (9 1/4% Seven Year Notes) and our 9 3/8% Senior
Notes due 2009 (9 3/8% Ten Year Notes), is payable in arrears on February 1 and
August 1 each year. Semi-annual cash debt service requirements of approximately
$24 million related to our 4 7/8% Convertible Subordinated Notes due 2007 is
payable in arrears on January 1 and July 1 of each year. Semi-annual cash debt
service of approximately $52 million related to our 10 3/8% Senior Notes due
2007 (10 3/8% Seven Year Notes) is payable in arrears on April 1 and October 1
of each year. Semi-annual debt service requirements of approximately $29 million
related to our 5 3/4% Convertible Subordinated Notes due 2008 is payable in
arrears on May 15 and November 15 of each year, commencing November 15, 2001.
There are no scheduled principal payment or sinking fund requirements prior to
maturity of any of these notes.
The indentures related to our 9 1/4% Seven Year Notes, our 9 3/8% Ten
Year Notes, and our 10 3/8% Seven Year Notes contain restrictive covenants that
require us to maintain satellite insurance with respect to at least half of the
satellites we own. Insurance coverage is therefore required for at least three
of our six satellites currently in orbit. We had procured normal and customary
launch insurance for EchoStar VI, which expired on July 14, 2001. As a result,
we are currently self-insuring EchoStar I, EchoStar II, EchoStar III, EchoStar
IV, EchoStar V and EchoStar VI. To satisfy these insurance covenants, we
reclassified an amount equal to the depreciated cost of three of our satellites
from cash and cash equivalents to cash reserved for satellite insurance on our
balance sheet. As of September 30, 2001, cash reserved for satellite insurance
totaled approximately $128 million. The reclassifications will continue until
such time, if ever, as we can again insure our satellites on acceptable terms
and for acceptable amounts. We believe we have in-orbit satellite capacity
sufficient to expeditiously recover transmission of most programming in the
event one of our in-orbit satellites fails. However, the cash reserved for
satellite insurance is not adequate to fund the construction, launch and
insurance for a replacement satellite in the event of a complete loss of a
satellite. Programming continuity could not be assured in the event of multiple
satellite losses.
27
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - CONTINUED
We utilized $91 million of satellite vendor financing for our first
four satellites. As of September 30, 2001, approximately $18 million of that
satellite vendor financing remained outstanding. The satellite vendor financing
bears interest at 8 1/4% and is payable in equal monthly installments over five
years following launch of the satellite to which it relates. A portion of the
contract price with respect to EchoStar VII is payable over a period of 13 years
following launch with interest at 8%, and a portion of the contract price with
respect to EchoStar VIII and EchoStar IX is payable following launch with
interest at 8%. Those in orbit payments are contingent on the continued health
of the satellites.
Effective July 6, 2001, we redeemed, for cash, all of our remaining
outstanding 6 3/4% Series C Cumulative Convertible Preferred Stock at a total
redemption price of approximately $2,400 or $51.929 per share.
During the remainder of 2001, we anticipate total capital expenditures
of between $150-$200 million depending upon the strength of the economy and
other factors. We expect approximately 33% of that amount to be utilized for
satellite construction and approximately 67% for EchoStar receiver systems in
connection with our Digital Home Plan and for general corporate expansion. These
percentages could change depending on actual total expenditures for the year.
While the Digital Home Plan is a competitive promotion for consumers who want
multiple receivers, consumers who only want a single receiver tend to be more
attracted to other industry promotions. Consequently, our anticipated capital
expenditures related to the Digital Home Plan promotion will decrease to the
extent those consumers find other promotions we offer to be more compelling.
In addition to our DBS business plan, we have licenses, or applications
pending with the FCC, for a two satellite FSS Ku-band satellite system and a two
satellite FSS Ka-band satellite system. We will need to raise additional capital
to fully construct these satellites. We are currently funding the construction
phase for three satellites. Two of these satellites, EchoStar VII and EchoStar
VIII, will be advanced, high-powered DBS satellites. The third satellite,
EchoStar IX, will be a hybrid Ku/Ka-band satellite.
During November 2000, one of our wholly-owned subsidiaries purchased a
49.9% interest in VisionStar, Inc. VisionStar holds an FCC license for, and is
constructing a Ka-band satellite to launch into, the 113 W.L. orbital slot.
Together with VisionStar we have requested FCC approval to acquire control over
VisionStar by increasing our ownership of VisionStar to 90%, for a total
purchase price of approximately $2.8 million. We have also provided loans to
VisionStar totaling less than $10 million to date for the construction of their
satellite and expect to provide additional funding to VisionStar in the future.
