Item 1.
Business
THE COMPANY
Overview
Loral Space & Communications Ltd., together with our subsidiaries (“Loral”, the “Company”, “we”, “our” and “us”), is a leading satellite communications company. We own and operate a fleet of telecommunications satellites, manage a global network that integrates our satellites with terrestrial facilities and have the rights to numerous well-positioned orbital slots. Managed by our Loral Skynet division, the fleet provides satellite capacity and platforms for use by television and cable networks to broadcast video programming, and by communication service providers, resellers, corporate and government customers for broadband data transmission, Internet services and other value-added communications services. Our subsidiary, Space Systems/ Loral, Inc. (“SS/ L”), is one of the world’s largest designers and manufacturers of satellites and satellite systems for commercial and government applications including satellite services, television broadcasting, direct-to-home (DTH) television services, broadband communications, military communications, wireless telephony, digital satellite radio, weather monitoring and air traffic management. (See “Segment Overview” below for further details on each of our businesses.)
On July 15, 2003, Loral and certain of our subsidiaries (the “Debtor Subsidiaries”, and collectively with Loral, the “Debtors”) filed voluntary petitions for reorganization under chapter 11 of title 11 (“Chapter 11”) of the United States Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”) (Lead Case No. 03-41710 (RDD), Case Nos. 03-41709 (RDD) through 03-41728 (RDD), collectively, the “Chapter 11 Cases”). The Debtors include, among others, Loral Space & Communications Corporation, Loral SpaceCom Corporation (“Loral SpaceCom”), Loral Satellite, Inc. (“Loral Satellite”), SS/ L and Loral Orion, Inc. (“Loral Orion”). We continue to manage our properties and operate our businesses as “debtors in possession” under the jurisdiction of the Bankruptcy Court and in accordance with the provisions of the Bankruptcy Code. (See “Bankruptcy Filings” below for further details.)
Also on July 15, 2003, Loral Space & Communications Corporation, Loral SpaceCom and Loral Satellite (collectively, the “Sellers”) entered into a definitive agreement, as amended, (the “Asset Purchase Agreement”) to sell to Intelsat, Ltd. and certain of its affiliated companies (“Intelsat”), satellites serving the North American market. The transaction is expected to conclude by early April 2004. Loral expects to use the proceeds from the sale of the assets to repay its outstanding secured bank debt. On March 5, 2004, we and Intelsat entered into an amendment to the Asset Purchase Agreement, the effectiveness of which is subject to approval by the Bankruptcy Court and Intelsat’s bank lenders (See “Sale of Assets” below for further details).
We plan to reorganize Loral around our remaining fleet of international satellites and our satellite manufacturing business.
Loral was incorporated on January 12, 1996, as a Bermuda exempt company and has its registered and principal executive offices at Canon’s Court, 22 Victoria Street, Hamilton HM 12, Bermuda.
Bankruptcy Filings
As previously stated, we filed for reorganization under Chapter 11 on July 15, 2003 and continue to operate as debtors in possession.
Also on July 15, 2003, Loral and one of our Bermuda subsidiaries (the “Bermuda Group”) filed parallel insolvency proceedings in the Supreme Court of Bermuda (the “Bermuda Court”). On that date, the Bermuda Court entered an order appointing Philip Wallace, Chris Laverty and Michael Morrison, partners of KPMG, as Joint Provisional Liquidators (“JPLs”) in respect of the Bermuda Group. The Bermuda Court granted the JPLs the power to oversee the continuation and reorganization of these businesses under the control of their boards of directors and under the supervision of the U.S. Bankruptcy Court and the Bermuda Court. The JPLs have not audited the contents of this report.
A creditors’ committee has been appointed in the Chapter 11 Cases to represent all unsecured creditors, including all holders of Loral’s and Loral Orion’s senior unsecured notes, and, in accordance with the provisions of the Bankruptcy Code, has the right to be heard on all matters that come before the Bankruptcy Court.
As provided by the Bankruptcy Code, we had the exclusive right to submit our plan (or plans) of reorganization for 120 days from the date of the Chapter 11 filing. On November 12, 2003, the Bankruptcy Court extended this exclusive period for another 120 days. On March 16, 2004, a hearing will be held to consider a further extension of the exclusivity period. We have no assurance that this extension request will be granted. If we fail to file our plan of reorganization during the exclusive period, or if we file a plan of reorganization and the required number of creditors and equity holders do not approve our plan of reorganization within the required period, any party in interest may subsequently file its own plan of reorganization for Loral and its Debtor Subsidiaries.
As a result of the commencement of the Chapter 11 Cases, the pursuit of all pending claims and litigation against the Debtors, arising prior to or relating to events which occurred prior to the Chapter 11 filing, is generally subject to an automatic stay under Section 362 of the Bankruptcy Code. Absent further order of the Bankruptcy Court, a party is generally prohibited from taking any action to recover any pre-petition claims, enforce any lien against or obtain possession of any property from the Debtors. In addition, pursuant to Section 365 of the Bankruptcy Code, the Debtors may reject or assume pre-petition executory contracts and unexpired leases. Parties whose contracts or leases are rejected may file claims with the Bankruptcy Court.
As a result of our Chapter 11 filing, on July 15, 2003, the New York Stock Exchange (“NYSE”) suspended trading of Loral’s common stock and on September 2, 2003 removed our securities from listing and registration. Our common stock is being quoted under the ticker symbol LRLSQ on the Pink Sheets and on the Over-The-Counter Bulletin Board Service.
Sale of Assets
As stated above, the Sellers agreed on July 15, 2003, to sell certain assets to Intelsat for $1 billion, subject to certain purchase price adjustments. These assets consisted of four satellites then in-orbit: Telstar 5, Telstar 6, Telstar 7 and Telstar 4 (which failed in September 2003); two satellites then under construction: Telstar 13 (which was successfully launched and placed into service on September 12, 2003) and Telstar 8, scheduled for launch in 2004; and certain related assets and liabilities. At the same time, Intelsat agreed to order a new satellite from SS/ L when the sale closes and, subject to obtaining a security interest in certain of our assets, agreed to make a $100 million down payment on that order. Proceeds of the sale will be used to pay off our secured bank debt.
On March 5, 2004, as part of an arrangement to reach agreement with Intelsat on the satisfaction of certain closing conditions, we entered into an amendment to the Asset Purchase Agreement. Among other things, the amendment reduces the purchase price by $20 million (subject to further adjustment based on future events) to cover certain contingent liabilities relating to the transferred assets, reduces from $100 million to $50 million the deposit Intelsat is to make for its new satellite construction contract with SS/L, and provides for a dollar-for-dollar reduction in the price of this satellite if and to the extent the Telstar 4 insurance proceeds are less than $141 million. As part of this amendment, Intelsat agreed to pay SS/L $12.5 million in full settlement and satisfaction of all remaining obligations to make certain orbital payments to SS/ L under the construction contracts relating to the purchased satellites. The effectiveness of this amendment is subject to approval by the Bankruptcy Court and Intelsat’s bank lenders.
Segment Overview: Satellite Services
We formed our satellite services business by acquiring assets from AT&T in March 1997 and Orion Network Services in 1998, and rapidly established Loral Skynet, which manages and operates our Satellite Services business, as one of the world’s leading satellite operators. We further grew our business through placing additional satellites in service and expanding our product offerings. Our satellites operate in geosynchronous earth orbit approximately 23,000 miles above the equator. In this orbit, satellites remain in a
fixed position relative to points on the earth’s surface. They provide reliable, high-bandwidth services anywhere in their coverage areas and serve as the backbone for many forms of telecommunications.
Customers lease transponder capacity for distribution of network and cable television programming, for direct-to-home (“DTH”) video transmission and for live video feeds from breaking news and sporting events and broadband data distribution. Increasingly, satellites are being used for international communications using Internet Protocol (IP)-based technologies, for high-speed data services for businesses through very small aperture terminal (VSAT) networks, and for distance learning and educational television. Skynet operates in a highly competitive market with other well-established satellite operators including PanAmSat, Intelsat, SES Global, Eutelsat and New Skies. While we also compete with fiber optic cable and other terrestrial delivery systems, satellites are considerably more efficient for certain applications, such as broadcast or point-to-multipoint transmission of video and data. For point-to-point applications, however, fiber may cost less, so satellites compete on the basis of superior reliability, or serve as a back-up service. Satellites also better serve areas with inadequate terrestrial infrastructures, low-density populations or difficult geographic terrain.
The satellite services market has been characterized in recent years by over-capacity, pricing pressure and increased competition from fiber. The downturn in the telecommunications sector led many existing Skynet customers, hampered by a slow-down in demand and lack of access to the capital markets, to postpone expansion plans. Similarly, several start-up companies that leased Skynet’s satellite capacity for the delivery of new applications failed to meet their business objectives. Following the closing of the Intelsat transaction, Skynet’s growth will rely on its ability to differentiate itself from the competition through its customized product offerings, its superior customer service and its successful marketing of available capacity on its international fleet, which is well positioned to serve regions of the world where demand is growing.
When we use the term “Loral Skynet” and “Skynet” in this report, we are, unless the context provides otherwise, referring to our Satellite Services business, the assets (including satellites) of which are held in various companies including Loral SpaceCom, Loral Orion, Loral Satellite, Loral Skynet do Brasil, Ltda. (“Skynet do Brasil”), Loral Skynet Network Services, Inc. (formerly known as Loral Cyberstar, Inc., “Skynet Network Services”) and Cyberstar, LP (“Cyberstar”).
Transponder Leasing
Loral Skynet’s heritage transponder leasing business provides a platform for the global distribution of television programming, video applications and data for large programmers and data service providers, including HBO, AT&T, Cable & Wireless, Singapore Telecom (SingTel), Univision, Telecom Italia, Connexion by BoeingSM and China Central TV.
The following chart provides details on the satellites that will comprise Loral’s fleet after the sale to Intelsat.
The following chart provides details on the satellites to be sold to Intelsat.
(1)
During the fourth quarter of 2003, we determined that Telstar 11 would go out of service in June 2004 which is earlier than its previously expected end of life of March 2005.
(2)
Brazil 1T is operating in inclined orbit and is not currently generating revenues. Its replacement, Estrela do Sul-1, was launched in January 2004, but failed to deploy its North solar array. The satellite is currently operating between 10 and 14 of its 41 transponders and has a life expectancy of three to six years. See Management’s Discussion and Analysis of Results of Operations and Financial Condition, Results by Operating Segment - Satellite Services.
(3)
Loral owns the Telstar 18/ Apstar V satellite and will initially lease 37 transponders on the satellite to an Asian satellite services company, in return for its funding a substantial portion of the project cost for Telstar 18.
(4)
In September 2003, Telstar 4 experienced a short-circuit of its primary power bus and ceased operations.
(5)
Our cash collateral order with our secured lenders imposes restrictions on our ability to incur capital expenditures.
(6)
Telstar 13, which is to be sold to Intelsat, is subject to a condosat arrangement: Loral owns the C-band payload on the satellite, consisting of 24 transponders, while EchoStar Communications Corporation owns the Ku- and Ka-band payload.
(7)
To be determined after launch and in-orbit testing.
Network Services
We offer customers access services and transmission platforms that enable the rapid and reliable transport of content. Our hybrid satellite and ground-based network services solutions allow them to enter the market quickly and easily through a combination of applications that include broadband transport, bandwidth-on-demand, broadcast MCPC (multiple-carriers per channel) platforms, and teleport services. Skynet Network Services’ newest offering is SkyReachSM, a group of IP-based services that provides customers with secure private networks and high-speed Internet access using Skynet’s established satellite/fiber infrastructure. SkyReach can deliver a wide range of one-way and two-way IP services around the world.
These services are currently provided through an integrated satellite and fiber network that interconnects with customer networks through points of presence in San Jose, California; Ashburn, Virginia; New York, New York and London, England and interconnects with satellite and VSAT services via teleports in Mount Jackson, Virginia, Hawaii and London.
Professional Services
Our team of world-class network architects, engineers, program managers and satellite operations professionals, provides customized services tailored to unique customer requirements for deploying satellites and network services, including satellite operational services (TT&C), satellite construction oversight services, network architecture design, regulatory issue management and customized distribution solutions.
Satellite Services Performance
The following information for Satellite Services includes amounts related to the satellites serving the North American market which we have agreed to sell to Intelsat. See Management’s Discussion and Analysis of Results of Operations and Financial Condition.
(1)
See Consolidated Operating Results in Management’s Discussion and Analysis of Results of Operations and Financial Condition for the definition of Adjusted EBITDA.
Total Satellite Services assets were $2.0 billion, $1.9 billion and $2.8 billion as of December 31, 2003, 2002 and 2001, respectively. As of December 31, 2003 and 2002, backlog was $1.3 billion and $1.4 billion, respectively, including intercompany backlog of $37 million in 2003 and $41 million in 2002.
Segment Overview: Satellite Manufacturing
Space Systems/ Loral designs, manufactures and integrates satellites and space systems. SS/ L-built satellites have achieved over 1000 years of cumulative on-orbit experience over its 40-year history. SS/ L is a leading supplier of commercial telecommunications satellites, high-powered direct-to-home broadcast satellites, commercial weather satellites, digital audio radio satellites and innovative spot-beam satellites for data networking applications. SS/ L customers include some of the largest satellite service providers, such as Intelsat, DirecTV, EchoStar, Loral Skynet, PanAmSat, Optus, APT Satellite, SingTel, Shin Satellite and Japan’s Ministry of Transport and Civil Aviation Bureau.
SS/ L has a history of technical innovation that includes the first three-axis spin stabilized satellites; bipropellant propulsion systems for commercial satellites that permit significant increases in the satellites’ payload and extend the satellites’ on-orbit lifetime; rechargeable nickel-hydrogen batteries; the use of advanced composites to significantly enhance satellite performance at lighter weights; and, as a result of these innovations, the first communications satellite with more than ten kilowatts of power. SS/ L was also the first satellite manufacturer to employ heat pipes to control heat transfer in commercial satellites, thereby providing a more benign temperature environment, increased reliability and high power. SS/ L also created the first multi-mission geostationary satellite and was one of the first U.S. companies to acquire space technology from Russia’s space industry, obtaining exclusive rights outside the former Eastern bloc to an electric propulsion subsystem that is five times more efficient than bipropellant propulsion systems.
SS/ L offers a broad product line covering the vast majority of customer requirements for satellites with six to 20 kilowatts of power. The capacity offered on these satellites ranges from one to as many as 150 transponders.
SS/ L competes principally on the basis of technical excellence, reliability and pricing with Boeing, Lockheed Martin, Alcatel Space, Astrium and Orbital Sciences. Historically, SS/ L has provided customers with satellites that significantly exceed their designed life expectancies. SS/ L’s continued success depends on its ability to perform on a cost-effective and timely basis. The commercial satellite industry is highly competitive. In recent years, a combination of on-orbit over-capacity and economic pressures profoundly diminished demand for satellites. After a period of nearly two years without being awarded a satellite contract, SS/ L received orders or authorizations to proceed on the construction of four satellites (including the expected Intelsat order) in late 2003. Total SS/ L assets were $362 million, $690 million and $1.2 billion as of December 31, 2003, 2002 and 2001, respectively. Backlog at December 31, 2003 and 2002 was $536 million (excluding approximately $240 million associated with the fourth quarter awards and authorizations to proceed, see Management’s Discussion and Analysis of Results of Operations and Financial Condition) and $763 million, respectively, including intercompany backlog of $145 million and $275 million, respectively.
Satellite Manufacturing Performance
(1)
See Consolidated Operating Results in Management’s Discussion and Analysis of Results of Operations and Financial Condition for the definition of Adjusted EBITDA and for significant items that affect comparability between the periods presented.
Investment in Affiliates and Globalstar Joint Ventures
XTAR
We own 56 percent of XTAR, L.L.C. (“XTAR”), a joint venture between Loral and Hisdesat Servicios Estrategicos, S.A. (“Hisdesat”). XTAR is accounted for under the equity method since we do not control certain significant operating decisions. XTAR is constructing and plans to launch an X-band satellite in 2004, to provide X-band services to government users in the United States and Spain, and to other friendly and allied nations. For more information on XTAR, see Management’s Discussion and Analysis of Results of Operations and Financial Condition and Note 7 to the consolidated financial statements.
Satmex
We own 49 percent of Satelites Mexicanos, S.A. de C.V. (“Satmex”), a satellite communications company providing satellite services in Mexico and Latin America. Satmex has two satellites in operation and a third satellite, Satmex 6, scheduled for launch this year. Satmex is in default on its existing financing and has ceased paying interest on its unsecured debt. It will require additional liquidity to complete its business plan. During 2003, Loral wrote-off its remaining investment in Satmex. For more information on Satmex, see Note 7 to the consolidated financial statements.
Globalstar
Globalstar, L.P. (“Globalstar”) owns and operates a satellite constellation that forms the backbone of a global telecommunications system (the “Globalstar System”). On February 15, 2002, Globalstar and certain of its direct subsidiaries filed voluntary bankruptcy petitions under Chapter 11. For further details, see Note 7 to the consolidated financial statements.
On December 8, 2003, the bankruptcy court approved Globalstar’s plan which includes an investment of $43 million by Thermo Capital Partners, LLC (“Thermo”) and the creation of a new Globalstar company (“New Globalstar”). The effectiveness of Globalstar’s plan is subject to a number of material conditions. If Globalstar’s plan is effected, Loral’s ownership in New Globalstar is expected to be approximately 2.5 percent, which based on the Thermo transaction, is expected to have minimal value.
Loral holds various indirect ownership interests in three foreign companies that currently serve as exclusive service providers for Globalstar service in Brazil, Mexico and Russia and an indirect ownership interest in a U.S.-based distributor that has the exclusive right to sell Globalstar services to certain agencies within the U.S. Government. Globalstar is currently renegotiating its service provider agreements with the various Globalstar service providers, and there can be no assurance that such agreements will be successfully negotiated.
In 2000, we wrote-off $1.7 billion of investments in Globalstar leaving us with an investment balance of $3 million as of December 31, 2003. We do not currently intend to invest further in Globalstar or the service providers in which we continue to have an equity interest.
REGULATION
Telecommunications Regulation
As an operator of a privately owned global satellite system, we are subject to: the regulatory authority of the U.S. government; the regulatory authority of other countries in which we operate; and the frequency coordination process of the International Telecommunications Union (“ITU”). Our ability to provide satellite services in a particular country or region is subject also to the technical constraints of our satellites, international coordination, local regulatory approval and any limitation to those approvals.
U.S. Regulation
The Federal Communications Commission (FCC) regulates our U.S.-licensed satellites as well as our non-U.S. licensed satellites authorized to operate in the U.S. We are subject to the FCC’s jurisdiction primarily for the licensing of satellites and earth stations, avoidance of interference with other radio stations and compliance with FCC rules. Violations of the FCC’s rules can result in various sanctions including fines, loss of authorizations, forfeiture of bonds, or the denial of new or renewal authorizations. We are not regulated as a common carrier and, therefore, are not subject to rate regulation or the obligation not to discriminate among customers. We must pay FCC filing fees in connection with our space station and earth station applications and annual fees to defray the FCC’s regulatory expenses. We must file annual status reports with the FCC and, to the extent Loral is deemed to be providing interstate/international telecommunications, we must contribute funds supporting universal service. Loral has petitioned the FCC for exemptions from having to pay certain of such fees and contributions. These petitions are under review by the FCC.
Authorization to Launch and Operate Satellites
Pursuant to satellite licensing rules issued in 2003, the FCC grants satellite authorizations on a first-come, first-served basis to satellite operators that meet its legal and technical qualification requirements. The FCC often receives multiple applications to operate a satellite at a given orbital slot. There can be no assurance that our applications will be granted. Most satellite authorizations include specific construction and launch milestones; failure to meet them may result in license revocations. Under licensing rules, we must post a bond for up to $5,000,000 when we are granted a satellite authorization. The bond may be forfeited if we fail to meet any of the milestones for satellite construction, launch and commencement of operation. In accordance with the current licensing rules, the FCC will issue new satellite licenses for an initial fifteen-year term and will provide a licensee with an “expectancy” that a subsequent license will be granted for the replacement of an authorized satellite. At the end of a fifteen-year term, a satellite that has not been replaced, or that has been relocated to another orbital location following its replacement, may be allowed to continue operations for a limited period of time subject to certain restrictions.
We have final FCC authorization for the following existing or planned satellites which operate or will operate in the C-band, the Ku-band, or both bands: Telstar 9 at 69° W.L., Telstar 11 at 37.5°W.L., Telstar 12 at 15° W.L. and Orion A at 47°W.L. In addition, we have final authorization to operate at the following orbital slots: Ka-band at 15° W.L., 67° W.L., 93° W.L., 115° W.L., 139° E.L., and 126.5° E.L. Certain of our authorizations are subject to pending petitions for reconsideration or review submitted to the FCC by third parties. The final FCC authorizations for certain of the satellites that are not yet in orbit also do not cover certain design changes or milestone extension requests that are the subject of pending modification applications. There can be no assurance that such design changes or milestone extensions will be granted by the FCC. The failure to obtain a milestone extension could result in the loss of the related FCC authorization. If we are unable to obtain FCC approval to implement its requested technical modifications for any particular authorization, we will be obligated to operate the related satellite in accordance with the original authorization. We also have an application pending before the FCC at 126° E.L. for use of the Ku-band. There can be no assurance that the FCC will grant this application.
Under the FCC’s rules, an applicant may commence satellite construction prior to receiving an authorization to launch and operate, but must notify the FCC of its intention to do so. The applicant
undertakes construction at its own risk. We may begin construction, but must recognize that the FCC may not grant the application, may not assign the satellite to its proposed orbital location, or otherwise may reduce or eliminate the value of the construction begun on the satellite.
Scope of Services Authorized
In 1996, the FCC largely eliminated the regulatory distinction between U.S. domestic satellites and U.S.-licensed international satellites. As a result, each of our FCC-licensed satellites may be used, to the extent technically feasible, to provide both U.S. domestic and international services.
Coordination Requirements
The FCC requires applicants to demonstrate that their proposed satellites would be compatible with the operations of adjacent satellites. Adjacent satellite operators must coordinate with one another to minimize frequency conflicts. The FCC reserves the right to require that an FCC-licensed satellite be relocated if it deems such a change to be in the public interest.
