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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------
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 333-52756
ECHOSTAR BROADBAND CORPORATION
(Exact Name of Registrant as Specified in its Charter)
<Table>
COLORADO 84-1560440
(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)
</Table>
(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 NOVEMBER 13, 2001, REGISTRANT'S OUTSTANDING COMMON STOCK CONSISTED OF
1,000 SHARES OF COMMON STOCK.
THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION
(H)(1)(a) AND (b) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM 10-Q WITH THE
REDUCED DISCLOSURE FORMAT.
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TABLE OF CONTENTS
<Table>
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 Narrative Analysis of Results of Operations........................................... 16
Item 3. Quantitative and Qualitative Disclosures About Market Risk......................................... 24
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.................................................................................. 25
Item 2. Changes in Securities and Use of Proceeds.......................................................... *
Item 3. Defaults Upon Senior Securities.................................................................... *
Item 4. Submission of Matters to a Vote of Security Holders................................................ *
Item 5. Other Information.................................................................................. None
Item 6. Exhibits and Reports on Form 8-K................................................................... 31
</Table>
- ----------
* This item has been omitted pursuant to the reduced disclosure format as set
forth in General Instruction (H)(1)(a) and (b) of Form 10-Q.
ECHOSTAR BROADBAND CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
<Table>
<Caption>
DECEMBER 31, SEPTEMBER 30,
2000 2001
------------ ------------
(Unaudited)
ASSETS
Current Assets:
Cash and cash equivalents .............................................................. $ 657,592 $ 413,965
Marketable investment securities ....................................................... 370,595 397,342
Trade accounts receivable, net of allowance for uncollectible accounts of
$19,934 and $9,354, respectively .................................................... 276,081 285,868
Insurance receivable ................................................................... 106,000 106,000
Inventories ............................................................................ 159,665 205,466
Other current assets ................................................................... 33,919 39,128
----------- -----------
Total current assets ...................................................................... 1,603,852 1,447,769
Cash reserved for satellite insurance (Note 5) ............................................ 82,393 128,218
Property and equipment, net ............................................................... 1,474,265 1,793,428
FCC authorizations, net ................................................................... 709,817 700,860
Other noncurrent assets ................................................................... 95,549 86,356
----------- -----------
Total assets ......................................................................... $ 3,965,876 $ 4,156,631
=========== ===========
LIABILITIES AND STOCKHOLDER'S DEFICIT
Current Liabilities:
Trade accounts payable ................................................................. $ 144,263 $ 312,843
Deferred revenue ....................................................................... 282,939 352,231
Accrued expenses ....................................................................... 643,359 710,941
Advances from affiliates, net .......................................................... 832,334 706,908
Current portion of long-term debt ...................................................... 19,642 12,712
----------- -----------
Total current liabilities ................................................................. 1,922,537 2,095,635
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
Mortgages and other notes payable, net of current portion .............................. 11,644 11,210
Long-term deferred distribution and carriage revenue and other long-term liabilities ... 56,047 83,876
----------- -----------
Total long-term obligations, net of current portion ....................................... 3,067,691 3,095,086
----------- -----------
Total liabilities .................................................................... 4,990,228 5,190,721
Commitments and Contingencies (Note 6)
Stockholder's Deficit:
Common Stock, $.01 par value, 1,000 shares authorized, issued and
outstanding ............................................................................ -- --
Additional paid-in capital ............................................................. 1,440,253 1,436,782
Deferred stock-based compensation ...................................................... (58,193) (33,424)
Accumulated other comprehensive income (loss) .......................................... (1,150) 1,818
Accumulated deficit .................................................................... (2,405,262) (2,439,266)
----------- -----------
Total stockholder's deficit ............................................................... (1,024,352) (1,034,090)
----------- -----------
Total liabilities and stockholder's deficit .......................................... $ 3,965,876 $ 4,156,631
=========== ===========
</Table>
See accompanying Notes to Condensed Consolidated Financial Statements.