We are not obligated to finance the full remaining cost to construct and launch
the VisionStar satellite, but VisionStar's FCC license currently requires
construction of the satellite to be completed by April 30, 2002 or the license
could be revoked. There can be no assurance construction of the satellite will
be completed within this time frame. We currently expect to continue to fund
loans and equity contributions for construction of the satellite in the near
term from cash on hand, and expect that we may spend approximately $79.5 million
during the fourth quarter 2001 for that purpose subject to, among other things,
FCC approval. In the future we may fund construction, launch and insurance of
the satellite through cash from operations, public or private debt or equity
financing, joint ventures with others, or from other sources.
Effective September 27, 2001, we invested an additional $50 million in
StarBand, increasing our equity interest from approximately 19% to approximately
32%. If and when construction is commenced for a next generation satellite to be
allocated for StarBand's service, our equity interest would increase to
approximately 60%. We originally invested $50 million in StarBand in April 2000.
As a result of the increased equity stake, this investment is now accounted for
using the equity method of accounting. As required by generally accepted
accounting principles, the equity method accounting has been retroactively
applied back to April 2000, the date of our original investment in StarBand. In
the future we may fund construction, launch and insurance of satellites through
cash from operations, public or private debt or equity financing, joint ventures
with others, or from other sources.
28
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - CONTINUED
From time to time we evaluate opportunities for strategic investments
or acquisitions that would complement our current services and products, enhance
our technical capabilities or otherwise offer growth opportunities. As a result,
acquisition discussions and offers, and in some cases, negotiations may take
place and future material investments or acquisitions involving cash, debt or
equity securities or a combination thereof may result.
We expect that our future working capital, capital expenditure and debt
service requirements will be satisfied from existing cash and investment
balances, and cash generated from operations. Our ability to generate positive
future operating and net cash flows is dependent, among other things, upon our
ability to retain existing DISH Network subscribers, our ability to manage the
growth of our subscriber base, and our ability to grow our ETC business. To the
extent future subscriber growth exceeds our expectations, it may be necessary
for us to raise additional capital to fund increased working capital
requirements. There may be a number of other factors, some of which are beyond
our control or ability to predict, that could require us to raise additional
capital. These factors include unexpected increases in operating costs and
expenses, a defect in or the loss of any satellite, or an increase in the cost
of acquiring subscribers due to additional competition, among other things. If
cash generated from our operations is not sufficient to meet our debt service
requirements or other obligations, we would be required to obtain cash from
other financing sources. If we were required to raise capital today a variety of
debt and equity funding sources would likely be available to us. However, there
can be no assurance that such financing would be available on terms acceptable
to us, or if available, that the proceeds of such financing would be sufficient
to enable us to meet all of our obligations.
29
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISKS ASSOCIATED WITH FINANCIAL INSTRUMENTS
As of September 30, 2001, our unrestricted cash, cash equivalents and
marketable investment securities had a fair value of $2.2 billion. Of that
amount, a total of $2.1 billion was invested in: (a) cash; (b) debt instruments
of the U.S. Government and its agencies; (c) commercial paper with an average
maturity of less than one year and rated in one of the four highest rating
categories by at least two nationally recognized statistical rating
organizations; and (d) instruments with similar risk characteristics to the
commercial paper described above. The primary purpose of these investing
activities has been to preserve principal until the cash is required to fund
operations. Consequently, the size of this portfolio fluctuates significantly as
cash is raised and used in our business.
The value of certain of the investments in this portfolio can be
impacted by, among other things, the risk of adverse changes in securities and
economic markets generally, as well as the risks related to the performance of
the companies whose commercial paper and other instruments we hold. However, the
high quality of these investments (as assessed by independent rating agencies),
reduces these risks. The value of these investments can also be impacted by
interest rate fluctuations. At September 30, 2001, all of our investments in
this category were in fixed rate instruments or money market type accounts.
While an increase in interest rates would ordinarily adversely impact the fair
value of fixed rate investments, we normally hold these investments to maturity.
Consequently, neither interest rate fluctuations nor other market risks
typically result in significant gains or losses to this portfolio. A decrease in
interest rates has the effect of reducing our future annual interest income from
this portfolio, since funds would be re-invested at lower rates as the
instruments mature. Over time, any net percentage decrease in interest rates
could be reflected in a corresponding net percentage decrease in our interest
income. As of September 30, 2001 our marketable securities portfolio balance was
approximately $2.2 billion with an average annual interest rate of approximately
4%. A hypothetical 10% decrease in interest rates would result in a decrease of
approximately $9 million in annual interest income.
We also invest in debt and equity of public and private companies for
strategic and financial purposes. As of September 30, 2001, we held strategic
and financial debt and equity investments of public companies with a fair value
of approximately $126 million. We acquired stock in one of those companies,
OpenTV, in connection with establishment of a strategic relationship which did
not involve the investment of cash by us. None of these investments accounted
for more than 40% of the total fair value of the portfolio. We may make
additional strategic and financial investments in other debt and equity
securities in the future.