Regulation by Non-U.S. National Telecommunications Authorities
Foreign laws and regulatory practices governing the provision of satellite services to licensed entities and directly to end-users vary substantially from country to country. Some countries may require us to confirm that we have successfully completed technical consultation with other satellite service providers before offering services on a given satellite. In addition, we may be subject to varying communications and/or broadcasting laws with respect to our provision of international satellite services.
Foreign laws and regulatory practices may be applied or changed in ways that may adversely affect our ability to operate or provide service. There are no guarantees that other countries will grant our applications to construct, launch, operate or provide service via satellites, or extend construction or launch milestones, or that we will be permitted to retain or renew our authorizations. As in the U.S., violations of other countries’ laws and rules may result in sanctions, fines, loss of authorizations or denial of applications for new or renewal authorizations. Application and other administrative fees may be required in other countries. License terms for non-U.S. authorizations held by Loral vary but generally authorize operation for at least the life of the satellite and include rights to operate a replacement satellite. Loral’s failure to operate or maintain operation of a satellite pursuant to a non-U.S. authorization may result in revocation.
Many countries have liberalized their regulations for the provision of voice, data or video services. This trend should accelerate with the commitments by many World Trade Organization (“WTO”) members, in the context of the WTO Agreement on Basic Telecommunications Services, to open their satellite markets to competition. Other countries, however, have maintained strict monopoly regimes. In such markets, the provision of service from Loral and other U.S.-licensed satellites may be more complicated.
In addition to the orbital slots licensed by the FCC, Loral has been assigned orbital slots by certain other countries. For example, we have been authorized to use numerous Ku- and Ka-band orbital slots by the Papua New Guinea government. In March 1999, the Brazilian telecommunications authority announced that Loral had won Brazil’s auction for its 63° W.L. Ku-band orbital slot. Telstar 14/ Estrela do Sul 1 is licensed by Brazil and is authorized to operate in the U.S. by the FCC. Pursuant to a lease, Loral operates all of the capacity (with the exception of one transponder) on the Telstar 10/ Apstar IIR C/ Ku-band satellite licensed by China and located at 76.5° E.L. We plan to operate the extended C- and Ku-band payload on Telstar 18/ Apstar V at 138° E.L. using licenses provided by China and Tonga, respectively.
The ITU Frequency Coordination Process
All satellite systems are subject to ITU frequency coordination requirements and must obtain appropriate authority to provide service in a given territory. The required international coordination process may limit the extent to which all or some portion of a particular authorized orbital slot may be used for commercial operations, with a corresponding impact on the useable capacity of a satellite at that location.
All of our satellite registrations are or will be subject to the ITU coordination process. There may be more than one ITU filing submitted for a particular orbital slot, or one adjacent to it, thus requiring coordination between or among the affected operators. Loral cannot guarantee successful frequency coordination for its satellites.
Additional ITU Filings
In addition to the ITU filings associated with our satellite authorizations and applications noted above, we have ITU filings at 98° E.L., 122° E.L., 130° E.L., 167.45° E.L., 175° W.L., and 115°W.L. for use of the C- and Ku-band frequencies. We also have ITU filings at 9.9° E.L., 16.1° E.L., 22.3° E.L., 115.5° E.L., 161° E.L., and 97° W.L. for the use of C-, Ku-, and Ka-band frequencies and at 37.5° W.L. for the use of C- and Ka-band frequencies. We have filings at 96.5° W.L. and 123.5° W.L. for Broadcast Satellite Service. Loral also has ITU filings at 1° E.L., 3.5° E.L., 8° E.L., 10° E.L., 11° E.L., 30° E.L., 81° E.L., 105.5° E.L., 135° E.L., 135° W.L., 115° W.L., 95° W.L., 58° W.L. for use of the V-band frequency.
Export Regulation
Commercial communication satellites and certain related items, technical data and services, are subject to United States export controls. These laws and regulations affect the export of products and services to foreign launch providers, subcontractors, insurers, customers, potential customers, and business partners, as well as to foreign Loral employees, foreign regulatory bodies, foreign national telecommunications authorities and to foreign persons generally. Commercial communications satellites and certain related items, technical data and services are on the United States Munitions List and are subject to the Arms Export Control Act and the International Traffic in Arms Regulations. Export jurisdiction over these products and services resides with the U.S. Department of State. Other Loral exports remain subject to the jurisdiction of the U.S. Department of Commerce, pursuant to the Export Administration Act and the Export Administration Regulations.
U.S. Government licenses or other approvals generally must be obtained before satellites and related items, technical data and services are exported and may be required before they are re-exported or transferred from one foreign person to another foreign person. There can be no assurance that such licenses or approvals will be granted. Also, licenses or approvals may be granted with limitations, provisos or other requirements imposed by the U.S. Government as a condition of approval, which may affect the scope of permissible activity under the license or approval.
PATENTS AND PROPRIETARY RIGHTS
SS/ L relies, in part, on patents, trade secrets and know-how to develop and maintain its competitive position. It holds 218 patents in the United States and 115 patents abroad and has applications for 40 patents pending in the United States. SS/ L patents include those relating to communications, station keeping, power control systems, antennae, filters and oscillators, phased arrays and thermal control as well as assembly and inspections technology. The SS/ L patents that are currently in force expire between 2004 and 2022.
Skynet Network Services, CyberStar and Loral SpaceCom have four, six and two patents in the United States, respectively. Loral SpaceCom holds one patent abroad. Skynet Network Services and Loral SpaceCom have three and four patents pending in the United States, respectively. In addition, Loral SpaceCom has nine patents pending abroad. The Skynet Network Services, CyberStar and Loral SpaceCom patents that are currently in force expire between 2016 and 2020.
There can be no assurance that any of our pending patent applications will be issued. Moreover, because the U.S. patent application process is confidential, there can be no assurance that third parties, including competitors, do not have patents pending that could result in issued patents which we would infringe. In such an event, we could be required to pay royalties to obtain a license, which could increase costs.
FOREIGN OPERATIONS
Sales to foreign customers, primarily in Asia, Europe and Mexico, represented 29%, 46% and 35% of our consolidated revenues for 2003, 2002 and 2001, respectively. As of December 31, 2003 and 2002, we had substantially all of our long-lived assets located in the United States with the exception of the in-orbit satellites. See Commitments and Contingencies in Management’s Discussion and Analysis of Results of Operations and Financial Condition for a discussion of the risks related to operating internationally.
EMPLOYEES
As of December 31, 2003, we had approximately 1,900 full-time employees, approximately 3% of whom are subject to collective bargaining agreements. We consider our employee relations to be good.
AVAILABLE INFORMATION
We make available free of charge through our website our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports as soon as reasonably practicable after such reports are filed electronically with the SEC. Our Internet address is www.loral.com. Loral.com is an inactive textual reference only, meaning that the information contained on the website is not part of this report and is not incorporated in this report by reference.
Item 2.
Item 2.
Properties
We lease approximately 38,000 square feet of space for our corporate offices in New York and 8,000 square feet in Washington, D.C. We also maintain office space, manufacturing facilities, and telemetry, tracking and control facilities primarily in the United States.
Satellite Services
Loral Skynet owns three telemetry, tracking and control stations covering approximately 66,000 square feet on 212 acres in Hawley, Pennsylvania and Three Peaks, California and on three leased acres in Richmond, California. It also leases two telemetry, tracking and control stations covering approximately 11,000 square feet in Rio de Janeiro, Brazil and Utive, Panama. Loral Skynet also leases approximately 65,000 square feet of office space in Bedminster, New Jersey and 8,100 square feet in various locations around the world.
Skynet Network Services owns seven acres of land including 8,000 square feet of office space in Mt. Jackson, Virginia and leases approximately 77,000 square feet of office space and three acres of land in various locations around the world.
Satellite Manufacturing
SS/ L’s research, production and testing are conducted in SS/ L-owned facilities covering approximately 563,000 square feet on 28 acres in Palo Alto, California. In addition, SS/ L leases approximately 518,000 square feet of space on 23 acres from various third parties primarily in Palo Alto, Menlo Park and Mountain View, California and Kent, Washington.
Management believes that the facilities are sufficient for its current operations.
Item 3.
Item 3.
Legal Proceedings
Consent Agreement. On January 9, 2002, Loral, SS/ L and the United States Department of State (“Department of State”) entered into a consent agreement (the “Consent Agreement”) settling and disposing of all civil charges, penalties and sanctions associated with alleged violations by SS/ L of the Arms Export Control Act and its implementing regulations. Under the Consent Agreement, SS/ L remains obligated
to, among other things, pay the Department of State $10 million over the next five years and to implement enhanced export control compliance measures.
Alcatel Settlement. SS/ L was a party to an Operational Agreement with Alcatel Space Industries, under which the parties had agreed to cooperate on certain satellite programs. It also was a party to an Alliance Agreement with Alcatel Space (together with Alcatel Space Industries, “Alcatel”), under which Alcatel had certain rights with respect to SS/ L. On June 30, 2003, Loral, SS/ L and Alcatel entered into a master agreement settling all claims among the parties, including arbitration claims brought by Alcatel against Loral alleging breaches of the Operational Agreement and Alliance Agreement. Pursuant to the master settlement agreement, Loral paid Alcatel $5 million and agreed to pay an additional $8 million within one year, resulting in a charge to operations of $13 million. In addition, Alcatel transferred to Loral its minority interest in CyberStar and Loral transferred to Alcatel its minority interests in Europe*Star Limited and SkyBridge Limited Partnership that Loral had previously written off. As a result of receiving Alcatel’s minority interest in CyberStar, Loral recognized an extraordinary gain of $14 million, which represents the extinguishment of the minority interest liability less the fair value of the acquired net assets. Under the terms of the master settlement agreement, because of the commencement of the Chapter 11 Cases, the arbitration and a related court proceeding to confirm a partial arbitration award were suspended, with termination to occur on the date of confirmation of a plan of reorganization or a liquidation, provided that if any action is commenced in the Chapter 11 Cases seeking the repayment, disgorgement or turnover of the transfers made in connection with the master settlement agreement, the arbitration and related court confirmation proceeding would not be terminated until such repayment, disgorgement or turnover action had been dismissed. The master settlement agreement also provides that Alcatel is entitled to reinstate the arbitration if it is required by judicial order to repay, disgorge or turn over the consideration paid to it under the agreement in the context of the Chapter 11 Cases.
PanAmSat Arbitration. In September 2001, the PAS 7 satellite built by SS/ L for PanAmSat experienced an electrical power failure on its solar arrays that resulted in the loss of use of certain transponders on the satellite. Also, the PAS 8 satellite has experienced minor losses of power from its solar arrays, the cause of which is unrelated to the loss of power on the PAS 7 satellite. On June 30, 2003, PanAmSat commenced an arbitration claiming that under its contract with SS/ L it is entitled to $23.7 million as a result of these losses. This arbitration is subject to the automatic stay as a result of the commencement of SS/ L’s Chapter 11 case, and further proceedings in the matter have been suspended. In March 2004, the Company reached an agreement in principle to settle this matter with PanAmSat, which is subject to documentation and Bankruptcy Court approval and has recorded a charge to operations of $8 million in the fourth quarter of 2003.
Globalstar Related Matters. On September 26, 2001, the nineteen separate purported class action lawsuits filed in the United States District Court for the Southern District of New York by various holders of securities of Globalstar Telecommunications Limited (“GTL”) and Globalstar against GTL, Loral, Bernard L. Schwartz and other defendants were consolidated into one action titled In re: Globalstar Securities Litigation. In November 2001, plaintiffs in the consolidated action filed a consolidated amended class action complaint against Globalstar, GTL, Globalstar Capital Corporation, Loral and Bernard L. Schwartz alleging (a) that all defendants (except Loral) violated Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”) and Rule 10b-5 promulgated thereunder, by making material misstatements or failing to state material facts about Globalstar’s business and prospects, (b) that defendants Loral and Mr. Schwartz are secondarily liable for these alleged misstatements and omissions under Section 20(a) of the Exchange Act as alleged “controlling persons” of Globalstar, (c) that defendants GTL and Mr. Schwartz are liable under Section 11 of the Securities Act of 1933 (the “Securities Act”) for untrue statements of material facts in or omissions of material facts from a registration statement relating to the sale of shares of GTL common stock in January 2000, (d) that defendant GTL is liable under Section 12(2)(a) of the Securities Act for untrue statements of material facts in or omissions of material facts from a prospectus and prospectus supplement relating to the sale of shares of GTL common stock in January 2000, and (e) that defendants Loral and Mr. Schwartz are secondarily liable under Section 15 of the Securities Act for GTL’s primary violations of Sections 11 and 12(2)(a) of the Securities Act as alleged “controlling persons” of GTL. The class of plaintiffs on whose behalf the lawsuit has been asserted consists of all buyers of securities of Globalstar, Globalstar
Capital and GTL during the period from December 6, 1999 through October 27, 2000, excluding the defendants and certain persons related to or affiliated with them. Loral believes that it has meritorious defenses to this class action lawsuit and intends to pursue them vigorously. As a result of the commencement of the Chapter 11 Cases, however, this lawsuit is subject to the automatic stay and further proceedings in the matter have been suspended insofar as Loral is concerned but are proceeding as to GTL and Mr. Schwartz. Loral is obligated to indemnify Mr. Schwartz for any losses or costs he may incur as a result of this lawsuit. In December 2003, a motion to dismiss the amended complaint in its entirety was denied by the court insofar as GTL and Mr. Schwartz are concerned, and discovery has commenced.
On March 2, 2002, the seven separate purported class action lawsuits filed in the United States District Court for the Southern District of New York by various holders of our common stock against Loral, Bernard L. Schwartz and Richard J. Townsend were consolidated into one action titled In re: Loral Space & Communications Ltd. Securities Litigation. On May 6, 2002, plaintiffs in the consolidated action filed a consolidated amended class action complaint alleging (a) that all defendants violated Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder, by making material misstatements or failing to state material facts about Loral’s financial condition and its investment in Globalstar and (b) that Mr. Schwartz is secondarily liable for these alleged misstatements and omissions under Section 20(a) of the Exchange Act as an alleged “controlling person” of Loral. The class of plaintiffs on whose behalf the lawsuit has been asserted consists of all buyers of Loral common stock during the period from November 4, 1999 through February 1, 2001, excluding the defendants and certain persons related to or affiliated with them. After oral argument on a motion to dismiss filed by Loral and Messrs. Schwartz and Townsend, in June 2003, the plaintiffs filed an amended complaint alleging essentially the same claims as in the original amended complaint. Loral believes that it has meritorious defenses to this class action lawsuit and intends to pursue them vigorously. As a result of the commencement of the Chapter 11 Cases, however, this lawsuit is subject to the automatic stay, and further proceedings in the matter have been suspended, insofar as Loral is concerned but are proceeding as to the other defendants. Loral is obligated to indemnify Messrs. Schwartz and Townsend for any losses or costs they may incur as a result of this lawsuit. On February 23, 2004, a motion to dismiss the amended complaint was granted by the court insofar as Messrs. Schwartz and Townsend are concerned.
The primary insurer under Loral’s directors and officers liability insurance policy has denied coverage for the case filed by Loral shareholders under the policy and, on March 24, 2003, filed a lawsuit in the Supreme Court of New York county seeking a declaratory judgment upholding their coverage position. In May 2003, Loral and the other defendants served their answer and filed counterclaims seeking a declaration that the insurer is obligated to provide coverage and damages for breach of contract and the implied covenant of good faith. In May 2003, Loral and the other defendants also filed a third party complaint against the excess insurers seeking a declaration that they are obligated to provide coverage. Loral believes that the insurers have wrongfully denied coverage and intends to defend against the denial vigorously. As a result of the commencement of the Chapter 11 Cases, however, this lawsuit is subject to the automatic stay, and further proceedings in the matter have been suspended insofar as Loral is concerned but are proceeding as to the other defendants.
Lawsuits against our Directors and Officers. In August 2003, plaintiffs Robert Beleson and Harvey Matcovsky filed a purported class action complaint against Bernard Schwartz in the United States District Court for the Southern District of New York. The complaint alleges (a) that Mr. Schwartz violated Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder, by making material misstatements or failing to state material facts about Loral’s financial condition relating to the sale of assets to Intelsat and Loral’s Chapter 11 filing and (b) that Mr. Schwartz is secondarily liable for these alleged misstatements and omissions under Section 20(a) of the Exchange Act as an alleged “controlling person” of Loral. The class of plaintiffs on whose behalf the lawsuit has been asserted consists of all buyers of Loral common stock during the period from June 30, 2003 through July 15, 2003, excluding the defendant and certain persons related to or affiliated with them. In November 2003, three other complaints against Mr. Schwartz with substantially similar allegations were consolidated into the Beleson case. In February 2004, a motion to dismiss the complaint in its entirety was denied by the court. Defendant filed an answer on March 2, 2004, and discovery has commenced.
In November 2003, plaintiffs Tony Christ, individually and as custodian for Brian and Katelyn Christ, Casey Crawford, Thomas Orndorff and Marvin Rich filed a purported class action complaint against Bernard Schwartz and Richard J. Townsend in the United States District Court for the Southern District of New York. The complaint alleges (a) that defendants violated Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder, by making material misstatements or failing to state material facts about Loral’s financial condition relating to the restatement in 2003 of the financial statements for the second and third quarters of 2002 to correct accounting for certain general and administrative expenses and the alleged improper accounting for a satellite transaction with APT Satellite Company Ltd. and (b) that defendants are secondarily liable for these alleged misstatements and omissions under Section 20(a) of the Exchange Act as an alleged “controlling person” of Loral. The class of plaintiffs on whose behalf the lawsuit has been asserted consists of all buyers of Loral common stock during the period from July 31, 2002 through June 29, 2003, excluding the defendants and certain persons related to or affiliated with them. This case is in its preliminary stages, and, on March 11, 2004, a conference was held with the court concerning selection of a lead plaintiff.
In December 2003, plaintiff Wendy Koch, a former employee, filed a purported class action complaint against the Loral Space & Communications Ltd. Savings Plan Administrative Committee, all Loral directors, Richard J. Townsend and certain other Loral officers and employees in the United States District Court for the Southern District of New York. The complaint alleges (a) that defendants violated Section 404 of the Employee Retirement Income Security Act (“ERISA”), by breaching their fiduciary duties to prudently and loyally manage the assets of the Loral Savings Plan (the “Plan”) by including Loral common stock as an investment alternative and by providing matching contributions under the Plan in Loral stock, (b) that the director defendants violated Section 404 of ERISA by breaching their fiduciary duties to monitor the committee defendants and (c) that defendants violated Sections 404 and 405 of ERISA by failing to provide complete and accurate information to Plan participants and beneficiaries. The class of plaintiffs on whose behalf the lawsuit has been asserted consists of all participants in or beneficiaries of the Plan at any time between November 4, 1999 and the present and whose accounts included investments in Loral stock. One other similar complaint against the defendants with substantially similar allegations has been filed, and a motion to consolidate the cases is pending.
Loral is obligated to indemnify its directors and officers for any losses or costs they may incur as a result of these lawsuits.
Natelco. On October 21, 2002, National Telecom of India Ltd. (“Natelco”) filed suit against Loral and a subsidiary in the United States District Court for the Southern District of New York. The suit relates to a joint venture agreement entered into in 1998 between Natelco and ONS Mauritius, Ltd., a Loral Orion subsidiary, the effectiveness of which was subject to express conditions precedent. In 1999, ONS Mauritius had notified Natelco that Natelco had failed to satisfy those conditions precedent. In Natelco’s amended complaint filed in March 2003, Natelco has alleged wrongful termination of the joint venture agreement, has asserted claims for breach of contract and fraud in the inducement and is seeking damages and expenses in the amount of $97 million. Loral believes that the claims are without merit and intends to vigorously defend against them. As a result of the commencement of the Chapter 11 Cases, this lawsuit is subject to the automatic stay and further proceedings in the matter have been suspended.
Environmental Regulation. Our operations are subject to regulation by various federal, state and local agencies concerned with environmental control. We believe that our facilities are in substantial compliance with all existing federal, state and local environmental regulations. With regard to certain sites, environmental remediation is being performed by prior owners who retained liability for such remediation arising from occurrences during their period of ownership. To date, these prior owners have been fulfilling these obligations; their size and current financial condition make it probable that they will be able to complete their remediation obligations without cost to us.
We are subject to various other legal proceedings and claims, either asserted or unasserted, that arise in the ordinary course of business. Although the outcome of these claims cannot be predicted with certainty, we do not believe that any of these other existing legal matters will have a material adverse effect on our consolidated financial position or results of operations.
Item 4.
Item 4.
Submission of Matters to a Vote of Security Holders
None.
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
(a) Market Price and Dividend Information
As a result of the commencement of our Chapter 11 Cases, on July 15, 2003, the NYSE suspended trading of Loral’s common stock and removed our securities from listing and registration on September 2, 2003. Loral’s common stock is being quoted under the ticker symbol LRLSQ on the Pink Sheets and on the Over-The-Counter Bulletin Board Service (OTC). In addition, on June 4, 2003, our Board of Directors approved a reverse stock split of Loral’s common stock at a ratio of one-for-ten, resulting in a new par value of $0.10 per common share. The reverse stock split became effective after the close of business on June 13, 2003. All references to common stock and per share amounts for all prior periods presented have been retroactively restated to reflect this reverse stock split. The following table presents the reported high and low closing prices of our common stock as reported on the Pink Sheets and the NYSE for 2003 and the intra-day high and low sales prices for 2002:
(b)
Approximate Number of Holders of Common Stock
At March 1, 2004, there were 6,476 holders of record of Loral’s common stock.
(c)
Dividends
We have not paid any dividends on our common stock. In August 2002, Loral’s Board of Directors approved a plan to suspend indefinitely the future payment of dividends on our two series of preferred stock. Accordingly, we have deferred the payments of quarterly dividends due on our Series C and Series D preferred stock. The Debtors will not pay any dividends or make any distributions during the pendency of the Chapter 11 Cases. The ability of the Debtors to pay dividends or distributions following any emergence from Chapter 11 will depend on various factors that cannot be determined at this time.