1
ECHOSTAR BROADBAND CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands)
(Unaudited)
<Table>
<Caption>
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- -------------------------------
2000 2001 2000 2001
----------- ----------- ----------- -----------
REVENUE:
DISH Network:
Subscription television services ............................. $ 614,975 $ 919,856 $ 1,645,514 $ 2,595,441
Other ........................................................ 1,763 4,784 6,571 12,511
----------- ----------- ----------- -----------
Total DISH Network ............................................. 616,738 924,640 1,652,085 2,607,952
DTH equipment sales and integration services ................... 55,042 72,348 174,542 158,022
Other .......................................................... 22,447 22,347 77,857 74,267
----------- ----------- ----------- -----------
Total revenue ..................................................... 694,227 1,019,335 1,904,484 2,840,241
COSTS AND EXPENSES:
DISH Network Operating Expenses:
Subscriber-related expenses .................................. 255,083 365,647 693,225 1,046,676
Customer service center and other ............................ 60,288 72,790 184,677 207,487
Satellite and transmission ................................... 9,368 10,745 33,282 27,779
----------- ----------- ----------- -----------
Total DISH Network operating expenses .......................... 324,739 449,182 911,184 1,281,942
Cost of sales - DTH equipment and integration services ......... 40,612 49,304 134,683 109,205
Cost of sales - other .......................................... 7,121 13,712 22,352 48,201
Marketing:
Subscriber promotion subsidies - promotional DTH equipment ... 210,067 113,501 536,773 348,232
Subscriber promotion subsidies - other ....................... 38,888 112,923 202,390 380,293
Advertising and other ........................................ 41,308 44,800 88,805 97,838
----------- ----------- ----------- -----------
Total marketing expenses ....................................... 290,263 271,224 827,968 826,363
General and administrative ..................................... 59,299 81,836 164,721 236,056
Non-cash, stock-based compensation ............................. 11,568 6,831 38,599 21,298
Depreciation and amortization .................................. 43,356 69,750 123,279 184,958
----------- ----------- ----------- -----------
Total costs and expenses .......................................... 776,958 941,839 2,222,786 2,708,023
----------- ----------- ----------- -----------
Operating income (loss) .......................................... (82,731) 77,496 (318,302) 132,218
Other Income (Expense):
Interest income ................................................ 4,198 10,252 9,880 37,833
Interest expense, net of amounts capitalized ................... (49,732) (66,877) (146,948) (205,187)
Other .......................................................... (643) (1,782) (2,593) 1,132
----------- ----------- ----------- -----------
Total other expense ............................................... (46,177) (58,407) (139,661) (166,222)
----------- ----------- ----------- -----------
Income (loss) before income taxes ................................. (128,908) 19,089 (457,963) (34,004)
Income tax provision, net ......................................... (44) -- (103) --
----------- ----------- ----------- -----------
Net income (loss) ................................................. $ (128,952) $ 19,089 $ (458,066) $ (34,004)
=========== =========== =========== ===========
</Table>
See accompanying Notes to Condensed Consolidated Financial Statements.
2
ECHOSTAR BROADBAND CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<Table>
<Caption>
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
2000 2001
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ......................................................................... $ (458,066) $ (34,004)
Adjustments to reconcile net loss to net cash flows from operating activities:
Deferred stock-based compensation recognized .................................. 38,599 21,298
Depreciation and amortization ................................................. 123,279 184,958
Amortization of debt discount and deferred financing costs .................... 2,481 3,491
Change in long-term deferred distribution and carriage revenue
and other long-term liabilities ............................................. 5,586 27,688
Other, net .................................................................... 7,769 12,405
Changes in current assets and current liabilities ............................. 23,751 232,796
----------- -----------
Net cash flows from operating activities ......................................... (256,601) 448,632
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of marketable investment securities .................................... -- (760,248)
Sales of marketable investment securities ........................................ 19,775 736,469
Cash reserved for satellite insurance (Note 5) ................................... (89,591) (59,488)
Change in cash reserved for satellite insurance due to depreciation
on related satellites (Note 5) ................................................. -- 13,663
Purchases of property and equipment .............................................. (178,515) (489,865)
----------- -----------
Net cash flows from investing activities ......................................... (248,331) (559,469)
CASH FLOWS FROM FINANCING ACTIVITIES:
Non-interest bearing advances from affiliates .................................... 465,217 (125,426)
Net proceeds from issuance of 10 3/8% Seven Year Notes ........................... 989,375 --
Repayments of mortgage indebtedness and notes payable ............................ (9,219) (7,364)
Other ............................................................................ (2,614) --
----------- -----------
Net cash flows from financing activities ......................................... 1,442,759 (132,790)
----------- -----------
Net increase (decrease) in cash and cash equivalents ............................. 937,827 (243,627)
Cash and cash equivalents, beginning of period ................................... 159,761 657,592
----------- -----------
Cash and cash equivalents, end of period ......................................... $ 1,097,588 $ 413,965
=========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Forfeitures of deferred non-cash, stock-based compensation .................... $ 8,072 $ 3,471
</Table>
See accompanying Notes to Condensed Consolidated Financial Statements.