The fair value of our strategic debt investments can be impacted by
interest rate fluctuations. Absent the effect of other factors, a hypothetical
10% increase in LIBOR would result in a decrease in the fair value of our
investments in these debt instruments of approximately $4 million. The fair
value of our strategic debt and equity investments can also be significantly
impacted by the risk of adverse changes in securities markets generally, as well
as risks related to the performance of the companies whose securities we have
invested in, risks associated with specific industries, and other factors. These
investments are subject to significant fluctuations in fair market value due to
the volatility of the securities markets and of the underlying businesses. A
hypothetical 10% adverse change in the price of our public strategic debt and
equity investments would result in approximately a $12.6 million decrease in the
fair value of that portfolio.
In accordance with generally accepted accounting principles, declines
in the fair market value of a marketable investment security which are estimated
to be "other than temporary" must be recognized in the statement of operations,
thus establishing a new cost basis for such investment. We evaluate our
marketable investment securities portfolio on a quarterly basis to determine
whether declines in the market value of these securities are other than
temporary. This quarterly evaluation consists of reviewing, among other things,
the fair value of its marketable investment securities compared to the carrying
value of these securities and any market and company specific factors related to
each security. Generally, absent specific factors to the contrary, declines in
the fair value of investments below cost basis for a period of less than six
months are considered to be temporary. Declines in the fair value of investments
for a period of six to nine months are evaluated on a case by case basis to
determine whether any company or market-specific factors exist which would
indicate that such declines are other than temporary. Declines in the fair value
of investments below cost basis for greater than nine months are considered
other than temporary and are recorded as charges to earnings, absent specific
factors to the contrary. During the nine months ended September 30,
30
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK - CONTINUED
2001, we recorded an aggregate charge to earnings for other than temporary
declines in the fair market value of certain of our marketable investment
securities of approximately $33.3 million, and established a new cost basis for
these securities. All of these charges were recorded during the first half of
2001. In addition, we have recorded unrealized losses totaling approximately $42
million as of September 30, 2001. If the fair market value of our marketable
securities portfolio does not increase to cost basis or if we become aware of
any market or company specific factors that indicate that the carrying value of
certain of our securities is impaired, we may be required to record an
additional charge to earnings in future periods equal to the amount of the
decline in fair value.
In addition to the $2.2 billion, we have made strategic equity
investments in certain non-marketable investment securities including Wildblue
Communications, StarBand Communications, VisionStar, Inc. and Replay TV. Through
September 30, 2001, the original cost basis of our investments in these
non-marketable investment securities totaled approximately $166 million. The
securities of these companies are not publicly traded. During August 2001,
SONICblue, a publicly-traded company, completed its acquisition of Replay TV. As
such, during the quarter ended September 30, 2001, EchoStar reclassified this
investment as an available-for-sale marketable investment security. Our ability
to create realizable value for our strategic investments in companies that are
not public is dependent on the success of their business plans. Among other
things, there is relatively greater risk that those companies may not be able to
raise sufficient capital to fully finance and execute their business plans.
Since private markets are not as liquid as public markets, there is also
increased risk that we will not be able to sell these investments, or that when
we desire to sell them that we will not be able to obtain full value for them.
StarBand and Wildblue cancelled their planned initial public stock offerings. As
a result of the cancellation of those offerings and other factors, during the
nine months ended September 30, 2001, we recorded a non-recurring charge, net of
retroactive StarBand equity method accounting adjustments, of approximately $52
million to reduce the carrying value of certain of these non-marketable
investment securities to their estimated fair values. As of September 30, 2001,
the carrying value of all non-marketable investment securities totaled
approximately $64 million, net of equity in losses of StarBand. If we become
aware of any factors that indicate that the carrying value of certain of our
non-marketable investment securities is impaired, we may be required to record
an additional charge to earnings in future periods.
As of September 30, 2001, we estimated the fair value of our fixed-rate
debt and mortgages and other notes payable to be approximately $4.6 billion
using quoted market prices where available, or discounted cash flow analyses.
The fair value of our fixed rate debt and mortgages is affected by fluctuations
in interest rates. A hypothetical 10% decrease in assumed interest rates would
increase the fair value of our debt by approximately $221 million. To the extent
interest rates increase, our costs of financing would increase at such time as
we are required to refinance our debt. As of September 30, 2001, a hypothetical
10% increase in assumed interest rates would increase our annual interest
expense by approximately $40 million.
We have not used derivative financial instruments for speculative
purposes. We have not hedged or otherwise protected against the risks associated
with any of our investing or financing activities.