Item 6.
Item 6.
Selected Financial Data
The following consolidated selected financial data has been derived from, and should be read in conjunction with, the related consolidated financial statements.
LORAL SPACE & COMMUNICATIONS LTD., A DEBTOR IN POSSESSION
(In thousands, except per share data)
(1)
Includes the increase in the deferred tax valuation allowance of $390.4 million to a balance of $576.5 million, based upon management’s assessment during the fourth quarter of 2002 that insufficient positive evidence existed substantiating recoverability of our loss carryforwards and other deferred tax assets (see Note 12 to the consolidated financial statements).
(2)
Our principal affiliates are XTAR and Satmex. Loral also has investments in Globalstar and other ventures, which are accounted for under the equity method. During 2003, Loral wrote-off its remaining investment of $29 million in Satmex.
(3)
The results of operations for 2000 includes Loral’s share of Globalstar’s related equity losses and after-tax impairment charges of approximately $1.29 billion (approximately $1.6 billion on a pre-tax basis), which is included in equity in net loss of affiliates and after-tax impairment charges of $112 million ($125 million pre-tax) relating to Loral’s investments in and advances to Globalstar service provider partnerships.
(4)
On January 1, 2002, we recorded a charge of $890 million to write-off all of our goodwill as the cumulative effect of change in accounting principle (see Note 8 to the consolidated financial statements).
(5)
As a result of our Chapter 11 filing, our debt obligations, preferred stock obligations and certain other liabilities existing at July 15, 2003, have been classified as liabilities subject to compromise on our balance sheet as of December 31, 2003 (see Note 9 to the consolidated financial statements).
(6)
On December 21, 2001, Loral Orion completed exchange offers and consent solicitations by issuing $613 million principal amount of new senior notes guaranteed by Loral and 0.6 million five year warrants to purchase Loral common stock in exchange for a total of $841 million principal amount of Loral Orion senior notes due 2007 and senior discount notes due 2007.
Item 7.
Item 7.
Management’s Discussion and Analysis of Results of Operations and Financial Condition
The following discussion and analysis should be read in conjunction with our consolidated financial statements included in Item 16.
We use the terms “Loral,” the “Company,” “we,” “our,” and “us” in this report to refer to Loral Space & Communications Ltd. and its subsidiaries. When we use the term “Loral Skynet” or “Skynet”, we are, unless the context provides otherwise, referring to our entire Satellite Services business, the assets of which are held in various companies.
Disclosure Regarding Forward-Looking Statements
Except for the historical information contained in the following discussion and analysis, the matters discussed are not historical facts, but are “forward-looking statements” as that term is defined in the Private Securities Litigation Reform Act of 1995. In addition, Loral or our representatives have made and may continue to make forward-looking statements, orally or in writing, in other contexts. These forward-looking statements can be identified by the use of words such as “believes,” “expects,” “plans,” “may,” “will,” “would,” “could,” “should,” “anticipates,” “estimates,” “project,” “intend,” or “outlook” or other variations of these words. These statements are not guarantees of future performance and involve risks and uncertainties that are difficult to predict or quantify. Actual events or results may differ materially as a result of a wide variety of factors and conditions, many of which are beyond our control. These include the development of a plan of reorganization, confirmation of the plan by the Bankruptcy Court, and our ability to maintain good relations with our customers, suppliers and employees. For a detailed discussion of these and other factors and conditions, please refer to the Commitments and Contingencies section below and to the other periodic reports filed with the SEC by Loral, our wholly owned subsidiary Loral Orion, Inc. (“Loral Orion”) and our affiliate Satelites de Mexico, S.A. de C.V. (“Satmex”). Loral operates in an industry sector in which securities values may be volatile and may be influenced by economic and other factors beyond our control. We undertake no obligation to update any forward-looking statements.
Overview
Businesses
Loral is a leading satellite communications company organized into two operating segments: Satellite Services and Satellite Manufacturing. Revenues in 2003 were $533 million.
Satellite Services
Through our Loral Skynet division we lease satellite capacity and platforms to our customers for video and direct-to-home (“DTH”) broadcasting, high-speed data distribution, Internet access, communications and networking services. The satellite services business is capital intensive and highly competitive. We compete with other satellite operators and with ground-based service providers. The build-out of a satellite fleet requires substantial investment. Once these investments are made, however, the costs to maintain and operate the fleet are relatively low. The upfront investments are earned back through the leasing of transponders to customers over the life of the satellite. Beyond construction, one of the major cost factors is in-orbit insurance, an essential component given the harsh and unpredictable environment in which the satellites operate. Annual receipts from this business are fairly predictable because they are based on an established base of long-term customer contracts. In 2003, Satellite Services sales were $296 million before eliminations of $8 million. Worldwide satellite services industry sales in 2002 were approximately $7 billion, according to available industry estimates. Satellite Services’ backlog at December 31, 2003 was $1.3 billion.
The satellite services market has been characterized in recent years by over-capacity, pricing pressure and competition from fiber. The downturn in the telecommunications sector led many existing Skynet customers, hampered by a slow-down in demand and lack of access to the capital markets, to postpone expansion plans. Similarly, several start-up companies that leased Skynet’s satellite capacity for the delivery of new applications failed to meet their business objectives. Following the closing of the Intelsat transaction, Skynet’s growth will
rely on its ability to differentiate itself from the competition through customized product offerings, its superior customer service and its successful marketing of available capacity on its international fleet which is well positioned to serve regions of the world where demand is growing.
Satellite Manufacturing
Our Space Systems/ Loral (“SS/L”) subsidiary designs and manufactures satellites, space systems and space systems components for customers in the commercial and government sectors for applications including satellite services, DTH broadcasting, broadband data distribution, wireless telephony, digital radio, military communications, weather monitoring and air traffic management.
While its requirement for ongoing capital investment is low, the satellite manufacturing industry is a knowledge-intensive business, the success of which relies heavily on its technological heritage and the skills of its workforce. The breadth and depth of talent and experience resident in SS/ L’s workforce of approximately 1,500 employees is one of our key competitive advantages.
Satellite manufacturers have high fixed costs relating primarily to labor and overhead. Based on its current cost structure, we estimate that SS/ L covers its fixed costs with an average of four satellite awards a year. Cash flow in the satellite manufacturing business tends to be uneven. It takes two to three years to complete a satellite project and numerous assumptions are built into the estimated costs. Cash receipts are tied to the achievement of contract milestones, which depend in part on the ability of our subcontractors to deliver on time. In addition, the timing of satellite awards is difficult to predict, contributing to the unevenness of revenue and making it more challenging to match the workforce to the workflow.
Satellites are extraordinarily complex devices designed to operate in the very hostile environment of space. This complexity may lead to unanticipated costs during the design, manufacture and testing of a satellite. SS/ L establishes provisions for costs based on historical experience and program complexity to cover anticipated costs. Since most of SS/ L’s contracts are fixed price, cost increases in excess of the provisions reduces profitability and may result in losses borne solely by SS/ L, which may be material. The satellite manufacturing industry is highly competitive and, in recent years, order levels reached an unprecedented low level, resulting in manufacturing over-capacity. Buyers, as a result, are in the advantageous position of being able to negotiate contracts with favorable prices, terms and conditions. In the latter part of 2003, the order rate for new commercial satellites picked up and is expected to continue into 2004. This pick up has been driven by the need for replacement satellites and the resumption of some customers’ expansion plans. Backlog as of December 31, 2003, was $536 million. Backlog excludes approximately $240 million associated with orders or authorizations to proceed on the construction of four satellites (including the expected Intelsat order) received in the fourth quarter of 2003. SS/ L had sales in 2003 of $474 million including $229 million for internal satellites. Commercial satellite manufacturing industry sales in 2002 totaled $3.5 billion worldwide, according to available industry estimates.
Bankruptcy Proceedings
We operate in extremely competitive markets characterized in recent years by over-capacity and pricing pressures brought on by the downturn in the telecommunications sector. Our existing and potential customers, having limited access to the capital markets, postponed or reduced the scope of their planned satellite-based applications and services. This resulted in an excess of transponder capacity and a standstill in satellite orders. In the face of these pressures, we further increased our emphasis on cash conservation over the last 18 months, reducing operating expenses, suspending dividend payments on our preferred stock, and closely monitoring capital expenditures. The sustained and unprecedented decline in demand for our satellites and satellite services, however, exacerbated our already strained financial condition brought on primarily by the investments we had previously made in Globalstar and subsequently wrote off. On July 2003, Loral and certain of its subsidiaries filed voluntary petitions for reorganization under Chapter 11. As a result of our Chapter 11 filing, all of our prepetition debt obligations aggregating $2.2 billion at December 31, 2003 have been accelerated. Our $2.2 billion of debt includes $967 million of bank debt that is secured by liens on the assets of Loral SpaceCom and Loral Satellite, consisting primarily of our Satellite Manufacturing assets and satellites serving
the North American market. On July 15, 2003, we suspended interest payments on all of our senior unsecured notes, with a principal amount of $1.05 billion.
For the duration of the bankruptcy proceedings, our businesses are subject to risks and uncertainties of bankruptcy (see “Commitments and Contingencies” section below for examples of such risks and uncertainties).
Sale of Assets
In a further effort to strengthen our balance sheet, on July 15, 2003, we agreed to sell our satellites serving the North American market and related assets to Intelsat. Proceeds from the sale will be used to repay our outstanding secured bank debt, which was $967 million at December 31, 2003. This will reduce our outstanding principal debt obligations by almost 50 percent. On March 5, 2004, we and Intelsat entered into an amendment to the Asset Purchase Agreement, the effectiveness of which is subject to approval by the Bankruptcy Court and Intelsat’s bank lenders.
Future Outlook
We intend to reorganize around our satellite manufacturing operations and our remaining fleet of international satellites, which will cover regions with high growth potential, such as Southeast Asia and South America, where the ground infrastructure is inadequate to support increased demand. We consider these operations to be a viable foundation for the further expansion of our company. We anticipate using excess cash flows from operations to populate our available slots with new satellites to meet market demand. We are in the process now of completing our long-term business plan. We believe the plan is sound and that we will not require any additional financing to fund operations. At this time, however, it is impossible to predict accurately the effect of the Chapter 11 reorganization on Loral, when it may emerge from Chapter 11 and what its capital structure will be. The rights and claims of various creditors and security holders will be determined by our plan of reorganization. No assurance can be given as to what values, if any, will be ascribed in the bankruptcy proceedings to each of these constituencies. We anticipate that, in any plan of reorganization ultimately confirmed by the Bankruptcy Court, our common and preferred stock will, at best, be severely diluted and may be eliminated entirely, with the result that common and preferred stockholders would receive no distribution. Accordingly, we urge that appropriate caution be exercised with respect to existing and future investments in any of such securities and claims.
Critical success factors for us include maintaining our reputation for reliability, quality and superior customer service. During reorganization, in particular, these factors are vital to securing new customers and retaining current ones. In addition, we must align our workforce levels with the needs of the business, continue to contain costs, and maximize the efficiency of both of our operations. Loral Skynet is focused on increasing the capacity utilization of its satellite fleet and successfully introducing new value-added services to its markets. Space Systems/ Loral, which received orders or authorizations to proceed for four new satellites (including the expected Intelsat order) in the fourth quarter of 2003, is focused on increased bookings and backlog in 2004.
See Part 1, Item 1, for a complete description of Loral’s businesses, our Chapter 11 Cases and the sale of our satellite assets serving the North American market.
Consolidated Operating Results
Please refer to Critical Accounting Matters further on in this section.
The accompanying consolidated financial statements have been prepared assuming Loral in its current structure will continue as a going concern. However, the factors mentioned above among other things, raise substantial doubt about our ability to continue as a going concern. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. The ability of Loral to continue as a going concern is dependent on a number of factors including, but not limited to, developing a plan of reorganization, confirmation of the plan by the Bankruptcy Court and maintaining good relations with
our customers, suppliers and employees. If a plan of reorganization is not confirmed and implemented, we may be forced to liquidate under applicable provisions of the Bankruptcy Code. There can be no assurance of the level of recovery that Loral’s creditors would receive in the event of a liquidation. The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities if Loral were forced to liquidate.
The common definition of EBITDA is “Earnings Before Interest, Taxes, Depreciation and Amortization.” In evaluating financial performance, we use revenue and operating income (loss) before depreciation and amortization including amortization of unearned stock compensation, and reorganization expenses due to bankruptcy (“Adjusted EBITDA”) as a measure of a segment’s profit or loss. Adjusted EBITDA is equivalent to the common definition of EBITDA before amortization of stock compensation; reorganization expenses due to bankruptcy; gain (loss) on investments and debt exchanges; equity in net losses of affiliates, net of tax; minority interest, net of tax; cumulative effect of change in accounting principle, net of tax, and extraordinary gain on acquisition of minority interest, net of tax. Adjusted EBITDA should be used in conjunction with GAAP financial measures and is not presented as an alternative to cash flow from operations as a measure of our liquidity or as an alternative to net income as an indicator of our operating performance.
We believe the use of Adjusted EBITDA along with GAAP financial measures enhances the understanding of our operating results and is useful to investors in comparing performance with competitors, estimating enterprise value and making investment decisions. Adjusted EBITDA allows investors to compare operating results of competitors exclusive of depreciation and amortization, net losses of affiliates and minority interest, a useful tool given the significant variation that can result from the timing of capital expenditures, the amount of intangible assets recorded, the differences in assets’ lives, the timing and amount of investments, and effects of investments not managed by Loral. Adjusted EBITDA as used here may not be comparable to similarly titled measures reported by other companies. We also use Adjusted EBITDA to evaluate operating performance, to allocate resources and capital, to measure performance for incentive compensation programs, and to evaluate future growth opportunities. See the table below for reconciliations of Adjusted EBITDA to net loss.
The following discussion of revenues and Adjusted EBITDA reflects the results of our operating businesses for 2003, 2002 and 2001. The balance of the discussion relates to our consolidated results, unless otherwise noted. Both of our business segments have been adversely affected by the downturn in the telecommunications sector, which has caused a delay in demand for new telecommunications applications and services.
Revenues:
Adjusted EBITDA:
(1)
Represents: (a) the elimination of intercompany sales and intercompany Adjusted EBITDA, primarily for satellites under construction by SS/ L for wholly owned subsidiaries and (b) the reversal of satellite manufacturing sales of $83 million and $73 million of cost of satellite manufacturing on a satellite program with a customer where the contract was changed to a lease arrangement in 2003 (see Note 17 to the consolidated financial statements).
(2)
Includes revenues from affiliates of $28.7 million, $85.9 million and $100.9 million in 2003, 2002 and 2001, respectively.
(3)
See 2003 Compared with 2002 and 2001 - Cost of Satellite Manufacturing, for significant items that effect comparability between the periods presented.
(4)
Represents corporate expenses incurred in support of our operations.
Financial Information for Assets Serving the North American Market to be Sold to Intelsat
The net book value of the satellites to be sold to Intelsat was $935 million (including insurance proceeds receivable of $123 million on our balance sheet) and the related assets and liabilities was $30 million and $31 million, respectively, as of December 31, 2003. The net assets to be sold, as well as the results of operations relating to such net assets, have not been segregated in the accompanying financial statements since Bankruptcy Court approval is still required with respect to certain provisions of the asset purchase agreement.
Upon receipt of Bankruptcy Court approval relating to certain closing conditions, the satellites serving the North American market will be accounted for as a discontinued operation, resulting in our historical consolidated financial statements being reclassified to reflect such discontinued operations separately from continuing operations.
The following table represents the results of operations that are expected to be reclassified for the satellite assets to be sold to Intelsat, for the three years in the period ended December 31, 2003. For the purpose of this presentation, all indirect costs normally associated with these operations have been omitted, including telemetry, tracking and control, access control, maintenance and engineering, selling and marketing and general and administrative.
Revenues:
Adjusted EBITDA:
2003 Compared with 2002 and 2001
Revenues from Satellite Services
Revenues from Satellite Services decreased $99 million in 2003 as compared to 2002 primarily due to decreases in prices of $43 million, reduced transponder and network utilization of $48 million and lower customer lease termination fees of $8 million in both transponder leasing and network services. Revenues from Satellite Services decreased $69 million in 2002 as compared to 2001 primarily due to decreases in prices of $15 million, reduced transponder and network utilization of $46 million and lower customer lease termination fees of $5 million in both transponder leasing and network services. Eliminations primarily consist of revenues from leasing transponder capacity to Satellite Manufacturing and an adjustment to present revenues without the implicit interest discount provided to customers who have made prepayments under long-term contracts. As a result of the above, revenues from Satellite Services as reported decreased $102 million and $66 million in 2003 and 2002, respectively, as compared to the respective prior year.
Revenues from Satellite Manufacturing
Revenues from Satellite Manufacturing decreased $379 million in 2003 as compared to 2002, primarily resulting from satellite programs nearing completion under the percentage of completion method with no new satellite orders from December 2001 to October 2003. Revenues from Satellite Manufacturing increased $38 million in 2002 as compared to 2001, primarily resulting from the timing of work performed and costs incurred on satellite backlog programs under the percentage of completion method. Eliminations primarily consist of revenues from satellites under construction by SS/ L for Satellite Services. In 2003, eliminations also include the reversal of $83 million of sales on a customer satellite contract that was changed to a lease arrangement in the third quarter (which became an internal program that will be leased to the customer in the future). See Note 17 to the consolidated financial statements. As a result of the above, revenues from Satellite Manufacturing as reported decreased $463 million in 2003 and increased $94 million in 2002 as compared to the respective prior year.
Cost of Satellite Services
The decrease of $17 million in 2003 as compared to 2002 was primarily due to (i) a $9 million insurance claim recovery on a satellite, (ii) reduced external satellite capacity costs totaling $14 million ($9 million due to lower network services revenues and $5 million due to expirations of capacity leases) and (iii) lower network service costs of $3 million. This was offset by (i) a net increase in depreciation expense of $7 million primarily due to the shortening in the estimated life of a satellite, offset by lower depreciation expense due to the loss of Telstar 4 in 2003, the timing of assets placed in service and assets that became fully depreciated and (ii) increased insurance costs of $5 million resulting from higher premiums on renewals and changes in insurance coverage requirements and the launch of Telstar 13. The decrease of $32 million in 2002 as compared to 2001 was primarily due to decreases of (i) $18 million in amortization expense for goodwill resulting from the adoption of SFAS No. 142 on January 1, 2002 (as we wrote-off our remaining balance of goodwill, see Note 8 to the consolidated financial statements) and (ii) $14 million in depreciation due to the timing of assets placed in service and assets that became fully depreciated. The increases in cost of satellite services as a percentage of revenues in 2003 and 2002, as compared to the prior year, were primarily due to reduced revenues.
Cost of Satellite Manufacturing
The decrease of $338 million in 2003 as compared to 2002 was primarily due to (i) lower overall sales as satellite programs neared completion under the percentage of completion method with no new satellite awards from December 2001 until October 2003, (ii) the reversal of $73 million of costs of satellite manufacturing on a satellite program where the contract was changed to a lease arrangement in the third quarter of 2003 and (iii) lower depreciation expense of $6 million primarily due to reduced capital spending from 2001 to 2003. These factors were offset by the following cost increases for the year ended December 31, 2003 (i) a charge of $24 million due to cancellation of a deposit on a launch vehicle contract; (ii) provisions for inventory obsolescence of $50 million primarily due to the absence of new satellite awards from December 2001 until October 2003; (iii) a charge of $13 million on the settlement of all outstanding issues with Alcatel including a contract dispute that was in arbitration; (iv) a loss of $11 million on the acceleration of receipt of long-term receivables; (v) a charge of $8 million related to an agreement in principle to settle a satellite contract dispute and (vi) a charge of $10 million recorded on SS/ L-provided vendor financing, representing the difference between the carrying value of SS/ L’s receivables of $38 million and the value of the common shares received by SS/ L based on the trading price of Sirius Satellite Radio, Inc. (“Sirius”) common stock on March 7, 2003 of $28 million (see Gain on Investments and Debt Exchanges for gains realized subsequent to receipt of the shares). The increase in cost of satellite manufacturing as a percentage of revenues in 2003 as compared to 2002, was affected by reduced revenues for overhead cost absorption.
The increase of $179 million in 2002 as compared to 2001 primarily resulted from (i) increased sales; (ii) valuation allowances of $69 million recorded on SS/ L-provided vendor financings (in connection with advances related to Europe*Star Limited (“Europe*Star”) and an agreement reached with Sirius to convert vendor financing receivables into Sirius’ equity) and (iii) provisions for inventory obsolescence of $14 million due to the absence of new satellite awards. These factors were offset by (i) $13 million of income recorded from a recovery of a claim from a vendor; (ii) a decrease of $9 million in amortization expense for goodwill resulting from the adoption of SFAS No. 142 on January 1, 2002 (as the Company wrote-off its remaining balance of goodwill, see Note 8 to the consolidated financial statements) and (iii) by lowering costs through workforce reductions since the beginning of 2001, by streamlining certain internal processes and by instituting tighter controls which are designed to provide that subcontracted components are received on time and meet all customer requirements. Costs in 2001, include $12 million for obligations to the U.S. government to settle a case relating to export controls.
Selling, General and Administrative Expenses
The decrease of $8 million in 2003 as compared to 2002 was primarily due to lower research and development costs of $7 million and sales and marketing costs of $2 million at SS/ L. Satellite Services had expense increases of $3 million, primarily due to an increase in bad debt expense of $4 million, offset by cost reductions for headcount and employee related expenses and marketing expenses of $2 million. The decrease
of $41 million in 2002 as compared to 2001 was primarily due to lower SS/ L research and development costs of $17 million in 2002 and lower Satellite Services expenses of $22 million in 2002, primarily due to lower headcount and employee related expenses of $11 million, lower marketing and selling expenses of $7 million and lower professional fees of $3 million.
Reorganization Expenses Due to Bankruptcy
Reorganization expenses due to bankruptcy in 2003 were $25 million for the period from July 15, 2003 (date of filing) to December 31, 2003, which includes a charge for lease rejection claims of $6 million, professional fees of $15 million associated with bankruptcy services, and employee retention costs of $5 million, offset by interest and investment income earned of $1 million (which represents the interest earned subsequent to filing for bankruptcy, excluding interest earned on satellite programs).