3
ECHOSTAR BROADBAND CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. ORGANIZATION AND BUSINESS ACTIVITIES
Principal Business
EchoStar Broadband Corporation ("EBC") is a wholly-owned subsidiary of
EchoStar Communications Corporation ("ECC" and together with its subsidiaries
"EchoStar"), a publicly traded company on the Nasdaq National Market. Unless
otherwise stated herein, or the context otherwise requires, references herein to
EchoStar shall include ECC, EBC and all direct and indirect wholly-owned
subsidiaries thereof. EBC's management refers readers of this Quarterly Report
on Form 10-Q to EchoStar's Quarterly Report on Form 10-Q for the nine months
ended September 30, 2001. Substantially all of EchoStar's operations are
conducted by subsidiaries of EBC. The operations of EchoStar include two
interrelated business units (Note 7):
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
Effective September 27, 2001, ECC 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, ECC's equity interest would
increase to approximately 60%.
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.
4
ECHOSTAR BROADBAND CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)
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.
Comprehensive Income (Loss)
The components of comprehensive loss, net of tax, are as follows (in
thousands):
<Table>
<Caption>
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------
2000 2001
--------- ---------
(Unaudited)
Net loss ..................................................................... $(458,066) $ (34,004)
Unrealized holding (losses) gains on available-for-sale securities arising
during period ............................................................. (28) 2,968
--------- ---------
Comprehensive loss ........................................................... $(458,094) $ (31,036)
========= =========
</Table>
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.
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. 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 stockholder's deficit,
5
ECHOSTAR BROADBAND CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)
net of related deferred income taxes, if applicable. The specific identification
method is used to determine cost in computing realized gains and losses.
Unrealized gains as of September 30, 2001 totaled approximately $2 million.
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.
4. INVENTORIES
Inventories consist of the following (in thousands):
<Table>
<Caption>
DECEMBER 31, SEPTEMBER 30,
2000 2001
------------ -------------
Finished goods - DBS ........................ $ 94,997 $ 123,886
Raw materials ............................... 40,069 53,396
Finished goods - reconditioned and other .... 23,101 22,323
Work-in-process ............................. 8,879 8,986
Consignment ................................. 2,461 2,260
Reserve for excess and obsolete inventory ... (9,842) (5,385)
--------- ---------
$ 159,665 $ 205,466
========= =========
</Table>
5. 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
6
ECHOSTAR BROADBAND CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)
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.
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
7
ECHOSTAR BROADBAND CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)
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 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 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.
6. COMMITMENTS AND CONTINGENCIES
DirecTV
During 2000, EchoStar filed suit against DirecTV, Thomson Consumer
Electronics/RCA and others in the Federal District Court of Colorado alleging
violations of antitrust and other laws. The DirecTV defendants filed
counterclaims against EchoStar. During November 2001 the parties mutually
dismissed the litigation with prejudice. DirecTV also released EchoStar's Kelly
Broadcasting Systems, Inc. subsidiary from any obligations in connection with a
recent $7 million arbitration award.
Fee Dispute
EchoStar had a contingent fee arrangement with 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 EchoStar in the News Corporation litigation. The attorneys
asserted that they might be entitled to receive payments totaling hundreds of
millions of dollars under this fee arrangement. EchoStar consistently
maintained that the demand significantly overstated the amount to which the
attorneys might reasonably be entitled.
During mid-1999, EchoStar initiated litigation against the attorneys
in the Arapahoe County, Colorado, District Court arguing that the fee
arrangement was void and unenforceable. In December 1999, the attorneys
initiated an arbitration proceeding before the American Arbitration Association.
The litigation was stayed while the arbitration proceeded. The arbitration
hearing commenced in April 2001. Closing arguments were presented to the
arbitration panel on October 11, 2001. During the four week arbitration hearing,
the attorneys presented a damage model for $56 million. EchoStar asserted even
that amount significantly overstated the amount to which the attorneys might
reasonably be entitled. During closing arguments, the attorneys presented a
separate damage calculation for $111 million to the arbitration panel.
On November 7, 2001, the arbitration panel awarded the attorneys
approximately $40 million for its contingency fee under the fee agreement. In
the award, the arbitration panel also dismissed EchoStar's claims against the
attorneys that EchoStar had initiated in the Arapahoe County, Colorado, District
Court. Pursuant to the award, approximately $8 million is to be paid within 30
days of the award with the balance to be paid in equal quarterly principal
installments over four years, commencing February 1, 2002. Interest is to be
paid at the rate of prime (calculated as the average amount over each relevant
year as published daily in the Wall Street Journal), compounded annually.