31
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
DirecTV
During February 2000, we filed suit against DirecTV and Thomson
Consumer Electronics/RCA in the Federal District Court of Colorado. The suit
alleges that DirecTV has utilized improper conduct in order to fend off
competition from the DISH Network, has demanded that certain retailers stop
displaying EchoStar's merchandise, has threatened to cause economic damage to
retailers if they continue to offer both product lines in head-to-head
competition, and has acted in violation of federal and state antitrust laws in
order to protect DirecTV's market share.
The DirecTV defendants filed a counterclaim against us. DirecTV alleges
that we tortiously interfered with a contract that DirecTV allegedly had with
Kelly Broadcasting Systems, Inc. ("KBS"). DirecTV alleges that we "merged" with
KBS in contravention of DirecTV's contract with KBS. DirecTV also alleges that
we have falsely advertised to consumers about its right to offer network
programming. DirecTV further alleges that we improperly used certain trademarks
owned by PrimeStar, which is now owned by DirecTV. Finally, DirecTV alleges that
we have been marketing National Football League games in a misleading manner.
Discovery has been stayed until the next scheduling conference on November 2,
2001. In an arbitration proceeding related to DirecTV's allegations with respect
to KBS, DirecTV had claimed damages totaling hundreds of millions of dollars.
During September 2001, the arbitration panel awarded DirecTV approximately $7.3
million, of which approximately $4 million would be payable by us. We intend to
challenge the arbitration panel's decision.
Fee Dispute
We had a contingent fee arrangement with the attorneys who represented
us in prior litigation with News Corporation. The contingent fee arrangement
provides for the attorneys to be paid a percentage of any net recovery obtained
by us in the News Corporation litigation. The attorneys have asserted that they
may be entitled to receive payments totaling hundreds of millions of dollars
under this fee arrangement.
During mid-1999, we initiated litigation against the attorneys in the
Arapahoe County, Colorado, District Court arguing that the fee arrangement is
void and unenforceable. In December 1999, the attorneys initiated an arbitration
proceeding before the American Arbitration Association. The litigation has been
stayed while the arbitration is ongoing. The arbitration hearing commenced April
2, 2001 and the presentation of evidence concluded on August 17, 2001. The
parties presented closing arguments to the arbitration panel on October 11,
2001. During the four week arbitration hearing, the attorneys presented a damage
model for $56 million. However, during closing arguments, the attorneys
presented a separate damage calculation for $111 million to the arbitration
panel. We believe that even the $56 million significantly overstates the amount
the attorneys should be reasonably entitled to receive under the fee agreement.
It is not possible for us to predict what the decision of the arbitration panel
will be with any degree of certainty. We anticipate that the panel will issue
its ruling within the next 90 days.
WIC Premium Television Ltd.
During July 1998, a lawsuit was filed by WIC Premium Television Ltd.,
an Alberta corporation, in the Federal Court of Canada Trial Division, against
General Instrument Corporation, HBO, Warner Communications, Inc., John Doe,
Showtime, United States Satellite Broadcasting Company, Inc., EchoStar
Communications Corporation, and two of EchoStar's wholly-owned subsidiaries,
Echosphere Corporation and Dish, Ltd. EchoStar Satellite Corporation, EchoStar
DBS Corporation, EchoStar Technologies Corporation, and EchoStar Satellite
Broadcast Corporation were subsequently added as defendants. The lawsuit seeks,
among other things, interim and permanent injunctions prohibiting the defendants
from activating receivers in Canada and from infringing any copyrights held by
WIC.
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PART II - OTHER INFORMATION
During September 1998, WIC filed another lawsuit in the Court of
Queen's Bench of Alberta Judicial District of Edmonton against certain
defendants, including us. WIC is a company authorized to broadcast certain
copyrighted work, such as movies and concerts, to residents of Canada. WIC
alleges that the defendants engaged in, promoted, and/or allowed satellite dish
equipment from the United States to be sold in Canada and to Canadian residents
and that some of the defendants allowed and profited from Canadian residents
purchasing and viewing subscription television programming that is only
authorized for viewing in the United States. The lawsuit seeks, among other
things, interim and permanent injunctions prohibiting the defendants from
importing hardware into Canada and from activating receivers in Canada, together
with damages in excess of $175 million.
The Court in the Alberta action recently denied our Motion to Dismiss,
which we appealed. The Court in the Federal action has stayed that case pending
the outcome of the Alberta action. The case is now currently in discovery. We
intend to vigorously defend the suit. It is too early to make an assessment of
the probable outcome of the litigation or to determine the extent of any
potential liability or damages.