Interest and Investment Income
The increase of $2 million in 2003 as compared to 2002 was principally due to higher interest income earned on satellite programs, offset by lower interest income earned on lower average cash balances prior to filing for bankruptcy and interest income earned on available cash balances subsequent to filing for bankruptcy being reclassified into reorganization expenses. The decrease of $16 million in 2002 as compared to 2001 was principally due to lower interest rates and lower average cash balances and lower interest earned on satellite programs.
Interest Expense
Interest cost before capitalized interest decreased $11 million in 2003 as compared to 2002, which was primarily attributable to the fact that subsequent to Loral’s voluntary petitions for reorganization on July 15, 2003, we only recognize and pay interest on our bank debt and have stopped recognizing and paying interest on all other outstanding borrowings. Interest cost before capitalized interest is expected to decrease in 2004 when we pay off our bank debt upon closing of the Intelsat transaction. Interest cost before capitalized interest decreased $100 million in 2002 as compared to 2001, primarily because we did not recognize any interest expense on our 10% senior notes issued in connection with exchange offers completed in December 2001. Interest expense on our 10% senior notes was fully offset by amortization of the deferred gain on the debt exchanges (see Note 10 to the consolidated financial statements) and lower debt balances and interest rates in 2002 as compared to 2001. Capitalized interest increased $4 million in 2003 and $7 million in 2002 as compared to the respective prior year, primarily due to higher satellite under construction balances. Capitalized interest is expected to decrease in 2004, as a result of the closing of the Intelsat transaction and the fact that our remaining satellite under construction is expected to be launched in 2004. As a result of the above, interest expense decreased $15 million in 2003 and $107 million in 2002, as compared to the respective prior year.
Gain on Investments and Debt Exchange
During 2003, Loral realized $18 million of gains from the sale of all 59 million shares of Sirius common stock received by us in settlement of the vendor financing owed to SS/ L by Sirius. During 2001, we recorded a $34 million gain related to Loral Orion’s debt exchanges (see Note 10 to the consolidated financial statements).
Income Tax (Provision) Benefit
During 2003, we continued to maintain a 100% valuation allowance against our net deferred tax assets and recorded no benefit for our domestic loss. For 2003, we recorded an income tax provision of $4.6 million on a pre-tax loss of $338.6 million, which is primarily for state, local and foreign income taxes and a deferred tax liability recorded for certain foreign entities. This compares to income tax provisions for 2002 and 2001 of $355 million and $2.2 million on pre-tax losses of $147 million and $126 million, respectively.
At December 31, 2002, we recorded a 100% valuation allowance against our domestic net deferred tax assets under the criteria of SFAS No. 109, Accounting for Income Taxes. The increase in tax expense in 2002 when compared to 2003 and 2001 was primarily attributable to an increase in the deferred tax valuation allowance. See Critical Accounting Matters.
Equity in Net Losses of Affiliates
The decrease in equity losses of $25 million in 2003 as compared to 2002, primarily resulted from a decrease in equity losses in Europe*Star of $42 million, as we wrote-off our remaining investment in Europe*Star in the fourth quarter of 2002. This was offset by an increase in equity losses in Satmex of $27 million, primarily because we wrote-off our remaining investment of $29 million in Satmex in the third quarter of 2003. Accordingly, there is no longer any requirement for us to provide for our allocated share of Satmex’s net losses subsequent to September 30, 2003 and Europe*Star’s net losses subsequent to December 31, 2002. The increase in equity losses of $10 million in 2002 as compared to 2001 primarily resulted from our recording increased equity losses in Satmex of $13 million, due primarily to the downturn in the telecommunications sector, and increased equity losses in Europe*Star of $13 million, due primarily to Europe*Star’s loss on the sale of an equity investment and to an impairment charge of $7 million we recorded relating to our investment in Europe*Star in 2002. This was offset by reduced equity losses in Globalstar related activities of $22 million, due primarily to reduced equity losses in Globalstar service provider partnerships. In 2002, equity losses in Globalstar related activities included a recovery of a claim from a vendor on the Globalstar program of which $14 million ($8 million after taxes) was recorded as a benefit to equity in net losses of affiliates, offset by a $9 million charge relating to liabilities we had guaranteed in connection with a Globalstar service provider partnership. See Note 7 to the consolidated financial statements.
Cumulative Effect of Change in Accounting Principle
On July 1, 2003, we adopted SFAS No. 150, and as a result, recorded a charge of $2 million for the amortization of expenses incurred on the issuance of our preferred stock from their issuance dates through
June 30, 2003, that were not previously amortized as a cumulative effect of change in accounting principle. See Note 3 to the consolidated financial statements.
On January 1, 2002, we adopted SFAS No. 142, Goodwill and Other Intangible Assets, which resulted in our recording a charge to write-off all of our goodwill of $890 million as the cumulative effect of change in accounting principle. See Note 8 to the consolidated financial statements.
On January 1, 2001, we adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, which resulted in our recording a charge for the cumulative effect of a change in accounting principle, net of taxes, of $2 million. See Note 3 to the consolidated financial statements.
Extraordinary Gain on Acquisition of Minority Interest
As a result of receiving Alcatel’s minority interest in CyberStar, L.P. on June 30, 2003 (as part of a settlement arrangement with Alcatel), we recognized an extraordinary gain of $14 million, which represents the extinguishment of the minority interest liability less the fair value of the acquired net assets.
Preferred Dividends
The $82 million decrease in 2003 from 2002 was primarily due to dividend charges of $60 million ($46 million non-cash charges and $13 million cash charges) and the reduction of dividend obligations. Both resulted from our 2002 exchange offers and privately negotiated exchange transactions where 11.5 million shares of our 6% Series C convertible redeemable preferred stock (the “Series C Preferred Stock”) and 6% Series D convertible redeemable preferred stock (the “Series D Preferred Stock”) were converted into 7.7 million shares of our common stock. Preferred dividends also decreased in 2003 from 2002, as a result of the adoption of SFAS 150 on July 1, 2003, which requires that dividends since adoption be included in interest expense. The increase of $8 million in 2002 from 2001 was due primarily to dividend charges of $60 million resulting from the Company’s 2002 exchange offers and privately negotiated exchange transactions, offset by lower dividends of $23 million as a result of these exchanges and the fact that we incurred non-cash dividend charges of $29 million in 2001 on the conversion of 5.6 million shares of Series C Preferred Stock and Series D Preferred Stock into 3.1 million shares of our common stock, in connection with our exchange offers.
Consolidated Backlog
Backlog before eliminations was $1.7 billion, including $479 million related to the satellites to be sold to Intelsat, and $1.8 billion at December 31, 2003 and 2002, which includes $45 million and $142 million, respectively, as a result of transactions entered into with affiliates and related parties for the construction of satellites (primarily with XTAR and Spainsat, Satmex, Europe*Star and Globalstar). Backlog at December 31, 2003, excludes approximately $240 million associated with orders or authorizations to proceed on the construction of four satellites (including the expected Intelsat order), received in the fourth quarter of 2003.
Results by Operating Segment
Satellite Services
See Revenues from Satellite Services, Cost of Satellite Services and Selling, General and Administrative Expenses, for an explanation of the changes in these items for the periods presented. The net increase in depreciation and amortization expense of $9 million in 2003 as compared to 2002 was primarily due to the shortening in the estimated life of a satellite, offset by lower depreciation expense due to the timing of assets placed in service and assets that became fully depreciated. The decrease in depreciation and amortization expense of $32 million in 2002 as compared to 2001 was primarily due to an $18 million decrease in amortization expense for goodwill resulting from the adoption of SFAS No. 142 and a $14 million decrease in depreciation, due to the timing of assets placed in service and assets that became fully depreciated. As a result of the above, Adjusted EBITDA before eliminations decreased $79 million in 2003 and decreased $43 million in 2002 as compared to the respective prior year.
As of December 31, 2003, Satellite Services had seven satellites in-orbit and three under construction (including one launched in January 2004 that has a problem with its solar array deployment, see below). At December 31, 2003, Satellite Services’ backlog totaled $1.3 billion, including intercompany backlog of $37 million and $479 million in backlog relating to the Intelsat transaction. As of December 31, 2002, backlog was $1.4 billion, including intercompany backlog of $41 million. Approximately $223 million of the 2003 backlog is expected to be realized in 2004, including approximately $4 million of intercompany backlog. Total assets for the segment were $2.0 billion and $1.9 billion as of December 31, 2003 and 2002, respectively. Capital expenditures were approximately $171 million in 2003 and are expected to substantially decrease in 2004, as a result of the sale of the satellite assets serving the North American market to Intelsat and the fact that the remaining satellite under construction is expected to be launched in 2004.
In January 2004, the Company’s Telstar 14/ Estrela do Sul-1 satellite was successfully launched, but after launch the satellite only partially deployed its North solar array. SS/ L, the manufacturer of the satellite, is raising the satellite to geostationary orbit. The satellite is currently generating enough power to operate between 10 and 14 Ku-band transponders, making it capable of meeting immediate customer requirements, as well as Brazilian government requirements. The book value of Telstar14/ Estrela do Sul-1 at December 31, 2003 was $253 million and is included in satellites under construction. It is insured for partial and total losses up to a maximum of $250 million.
Satellite Manufacturing
See Revenues from Satellite Manufacturing, Cost of Satellite Manufacturing and Selling, General and Administrative Expenses, for an explanation of the changes in these items for the periods presented. The decrease of $6 million in depreciation and amortization in 2003 as compared to 2002 was primarily due to reduced capital spending from 2001 to 2003. The decrease of $8 million in depreciation and amortization expense in 2002 as compared to 2001 was primarily due to the adoption of SFAS No. 142. As a result of the above, Adjusted EBITDA before eliminations decreased $125 million in 2003 and $78 million in 2002, as compared to the respective prior year.
Adjusted EBITDA before eliminations also decreased because of the absence of new satellite awards from December 2001 to October 2003.
In October 2003, SS/ L received three new satellite orders through authorizations to proceed from existing customers (two from DIRECTV and one from PanAmSat) having an aggregate value in excess of $320 million and an option for another satellite for PanAmSat. DIRECTV also increased the total contract value for the nearly completed DIRECTV 7S by $25 million to approximately $165 million. In addition, Intelsat has agreed to order a new satellite from SS/ L upon closing of the sale of the fleet serving the North American market.
As of December 31, 2003 and 2002, backlog for SS/ L was $536 million (excluding approximately $240 million associated with the fourth quarter awards, see Consolidated Backlog) and $763 million, including intercompany backlog of $145 million and $275 million, respectively. Approximately $471 million of the 2003 backlog is expected to be realized in 2004, including approximately $145 million of intercompany backlog. The decline in backlog is due to a lack of new satellite orders resulting from an industry-wide slowdown in orders and concerns regarding Loral’s financial condition. Total SS/ L assets were $362 million and $690 million as of December 31, 2003 and 2002, respectively. Capital expenditures in 2003 were approximately $6 million and are expected to increase slightly in 2004.
Critical Accounting Matters
The preparation of financial statements in conformity with U.S. GAAP requires us 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 amounts of revenues and expenses reported for the period. Actual results could differ from estimates.
Revenue recognition
The majority of our Satellite Manufacturing revenue is associated with long-term fixed-price contracts. Revenue and profit from satellite sales under these long-term contracts are recognized using the cost-to-cost percentage of completion method, which requires significant estimates. Loral uses this method because reasonably dependable estimates can be made based on historical experience and various other assumptions that are believed to be reasonable under the circumstances. These estimates include forecasts of costs and
schedules, estimating contract revenue related to contract performance (including estimated amounts for penalties, performance incentives and orbital incentives that will be received as the satellite performs on orbit) and the potential for component obsolescence in connection with long-term procurements. These estimates are assessed continually during the term of the contract and revisions are reflected when the conditions become known. Provisions for losses on contracts are recorded when estimates determine that a loss will be incurred on a contract at completion. Under firm fixed-price contracts, work performed and products shipped are paid for at a fixed price without adjustment for actual costs incurred in connection with the contract; accordingly, favorable changes in estimates in a period will result in additional revenue and profit, and unfavorable changes in estimates will result in a reduction of revenue and profit or the recording of a loss that will be borne solely by Loral.
Depreciation
Depreciation is provided for on the straight-line method for satellites over the estimated useful life of the satellite, which is determined by engineering analyses performed at the satellite’s in-service date and re-evaluated periodically. A decrease in the useful life of a satellite would result in increased depreciation expense.
Billed receivables, vendor financing and long-term receivables
Loral is required to estimate the collectibility of its billed receivables, vendor financing and long-term receivables. A considerable amount of judgment is required in assessing the collectibility of these receivables, including the current creditworthiness of each customer and related aging of the past due balances. Charges for bad debts recorded to the income statement on billed receivables during 2003, 2002, and 2001 were $7.4 million, $4.3 million and $3.7 million, respectively. At December 31, 2003 and 2002, billed receivables were net of allowances for doubtful accounts of $11.7 million and $7.1 million, respectively. Long-term receivables were net of allowances of $8.1 million as of December 31, 2003 and vendor financing was net of a valuation allowance of $32.6 million as of December 31, 2002 (relating to vendor financings in connection with an agreement reached with Sirius to convert vendor financing receivables into Sirius’ equity). We evaluate specific accounts when we become aware of a situation where a customer may not be able to meet its financial obligations due to a deterioration of its financial condition, credit ratings or bankruptcy. The reserve requirements are based on the best facts available to us and are re-evaluated periodically.
Inventories
Inventory is reviewed for estimated obsolescence or unusable items and, if appropriate, is written down to the net realizable value based upon assumptions about future demand and market conditions. If actual future demand or market conditions are less favorable than those we project, additional inventory write-downs may be required. These are considered permanent adjustments to the cost basis of the inventory. Charges for inventory obsolescence recorded to the income statement during 2003, 2002, and 2001 were $49.5 million, $14.0 million and $5.9 million, respectively.
Taxation
Loral, as a Bermuda company, is subject to U.S. federal, state and local income taxation at regular corporate rates on any income that is effectively connected with the conduct of a U.S. trade or business. When such income is deemed removed from the U.S. business, it is subject to an additional 30% “branch profits” tax. While any portion of Loral’s income from sources outside the United States may also be subject to taxation by foreign countries, the extent to which these countries may require Loral to pay tax or to make payments in lieu of tax cannot be determined in advance. From its inception, Loral has not received any cumulative benefit as a result of being established in Bermuda because of substantial losses incurred outside the U.S. Loral’s U.S. subsidiaries are subject to U.S. taxes on their worldwide income. In addition, a 30% U.S. withholding tax will be imposed on dividends and interest paid by such subsidiaries to Loral.
We use the liability method in accounting for taxes whereby income taxes are recognized during the year in which transactions enter into the determination of financial statement income or loss. Deferred taxes reflect the future tax effect of temporary differences between the carrying amount of assets and liabilities for financial and income tax reporting and are measured by applying statutory tax rates in effect for the year during which the differences are expected to reverse. We assess the recoverability of our deferred tax assets and, based upon this analysis, record a valuation allowance against the deferred tax assets to the extent recoverability does not satisfy the “more likely than not” recognition criteria in SFAS No. 109.
Based upon this analysis, we concluded during the fourth quarter of 2002 that, due to insufficient positive evidence substantiating recoverability, a 100% valuation allowance should be established for the entire balance of our net deferred tax assets. During 2003, we recorded no benefit for our domestic loss and continued to maintain the valuation allowance, increasing the reserve by $94.4 million to a balance of $670.9 million.
We will maintain the valuation allowance until sufficient positive evidence exists to support its reversal. Until such time, we expect to report no income tax provision net of valuation allowance adjustments, except for potential alternative minimum taxes and minor state, local and foreign tax provisions. When we determine that we will be able to realize all or a part of the benefit from our deferred tax assets, reversal of the valuation allowance will increase income in the period the determination is made.
Pension and other employee benefits
We maintain a pension plan and a supplemental retirement plan. These plans are defined benefit pension plans. In addition to providing pension benefits, we provide certain health care and life insurance benefits for retired employees and dependents. These pension and other employee benefit costs are developed from actuarial valuations. Inherent in these valuations are key assumptions, including the discount rate and expected long-term rate of return on plan assets. Material changes in these pension and other employee benefit costs may occur in the future due to changes in these assumptions, as well as our actual experience.
The discount rate is subject to change each year, consistent with changes in applicable high-quality long-term corporate bond indices, such as the Moody’s AA Corporate Bond Index. The discount rate determined on this basis was 6.25% as of December 31, 2003, a decline of 50 basis points from December 31, 2002. This had the effect of increasing our accumulated benefit obligations (“ABO”) for pensions by $17.6 million and for other employee benefits by $3.8 million as of December 31, 2003.
The expected long-term rate of return on pension plan assets is selected by taking into account the expected duration of the plan’s projected benefit obligation, asset mix and the fact that its assets are actively managed to mitigate risk. Allowable investment types include equity investments and fixed income investments. Pension plan assets are managed by Russell Investment Corp., which allocates the assets into specified Russell-designed funds as we direct. Each specified Russell fund is then managed by investment managers chosen by Russell. The targeted short and long-term allocation of our pension plan assets is 60% in equity investments and 40% in fixed income investments. Based on this target allocation, the fifteen-year historical return of our investment managers has been 10.9%. The expected long-term rate of return on plan assets determined on this basis was 9.0% for 2003, a decline of 50 basis points from 2002.
These pension and other employee costs are expected to decrease to approximately $22 million in 2004 from $28 million in 2003 primarily due to better asset returns, a reduction in force and other employee benefit plan changes, offset by the drop in discount rate. Lowering the discount rate and the expected long-term rate of return each by 0.5% would have increased these pensions and other employee benefits costs by approximately $3.3 million and $1.0 million, respectively, in 2003.
On December 8, 2003, President Bush signed the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (DIMA). The Act introduces a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. In accordance with the FASB Staff Position No. 106-1, we are electing to defer recognition of any potential savings on the measure of accumulated postretirement benefit obligation or net periodic benefit cost as a result of DIMA
until specific authoritative guidance on the accounting of the federal subsidy is issued. Therefore, the financial statements do not reflect the effects of the Act on the plan.
The ABO for the pension plan exceeded the fair value of plan assets by $94 million at December 31, 2003 (the “unfunded ABO”). This was primarily due to the negative returns on the pension funds in previous years arising from the overall decline in the equity markets, and a decline in the discount rate used to estimate the pension liability as a result of declining interest rates. Therefore, Loral was required to establish a minimum liability and record an additional $4.5 million during 2003, for a total charge to equity of $69.2 million for the unfunded ABO, to the extent not already reflected as a liability. The ABO was measured using a discount rate of 6.25% as of December 31, 2003. Lowering the discount rate by 0.5% would have increased the ABO and the resulting minimum liability and charge to equity by approximately $17.6 million. Market conditions and interest rates significantly impact future assets and liabilities of Loral’s pension plans. This charge to equity will be revalued based upon plan assets and the measurement of plan obligations at the end of each fiscal year.
Contingencies
Contingencies by their nature relate to uncertainties that require management to exercise judgment both in assessing the likelihood that a liability has been incurred as well as in estimating the amount of potential loss, if any. The most important contingencies affecting our financial statements are detailed below under Commitments and Contingencies.
Liquidity and Capital Resources
Cash and Available Credit
As of December 31, 2003, we had $142 million of cash (not including $3 million of restricted cash presented in other current assets, which we will have access to upon repayment of our bank debt), $6 million of outstanding letters of credit and had no further credit available from our credit facilities. Transfer of this cash, which is held in various separate legal entities, is subject to the provisions of the cash collateral order (see Cash Collateral Order below). Cash flow from Satellite Services is fairly predictable because it is based on an existing base of long-term customer contracts. Cash flow from Satellite Manufacturing, however, is not as predictable, because it depends on a number of factors, some of which are not within SS/ L’s control. For example, most satellite contracts are long-term (two to three years) fixed price contracts that require significant estimates when they are competitively bid (which may include cost estimates for new technologies). In addition, various component manufacturers that subcontract for SS/ L may not meet required manufacturing specifications or timetables, which may cause SS/ L to miss milestones and incur penalties. Customers may also require SS/ L to have a source of liquidity to support new satellite orders in light of Loral’s financial condition.
Contractual Obligations and Other Commercial Commitments
The following tables aggregate our contractual obligations and other commercial commitments as of December 31, 2003 (in thousands).
Contractual Obligations(1):
Other Commercial Commitments:
(1)
Pursuant to Section 365 of the Bankruptcy Code, Loral and its Debtor subsidiaries may reject or assume prepetition executory contracts and unexpired leases, and parties affected by rejections of these contracts or leases may file claims with the Bankruptcy Court which will be addressed in the context of the Chapter 11 Cases. The above table includes amounts that are subject to compromise under a plan of reorganization, including: all of our debt and preferred stock, and certain of our operating leases, unconditional purchase obligations and other long-term obligations. See Note 9 to the consolidated financial statements for further detail on liabilities subject to compromise.
(2)
Represents cash obligations for principal payments and the difference in the carrying value and principal amount for Loral Orion’s 10% senior notes that was amortized over the life of the notes. As a result of our Chapter 11 filing on July 15, 2003, all of our debt obligations have been accelerated. While we have continued to pay interest on our bank debt, we have stopped accruing and paying interest on all of our senior unsecured notes with an aggregate principal amount of $1.05 billion. This has significantly reduced our cash interest payments. See Note 10 to the consolidated financial statements for further detail on our debt obligations.
(3)
Represents future minimum payments under operating leases with initial or remaining terms of one year or more, net of sub-lease rentals of $2.0 million.
(4)
SS/ L has entered into various purchase commitments with suppliers due to the long lead times required to produce purchased parts and launch vehicles (year 1 amount includes $36 million of launch vehicle obligations expected to be paid by Intelsat for one of the satellites to be sold). Unassigned launch vehicle commitments represent the minimum amount due if the launch contract is terminated.
(5)
Primarily represents vendor financing related amounts owed to subcontractors, of which $47 million is non-recourse to SS/ L in the event of non-payment by Globalstar due to bankruptcy, and amounts due to APT representing Loral’s share of the project cost of Telstar 18.