EchoStar believes that even this reduced award includes calculation errors and
intends to file a motion asking that the award be modified and/or corrected.
EchoStar is also studying other grounds for vacating the award in part or in
whole. There can be no assurance that the arbitration panel will modify or
correct the award or that EchoStar will succeed in any effort to vacate, in
whole or in part, the arbitration award.
8
ECHOSTAR BROADBAND CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)
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.
9
ECHOSTAR BROADBAND CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)
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 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
10
ECHOSTAR BROADBAND CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)
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 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's order indicated that the matter was to be
remanded to the District Court for an evidentiary hearing. On October 9, 2001,
EchoStar filed with the Eleventh Circuit its Petition for Rehearing and Petition
for Rehearing En Banc on the Eleventh Circuit's denial of EchoStar's First
Amendment challenge to the SHVA. This Petition remains pending before the
Eleventh Circuit. As a result of the filing of the Petition, the Eleventh
Circuit has not issued a mandate remanding the case to the District Court.
EchoStar can not predict when the Eleventh Circuit will rule upon the pending
Petition. Consequently, EchoStar can not predict when a mandate will issue
remanding the case to the District Court or when the evidentiary hearing will be
set.
If the Eleventh Circuit denies EchoStar's Petition for Rehearing on
its First Amendment challenge to the SHVA, EchoStar will likely appeal the First
Amendment issue to the United States Supreme Court. There is no guarantee,
however, that the United States Supreme Court will accept certorari on any
petition filed or that if the United State Supreme Court accepts certorari that
EchoStar's appeal will be heard before the evidentiary hearing in the District
Court.
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.
11
ECHOSTAR BROADBAND CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)
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 in December 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 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 ruling was recently issued by the Court and in response to
that ruling the defendants are filing motions for summary judgement of
non-infringement for each of the asserted patents. 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. One patent was subsequently dropped by plaintiffs. The remaining
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. 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 have completed briefing of post-trial motions and expect to
complete oral arguments
12
ECHOSTAR BROADBAND CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)
for those motions on November 14, 2001. EchoStar intends to appeal any adverse
decision and plaintiffs have indicated they may 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
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.
13
ECHOSTAR BROADBAND CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)
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.
7. 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. 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.
<Table>
<Caption>
ECHOSTAR ECHOSTAR OTHER
DISH TECHNOLOGIES ALL ELIMINATIONS CONSOLIDATED ECHOSTAR EBC AND
NETWORK CORPORATION OTHER AND OTHER TOTAL ACTIVITY SUBSIDIARIES
----------- ------------ ----------- ------------ ------------ ----------- ------------
THREE MONTHS ENDED
SEPTEMBER 30, 2000
Revenue ............... $ 641,381 $ 40,889 $ 16,309 $ (607) $ 697,972 $ (3,745) $ 694,227
Net income (loss) ..... (134,930) (2,580) (4,450) (89) (142,049) 13,097 (128,952)
THREE MONTHS ENDED
SEPTEMBER 30, 2001
Revenue ............... $ 944,274 $ 52,526 $ 27,066 $ (1,360) $ 1,022,506 $ (3,171) $ 1,019,335
Net income (loss) ..... 58,351 1,149 (11,075) (45,330) 3,095 15,994 19,089
NINE MONTHS ENDED
SEPTEMBER 30, 2000
Revenue ............... $ 1,714,596 $ 141,403 $ 55,906 $ (2,083) $ 1,909,822 $ (5,338) $ 1,904,484
Net income (loss) ..... (455,580) (2,935) (7,427) (200) (466,142) 8,076 (458,066)
NINE MONTHS ENDED
SEPTEMBER 30, 2001
Revenue ............... $ 2,668,855 $ 97,014 $ 87,908 $ (3,069) $ 2,850,708 $ (10,467) $ 2,840,241
Net income (loss) ..... (174,801) (14,108) (27,000) 43,282 (172,627) 138,623 (34,004)
</Table>
14
ECHOSTAR BROADBAND CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)
8. SUBSEQUENT EVENTS
On October 28, 2001, EchoStar announced the signing of definitive
agreements with General Motors Corporation and its subsidiary Hughes Electronics
Corporation, providing for the spin-off of Hughes from GM and the merger of
Hughes with EchoStar. In connection with the merger, at least $5.525 billion of
total financing is expected to be required, which EchoStar intends to fund in
the capital markets on or prior to closing through equity offerings, debt
offerings, bank debt or a combination thereof and possibly through privately
negotiated transactions. A portion of this financing may be raised by EBC.