Broadcast network programming
Until July 1998, we obtained distant broadcast network channels (ABC,
NBC, CBS and FOX) for distribution to our customers through PrimeTime 24. In
December 1998, the United States District Court for the Southern District of
Florida entered a nationwide permanent injunction requiring PrimeTime 24 to shut
off distant network channels to many of its customers, and henceforth to sell
those channels to consumers in accordance with certain stipulations in the
injunction.
In October 1998, we filed a declaratory judgment action against ABC,
NBC, CBS and FOX in Denver Federal Court. We asked the court to enter a judgment
declaring that our method of providing distant network programming did not
violate the Satellite Home Viewer Act ("SHVA") and hence did not infringe the
networks' copyrights. In November 1998, the networks and their affiliate groups
filed a complaint against us in Miami Federal Court alleging, among other
things, copyright infringement. The court combined the case that we filed in
Colorado with the case in Miami and transferred it to the Miami court. The case
remains pending in Miami. While the networks have not sought monetary damages,
they have sought to recover attorney fees if they prevail.
In February 1999, the networks filed a "Motion for Temporary
Restraining Order, Preliminary Injunction and Contempt Finding" against DirecTV,
Inc. in Miami related to the delivery of distant network channels to DirecTV
customers by satellite. DirecTV settled this lawsuit with the networks. Under
the terms of the settlement between DirecTV and the networks, some DirecTV
customers were scheduled to lose access to their satellite-provided distant
network channels by July 31, 1999, while other DirecTV customers were to be
disconnected by December 31, 1999. Subsequently, PrimeTime 24 and substantially
all providers of satellite-delivered network programming other than EchoStar
agreed to this cut-off schedule, although we do not know if they adhered to this
schedule.
In December 1998, the networks filed a Motion for Preliminary
Injunction against us in the Miami court, and asked the court to enjoin us from
providing network programming except under limited circumstances. A preliminary
injunction hearing was held on September 21, 1999. The court took the issues
under advisement to consider the networks' request for an injunction, whether to
hear live testimony before ruling upon the request, and whether to hear argument
on why the Satellite Home Viewer Act may be unconstitutional, among other
things.
In March 2000, the networks filed an emergency motion again asking the
court to issue an injunction requiring us to turn off network programming to
certain of our customers. At that time, the networks also argued that our
compliance procedures violate the Satellite Home Viewer Improvement Act. We
opposed the networks' motion and again asked the court to hear live testimony
before ruling upon the networks' injunction request.
During September 2000, the Court granted the Networks' motion for
preliminary injunction, denied the Network's emergency motion and denied our
request to present live testimony and evidence. The Court's original order
required us to terminate network programming to certain subscribers "no later
than February 15, 1999," and contained other dates with which it would be
physically impossible to comply. The order imposes restrictions on
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PART II - OTHER INFORMATION
our past and future sale of distant ABC, NBC, CBS and Fox channels similar to
those imposed on PrimeTime 24 (and, we believe, on DirecTV and others). Some of
those restrictions go beyond the statutory requirements imposed by the Satellite
Home Viewer Act and the Satellite Home Viewer Improvement Act. For these and
other reasons we believe the Court's order is, among other things, fundamentally
flawed, unconstitutional and should be overturned. However, it is very unusual
for a Court of Appeals to overturn a lower court's order and there can be no
assurance whatsoever that it will be overturned.
On October 3, 2000, and again on October 25, 2000, the Court amended
its original preliminary injunction order in an effort to fix some of the errors
in the original order. The twice amended preliminary injunction order required
us to shut off, by February 15, 2001, all subscribers who are ineligible to
receive distant network programming under the court's order. We have appealed
the September 2000 preliminary injunction order and the October 3, 2000 amended
preliminary injunction order. On November 22, 2000, the United States Court of
Appeals for the Eleventh Circuit stayed the Florida Court's preliminary
injunction order pending our appeal. At that time, the Eleventh Circuit also
expedited its consideration of our appeal.
During November 2000, EchoStar filed its appeal brief with the Eleventh
Circuit. Oral argument before the Eleventh Circuit was held on May 24, 2001. At
the oral argument, the parties agreed to participate in a court supervised
mediation and that the mediator was to report back to the Eleventh Circuit on
July 11, 2001. The Eleventh Circuit indicated that it would not rule on the
pending appeal until after July 11, 2001. Since May 24, 2001, the parties
participated in the court supervised mediation. On July 11, 2001 the mediator
reported to the Eleventh Circuit the status of the parties' mediation efforts.
On July 16, 2001, the Eleventh Circuit issued an order for the parties to engage
in further mediation efforts until August 10, 2001. On August 8, 2001, the
parties participated in another court ordered mediation but were unable to reach
a resolution. On August 10, 2001, the mediator reported to the Eleventh Circuit
that despite the parties' extensive efforts, the parties were unable to resolve
their differences and that further efforts at mediation will not contribute to a
resolution of the dispute between the parties at this time. The mediator
therefore advised the Eleventh Circuit that it may rule upon our appeal.