(6)
In August 2002, Loral’s Board of Directors approved a plan to suspend indefinitely the future payment of dividends on its two series of preferred stock. Accordingly, we have deferred the payments of quarterly dividends due on our Series C and Series D preferred stock. We stopped accruing dividends on our two
series of preferred stock on July 15, 2003 in our consolidated financial statements, as a result of our Chapter 11 filing.
Our Series C and Series D preferred stock have mandatory redemption dates in 2006 and 2007, respectively. We have the right to make mandatory redemption payments to the holders in either cash or common stock, or a combination of the two. As a consequence of the Chapter 11 Cases, it is not likely that a mandatory redemption will occur. As a result of the adoption of SFAS 150, we reclassified our preferred stock to liabilities from shareholders’ deficit at June 30, 2003 and the related dividends since adoption have been included in interest expense (see Note 3 to the consolidated financial statements).
(7)
Letters of credit have a maturity of one year and are renewed annually.
Cash Collateral Order
As previously stated, substantially all of the assets of Loral SpaceCom and Loral Satellite constitute collateral security for the obligations that are owed to our bank lenders. Under the Bankruptcy Code, Loral SpaceCom and Loral Satellite are authorized to use the existing cash or cash proceeds of this collateral (the “Cash Collateral”) only in accordance with the cash collateral order.
On the date the Chapter 11 Cases were commenced, the Bankruptcy Court entered an order authorizing the Debtors to use the Cash Collateral to fund all operating expenses associated with their businesses in accordance with an agreed upon budget and in accordance with certain other terms set forth in the order. The use of the Cash Collateral can be terminated by the bank lenders upon the occurrence of certain events specified in the order. The bank lenders have granted the Debtors a number of waivers in the past. In fact, the Debtors currently are operating under a waiver that temporarily sets aside certain of the order’s requirements, among them, the requirement for an agreed upon business plan, certain financial tests, maintenance of in-orbit insurance at certain levels and delivery of financial statements. There can be no assurance that the bank lenders will grant future waivers. In the event the Debtors’ ability to use the Cash Collateral is terminated, the Debtors would still have the right to seek the authority of the Bankruptcy Court to use the Cash Collateral notwithstanding any objection by the bank lenders. There can be no assurance, however, that the Bankruptcy Court would grant this request.
Net Cash Provided by Operating Activities
Net cash provided by operating activities for 2003 was $225 million, due primarily to (i) a $74 million decrease in long-term receivables arising from the accelerated collection of orbital receivables, (ii) a $41 million increase in accounts payable due primarily to the timing of satellite related payments, including the start up of the three new satellite programs in the fourth quarter of 2003 and unpaid prepetition liabilities, (iii) a $34 million decrease in other current assets and other assets primarily resulting from a decrease in prepaid insurance and pension costs recorded in 2003, (iv) a $32 million decrease in contracts-in-process primarily resulting from net collections on customer contracts, (v) a $50 million increase in customer advances primarily due to the start up of the three new satellite programs in the fourth quarter of 2003 and (vi) a $26 million decrease in deposits primarily arising from the assignment of launch vehicles to satellite programs. These factors were offset by a decrease in long-term liabilities of $20 million due primarily to a decrease in deferred revenue and the settlement of the guaranteed residual value of a leased asset and net loss as adjusted for non-cash items of $30 million.
Net cash provided by operating activities for 2002 was $193 million, due primarily to (i) net income as adjusted for non-cash items of $155 million, (ii) a $97 million decrease in contracts-in-process resulting from net collections on customer contracts and (iii) a $59 million decrease in deposits arising primarily from the assignment of launch vehicles to satellite programs. Offsetting factors include an $89 million decrease in accounts payable due primarily to the timing of satellite related payments and a $35 million decrease in customer advances due primarily to progress on satellite programs.
Net Cash Used in Investing Activities
Net cash used in investing activities was $150 million for 2003, primarily reflecting capital expenditures of $177 million mainly for the construction of satellites, and investments in and advances to affiliates of $19 million (primarily for XTAR), offset by proceeds of $46 million from the sale of Sirius common stock.
Net cash used in investing activities was $139 million for 2002, primarily reflecting capital expenditures of $98 million mainly for the construction of satellites, and investments in and advances to affiliates of $41 million (including $29 million for XTAR).
Net Cash Provided by (Used in) Financing Activities
Net cash provided by financing activities in 2003 was $1 million, primarily due to net borrowings under revolving credit facilities of $71 million, offset by debt amortization payments of $70 million (including $31 million of interest payments on our 10% senior notes) and payment of bank amendment costs of $5 million.
Net cash used in financing activities in 2002 was $148 million, primarily due to debt amortization payments of $133 million (including $46 million of interest payments on our 10% senior notes) and net cash used in equity transactions of $33 million (primarily dividend related payments), offset by net borrowings under revolving credit facilities of $18 million.
Equity
On June 4, 2003, our Board of Directors approved a reverse stock split of our common stock at a ratio of one-for-ten, resulting in a new par value of $0.10 per common share (previously $0.01 par value per common share). The reverse stock split became effective after the close of business on June 13, 2003. All references to common stock and per share amounts for all periods presented have been retroactively restated to reflect this reverse stock split.
Other
For 2003, our qualified pension plan, under the Internal Revenue Code and its regulations, was considered fully funded (i.e. assets are greater than liabilities) and there was no contribution required to be made in 2003. During 2004, based on current estimates, we expect to contribute $13 million to the qualified pension plan and expect to fund $3 million for other employee benefit plans.
Affiliate Matters
Loral has made certain investments in joint ventures in the satellite services business that are accounted for under the equity method of accounting. See Note 7 to the consolidated financial statements and Commitments and Contingencies in this Management’s Discussion and Analysis of Results of Operations and Financial Condition for further information on affiliate matters.
Our consolidated statements of operations reflect the effects of the following amounts related to transactions with or investments in affiliates (in millions).
Our revenues from affiliates have declined from 2001 to 2003, primarily because satellite construction programs are nearing completion. We expect that revenues from affiliates will continue to decline for the foreseeable future.
XTAR, L.L.C.
XTAR, a joint venture between Loral and Hisdesat Servicios Estrategicos, S.A. (“Hisdesat”), a consortium comprised of leading Spanish telecommunications companies, including Hispasat, S.A., and agencies of the Spanish government, is constructing and plans to launch an X-band satellite in 2004 to provide X-band services to government users in the United States, Spain, and other friendly and allied nations. XTAR is owned 56% by Loral (accounted for under the equity method since we do not control certain significant operating decisions) and 44% by Hisdesat. For more information on XTAR, see Note 7 to the consolidated financial statements.
Commitments and Contingencies
Our business and operations are subject to a significant number of risks, the most significant of which are summarized below.
I.
Financial Risk Factors
We filed for bankruptcy protection on July 15, 2003 and are subject to its associated risks and uncertainties.
The Chapter 11 Cases could adversely affect relationships with our customers, suppliers and employees. This in turn could adversely affect the going concern value of the business and of its assets, particularly if the Chapter 11 Cases are protracted. Also, transactions outside the ordinary course of business will be subject to the prior approval of the Bankruptcy Court which may limit our ability to respond to certain market events or take advantage of certain market opportunities, and, as a result, our operations could be materially adversely affected.
As a result of the Chapter 11 Cases, all $2.0 billion principal amount of our debt has been accelerated. During the pendency of the Chapter 11 Cases, we have not paid, and will not pay, interest on $1.05 billion of our unsecured debt. Although we and our Debtor Subsidiaries expect to file a plan or plans of reorganization that provide for emergence from Chapter 11 reorganization sometime in 2004, we cannot now describe the components or features of the plan, including whether the plan will provide for creditors to be paid in whole or in part or whether consideration they will receive will consist of cash, debt, equity or some combination thereof. In addition, there can be no assurance that we will be able to propose a plan, obtain court approval of any plan we propose, obtain acceptances from the number of creditors necessary to confirm a plan, or actually confirm and consummate a plan.
We anticipate that, in any plan of reorganization ultimately confirmed by the Bankruptcy Court, our common and preferred stock will, at best, be severely diluted and may be eliminated entirely, with the result that common and preferred stockholders would receive no distribution.
Our emergence from Chapter 11 reorganization depends on the success of our business plan and our ability to generate enough cash to pay our obligations and fund our operations.
We intend to reorganize around our remaining fleet of international satellites and our satellite manufacturing operations. As discussed in our Overview, we operate in highly competitive markets. Our overall financial condition and outstanding debt, and that of our subsidiaries, are factors that potential customers will consider prior to contracting for satellite services or making a satellite procurement decision. Our success depends on our ability to respond to these financial concerns and perform on a cost-effective and timely basis.
There may be certain tax implications upon our emergence from Chapter 11 reorganization.
As of December 31, 2003, our U.S. subsidiaries had net operating loss carryforwards, or NOLs, of approximately $1.5 billion that can be used to offset future taxable income, including the tax gain that will be recognized upon the sale of our satellite assets serving the North American market to Intelsat. Our ability to use these NOLs, however, may be impaired in the future, depending upon various factors relating to our plan of reorganization such as how creditor claims are satisfied, how the equity interests in the reorganized company are distributed, the extent of any capital infusion by new investors, and our value and level of debt at
the time we emerge from bankruptcy, which are all unknown factors at this time. Moreover, if it is determined that an “ownership change” occurred in the three-year period preceding our emergence from bankruptcy, future use of these NOLs would be severely limited. An ownership change would be triggered if shareholders owning 5% or more of our total equity value change their holdings during this three-year period by more than 50% in the aggregate. On August 22, 2003, the Bankruptcy Court entered an order to assist us in protecting our NOLs by establishing procedures that require certain proposed acquirers of our securities to notify us about a prospective acquisition, thus giving us an opportunity to file an objection with the Bankruptcy Court if we deem necessary. There is no guarantee that the Bankruptcy Court will rule in our favor in the event of a dispute between a proposed acquirer and us. A ruling against us could jeopardize a substantial portion of our NOLs.
We may lose our investment stake in Satmex.
As of August 1, 2003, Satmex, our 49%-owned Mexican affiliate, ceased paying interest on its unsecured debt, constituting a default under all of its debt agreements. The potential acceleration of Satmex’s debt of $524 million and the shortfall of cash flow to pay interest could force Satmex to file for bankruptcy protection under Chapter 11 in the United States or reorganization under Mexican law or both. Following such a proceeding, our investment in Satmex would likely be worthless.
In addition to Satmex’s debt, Servicios Corporativos Satelitales, S.A. de C.V. (“Servicios”), the parent company of Satmex, has defaulted on its debt obligation. Loral and Principia had previously pledged their respective shares in Servicios’ parent company, the primary vehicle through which our equity interest in Satmex is held, as collateral for Servicios’ debt obligation. These shares are now subject to foreclosure by the Mexican government. See Note 7 to the consolidated financial statements.
II.
Operational Risk Factors
Launch failures have delayed some of our operations in the past and may do so again in the future.
We depend on third parties, in the United States and abroad, to launch our satellites. Satellite launches are risky, and some launch attempts have ended in complete or partial failure. We ordinarily insure against launch failures, but at considerable cost. The cost and the availability of insurance vary depending on market conditions and the launch vehicle used. Our insurance typically does not cover business interruption; launch failures may therefore result in uninsured economic losses. Replacing a lost satellite typically requires at least 24 months from contract execution to launch.
For example, on January 10, 2004, Loral’s Telstar 14/ Estrela do Sul-1 communications satellite was launched by Boeing Sea Launch, but only partially deployed its North solar array. Although insured for partial and total losses up to a maximum of $250 million, the failed solar array deployment has resulted in only 10 to 14 ku-band transponders currently being available to customers, which will impact the roll out of our Brazilian business and will reduce operating revenues pending construction of a replacement satellite.
After launch, our satellites remain vulnerable to in-orbit failures which may result in reduced revenues and profits and other financial impact.
In-orbit damage to or loss of a satellite before the end of its expected life results from various causes, some random, including component failure, degradation of solar panels, loss of power or fuel, inability to maintain the satellite’s position, solar and other astronomical events, and space debris. Satellites are built with redundant components to permit their continued operation in case of a component failure. Certain of our satellites are currently operating using back-up components because of the failure of primary components. If these back-up components fail and the primary components cannot be restored, these satellites could lose capacity or be total losses resulting in a loss of revenues and profits. Repair of satellites in space is not feasible.
For example, in September 2003 the high voltage bus on Loral’s Telstar 4 satellite short circuited, causing it to cease operations. The satellite was insured for $141 million. The agent for the secured lenders of Loral SpaceCom is named as the loss payee on the Telstar 4 insurance policy. Under Loral’s agreement to sell its satellite assets serving the North American market to Intelsat as previously discussed, the purchase price for those assets will be reduced by any Telstar 4 insurance proceeds received prior to closing, net of any
payments by Loral to customers for warranty claims. Moreover, to the extent that the insurance proceeds actually received are less than $141 million, our recent amendment to the Intelsat purchase agreement would provide for a dollar-for-dollar reduction in the price paid by Intelsat under its new satellite construction contract with SS/ L. For further details see Note 2 to the consolidated financial statements.
Loral Skynet has in the past entered into prepaid leases, sales contracts and other arrangements relating to transponders on its satellites. Under the terms of these agreements, Loral Skynet may be required to replace transponders that do not meet operating specifications. Failure to replace such transponders may result in a payment obligation on the part of Loral Skynet.
Some satellites built by SS/ L, including six satellites operated by subsidiaries or affiliates of Loral, have experienced minor losses of power from their solar arrays.
Fourteen satellites built by SS/ L have experienced minor losses of power from their solar arrays. None of these, however, have exhibited any performance problems but there can be no assurance that one or more will not experience an additional power loss that could lead to a loss of transponder capacity and performance degradation. A partial or complete loss of a satellite could result in a loss of orbital incentive payments to SS/L and a loss of revenues and profits for Loral Skynet or other affiliates. SS/ L has instituted remedial measures to prevent similar anomalies from occurring on satellites under construction or in development. For further details see Note 17 to the consolidated financial statements.
It may be difficult to obtain full insurance coverage for satellites that have, or are part of a family of satellites that has, experienced problems in the past.
We cannot assure that, upon the expiration of an insurance policy, we will be able to renew the policy on terms acceptable to us. Insurers may require either exclusions of certain components or may place similar limitations on coverage in connection with insurance renewals for such satellites in the future. An uninsured loss of a satellite would have a material adverse effect on our financial performance. For further details see Note 17 to the consolidated financial statements.
Like other satellite operators, we are faced with increased launch and in-orbit insurance premiums and shorter coverage periods.
Insurers also have made more stringent the coverage terms of our launch and in-orbit insurance. At the same time, the cost of obtaining this insurance has increased significantly. While these developments in the insurance industry have increased our cost of doing business there can be no assurance that we will be able to pass the cost on to our customers. For further details see Note 17 to the consolidated financial statements.
Our satellite services businesses compete with other providers for market share and customers.
We face heavy competition in the transponder leasing business from companies such as PanAmSat Corporation, SES Global, New Skies, Intelsat and Eutelsat. Competition puts downward pressure on prices and may result in the reduced utilization of our fleet capacity, both of which may have an adverse effect on our financial performance.
Furthermore, upon closing of the Intelsat transaction, we will be prohibited, subject to certain exceptions, for two years following the closing, from engaging in the following activities:
•
Leasing or otherwise providing satellite services transponder capacity (other than for our network services business) to a customer for transmission within the United States;
•
Locating a satellite in the orbital arc between 54 degrees W.L. and 143 degrees W.L. for the purpose of engaging in the prohibited service; and
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Soliciting existing customers on the satellite fleet serving the North American market to migrate their service to our satellites.
Our transponder leasing business also competes with fiber optic cable and other terrestrial delivery systems, which have a cost advantage in point-to-point applications. Competition in this sector has increased because there is an over-supply of transponders in the global market, existing customers are using less capacity
and fewer new customers are entering the market than in past years. Moreover, we have had a higher rate of customer defaults than in previous years, a trend, if it continues, that may further increase overcapacity.
Similarly, our network services business faces competition not only from other satellite-based providers, but also from providers of land-based data communications services, such as cable, DSL (digital subscriber line), wireless local loop and traditional telephone service providers. We will face further price pressure from these companies as they continue to compete for our Internet services.
As land-based telecommunications services expand and become more sophisticated, demand for some satellite-based services may be reduced. New technology could render satellite-based services less competitive by satisfying consumer demand in other ways or through the use of incompatible standards. We also compete for local regulatory approval in places where more than one provider may want to operate, and for scarce frequency assignments and fixed orbital positions.
The satellite manufacturing market continues to be highly competitive.
Space Systems/ Loral competes with several large, well-capitalized companies such as: Boeing and Lockheed Martin in the United States, and Alcatel and Astrium in Europe. In 2003, orders were placed for 18 commercial GEO satellites, an improvement over 2002 when only one of the seven orders placed was subject to a competitive bidding process. This compares to approximately 25 to 30 awards across the industry in each of 2001 and 2000. U.S. satellite manufacturers also must contend with export control regulations that put them at a disadvantage when competing for foreign customers. SS/ L, which had not won an order since December 2001, received orders and authorizations to proceed for four satellites in the fourth quarter of 2003 (including the expected Intelsat order) as the market began to improve. If SS/ L is not successful in sustaining a similar order rate and increasing its backlog this year and beyond, our financial performance would be materially and adversely affected.
SS/ L’s contracts are subject to adjustments, cost overruns and termination.
SS/ L’s accounting for long-term contracts requires adjustments to profit and loss based on estimates revised during the execution of the contract. These adjustments may have a material effect on our consolidated financial position and our results of operations in the period in which they are made. The estimates giving rise to these risks, which are inherent in long-term, fixed-price contracts, include the forecasting of costs and schedules, contract revenues related to contract performance, and the potential for component obsolescence due to procurement long before assembly.
SS/ L’s major contracts are primarily firm fixed-price contracts under which work performed and products shipped are paid for at a fixed price without adjustment for actual costs incurred. While cost savings under these fixed-price contracts would result in gains to SS/ L, cost increases would result in losses borne solely by SS/ L. Under such contracts, SS/ L may receive progress payments, or it may receive partial payments upon the occurrence of certain program milestones. Moreover, some of SS/ L’s customers are start-up companies, and there can be no assurance that these companies will be able to fulfill their payment obligations under their contracts with SS/ L.
SS/ L’s contracts are terminable for default for non-performance, including schedule delays. In that event, SS/ L is generally obligated to refund to the customer all payments received plus penalties, and SS/ L may be liable for damages. A termination for default could have a material adverse effect on SS/ L and us.
In addition, many of SS/ L’s contracts and subcontracts may be terminated at will by the customer or the prime contractor. In the event of such a termination, SS/ L is normally entitled to recover the purchase price for delivered items, reimbursement for allowable costs for work in process, and an allowance for profit or an adjustment for loss, depending on whether completion of the project would have resulted in a profit or loss. Such terminations may occur in the future.
SS/ L may forfeit payments from customers as a result of satellite failures or losses after launch, or may be liable for penalty payments under certain circumstances, and these losses may be uninsured.
Some of SS/ L’s satellite manufacturing contracts provide that some of the total price is payable as “incentive” payments earned over the life of the satellite. SS/ L generally does not insure for these payments and in some cases agrees with its customers not to insure them.
SS/ L records the present value of incentive payments as revenue during the construction of the satellite. SS/ L generally receives the present value of these incentive payments if there is a launch failure or a failure caused by customer error. SS/ L forfeits some or all of these payments, however, if the loss is caused by satellite failure or as a result of its own error.
Some of SS/ L’s contracts call for in-orbit delivery, transferring the launch risk to SS/ L. SS/ L generally insures against that exposure. In addition, some of SS/ L’s contracts provide that SS/ L may be liable to a customer for penalty payments under certain circumstances, including late delivery or that a portion of the price paid by the customer are subject to “warranty payback” in the event satellite anomalies were to develop (see Note 17 to the consolidated financial statements). These contingent liabilities are not insured by SS/ L.
We are subject to export controls, which may result in delays and additional costs. SS/ L is still awaiting approval for the launch of ChinaSat 8.
SS/ L is required by the U.S. State Department to obtain licenses and enter into technical assistance agreements to export satellites and related equipment, and to disclose technical data to foreign persons. The delayed receipt of or the failure to obtain the necessary licenses and agreements may interrupt the completion of a satellite contract by SS/ L and could lead to a customer’s cancellation of a contract, monetary penalties and/or the loss of incentive payments. For example, SS/ L completed construction of the ChinaSat 8 satellite in December 1998 but the launch of the satellite has been delayed pending the necessary approvals from the State Department. If, as a result of the delay, ChinaSat were to terminate its contract with SS/ L, it could seek a refund of $82 million for payments made to SS/ L for the satellite as well as up to $11 million in penalties. Moreover, there can be no assurance that an agreement to release SS/ L from $52.5 million of potential liabilities relating to the launcher will be completed. For further details see Note 17 to the consolidated financial statements.
Some of our customers and potential customers, along with insurance underwriters and brokers have raised concerns that U.S. export control laws and regulations excessively restrict their access to information about the satellite during construction and on-orbit. To the extent that our non-U.S. competitors are not subject to these export control laws and regulations, they may enjoy a competitive advantage with foreign customers, and, to the extent that our foreign competitors continue to gain market share, it could become increasingly difficult for the U.S. satellite manufacturing industry, including SS/ L, to recapture this lost market share.
Our business is regulated, causing uncertainty and additional costs.
Multiple authorities regulate our business, including the Federal Communications Commission, the International Telecommunication Union (ITU) and the European Union. Regulatory authorities can modify, withdraw or impose charges or conditions upon, or deny or delay action on applications for, the licenses we need, and so increase our costs.
To prevent frequency interference, the regulatory process requires potentially lengthy and costly negotiations with third parties who operate or intend to operate satellites at or near the locations of our satellites. For example, as part of our coordination effort on Telstar 12, we agreed to provide four 54 MHz transponders on Telstar 12 to Eutelsat for the life of the satellite and have retained risk of loss with respect to those transponders. We also granted Eutelsat the right to acquire, at cost, four transponders on the replacement satellite for Telstar 12. We are in discussions with various administrations regarding Telstar 12’s continued operation at 15 degrees W.L. If these coordination discussions are not successful, Telstar 12’s useable capacity may be reduced.