EchoStar has obtained $2.7625 billion bridge commitments from each of Deutsche
Bank and Credit Suisse First Boston which in certain circumstances may be drawn
down in the event EchoStar is unable to raise the full $5.525 billion in the
capital markets. As compensation for extension of the bridge commitments,
EchoStar has paid a total of approximately $55 million to Deutsche Bank and
Credit Suisse First Boston.
15
ITEM 2. MANAGEMENT'S NARATIVE ANALYSIS OF 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 $1.019 billion, an increase of $325 million compared to total revenue for
the three months ended September 30, 2000 of $694 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 $920
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 a 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.
16
ITEM 2. MANAGEMENT'S NARRATIVE ANALYSIS OF 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 $72 million, an increase of $17 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.
17
ITEM 2. MANAGEMENT'S NARRATIVE ANALYSIS OF RESULTS OF OPERATIONS - CONTINUED
In combination, these terminations would result in a small reduction in average
monthly revenue per subscriber and could increase subscriber churn.
DISH Network Operating Expenses. DISH Network operating expenses
totaled $449 million during the three months ended September 30, 2001, an
increase of $124 million or 38% 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 $366 million during the three
months ended September 30, 2001, an increase of $111 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 40% 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 increase 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 $8 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 68% and 74% of DTH
equipment revenue, during the three months ended September 30, 2001 and 2000,
respectively.
18
ITEM 2. MANAGEMENT'S NARRATIVE ANALYSIS OF 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 $271 million during the three
months ended September 30, 2001 compared to $290 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.
19
ITEM 2. MANAGEMENT'S NARRATIVE ANALYSIS OF 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 $82 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:
<Table>
<Caption>
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
============== ==============
</Table>
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 42% during the three months ended September 30, 2001
compared to 38% 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 $154 million during the three
months ended September 30, 2001, compared to negative $28 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.
20
ITEM 2. MANAGEMENT'S NARRATIVE ANALYSIS OF 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 $70 million during the three months ended September 30, 2001, a $27
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 $58 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. 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 $2.840 billion, an increase of $936 million compared to total revenue for
the nine months ended September 30, 2000 of $1.904 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 $2.595
billion for the nine months ended September 30, 2001, an increase of $949
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 $158 million, a decrease of $17 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 $1.282 billion during the nine months ended September 30, 2001, an
increase of $371 million or 41% 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 $1.047 billion during the nine
months ended September 30, 2001, an increase of $354 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.
21
ITEM 2. MANAGEMENT'S NARRATIVE ANALYSIS OF RESULTS OF OPERATIONS - CONTINUED
Satellite and transmission expenses totaled $28 million during the
nine months ended September 30, 2001, a $5 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 $26 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 69% and 77% of DTH equipment revenue, during the nine months ended
September 30, 2001 and 2000, respectively.
Marketing Expenses. Marketing expenses totaled $826 million during the
nine months ended September 30, 2001, a decrease of $2 million compared to the
same period in 2000. Advertising and other expenses totaled $98 million and $89
million during the nine months ended September 30, 2001 and 2000, respectively.
General and Administrative Expenses. General and administrative
expenses totaled $236 million during the nine months ended September 30, 2001,
an increase of $71 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 nine months ended September 30, 2001 and 2000,
respectively.
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:
<Table>
<Caption>
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
============= =============
</Table>
Pre-Marketing Cash Flow. Pre-marketing cash flow is comprised of
EBITDA plus total marketing expenses. Pre-marketing cash flow was $1.165 billion
during the nine months ended September 30, 2001, an increase of 73% 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.
22
ITEM 2. MANAGEMENT'S NARRATIVE ANALYSIS OF 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 $338 million during the nine
months ended September 30, 2001, compared to negative $156 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 $185 million during the nine months ended September 30, 2001, a $62
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 $166 million
during the nine months ended September 30, 2001, an increase of $26 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. This increase in interest expense was partially offset
by an increase in interest income.
23
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 $811 million which 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 $811 million with an average annual interest rate of approximately
4%. A hypothetical 10% decrease in interest rates would result in a decrease of
approximately $3 million in annual interest income.
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. We have recorded unrealized gains totaling
approximately $2 million as of September 30, 2001.