On September 17, 2001, the Eleventh Circuit vacated the District
Court's nationwide preliminary injunction, which the Eleventh Circuit had stayed
in November 2000. The Eleventh Circuit also rejected our First Amendment
challenge to the SHVA. We have filed a petition for rehearing asking the
Eleventh Circuit to reconsider its rejection of our constitutional challenge.
There can be no assurance the Eleventh Circuit will reconsider or reverse its
decision on our First Amendment challenge. However, the Eleventh Circuit found
that the District Court had made factual findings that were clearly erroneous
and not supported by the evidence, and that the District Court had
misinterpreted and misapplied the law. The Eleventh Circuit also found that the
District Court came to the wrong legal conclusion concerning the grandfathering
provision found in 17 U.S.C. Section 119(d); the Eleventh Circuit reversed the
District Court's legal conclusion and instead found that this grandfathering
provision allows subscribers who switch satellite carriers to continue to
receive the distant network programming that they had been receiving. The
Eleventh Circuit remanded the matter to the District Court for an evidentiary
hearing. We can not predict when the evidentiary hearing will be set.
If, after an evidentiary hearing, the District Court enters a
preliminary injunction against us, the preliminary injunction could force us to
terminate delivery of distant network channels to a substantial portion of our
distant network subscriber base, which could also cause many of these
subscribers to cancel their subscription to our other services. Management has
determined that such terminations would result in a small reduction in our
reported average monthly revenue per subscriber and could result in a temporary
increase in churn. If we lose the case at trial, the judge could, as one of many
possible remedies, prohibit all future sales of distant network programming by
us, which would have a material adverse affect on our business.
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PART II - OTHER INFORMATION
Gemstar
During October 2000, Starsight Telecast, Inc., a subsidiary of
Gemstar-TV Guide International, Inc., filed a suit for patent infringement
against us and certain of its subsidiaries in the United States District Court
for the Western District of North Carolina, Asheville Division. The suit alleges
infringement of United States Patent No. 4,706,121 (the "121 Patent") which
relates to certain electronic program guide functions. We have examined this
patent and believe that it is not infringed by any of our products or services.
We will vigorously defend against this suit.
In December 2000, we filed suit against Gemstar - TV Guide (and certain
of its subsidiaries) in the United States District Court for the District of
Colorado alleging violations by Gemstar of various federal and state anti-trust
laws and laws governing unfair competition. The lawsuit seeks an injunction and
monetary damages. Gemstar has also filed counterclaims in this lawsuit alleging
infringement of United States Patent Nos. 5,923,362 and 5,684,525 that relate to
certain electronic program guide functions. We have examined these patents and
believe they are not infringed by any of our products or services. We will
vigorously contest these counterclaims. In August 2001, the Federal
Multi-District Litigation panel combined this suit, for discovery purposes, with
other lawsuits asserting antitrust claims against Gemstar, which had previously
been filed by other plaintiffs.
In February 2001, Gemstar filed patent infringement actions against us
in District Court in Atlanta, Georgia and in the International Trade Commission
(ITC). These suits allege infringement of United States Patent Nos. 5,252,066,
5,479,268 and 5,809,204 all of which relate to certain electronic program guide
functions. In addition, the ITC action alleges infringement of the 121 Patent
which is asserted in the North Carolina case. In the Atlanta District Court
case, Gemstar seeks damages and an injunction. The North Carolina case has been
stayed pending resolution of the ITC action and we expect that the Atlanta
action will also be stayed pending resolution of the ITC action. ITC actions
typically proceed according to an expedited schedule. We expect the ITC action
to go to trial by the end of 2001. We further expect that the ITC will issue an
initial determination by March of 2002 and that a final determination will be
issued by April 2002. While the ITC cannot award damages, it can issue exclusion
orders that would prevent the importation of articles that are found to infringe
the asserted patents. Portions of our receivers are currently manufactured
outside the United States. In addition, it can issue cease and desist orders
that would prohibit the sale of infringing products that had been previously
imported. We have examined these patents and believe they are not infringed by
any of our products or services. We will vigorously contest the ITC, North
Carolina and Atlanta allegations of infringement and will, among other things,
challenge both the validity and enforceability of the asserted patents.
During 2000, Superguide Corp. also filed suit against us, DirecTV and
others in the United States District Court for the Western District of North
Carolina, Asheville Division, alleging infringement of United States Patent Nos.
5,038,211, 5,293,357 and 4,751,578 which relate to certain electronic program
guide functions, including the use of electronic program guides to control VCRs.