Failure to successfully coordinate our satellites’ frequencies or to resolve other required regulatory approvals could have an adverse effect on our consolidated financial position and our results of operations. For further details, see Note 17 to the consolidated financial statements.
We face risks in conducting business internationally.
For the year ended December 31, 2003, approximately 29% of our revenue was generated from customers outside of the United States. We could be harmed financially and operationally by changes in foreign regulations and telecommunications standards, tariffs or taxes and other trade barriers. Almost all of our contracts with foreign customers require payment in U.S. dollars, and customers in developing countries could have difficulty obtaining U.S. dollars to pay us due to currency exchange controls and other factors. Exchange rate fluctuations may adversely affect the ability of our customers to pay us in U.S. dollars. If we need to pursue legal remedies against our foreign business partners or customers, we may have to sue them abroad where it could be difficult for us to enforce our rights.
We share control of our affiliates with third parties.
Third parties have significant ownership, voting and other rights in our affiliates. As a result, we do not have control over management of these entities. The rights of these third parties and fiduciary duties under applicable law could result in others acting or omitting to act in ways that are not in our best interest. To the extent that these entities are or become customers of SS/ L, these conflicts could become acute. For example:
•
Primary control of Satmex is vested in Mexican nationals, as required by Mexican law, subject to certain approval rights that we retain.
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Hisdesat enjoys certain approval rights in XTAR, our X-band joint venture.
We rely on key personnel.
We need highly qualified personnel. Except for Bernard L. Schwartz, our Chairman and Chief Executive Officer, none of our officers has an employment contract nor do we maintain “key man” life insurance. The departure of any of our key executives could have an adverse effect on our business.
III.
Other Risks
Litigations and disputes. We are involved in a number of ongoing litigations. For further details see Item 3, Legal Proceedings. In addition, we are involved in a number of disputes which may not be resolved without recourse to litigation. For example, International Launch Services claims that it is entitled to termination charges of up to $54.75 million with respect to three terminated launches. For further details, see Note 17 to the consolidated financial statements. If any of these litigations or disputes are decided against us it could have a material adverse affect on our financial condition and our results of operation.
Globalstar. In April 2003, one of Globalstar’s creditors filed a motion seeking reconsideration of court approval of an agreement between Loral and Globalstar and Globalstar’s official creditor’s committee in which, among other things, Globalstar granted to Loral, subject to certain conditions, a general release of all claims Globalstar might have against Loral. The court denied this motion for reconsideration in May 2003, and, in June 2003, the creditor filed with the Federal Appeals Court a notice of appeal of the court’s order approving the Settlement. Although the Company believes that the appeal, which is currently pending, is without merit, no assurance can be given in this regard or as to what relief, if any, might be granted in the event the appeal were to be successful.
Shareholder Rights. Since we are a Bermuda company, the principles of law that govern shareholder rights, the validity of corporate procedures and other matters are different from those that would apply if we were a U.S. company. For example, it is not certain whether a Bermuda court would enforce liabilities against us or our officers and directors based upon United States securities laws either in an original action in Bermuda or under a United States judgment. Bermuda law giving shareholders the right to sue directors is less developed than in the United States and may provide fewer rights.
Other Matters
Accounting Pronouncements
During 2003, we adopted certain new accounting pronouncements (see Consolidated Operating Results - Cumulative Effect of Change in Accounting Principle above). There are also other pronouncements that have been issued, but are not yet required to be adopted (see Note 3 to the consolidated financial statements).
On January 1, 2002, we adopted SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS 142”) which addresses the initial recognition and measurement of intangible assets acquired outside of a business combination and the accounting for goodwill and other intangible assets subsequent to their acquisition. Our net loss for the year ended December 31, 2001, without the amortization of goodwill would have been $169.8 million, as adjusted, as compared to $196.5 million as reported. The decrease of $26.6 million would have lowered the reported loss per share from $8.56 to $7.74, as adjusted.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk
Foreign Currency
Upon filing Chapter 11, SS/ L’s hedges with counterparties (primarily yen denominated forward contracts) were cancelled leaving SS/ L vulnerable to foreign currency fluctuations in the future. The inability to enter into forward contracts exposes SS/ L’s future revenues, costs and cash associated with anticipated yen denominated receipts and payments to currency fluctuations. As of December 31, 2003, SS/ L had the following amounts denominated in Japanese Yen that were unhedged (in millions):
At December 31, 2003, SS/ L also had future expenditures in EURO’s of $1.5 million ($1.8 million U.S.) that were unhedged.
Interest
As of December 31, 2003, our primary interest rate exposure was from loss of earnings and cash flow that could result from the movement in market rates on its bank debt of $967 million, which had a blended interest rate of 5.47%. As a result of our Chapter 11 filing, all $2.2 billion of our debt has been accelerated and is included in liabilities subject to compromise.
As of December 31, 2002, approximately 58% of our outstanding debt had fixed interest rates. In 2002, we strived to manage our interest rate risk by balancing the composition of our fixed versus variable rate borrowings combined with the monitoring of the overall level of borrowings and did not actively manage our interest rate risk through the use of derivatives or other financial instruments.
As of December 31, 2003, the carrying value of our debt obligations was $2.2 billion and the fair value of such debt was $1.7 billion. As of December 31, 2002, the carrying value of our long-term debt was $2.2 billion and the fair value of such debt was $1.3 billion. The fair value of our debt obligations is based on the carrying value for those obligations that have short-term variable interest rates on the outstanding borrowings and quoted market prices for obligations with long-term or fixed interest rates (the fair value for the Loral Orion 11.25% and 12.5% senior notes was based on the quoted market price of the Loral Orion 10% senior notes, as there was no active market for those senior notes). Approximately $214 million and $245 million of the difference between the carrying amount and the fair value of our debt obligations as of December 31, 2003 and 2002, respectively, is attributable to the accounting for the Loral Orion exchange offers (see Note 10 to the consolidated financial statements).
Item 8.
Item 8.
Financial Statements and Supplementary Data
See Index to Financial Statements and Financial Statement Schedules on page.
Item 9.
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable.
Item 9A.
Item 9A.
Disclosure Controls and Procedures
(a) Disclosure controls and procedures. Our chief executive officer and our chief financial officer, after evaluating the effectiveness of our “disclosure controls and procedures” (as defined in the Securities and Exchange Act of 1934 Rules 13a-15(e) and 15-d-15(e)) as of December 31, 2003, have concluded that, our disclosure controls and procedures were effective and designed to ensure that material information relating to Loral and its consolidated subsidiaries required to be in our filings under the Securities and, Exchange Act of 1934 would be made known to them by others within those entities in a timely manner.
(b) Internal controls over financial reporting. There were no significant changes in our internal controls over financial reporting (as defined in the Securities and Exchange Act of 1934 Rules 13a-15(f) and 15-d-15(f)) during the most recent fiscal quarter that we judge to have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART III
Item 10.
Item 10.
Directors and Executive Officers of the Registrant
Directors
The following sets forth information concerning Loral’s directors as of March 1, 2004.
In addition to the Chapter 11 Cases commenced on July 15, 2003 by Loral and certain of its subsidiaries, as disclosed earlier in this report, on February 15, 2002, Globalstar and certain of its subsidiaries, Loral/ Qualcomm Satellite Services, L.P., the managing general partner of Globalstar, its general partner, Loral/ Qualcomm Partnership, L.P., and certain of Loral’s subsidiaries that serve as general partners of Loral/ Qualcomm Partnership, L.P. filed voluntary petitions with the Delaware bankruptcy court. Messrs. Schwartz and Zahler either currently serve or have previously served as executive officers of these general partner entities and Globalstar and certain of its subsidiaries.
In August 2002, Loral’s Board of Directors approved a plan to suspend indefinitely the future payment of dividends on Loral’s two series of preferred stock. Accordingly, Loral deferred the payment of quarterly dividends due on its Series C Preferred Stock commencing on November 1, 2002 and the payment of quarterly dividends due on its Series D Preferred Stock commencing on November 15, 2002. Because we have failed to pay dividends on the Series C and the Series D preferred stock for six quarters, holders of the majority of each class of such preferred stock are now entitled, subject to the applicable effects of the Chapter 11 Cases and Loral’s Bermuda insolvency proceedings, to elect two additional members, for a total of four, to Loral’s Board of Directors.
Audit Committee
The Board of Directors has a standing Audit Committee, the members of which are Messrs. Ruderman, Shapiro and Simon. The Board of Directors has determined that Mr. Simon meets the requirements of a financial expert within the meaning of Section 401(h) of Regulation S-K because of Mr. Simon’s business experience as a former partner of Coopers & Lybrand L.L.P., Certified Public Accountants. The Board of Directors has further determined that Mr. Simon is independent, within the meaning of Schedule 14A under the Securities Exchange Act of 1934, as amended.
Executive Officers of the Registrant
The following table sets forth information concerning the executive officers of Loral as of March 1, 2004.
In addition to being officers and directors of Loral and its subsidiaries, Messrs. Schwartz, Zahler, Townsend, Katz, Mastoloni and Rein and Ms. Yeung either currently serve or have previously served as executive officers of Globalstar and certain of its subsidiaries, Loral/ Qualcomm Satellite Services, L.P., the managing general partner of Globalstar, its general partner, Loral/ Qualcomm Partnership, L.P., and certain of Loral’s subsidiaries that serve as general partners of Loral/ Qualcomm Partnership, L.P., which entities filed voluntary petitions with the Delaware bankruptcy court on February 15, 2002.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our executive officers, directors and persons who own more than 10% of our common stock, to file reports with the Securities and
Exchange Commission and based solely on a review of the copies of such reports furnished to us and on written representations from certain reporting persons that no Form 5 was required for such person, Loral believes that during 2003 all executive officers, directors and persons who own more than 10% of Loral’s common stock timely filed all such reports as required to be filed under Section 16(a) of the Securities Exchange Act of 1934, as amended.
Code of Ethics
The Company has adopted a Code of Ethics for all of its employees, including its executive officers. A copy of this Code of Ethics has been filed as an exhibit to this report. This Code of Ethics is also available on Loral’s web site at www.loral.com. Any amendments or waivers to this Code of Ethics with respect to the Company’s principal executive officer, principal financial officer, principal accounting officer or controller (or persons performing similar functions) will be posted on such web site. One may also obtain, without charge, a copy of this Code of Ethics by contacting the Company’s Investor Relations Department at (212) 338-5345.
Item 11.
Item 11.
Executive Compensation
Executive Compensation
The Company has entered into a management agreement with Loral SpaceCom pursuant to which Loral SpaceCom provides certain services to the Company. In accordance with this agreement, compensation for the named executive officers (“NEOs”) and other executive officers and employees of the Company is paid by Loral SpaceCom. The following table summarizes the compensation paid to the NEOs.
(a)
For 2003, includes annual Board of Directors fee in the amount of $25,000 to each of Messrs. Schwartz and Zahler and Company matching contributions to the Savings Plan in the amount of $7,200 for each of Messrs. Schwartz, Zahler, Townsend and Katz, $8,000 for Mr. Hart and $7,197 for Mr. DeWitt and the value of supplemental life insurance premiums in the amounts of $21,746, $14,235, $4,689 and $8,721 for Messrs. Zahler, Townsend, Hart and Katz, respectively.
(b)
At Mr. Schwartz’s request, the Compensation Committee of the Board of Directors agreed to amend his employment agreement to provide for no base salary for the twelve-month period commencing March 1, 2003. Salary paid in 2003 is for the period of January 1, 2003 through February 28, 2003.
(c)
Represents the aggregate incremental cost to Loral for use of Loral’s corporate jet by Mr. Schwartz.
(d)
For 2002, represents a $275,000 one-time cash bonus payment to Mr. Hart on the fifth anniversary of the closing date of the purchase by Loral of Loral Skynet from AT&T.
(e)
Consists of $68,605 for Mr. Hart for a tax gross-up on his restricted stock award and the Company’s medicare match on this income of $995.
(f)
Represents the market value on 30,000 shares of restricted stock granted to Mr. Hart on March 6, 2003 for performance in 2002. Such shares had a market value of $6,300 based on the closing price of Loral’s common stock at December 31, 2003. The restrictions lapse on the third anniversary of the date of grant. This is the only restricted stock grant that has been awarded to Mr. Hart and represents his entire restricted stock holdings at year-end.
(g)
Mr. DeWitt will receive payments under a key employee retention program in lieu of his 2003 bonus.
(h)
Consists of $146,150 for Mr. DeWitt for a tax gross-up on his restricted stock award and the Company’s medicare match on this income of $2,119.
(i)
Represents the market value on 40,000 shares of restricted stock granted to Mr. DeWitt on December 18, 2002. Such shares had a market value of $8,400 based on the closing price of Loral’s common stock at December 31, 2003. The restrictions lapse on the third anniversary of the date of grant. This is the only restricted stock grant that has been awarded to Mr. DeWitt and represents his entire restricted stock holdings at December 31, 2003.
Other Compensation Arrangements
Mr. Schwartz is compensated pursuant to an employment agreement with Loral SpaceCom. This agreement, which expires on April 5, 2006, provides for a minimum annual base salary, to be increased each year by the percentage change in a specified consumer price index, plus such other annual increases as the Board of Directors or the Compensation Committee may grant from time to time. At Mr. Schwartz’s request, the Compensation Committee agreed to amend his employment agreement to provide for no base salary for the twelve-month period commencing March 1, 2003. Effective March 1, 2004, Mr. Schwartz resumed receiving a base salary in accordance with his employment agreement.
Pursuant to the amended employment agreement, if Mr. Schwartz is removed as Chairman of the Board of Directors or as Chief Executive Officer other than for cause, or if his duties, authorities or responsibilities are diminished, or if there is a change of control of the Company, Mr. Schwartz may elect to terminate the agreement. A change of control of the Company is defined generally to mean: (1) the acquisition by any person of 35% or more of either (i) the then outstanding common stock or (ii) the combined voting power of the then outstanding voting securities of the Company entitled to vote generally in the election of directors; (2) the incumbent directors cease for any reason to constitute at least a majority of the Board of Directors; (3) subject to certain exceptions, consummation of a reorganization, consolidation, merger or sale of substantially all of the assets of the Company; or (4) approval by the shareholders of the Company of a liquidation or dissolution of the Company. In any such event, or upon his death or disability, Mr. Schwartz will be entitled to receive a lump sum payment discounted at 3% per annum, in an amount equal to his highest annual base salary during the five years prior to his termination for a five-year period, an amount of incentive bonus equal to the highest bonus received by Mr. Schwartz during the term of the agreement for a five-year period, and an amount calculated to approximate the annual compensation elements reflected in the difference between fair market value and exercise price of stock options granted to Mr. Schwartz. All such sums are further increased to offset any tax due by Mr. Schwartz under the excise tax and related provisions of Section 4999 of the Internal Revenue Code.
Prior to 2003, Loral SpaceCom established a Supplemental Life Insurance Plan for certain key employees including Messrs. Schwartz, Zahler, Townsend, Hart and Katz. For Messrs. Zahler, Townsend, Hart and Katz, the Plan is funded with “universal” life insurance policies with death benefit amounts of $1,500,000, $1,000,000, $250,000 and $1,000,000, respectively. Mr. Schwartz’s Plan is funded with two “universal” life insurance policies, one with a death benefit of $500,000 (the “Policy”) and one with a death benefit of $20,000,000 (the “Split-Dollar Policy”). The Split-Dollar Policy is subject to a split-dollar agreement between Loral SpaceCom and the trustees of a life insurance trust (the “Trustees”) established by Mr. Schwartz (the “Life Insurance Trust”). Pursuant to the split-dollar agreement, upon the death of Mr. Schwartz, Loral SpaceCom, as sponsor of the Plan, would be entitled to reimbursement from the insurance proceeds of its cumulative contributions to the Split-Dollar Policy. If the split-dollar agreement
were to be terminated prior to Mr. Schwartz’s death, the sponsor would be entitled to the cash surrender value of the Split-Dollar Policy on the date of the termination. The Trustees may terminate the split-dollar agreement at any time, and this agreement will terminate if Mr. Schwartz’s employment with Loral SpaceCom is terminated for cause.
Loral SpaceCom suspended payments under both the Policy and the Split-Dollar Policy in 2002 and 2003 as a result of uncertainty as to whether such payments might be prohibited by the terms of the Sarbanes-Oxley Act, and in 2004, Mr. Schwartz agreed that Loral SpaceCom would not be required to make further payments thereunder. Instead, the Life Insurance Trust paid a total of approximately $955,350 in premium payments on the Split-Dollar Policy in 2003, funded through loans and gifts from Mr. Schwartz.
In December 2003, the United States Bankruptcy Court for the Southern District of New York approved a Key Employee Retention Program (“KERP”) for the Company in which, among others, Messrs. Zahler, Townsend and Katz are eligible to participate. The KERP provides that, in addition to the Company’s standard severance arrangements, if Messrs. Zahler, Townsend and Katz are terminated without cause during Loral’s Chapter 11 case, they will be entitled to a severance payment of up to 175% of their 2003 base salary. Mr. Schwartz does not participate in the KERP.
In connection with the KERP, Messrs. Zahler, Townsend and Katz have waived their rights and released the Company from any and all claims they might have under the employment protection agreements they had previously entered into with the Company.
Mr. Hart has an employment protection agreement that would provide him with certain protections in the event of a change of control of the Company. A change of control of the Company is defined generally to mean: (1) the acquisition by any person of 35% or more of either (i) the then outstanding common stock or (ii) the combined voting power of the then outstanding voting securities of the Company entitled to vote generally in the election of directors; (2) the incumbent directors cease for any reason to constitute at least a majority of the Board of Directors; (3) subject to certain exceptions, consummation of a reorganization, consolidation, merger or sale of substantially all of the assets of the Company; or (4) approval by the shareholders of the Company of a liquidation or dissolution of the Company. The agreement provides that, after a change of control, Mr. Hart would be entitled to certain protections relating to his responsibilities and duties, as well as compensation and benefits. In the event of a termination by the Company other than for “cause” or “disability” or a termination by Mr. Hart for “good reason,” in each case as such terms are defined therein, the agreement provides for a severance package consisting of: (i) Mr. Hart’s base salary through the date of termination; (ii) a cash amount equal to three times the sum of Mr. Hart’s base salary, annual bonus, the present value amount of the cost of certain benefit plans and programs in which Mr. Hart participates and the annualized value of his vacation and fringe benefits; and (iii) any deferred compensation and any other amounts or benefits then owing to Mr. Hart. In addition, under Loral Skynet’s standard severance arrangements, Mr. Hart would be entitled to receive a severance payment equal to 18 months of his base salary in the event of a termination.
Mr. DeWitt has an employment protection agreement that would provide him with certain protections in the event that his employment is terminated in connection with a change in control of SS/ L or Loral. A change in control under this agreement is defined generally to mean (i) a third party tender or exchange offer for common stock or securities convertible into common stock of SS/ L or Loral; (ii) subject to certain exceptions, an acquisition by any person of 20% or more of SS/ L’s or Loral’s voting power; (iii) a change in the composition of the board of directors of SS/ L or Loral so that the existing board members and their approved successors do not constitute a majority of the board; (iv) subject to certain exceptions, consummation of a merger or consolidation of SS/ L or Loral and (v) shareholder approval of either a liquidation or dissolution of, or sale of substantially all of the assets of, SS/ L or Loral. A change in control will not generally include a conversion of debt obligations to equity in connection with a plan of reorganization and any change in the board of directors resulting therefrom. This agreement provides that if Mr. DeWitt’s employment is terminated without “cause” or Mr. DeWitt terminates his employment for “good reason” any time within one year following a “change in control”, then Mr. DeWitt will be entitled to receive a cash payment equal to 1.5 times his annual base salary, together with the continuation of his medical and life insurance coverage for a
period expiring upon the earlier of 1.5 years or the date on which Mr. DeWitt starts receiving comparable benefits from another employer. This agreement further provides that if a “change in control” has not occurred by February 4, 2006, the agreement will terminate and have no further force or effect.
Option Exercises and Year-End Value Table
The following table presents the year-end values of options held by the NEOs. None of the NEOs exercised options during 2003. The Company granted no stock options in 2003.
Pension Plan
Loral maintains a defined benefit pension plan and trust (the “Pension Plan”) that is qualified under Section 401(a) of the Internal Revenue Code. The Pension Plan provides retirement benefits for eligible employees of Loral SpaceCom and Loral SpaceCom’s operating affiliates, including executive officers. Executive officers also participate in a supplemental executive retirement plan (the “SERP”) which provides supplemental retirement benefits to cover certain reductions in retirement benefits under the Pension Plan that are caused by various limitations imposed by the Internal Revenue Code. The benefit formulas differ by operating affiliate. Compensation used in determining benefits under the Pension Plan and SERP includes annual salary and bonus for executives employed by Loral SpaceCom Corporation and Loral Skynet and annual salary only for employees of SS/L. Compensation is the same salary and bonus as disclosed in the summary compensation table except for employees of SS/L. For these employees, the salary on December 31 is annualized and recognized as compensation for that year.
The benefit formula for executive officers employed by Loral SpaceCom, such as Messrs. Schwartz, Zahler, Townsend and Katz, for the period ending December 31, 1996 will generally provide an annual benefit equal to the greater of (A) or (B), where (A) equals (i) 1.2% of compensation up to the Social Security Wage Base and 1.45% of compensation in excess of the Social Security Wage Base for each year prior to the calendar year in which a participant completes 15 years of employment, plus (ii) 1.5% of compensation up to the Social Security Wage Base and 1.75% of compensation in excess of the Social Security Wage Base for the calendar year in which the participant has completed 15 years of employment and for each year thereafter; and (B) equals (i) 1.2% of average annual compensation paid during 1992-1996 up to the 1996 Social Security Wage Base and 1.45% of average annual compensation paid during 1992-1996 in excess of the 1996 Social Security Wage Base for each year prior to the calendar year in which a participant completes 15 years of employment, plus (ii) 1.5% of average annual compensation paid during 1992-1996 up to the 1996 Social Security Wage Base and 1.75% of average annual compensation paid during 1992-1996 in excess of the 1996 Social Security Wage Base for the calendar year in which the participant has completed 15 years of employment and for each year thereafter. The benefit for periods subsequent to December 31, 1996 will be based on (A) above. The estimated credited years of service through December 31, 2003 for Messrs. Schwartz, Zahler, Townsend and Katz are 31.75, 11.75, 5.25 and 7.37, respectively.