As of September 30, 2001, we estimated the fair value of our
fixed-rate debt and mortgages and other notes payable to be approximately $3.0
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 $144 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 $29 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.
24
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
DirecTV
During 2000, EchoStar filed suit against DirecTV, Thomson Consumer
Electronics/RCA and others in the Federal District Court of Colorado alleging
violations of antitrust and other laws. The DirecTV defendants filed
counterclaims against EchoStar. During November 2001 the parties mutually
dismissed the litigation with prejudice. DirecTV also released EchoStar's Kelly
Broadcasting Systems, Inc. subsidiary from any obligations in connection with a
recent $7 million arbitration award.
Fee Dispute
EchoStar had a contingent fee arrangement with 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 EchoStar in the News Corporation litigation. The attorneys
asserted that they might be entitled to receive payments totaling hundreds of
millions of dollars under this fee arrangement. EchoStar consistently
maintained that the demand significantly overstated the amount to which the
attorneys might reasonably be entitled.
During mid-1999, EchoStar initiated litigation against the attorneys
in the Arapahoe County, Colorado, District Court arguing that the fee
arrangement was void and unenforceable. In December 1999, the attorneys
initiated an arbitration proceeding before the American Arbitration Association.
The litigation was stayed while the arbitration proceeded. The arbitration
hearing commenced in April 2001. Closing arguments were presented to the
arbitration panel on October 11, 2001. During the four week arbitration hearing,
the attorneys presented a damage model for $56 million. EchoStar asserted even
that amount significantly overstated the amount to which the attorneys might
reasonably be entitled. During closing arguments, the attorneys presented a
separate damage calculation for $111 million to the arbitration panel.
On November 7, 2001, the arbitration panel awarded the attorneys
approximately $40 million for its contingency fee under the fee agreement. In
the award, the arbitration panel also dismissed EchoStar's claims against the
attorneys that EchoStar had initiated in the Arapahoe County, Colorado, District
Court. Pursuant to the award, approximately $8 million is to be paid within 30
days of the award with the balance to be paid in equal quarterly principal
installments over four years, commencing February 1, 2002. Interest is to be
paid at the rate of prime (calculated as the average amount over each relevant
year as published daily in the Wall Street Journal), compounded annually.
EchoStar believes that even this reduced award includes calculation errors and
intends to file a motion asking that the award be modified and/or corrected.
EchoStar is also studying other grounds for vacating the award in part or in
whole. There can be no assurance that the arbitration panel will modify or
correct the award or that EchoStar will succeed in any effort to vacate, in
whole or in part, the arbitration award.
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
25
PART II - OTHER INFORMATION
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 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.
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PART II - OTHER INFORMATION
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 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's order indicated that the matter was to be
remanded to the District Court for an evidentiary hearing. On October 9, 2001,
EchoStar filed with the Eleventh Circuit its Petition for Rehearing and Petition
for Rehearing En Banc on the Eleventh Circuit's denial of EchoStar's First
Amendment challenge to the SHVA. This Petition remains pending before the
Eleventh Circuit. As a result of the filing of the Petition, the Eleventh
Circuit has not issued a mandate remanding the case to the District Court.
EchoStar can not predict when
27
PART II - OTHER INFORMATION
the Eleventh Circuit will rule upon the pending Petition. Consequently, EchoStar
can not predict when a mandate will issue remanding the case to the District
Court or when the evidentiary hearing will be set.
If the Eleventh Circuit denies EchoStar's Petition for Rehearing on
its First Amendment challenge to the SHVA, EchoStar will likely appeal the First
Amendment issue to the United States Supreme Court. There is no guarantee,
however, that the United States Supreme Court will accept certorari on any
petition filed or that if the United State Supreme Court accepts certorari that
EchoStar's appeal will be heard before the evidentiary hearing in the District
Court.
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 in December 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 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.
28
PART II - OTHER INFORMATION
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 ruling was recently issued by the Court and in response to
that ruling the defendants are filing motions for summary judgement of
non-infringement for each of the asserted patents. 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. One patent was subsequently dropped by plaintiffs. The remaining
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. 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 have completed briefing of post-trial motions and expect to
complete oral arguments for those motions on November 14, 2001. EchoStar intends
to appeal any adverse decision and plaintiffs have indicated they may 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
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.
29
PART II - OTHER INFORMATION
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.
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.
30
PART II - OTHER INFORMATION
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.
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.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
None.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the third quarter of 2001.
31
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 BROADBAND 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: November 13, 2001
32