It is our understanding that these patents may be licensed by Superguide to
Gemstar. Gemstar has been added as a party to this case and is now asserting
these patents against us. We have examined these patents and believe that they
are not infringed by any of our products or services. A Markman was held in July
2001 but no decision has been issued to date. The case is not expected to go to
trial before early 2002. We intend to vigorously defend against this action and
assert a variety of counterclaims.
In the event it is ultimately determined that we infringe on any of the
aforementioned patents we may be subject to substantial damages, including the
potential for treble damages, and/or an injunction that could require us to
materially modify certain user friendly electronic programming guide and related
features it currently offers to consumers. It is too early to make an assessment
of the probable outcome of the suits.
IPPV Enterprises
IPPV Enterprises, LLC and MAAST, Inc. filed a patent infringement suit
against us, and our conditional access vendor Nagra, in the United States
District Court for the District of Delaware. The suit alleged infringement of 5
patents. The patents disclose various systems for the implementation of features
such as impulse-pay-per view, parental control and category lock-out. One patent
relates to an encryption technique. One patent was subsequently
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PART II - OTHER INFORMATION
dropped by plaintiffs. The Court entered summary judgment in favor of us that
the encryption patent, with respect to which the plaintiffs claimed $80 million
in damages, was not infringed by us. On July 13, 2001, a jury found that the
remaining three patents were infringed and awarded damages of $15 million. The
jury also found that one of the patents was willfully infringed which means that
the judge is entitled to increase the award of damages. The parties recently
completed post-trial briefings in this action which are scheduled for oral
argument before the Court on October 24, 2001. We intend to appeal the decision
and plaintiffs have indicated they will appeal as well. Any final award of
damages would be split between us and Nagra in percentages to be agreed upon
between us and Nagra.
California Actions
A purported class action was filed against us in the California State
Superior Court for Alameda County during May 2001 by Andrew A. Werby. The
complaint, relating to late fees, alleges unlawful, unfair and fraudulent
business practices in violation of California Business and Professions Code
Section 17200 et seq., false and misleading advertising in violation of
California Business and Professions Code Section 17500, and violation of the
California Consumer Legal Remedies Act. On September 24, 2001, we filed an
answer denying all material allegations of the Complaint. On September 27, 2001,
the Court entered an Order Pursuant to Stipulation for a provisional
certification of the class, for an orderly exchange of information and for
mediation. The provisional Order specifies that the class shall be de-certified
upon notice in the event mediation does not resolve the dispute. It is too early
in the litigation to make an assessment of the probable outcome of the
litigation or to determine the extent of any potential liability or damages. We
intend to deny all liability and intend to vigorously defend the lawsuit.
A purported class action relating to the use of terms such as "crystal
clear digital video," "CD-quality audio," and "on-screen program guide", and
with respect to the number of channels available in various programming
packages, has also been filed against us in the California State Superior Court
for Los Angeles County by David Pritikin and by Consumer Advocates, a nonprofit
unincorporated association. The complaint alleges breach of express warranty and
violation of the California Consumer Legal Remedies Act, Civil Code Sections
1750, et. seq., and the California Business & Professions Code Sections 17500,
17200. We have filed an answer and the case is currently in discovery. No motion
for class certification has been filed to date. It is too early in the
litigation to make an assessment of the probable outcome of the litigation or to
determine the extent of any potential liability or damages. We deny all
liability and intend to vigorously defend the lawsuit.
Retailer Class Actions
We have been sued by retailers in three separate purported class
actions. In two separate lawsuits filed in the District Court, Arapahoe County,
State of Colorado and the United States District Court for the District of
Colorado, respectively, Air Communication & Satellite, Inc. and John DeJong, et.
al. filed lawsuits on October 6, 2000 on behalf of themselves and a class of
persons similarly situated. The plaintiffs are attempting to certify nationwide
classes allegedly brought on behalf of persons, primarily retail dealers, who
were alleged signatories to certain retailer agreements with EchoStar Satellite
Corporation. The plaintiffs are requesting the Court to declare certain
provisions of the alleged agreements invalid and unenforceable, to declare that
certain changes to the agreements are invalid and unenforceable, and to award
damages for lost commissions and payments, charge backs, and other compensation.
We intend to vigorously defend against the suits and to assert a variety of
counterclaims. It is too early to make an assessment of the probable outcome of
the litigation or to determine the extent of any potential liability or damages.
Satellite Dealers Supply, Inc. filed a lawsuit in the United States
District Court for the Eastern District of Texas on September 25, 2000, on
behalf of itself and a class of persons similarly situated. The plaintiff is
attempting to certify a nationwide class on behalf of sellers, installers, and
servicers of satellite equipment who contract with us and claim the alleged
class has been "subject to improper chargebacks." The plaintiff alleges that we:
(1) charged back certain fees paid by members of the class to professional
installers in violation of contractual terms; (2) manipulated the accounts of
subscribers to deny payments to class members; and (3) misrepresented to class
members who own certain equipment related to the provision of satellite
television service. On September 18,
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PART II - OTHER INFORMATION
2001, the Court granted our Motion to Dismiss for lack of personal jurisdiction.