For executive officers employed by Space Systems/ Loral, such as Mr. DeWitt, the benefit formula for contributory service (in which a 1% post-tax contribution is required) provides an annual benefit equal to 1.3% of the final five year average salary times years of contributory service plus 0.45% of final five year average salary over 150% of the Social Security Covered Compensation for each year up to 35 years. The benefit formula for non-contributory service provides an annual benefit of $252 for each year of credited service. (See also the explanation
and table below.) The estimated credited years of service through December 31, 2003 for Mr. DeWitt is 30.25. The following table shows the amounts of annual retirement benefits that would be payable at normal retirement for executives who are employed by Space Systems/ Loral. Benefits are shown for various rates of final average salary, assuming that employee contributions were made for the periods indicated.
The table above shows estimated benefits payable under the Plan and SERP including amounts attributable to employee contributions, determined on a straight life annuity basis. Such estimated benefits shown have been offset by Social Security Covered Compensation.
Effective with the sale of Loral Skynet from AT&T to Loral on March 15, 1997, the benefit formula for executive officers employed by Loral Skynet, such as Mr. Hart, provides an annual benefit equal to 1.6% of compensation for each year of service. Service with AT&T preceding March 15, 1997 is recognized for eligibility and vesting purposes but not for benefit accrual. Mr. Hart’s estimated credited years of service with Loral Skynet through December 31, 2003 is 6.75.
Annual Benefits
Effective April 1, 1997, under the minimum distribution rules prescribed by the Internal Revenue Code, Mr. Schwartz began receiving an annual benefit under the Pension Plan and SERP of $2,165,700, determined on a joint and 50% survivor basis. In connection with the Chapter 11 Cases and subject to Bankruptcy Court approval, effective March 1, 2004, Mr. Schwartz agreed to forego current payment of his SERP benefits but will retain a claim for such benefits which will be addressed in the context of the Chapter 11 Cases. The projected annual benefit under the Pension Plan and SERP upon retirement is $378,727 for Mr. Zahler, $209,310 for Mr. Townsend, $91,045 for Mr. Hart, $206,102 for Mr. Katz and $174,478 for Mr. DeWitt. These projected benefits have been computed assuming that (i) employment will be continued until normal retirement, (ii) current levels of creditable compensation and the Social Security Wage Base will continue without increases or adjustments throughout the remainder of the computation period, (iii) contributions will continue to be made toward a contributory benefit and (iv) payments will be made on a life annuity basis.
Director Compensation
Directors are paid a fixed fee of $25,000 per year. Non-employee directors are also paid $6,000 for personal attendance or $2,000 for telephone participation at each meeting. In addition, the Chairman of the Audit Committee is paid $12,000 per year, and Audit Committee members are paid $4,000 per year. Audit Committee members are also paid $2,000 for personal attendance or $1,000 for telephone participation at each meeting. Compensation Committee members are paid an additional $2,000 per year and $1,000 for personal attendance or $500 for telephone participation at each meeting.
The Company provides certain life insurance and medical benefits to certain non-employee directors. For 2003, the cost of the life insurance benefits was $13,565 for Mr. Gittis, $14,553 for Mr. Kekst, $13,872 for
Mr. Ruderman, $15,000 for Mr. Shapiro, $12,500 for Mr. Simon and $14,170 for Mr. Yankelovich, and the cost of life insurance and medical benefits was $40,883 for Mr. Hodes.
Indemnification of Directors and Officers
The Company has purchased insurance from various insurance companies insuring the Company against obligations it might incur as a result of its indemnification of officers and directors for certain liabilities they might incur, and insuring such officers and directors for additional liabilities against which they might not be indemnified by the Company. The cost to the Company for the annual insurance premiums covering the period ending April 2004 was approximately $7,050,000. Pursuant to Bermuda law, the Company has entered into indemnity agreements with its directors and executive officers. These indemnity agreements are intended to provide the full indemnity protection authorized by Bermuda law.
Compensation Committee Interlocks and Insider Participation
The Board of Directors has a standing Compensation Committee comprised of Ms. Minard and Messrs. Shapiro and Simon. None of the members of such Compensation Committee are present or former officers or employed by the Company and its subsidiaries.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
On July 15, 2003, Loral and certain of its subsidiaries filed voluntary petitions for reorganization under chapter 11 of title 11 of the United States Code in the United States Bankruptcy Court for the Southern District of New York. The Company anticipates that, in any plan for reorganization ultimately confirmed by the Bankruptcy Court, the common and preferred stock of the Company, will, at best, be severely diluted and may be eliminated entirely, with the result that common and preferred stockholders would receive no distribution under such plan. Such a plan of reorganization would be deemed a change in control of the Company.
As of the date of this report, based upon filings made with the Securities and Exchange Commission, the Company is not aware of any persons who may be deemed beneficial owners of 5% or more of the outstanding shares of Loral’s common stock because they possessed or shared voting or investing power with respect to the shares of Loral’s common stock.
The following table shows the number of shares of Loral’s common stock beneficially owned by the directors, the NEOs and all directors, NEOs and all other executive officers as a group as of March 1, 2004 (except as
otherwise indicated). Individuals have sole voting and investment power over the stock unless otherwise indicated in the footnotes.
*
Represents holdings of less than one percent.
(1)
Includes shares which, as of March 1, 2004, may be acquired within sixty days pursuant to the exercise of options (which shares are treated as outstanding for the purposes of determining beneficial ownership and computing the percentage set forth) and shares held for the benefit of named executive directors as of February 16, 2004 in the Loral Savings Plan (the “Savings Plan”).
(2)
Except as noted, all shares are owned directly with sole investment and voting power.
(3)
Includes 16,000 shares owned by Mr. Schwartz’s wife, 718,000 shares exercisable under the Stock Option Plans and 2,599 shares held in the Savings Plan.
(4)
Includes 40,000 shares of restricted stock, 23,294 shares exercisable under the Stock Option Plans and 3,184 shares held in the Savings Plan.
(5)
Includes 25,340 shares exercisable under the Stock Option Plans.
(6)
Includes 30,000 shares of restricted stock, 11,312 shares exercisable under the Stock Option Plans and 2,752 shares held in the Savings Plan.
(7)
Consists of 2,000 shares held in Mr. Hodes’ IRA account, 200 shares held by Mr. Hodes’ minor children and 25,340 shares exercisable under the Stock Option Plans.
(8)
Includes 12,560 shares exercisable under the Stock Option Plans and 5,454 shares held in the Savings Plan..
(9)
Consists of 3,334 shares exercisable under the Stock Option Plans.
(10)
Consists of 25,000 shares of Series C Preferred Stock convertible into 6,250 shares of common stock owned by Mr. Shapiro’s wife and 25,340 shares exercisable under the Stock Option Plans.
(11)
Includes 2,975 shares held in Mr. Simon’s IRA account, 25 shares in his wife’s IRA account, 4,000 shares of Series C Preferred Stock convertible into 1,000 shares of common stock held in Mr. Simon’s IRA account and 25,340 shares exercisable under the Stock Option Plans.
(12)
Includes 2,500 shares of Series C Preferred Stock convertible into 625 shares of common stock, 46,664 shares exercisable under the Stock Option Plans and 2,872 shares held in the Savings Plan.
(13)
Includes 5,000 shares held in Mr. Zahler’s IRA account, 67,912 shares exercisable under the Stock Option Plans and 4,026 shares held in the Savings Plan.
(14)
Includes 31,500 shares of Series C Preferred Stock convertible into 7,875 shares of common stock, 1,172,718 shares exercisable under the Stock Option Plans and 44,902 shares held in the Savings Plan.
The following table presents all of the Company’s stock compensation plans previously approved and not previously approved by the Company’s shareholders:
(1)
Does not include 34,262 of outstanding options that Loral assumed in connection with the acquisition of Loral Orion. These options have a weighted-average exercise price of $155.07.
(2)
During the pendency of our Chapter 11 Cases, no grants of stock or stock options will be made under our employee benefit plans.
Equity Compensation Plan Not Approved by Security Holders: 2000 Stock Option Plan
The Company’s 2000 Stock Option Plan (the “2000 Plan”) was adopted by the Board of Directors on April 18, 2000. The 2000 Plan is a “broadly-based plan” as defined in Section 312.04(h) of the New York Stock Exchange Listed Company Manual, which provides that during any three-period at least 50% of grants thereunder exclude senior management. The 2000 Plan provides for the grant of non-qualified stock options and restricted stock. The total number of shares of common stock available under the 2000 Plan is 3,700,000, of which there are 2,114,569 shares remaining for future issuances.
Recipients of stock options under the 2000 Plan are selected by a committee (the “Committee”) consisting of at least two persons, appointed by the Board of Directors of the Company, each of whom must be an “outside director” for purposes of Section 162(m) of the Internal Revenue Code. The Committee determines the terms of each stock option grant, including (i) the purchase price of shares subject to options, (ii) the date on which each option becomes exercisable and (iii) the expiration date of each option (which may not exceed ten years from the date of grant). The terms and conditions of each grant are evidenced by a stock option agreement. The Committee has the power to accelerate the exercisability of outstanding stock options at any time.
The purchase price of the shares of common stock subject to stock options are fixed by the Committee, in its discretion, at the time options are granted; provided that in no event shall the per share purchase price be less than the lower of (i) 50% of the fair market value of a share of common stock on the date of grant and (ii) $20 below the aforesaid fair market value.
Optionees have no voting, dividend, or other rights as shareholders with respect to shares of common stock covered by options prior to becoming the holders of record of such shares. All option grants permit the purchase price to be paid in cash, by tendering stock, or by a brokered or “cashless” exercise.
Recipients of restricted stock under the 2000 Plan are selected by the Committee. The terms and conditions of each restricted stock grant are evidenced by a restricted stock agreement. The holder generally has the rights and privileges of a stockholder as to such restricted stock, including the right to vote such restricted stock. In addition to any other restrictions set forth in a holder’s restricted stock agreement, until the expiration of the applicable restricted period set forth in such restricted stock agreement, the holder is not permitted to sell, transfer, pledge or otherwise encumber the restricted stock. Stop transfer orders are entered with the Company’s transfer agent and registrar against the transfer of legended securities.
In the event that the outstanding shares of common stock are changed by reason of reorganization, merger, consolidation, recapitalization, reclassification, stock split, combination or exchange of shares and the like, or dividends payable in shares of common stock, an appropriate adjustment shall be made by the Committee in the aggregate number of shares of common stock available under the 2000 Plan and in the number of shares of common stock and price per share of common stock subject to outstanding stock options. If the Company shall be sold, reorganized, consolidated or merged with another corporation, or if all or substantially all of the assets of the Company shall be sold or exchanged (a “Corporate Event”), a holder shall at the time of issuance of the stock under such Corporate Event be entitled to receive upon the exercise of his option the same number and kind of shares of stock or the same amount of property, cash or securities as he would have been entitled to receive upon the occurrence of any such Corporate Event as if he had been, immediately prior to such event, the holder of the number of shares of common stock covered by his option; provided, however, that the Committee may, in its discretion, accelerate the exercisability of outstanding options, and shorten the term thereof, to any date within 30 days prior to or concurrent with the occurrence of such Corporate Event.
Restricted stock shall be adjusted as a result of a Corporate Event or changes in capitalization on the same basis as the common stock is adjusted in such events generally.
Item 13.
Item 13.
Certain Relationships and Related Transactions
Lockheed Martin
In connection with contract performance, Loral subsidiaries acquired services from Lockheed Martin for the year ended December 31, 2003. For 2003, the cost of services purchased by Loral subsidiaries from Lockheed Martin was $8,573,000, and such subsidiaries’ net payable to Lockheed Martin at December 31, 2003 was $2,590,000.
K&F Industries, Inc.
Loral SpaceCom has a management services agreement with K&F Industries (“K&F”), a company of which Bernard L. Schwartz is chief executive officer and a 50% owner, to provide administrative and certain other services to K&F. Under this agreement, K&F pays Loral SpaceCom a fee based on the cost of such services plus out of pocket expenses. In 2003, K&F paid Loral SpaceCom $382,000 under this agreement.
In addition, K&F charged the Company $19,000 in 2003 for certain expenses related to the Company’s use of K&F’s corporate jet.
Other Relationships
Robert B. Hodes, a Director and a member of the Executive Committee, is counsel to the law firm of Willkie Farr & Gallagher, which acts as counsel to the Company.
For the year ended December 31, 2003, the Company paid fees and disbursements in the amount of approximately $335,000 for corporate communications consultations and related services to Kekst and Company Incorporated, of which company Gershon Kekst, a Director and member of the Executive Committee, is President and the principal stockholder. Kekst and Company continues to render such services to the Company.
Item 14.
Item 14.
Principal Accountant Fees and Services
During 2003 and 2002, Deloitte & Touche LLP, the member firms of Deloitte Touche Tohmatsu, and their respective affiliates (collectively, the “Deloitte Entities”) provided the following services to the Company.
Audit Fees
The aggregate fees billed or expected to be billed by the Deloitte Entities for professional services rendered for the audit of the Company’s annual consolidated financial statements for the fiscal years ended December 31, 2003 and 2002, for the reviews of the condensed consolidated financial statements included in the Company’s Quarterly Reports on Form 10-Q for the 2003 and 2002 fiscal years, stand-alone and statutory audits of the Company’s subsidiaries and accounting research and consultation related to the audits and reviews, totaled approximately $2,789,000 and $1,875,000, respectively. The prior year’s fees include final additional billings agreed to with respect to the fiscal 2002 audits.
Audit-Related Fees
The aggregate fees billed by the Deloitte Entities for audit-related services for the fiscal years ended December 31, 2003 and 2002 were $233,000 and $50,000, respectively. The fees in 2003 related primarily to research and consultation on a transfer of interest transaction and various other filings with the Securities and Exchange Commission (“SEC”). The fees in 2002 related primarily to various filings with the SEC.
Tax Fees
The aggregate fees billed by the Deloitte Entities for tax-related services for the fiscal years ended December 31, 2003 and 2002 were $388,000 and $231,000, respectively. These fees related to tax consultation and related services.
All Other Fees
The aggregate fees billed or expected to be billed by the Deloitte Entities for services rendered to the Company, other than the services described above under “Audit Fees,” “Audit-Related Fees” and “Tax Fees” for the fiscal years ended December 31, 2003 and 2002 totaled approximately $719,000 and $171,000, respectively. The services rendered in 2003 related primarily to the Company’s Chapter 11 filing and related filings and activities. The services in 2002 related to the license and implementation of tax system software.
In accordance with the Audit Committee’s charter, the Audit Committee pre-approves all services provided by the Deloitte Entities. These services are pre-approved annually and updates are provided on a regular basis. All services provided by the Deloitte Entities were approved by the Audit Committee.
PART IV
Item 15.
Item 15.
Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) 1. Financial Statements
INDEX TO EXHIBITS
(1)
Incorporated by reference from the Registrant’s Registration Statement on Form 10 (No. 1-14180).
(2)
Incorporated by reference from the Registrant’s Current Report on Form 8-K filed on September 27, 1996.
(3)
Incorporated by reference from the Registrant’s Current Report on Form 8-K filed on March 28, 1997.
(4)
Incorporated by reference from the Registrant’s Current Report on Form 8-K filed on October 10, 1997.
(5)
Incorporated by reference from the Registrant’s Registration Statement on Form S-4 filed on February 17, 1998 (File No. 333-46407).
(6)
Incorporated by reference from the Registrant’s Annual Report on Form 10-K for the nine month period ended December 31, 1996.
(7)
Incorporated by reference from the Registration Statement on Form S-1 of Globalstar Telecommunications Limited (File No. 33-86808).
(8)
Incorporated by reference from the Registrant’s Current Report on Form 8-K filed on August 13, 1996.
(9)
Incorporated by reference from the Registrant’s Current Report on Form 8-K filed on July 8, 1997.
(10)
Incorporated by reference from the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 1997.
(11)
Incorporated by reference from the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 1998.
(12)
Incorporated by reference from the Current Report on Form 8-K filed on December 21, 1999 by Globalstar Telecommunications Limited and Globalstar, L.P.
(13)
Incorporated by reference from Registrant’s Current Report on Form 8-K filed on August 23, 1999.
(14)
Incorporated by reference from the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 1999.
(15)
Incorporated by reference from Registrant’s Current Report on Form 8-K filed on November 20, 2000.
(16)
Incorporated by reference from Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2000.
(17)
Incorporated by reference from Registrant’s Current Report on Form 8-K filed on December 14, 2001.
(18)
Incorporated by reference from Registrant’s Current Report on Form 8-K filed on January 7, 2002.
(19)
Incorporated by reference from Registrant’s Current Report on Form 8-K filed on January 9, 2002.
(20)
Incorporated by reference from Registrant’s Current Report on Form 8-K filed on January 10, 2002.
(21)
Incorporated by reference from Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.
(22)
Incorporated by reference from Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2002.
(23)
Incorporated by reference from Registrant’s Quarterly Report on Form 10-Q filed on August 14, 2003.
(24)
Incorporated by reference from Registrant’s Current Report on Form 8-K filed on July 2, 2003.
(25)
Incorporated by reference from Registrant’s Current Report on Form 8-K filed on July 23, 2003.
(26)
Incorporated by reference from Registrant’s Current Report on Form 8-K filed on October 30, 2003.
 Filed herewith.
 Management compensation plan.
(b) Reports on Form 8-K.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
LORAL SPACE & COMMUNICATIONS LTD.
By:
/s/ BERNARD L. SCHWARTZ
Bernard L. Schwartz
Chairman of the Board and
Chief Executive Officer
Dated: March 15, 2004
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
INDEPENDENT AUDITORS’ REPORT
To the Shareholders of Loral Space & Communications Ltd. (a Debtor In Possession)
We have audited the accompanying consolidated balance sheets of Loral Space & Communications Ltd. (a Bermuda Company) and its subsidiaries (collectively, the “Company”) (a Debtor In Possession) as of December 31, 2003 and 2002, and the related consolidated statements of operations, shareholders’ (deficit) equity, and cash flows for each of the three years in the period ended December 31, 2003. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2003 and 2002, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 3 to the consolidated financial statements, the Company changed its method of accounting for its convertible redeemable preferred stock to adopt the provisions of Statement of Financial Accounting Standards No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity, effective July 1, 2003. As discussed in Notes 3 and 8 to the consolidated financial statements, the Company changed its method of accounting for goodwill and other intangibles to adopt the provisions of Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, effective January 1, 2002.
As discussed in Note 2 to the consolidated financial statements, the Company has filed for reorganization under Chapter 11 of the Federal Bankruptcy Code. The accompanying consolidated financial statements do not purport to reflect or provide for the consequences of the bankruptcy proceedings. In particular, such consolidated financial statements do not purport to show (a) as to assets, their realizable value on a liquidation basis or their availability to satisfy liabilities; (b) as to pre-petition liabilities, the amounts that may be allowed for claims or contingencies, or the status and priority thereof; (c) as to stockholder accounts, the effect of any changes that may be made in the capitalization of the Company; or (d) as to operations, the effect of any changes that may be made in its business.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company filed for reorganization under Chapter 11 of the Federal Bankruptcy Code. This factor, among others, raises substantial doubt about the Company’s ability to continue as a going concern. Management’s plans concerning these matters are also discussed in Note 2. The consolidated financial statements do not include adjustments that might result from the outcome of this uncertainty.
DELOITTE & TOUCHE LLP
San Jose, California
March 15, 2004
LORAL SPACE & COMMUNICATIONS LTD., A DEBTOR IN POSSESSION
CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
See notes to consolidated financial statements.
LORAL SPACE & COMMUNICATIONS LTD., A DEBTOR IN POSSESSION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
See notes to consolidated financial statements.
LORAL SPACE & COMMUNICATIONS LTD., A DEBTOR IN POSSESSION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ (DEFICIT) EQUITY
Years ended December 31, 2003, 2002 and
(in thousands, except per share amounts)
See notes to consolidated financial statements.
LORAL SPACE & COMMUNICATIONS LTD., A DEBTOR IN POSSESSION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
See notes to consolidated financial statements
LORAL SPACE & COMMUNICATIONS LTD., A DEBTOR IN POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1.
Organization and Principal Business
Loral Space & Communications Ltd. (“Loral” or the “Company”, which terms shall include its subsidiaries unless otherwise indicated or the context requires) together with its subsidiaries is a leading satellite communications company with substantial activities in satellite-based communications services and satellite manufacturing. Loral is organized into two operating segments (see Note 18):
Satellite Services
Satellite Services, managed through Loral Skynet, a division of Loral, generates substantially all of its revenues and cash from leasing transponder capacity to customers for video transmission, direct to home (“DTH”) broadcasting, high-speed data services, international Internet communications and telephone services. Satellite Services also provides network services such as managed communications networks, Internet and intranet services, business television and business media services to customers.
Satellite Manufacturing
Satellite Manufacturing, conducted by Loral’s subsidiary Space Systems/ Loral (“SS/ L”), generates its revenues and cash from designing and manufacturing satellites and satellite systems for commercial and government applications including satellite services, television broadcasting, DTH services, broadband communications, military communications, wireless telephony, digital satellite radio, weather monitoring and air traffic management.
2.
Bankruptcy Filings, Sale of Assets and Reorganization
Bankruptcy Filings
On July 15, 2003, Loral and certain of its subsidiaries (the “Debtor Subsidiaries” and collectively with Loral, the “Debtors”), including Loral Space & Communications Corporation, Loral SpaceCom Corporation (“Loral SpaceCom”), Loral Satellite, Inc. (“Loral Satellite”), SS/ L and Loral Orion, Inc. (“Loral Orion”), filed voluntary petitions for reorganization under chapter 11 of title 11 (“Chapter 11”) of the United States Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”) (Lead Case No. 03-41710 (RDD), Case Nos. 03-41709 (RDD) through 03-41728 (RDD)) (the “Chapter 11 Cases”). Loral and its Debtor Subsidiaries continue to manage their properties and operate their businesses as “debtors in possession” under the jurisdiction of the Bankruptcy Court and in accordance with the provisions of the Bankruptcy Code (see Basis of Presentation Note 3).