Plaintiff Satellite Dealers Supply has moved for reconsideration of the Court's
order dismissing the case.
Satellite Insurance
As a result of the failure of EchoStar IV solar arrays to fully deploy
and the failure of 30 transponders to date, a maximum of approximately 14 of the
44 transponders on EchoStar IV are available for use at this time. In addition
to the transponder and solar array failures, EchoStar IV experienced anomalies
affecting its thermal systems and propulsion system. There can be no assurance
that further material degradation, or total loss of use, of EchoStar IV will not
occur in the immediate future.
In September 1998, we filed a $219.3 million insurance claim for a
constructive total loss under the launch insurance policies covering EchoStar
IV. The satellite insurance consists of separate identical policies with
different carriers for varying amounts which, in combination, create a total
insured amount of $219.3 million.
The insurance carriers offered us a total of approximately $88 million,
or 40% of the total policy amount, in settlement of the EchoStar IV insurance
claim. The insurers allege that all other impairment to the satellite occurred
after expiration of the policy period and is not covered. We strongly disagree
with the position of the insurers and have filed an arbitration claim against
them for breach of contract, failure to pay a valid insurance claim and bad
faith denial of a valid claim, among other things. There can be no assurance
that we will receive the amount claimed or, if we do, that we will retain title
to EchoStar IV with its reduced capacity.
At the time we filed our claim in 1998, we recognized an impairment
loss of $106 million to write-down the carrying value of the satellite and
related costs, and simultaneously recorded an insurance claim receivable for the
same amount. We continue to believe we will ultimately recover at least the
amount originally recorded and do not intend to adjust the amount of the
receivable until there is greater certainty with respect to the amount of the
final settlement.
As a result of the thermal and propulsion system anomalies, we reduced
the estimated remaining useful life of EchoStar IV to approximately 4 years
during January 2000. We will continue to evaluate the performance of EchoStar IV
and may modify our loss assessment as new events or circumstances develop.
The in-orbit insurance policies for EchoStar I, EchoStar II, and
EchoStar III expired July 25, 2000. The insurers refused to renew insurance on
EchoStar I, EchoStar II and EchoStar III on reasonable terms. Based on the
carriers' actions, we added causes of action in our EchoStar IV demand for
arbitration for breach of the duty of good faith and fair dealing, and unfair
claim practices. Additionally, we filed a lawsuit against the insurance carriers
in the United States District Court for the District of Colorado asserting
causes of action for violation of Federal and State antitrust laws. While we
believe we are entitled to the full amount claimed under the EchoStar IV
insurance policy and believe the insurance carriers' position is wrongful, there
can be no assurance as to the outcome of these proceedings. During March 2001,
we voluntarily dismissed the antitrust lawsuit without prejudice. We have the
right to re-file an antitrust action against the insurers again in the future.
We are subject to various other legal proceedings and claims which
arise in the ordinary course of business. In the opinion of management, the
amount of ultimate liability with respect to those actions will not materially
affect our financial position or results of operations.
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PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
None.
(b) Reports on Form 8-K.
On July 12, 2001, we filed a Current Report on Form 8-K to report that,
subject, among other things, to customary regulatory approvals, it has increased
its equity stake in StarBand Communications Inc. to approximately 32% and
acquire four out of seven seats on the StarBand Board of Directors. In exchange,
EchoStar will invest an additional $50 million in StarBand. Further, EchoStar
will lease transponder capacity to StarBand from a next generation satellite. In
accordance with the agreement and subject to customary regulatory approvals,
EchoStar's equity stake will increase to approximately 60% upon commencement of
the construction of the next generation satellite.
On August 6, 2001, we filed a Current Report on Form 8-K to report that
we have made a proposal to General Motors Corporation to combine EchoStar with
Hughes Electronic Corporation in a stock-for-stock transaction.
On September 28, 2001, we filed a Current Report on Form 8-K to report
that we had completed our additional $50 million investment in StarBand
Communications Inc.
38
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ECHOSTAR COMMUNICATIONS CORPORATION
By: /s/ David K. Moskowitz
-----------------------------------------------
David K. Moskowitz
Senior Vice President, General Counsel,
Secretary and Director
(Duly Authorized Officer)
By: /s/ Michael R. McDonnell
-----------------------------------------------
Michael R. McDonnell
Senior Vice President and Chief Financial
Officer
(Principal Financial Officer)
Date: October 23, 2001
39