Also on July 15, 2003, Loral and one of its Bermuda subsidiaries (the “Bermuda Group”) filed parallel insolvency proceedings in the Supreme Court of Bermuda (the “Bermuda Court”). On such date, the Bermuda Court entered an order appointing Philip Wallace, Chris Laverty and Michael Morrison, partners of KPMG, as Joint Provisional Liquidators (“JPLs”) in respect of the Bermuda Group. The Bermuda Court granted the JPLs the power to oversee the continuation and reorganization of these companies’ businesses under the control of their boards of directors and under the supervision of the U.S. Bankruptcy Court and the Bermuda Court. The JPLs have not audited the contents of this report.
As a result of Loral’s and the Debtor Subsidiaries’ voluntary petitions for reorganization, all of Loral’s prepetition debt obligations (aggregating approximately $2.2 billion at December 31, 2003) have been accelerated (see below and Notes 9 and 10). On July 15, 2003, Loral suspended interest payments on all of its senior unsecured notes, with an aggregate principal amount of $1.05 billion. A creditors’ committee has been appointed in the Chapter 11 Cases to represent all unsecured creditors, including all holders of Loral’s and
LORAL SPACE & COMMUNICATIONS LTD., A DEBTOR IN POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Loral Orion’s senior unsecured notes, and, in accordance with the provisions of the Bankruptcy Code, has the right to be heard on all matters that come before the Bankruptcy Court (see Note 10).
During the pendency of the Chapter 11 Cases, Loral’s business will be subject to risks and uncertainties relating to the Chapter 11 Cases. For example, the Chapter 11 Cases could adversely affect relationships with Loral’s customers, suppliers and employees, which could adversely affect the going concern value of the business and of its assets, particularly if the Chapter 11 Cases are protracted. Also, transactions outside the ordinary course of business will be subject to the prior approval of the Bankruptcy Court which may limit Loral’s ability to respond to certain market events or take advantage of certain market opportunities, and, as a result, Loral’s operations could be materially adversely affected.
As a result of the commencement of the Chapter 11 Cases, the pursuit of all pending claims and litigation against Loral and its Debtor Subsidiaries arising prior to or relating to events which occurred prior to the commencement of the Chapter 11 Cases is generally subject to an automatic stay under Section 362 of the Bankruptcy Code, and, absent further order of the Bankruptcy Court, a party is generally prohibited from taking any action to recover any prepetition claims, enforce any lien against or obtain possession of any property from Loral or its Debtor Subsidiaries. In addition, pursuant to Section 365 of the Bankruptcy Code, Loral and its Debtor Subsidiaries may reject or assume prepetition executory contracts and unexpired leases, and parties affected by rejections of these contracts or leases may file claims with the Bankruptcy Court which will be addressed in the context of the Chapter 11 Cases.
On July 15, 2003, the New York Stock Exchange suspended trading of Loral’s common stock and removed Loral’s securities from listing and registration on September 2, 2003. Loral’s common stock is being quoted under the ticker symbol LRLSQ on the Pink Sheets and on the Over-The-Counter Bulletin Board Service. The Company anticipates that, in any plan of reorganization ultimately confirmed by the Bankruptcy Court, the common and preferred stock of the Company will, at best, be severely diluted and may be eliminated entirely, with the result that common and preferred stockholders would receive no distribution.
Sale of Assets
On July 15, 2003, Loral Space & Communications Corporation, Loral SpaceCom and Loral Satellite (collectively, the “Sellers”), direct or indirect subsidiaries of Loral, entered into a definitive agreement (the “Asset Purchase Agreement”) to sell to Intelsat, Ltd. and certain of its affiliated companies (together, the “Purchasers” or “Intelsat”), all of the Sellers’ satellites serving the North American market, then comprised of four satellites in-orbit (one of which failed in September 2003, see below) and two under construction (one of which has been successfully launched and placed into service on September 12, 2003 and one scheduled for launch in 2004), as well as certain related assets and liabilities. In addition, Intelsat has agreed to order a new satellite from SS/ L when the sale closes and, subject to obtaining a security interest in certain of our Brazilian Satellite Services assets, agreed to make a $100 million down payment on that order. The Asset Purchase Agreement provides for a base purchase price of $1.025 billion, subject to certain purchase price adjustments (which include a reduction for any insurance proceeds received prior to closing by the Company from the Telstar 4 failure - see below). On October 24, 2003, after a hearing on the matter, the Bankruptcy Court approved the transactions contemplated by the Asset Purchase Agreement.
On March 5, 2004, as part of an arrangement to reach agreement with Intelsat on the satisfaction of certain closing conditions, the Company entered into an amendment to the Asset Purchase Agreement. Among other things, the amendment reduces the purchase price by $20 million (subject to further adjustment based on future events) to cover certain contingent liabilities relating to the transferred assets, reduces from $100 million to $50 million the deposit Intelsat is to make for its new satellite construction contract with SS/L, and provides for a dollar-for-dollar reduction in the price of this satellite if and to the extent the Telstar 4 insurance proceeds are less than $141 million (see below). As part of this amendment, Intelsat agreed to pay SS/ L $12.5 million in full settlement and satisfaction of all remaining obligations to make certain orbital
LORAL SPACE & COMMUNICATIONS LTD., A DEBTOR IN POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
payments to SS/ L under the construction contracts relating to the purchased satellites. The effectiveness of this amendment is subject to approval by the Bankruptcy Court and Intelsat’s bank lenders.
Consummation of the transactions is still subject to a number of conditions, including that certain operating parameters continue to be met with respect to the assets being sold and certain other closing conditions typical for transactions of this type (see Note 17). The Sellers expect to use the proceeds from the sale of the assets to repay their outstanding secured bank debt. The Chapter 11 Cases will enable the Sellers to sell the satellites serving the North American market to the Purchasers free and clear of any interests. There can be no assurance, however, that the transactions contemplated by the Asset Purchase Agreement will be consummated. The net book value of the satellites to be sold was $935 million (including insurance proceeds receivable on the Company’s consolidated balance sheet at December 31, 2003, see below) and of the related assets and liabilities was $30 million and $31 million, respectively, as of December 31, 2003. The net assets to be sold, as well as the results of operations relating to such net assets, have not been segregated in the accompanying consolidated financial statements, since the satisfaction of certain closing conditions are still subject to Bankruptcy Court approval.
Upon receipt of Bankruptcy Court approval relating to certain closing conditions, the satellites serving the North American market will be accounted for as a discontinued operation, resulting in the Company’s historical consolidated financial statements being reclassified to reflect such discontinued operations separately from continuing operations. Income from operations for the satellites serving the North American market that will be reclassified to discontinued operations is expected to approximate $19.0 million, $57.6 million and $61.3 million for the years ended December 31, 2003, 2002 and 2001, respectively. For the purpose of this presentation, all indirect costs normally associated with these operations have been omitted, including telemetry, tracking and control, access control, maintenance and engineering, selling and marketing and general and administrative.
In September 2003, Loral’s Telstar 4 satellite experienced a short circuit of its high voltage bus causing the satellite to cease operations. Loral has been unable to reestablish contact with the satellite and has declared the satellite a total loss. At the time of the satellite’s failure, Loral initiated a comprehensive restoration plan that has provided capacity to nearly all Telstar 4 customers on other Loral satellites. Telstar 4 is insured for $141 million and the agent for secured lenders of Loral SpaceCom is currently named as the loss payee on the insurance policy. During October 2003, Loral filed the proof of loss with the insurance underwriters to recover $141 million. Under Loral’s agreement to sell its satellites serving the North American market discussed above, the purchase price will be reduced by any insurance proceeds received for Telstar 4 by Loral prior to closing, net of any payments by Loral to customers for warranty claims. The Company recorded a receivable for insurance proceeds of $123 million at December 31, 2003, primarily representing the carrying value of Telstar 4 and the estimated costs of warranty obligations to customers directly associated with the failure of Telstar 4. Customer cancellations resulting from the failure of Telstar 4 have reduced the future minimum lease receipts due from customers under long-term operating leases for transponder capacity by approximately $47 million.
Reorganization
Loral intends to reorganize around its satellite manufacturing operations and its remaining fleet of international satellites. Loral is in the process now of completing its long-term business plan. Loral believes it will not require any additional financing to fund operations.
As provided by the Bankruptcy Code, the Debtors had the exclusive right to submit their plan or plans of reorganization for 120 days from the date of the Chapter 11 filing. On November 12, 2003, the Bankruptcy Court extended this exclusive period for another 120 days. On March 16, 2004, a hearing will be held to consider a further extension of the exclusivity period and additional extensions may be sought and may be granted or rejected by the Bankruptcy Court. If Loral and its Debtor Subsidiaries fail to file their plan or plans
LORAL SPACE & COMMUNICATIONS LTD., A DEBTOR IN POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
of reorganization during such period, or if a plan is filed and such plan or plans is not accepted by the required number of creditors and equity holders within the required period, any party in interest may subsequently file its own plan or plans of reorganization for Loral and its Debtor Subsidiaries. A plan of reorganization must be confirmed by the Bankruptcy Court upon certain findings being made by the Bankruptcy Court which are required by the Bankruptcy Code. The Bankruptcy Court may confirm a plan of reorganization notwithstanding rejection of the plan by an impaired class of creditors or equity holders if certain requirements of the Bankruptcy Code are met. Although Loral and its Debtor Subsidiaries expect to file a plan or plans of reorganization that provide for emergence from bankruptcy sometime in 2004, Loral cannot now describe the components or features of the plan, including whether the plan will provide for creditors to be paid in whole or in part or whether consideration they will receive will consist of cash, debt, equity or some combination thereof. In addition, there can be no assurance that Loral will be able to propose a plan, obtain court approval of any plan we propose, obtain acceptances from the number of creditors necessary to confirm a plan, or actually confirm and consummate a plan.
3.
Summary of Significant Accounting Policies
Basis of Presentation
Loral, a Bermuda company has a December 31 year-end. The consolidated financial statements for the three years ended December 31, 2003, include the results of Loral and its subsidiaries and have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”). All intercompany transactions have been eliminated.
The accompanying consolidated financial statements have been prepared assuming the Company, in its current structure, will continue as a going concern. However, the factors mentioned in Note 2 above, among other things, raise substantial doubt about Loral’s ability to continue as a going concern. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. The ability of the Company to continue as a going concern is dependent on a number of factors including, but not limited to, the Company developing a plan of reorganization, confirmation of the plan by the Bankruptcy Court and Loral maintaining good relations with its customers, suppliers and employees. If a plan of reorganization is not confirmed and implemented, the Company may be forced to liquidate under applicable provisions of the Bankruptcy Code. There can be no assurance of the level of recovery that the Company’s creditors would receive in such liquidation. The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities if the Company is forced to liquidate (see Reorganization in Note 2).
The consolidated financial statements have been prepared in accordance with Statement of Position No. 90-7, Financial Reporting by Entities in Reorganization under the Bankruptcy Code (“SOP 90-7”). SOP 90-7 requires an entity to distinguish prepetition liabilities subject to compromise from postpetition liabilities in the Company’s consolidated balance sheet. The caption “liabilities subject to compromise” reflects the Company’s best current estimate of the amount of prepetition claims that will be restructured in Loral’s and its Debtor Subsidiaries’ Chapter 11 Cases. In addition, the Company’s consolidated statement of operations portrays the results of operations of the reporting entity during Chapter 11 proceedings. As a result, any revenue, expenses, realized gains and losses, and provision for losses resulting directly from the reorganization and restructuring of the organization are reported separately as reorganization items, except those required to be reported as discontinued operations and extraordinary items in conformity with Statement of Financial Accounting Standards (“SFAS”) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS 144”) and SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections (“SFAS 145”). The Company did not prepare condensed combined financial statements for Loral and the Debtor Subsidiaries, since the subsidiaries
LORAL SPACE & COMMUNICATIONS LTD., A DEBTOR IN POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
that did not file voluntary petitions for reorganization under Chapter 11 of the Bankruptcy Code were immaterial to the Company’s consolidated financial position and results of operations.
Investments in XTAR, L.L.C. (“XTAR”), Satelites Mexicanos, S.A. de C.V. (“Satmex”), Europe*Star Limited (“Europe*Star”) and Globalstar, L.P. (“Globalstar”) as well as other affiliates, are accounted for using the equity method, due to the Company’s inability to control significant operating decisions. Income and losses of affiliates are recorded based on Loral’s beneficial interest. Intercompany profit arising from transactions with affiliates is eliminated to the extent of the Company’s beneficial interest. Any difference in the carrying value of these investments as compared to Loral’s interest in the underlying net assets is amortized over the life of the primary asset of the affiliate. Advances to affiliates generally consist of amounts due under extended payment terms. Equity in losses of affiliates is not recognized after the carrying value of an investment, including advances and loans, has been reduced to zero, unless guarantees or other obligations exist. Loral capitalizes interest cost on its investments, until such entities commence commercial operations. Capitalized interest on investments is amortized over the life of the primary asset of the affiliate. Certain of the Company’s affiliates are subject to the risks associated with new businesses. See Note 7.
Use of Estimates in Preparation of Financial Statements
The preparation of financial statements in conformity with U.S. GAAP 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 amounts of revenues and expenses reported for the period. Actual results could differ from estimates.
A significant portion of Loral’s Satellite Manufacturing revenue is associated with long-term contracts which require significant estimates. These estimates include forecasts of costs and schedules, estimating contract revenue related to contract performance (including orbital incentives) and the potential for component obsolescence in connection with long-term procurements. Significant estimates also include the estimated useful lives of the Company’s satellites and, prior to 2002, the amortization period of cost in excess of net assets acquired.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash on hand and highly liquid investments with original maturities of three months or less.
Concentration of Credit Risk
Financial instruments which potentially subject Loral to concentrations of credit risk consist principally of cash and cash equivalents, foreign exchange contracts, contracts-in-process, long-term receivables and advances and loans to affiliates (see Note 7). Loral’s cash and cash equivalents are maintained with high-credit-quality financial institutions. Historically, Loral’s customers have been primarily large multinational corporations and U.S. and foreign governments for which the creditworthiness was generally substantial. In recent years, the Company has added commercial customers which include companies in emerging markets or the development stage, some of which are highly leveraged or partially funded. Management believes that its credit evaluation, approval and monitoring processes combined with negotiated billing arrangements mitigate potential credit risks with regard to the Company’s current customer base.
Billed Receivables
As of December 31, 2003 and 2002, billed receivables (including accounts receivable) were reduced by an allowance for doubtful accounts of $11.7 million and $7.1 million, respectively.
LORAL SPACE & COMMUNICATIONS LTD., A DEBTOR IN POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Inventories
Inventories consist principally of parts and subassemblies used in the manufacture of satellites which have not been specifically identified to contracts-in-process, and are valued at the lower of cost or market. Cost is determined using the first-in-first-out (FIFO) or average cost method.
Property, Plant and Equipment
Property, plant and equipment are stated at cost. Depreciation is provided on the straight-line method for satellites and related equipment over the estimated useful lives of the related assets. Depreciation is provided primarily on an accelerated method for other owned assets over the estimated useful life of the related assets. Leasehold improvements are amortized over the shorter of the lease term or the estimated useful life of the improvements. Below are the estimated useful lives of the Company’s property, plant and equipment as of December 31, 2003:
Costs incurred in connection with the construction and successful deployment of the Company’s satellites and related equipment are capitalized. Such costs include direct contract costs, allocated indirect costs, launch costs, launch insurance and construction period interest. Capitalized interest related to the construction of satellites for 2003, 2002 and 2001 was $32.9 million, $28.6 million and $23.0 million, respectively. All capitalized satellite costs are amortized over the estimated useful life of the related satellite. The estimated useful life of the satellites was determined by engineering analyses performed at the satellite’s in-service date. Satellite lives are reevaluated periodically. Losses from unsuccessful launches and in-orbit failures of the Company’s satellites, net of insurance proceeds, are recorded in the period a loss occurs.
Cost in Excess of Net Assets Acquired
On January 1, 2002, the Company adopted SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS 142”), which addresses the initial recognition and measurement of intangible assets acquired outside of a business combination and the accounting for goodwill and other intangible assets subsequent to their acquisition. In connection with the adoption, the Company recorded a non-cash charge for the cumulative effect of the change in accounting principle of $890 million, see Note 8. Prior to January 1, 2002, the excess of the cost of purchased businesses over the fair value of net assets acquired was being amortized over 40 years using the straight-line method.
Valuation of Long-Lived Assets and Investments in and Advances to Affiliates
The carrying value of Loral’s long-lived assets and investments in and advances to affiliates is reviewed for impairment in accordance with SFAS 144 and Accounting Principles Board (“APB”) Opinion No. 18, Equity Method of Accounting for Investments in Common Stock, respectively. Whenever events or changes in circumstances indicate that an asset may not be recoverable, the Company looks to current and future profitability, as well as current and future undiscounted cash flows, excluding financing costs (only for long-lived assets), as primary indicators of recoverability. If impairment is determined to exist, any related
LORAL SPACE & COMMUNICATIONS LTD., A DEBTOR IN POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
impairment loss is calculated based on fair value. Fair value is determined based on quoted market values, discounted cash flows or appraisals, as appropriate in the circumstances.
Deposits
Deposits primarily represent prepaid amounts on satellite launch vehicles which are expected to be utilized for the launch of customer or Company-owned satellites.
Investments in Available-For-Sale Securities and Other Securities
The Company’s investments in publicly traded common stock are classified as available-for-sale, and are recorded at fair value, with the resulting unrealized gain or loss excluded from net loss and reported as a component of other comprehensive loss until realized (see Notes 4 and 16). The Company accounts for its investment in Globalstar’s $500 million credit facility at fair value, with changes in the value (net of tax) recorded as a component of other comprehensive loss (see Note 7).
On March 7, 2003, Sirius Satellite Radio, Inc. (“Sirius”) completed its recapitalization plan and as part of this recapitalization, SS/ L converted all of its vendor financing receivables of approximately $76 million into 59 million shares of common stock of Sirius. For the year ended December 31, 2003, SS/ L realized net proceeds of $46 million from the sale of all of the shares of Sirius common stock that it received in the recapitalization, and realized gains on such sales of $18 million. In the first quarter of 2003, SS/ L recorded a charge on the vendor financing receivables due from Sirius of $10 million, representing the difference between the carrying value of SS/ L’s receivables of $38 million, and the value of the common shares received by SS/ L based on the trading price of Sirius’s common stock on March 7, 2003 of $28 million. At December 31, 2002, the receivables from Sirius were classified as short-term vendor financing receivables.
In 2002, the Company determined that its investment in The Fantastic Corporation common stock had an other than temporary decline in its value and recognized a loss of $1 million.
Revenue Recognition
Revenue from satellite sales under long-term fixed-price contracts is recognized following the provisions of Statement of Position 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts, using the cost-to-cost percentage-of-completion method. Revenue includes the basic contract price and estimated amounts for penalties and incentive payments, including award fees, performance incentives, and estimated orbital incentives discounted to their present value at launch date. Costs include the development effort required for the production of high-technology satellites, non-recurring engineering and design efforts in early periods of contract performance, as well as the cost of qualification testing requirements. Contracts are typically subject to termination for convenience or for default. If a contract is terminated for convenience by a customer or due to a customer’s default, the Company is generally entitled to its costs incurred plus a reasonable profit.
Revenue under cost-reimbursable type contracts is recognized as costs are incurred; incentive fees are estimated and recognized over the contract term.
U.S. government contract risks include dependence on future appropriations and administrative allotment of funds and changes in government policies. Costs incurred under U.S. government contracts are subject to audit. Management believes the results of such audits will not have a material effect on Loral’s financial position or its results of operations.
Losses on contracts are recognized when determined. Revisions in profit estimates are reflected in the period in which the conditions that require the revision become known and are estimable.
LORAL SPACE & COMMUNICATIONS LTD., A DEBTOR IN POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
In accordance with industry practice, contracts-in-process include unbilled amounts relating to contracts and programs with long production cycles, a portion of which may not be billable within one year.
The Company provides satellite capacity and network services under lease agreements that generally provide for the use of satellite transponders and, in certain cases, earth stations and other terrestrial communications equipment for periods generally ranging from one year to the end of life of the satellite. Some of these agreements have certain obligations, including providing spare or substitute capacity, if available, in the event of satellite failure. If no spare or substitute capacity is available, the agreement may be terminated. Revenue under transponder lease and network services agreements is recognized as services are performed, provided that a contract exists, the price is fixed or determinable and collectibility is reasonably assured. Revenues under contracts that include fixed lease payment increases are recognized on a straight-line basis over the life of the lease.
Other terrestrial communications equipment represents network elements (antennas, transmission equipment, etc.) necessary to enable communication between multiple terrestrial locations through a customer-selected satellite communications service provider. Revenue from equipment sales is primarily recognized upon acceptance by the customer, provided that a contract exists, the price is fixed or determinable and collectibility is reasonably assured. Revenue from equipment sales under long-term fixed price contracts is recognized using the cost-to-cost percentage-of-completion method. Losses on contracts are recognized when determined and revisions in profit estimates are reflected in the period in which the conditions that require the revision become known and are estimable. Revenues under arrangements that include both services and equipment elements are allocated based on the relative fair values of the elements of the arrangement.
Research and Development
Independent research and development costs, which are expensed as incurred, were $9 million, $16 million and $32 million for 2003, 2002 and 2001, respectively, and are included in selling, general and administrative expenses.
Foreign Exchange Contracts
Prior to filing Chapter 11, Loral entered into foreign exchange contracts as hedges against exchange rate fluctuations of future accounts receivable and accounts payable under contracts-in-process which are denominated in foreign currencies. On January 1, 2001, the Company adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS 133”), which among other things requires that all derivative instruments be recorded on the balance sheet at their fair value. Upon filing Chapter 11, SS/ L’s hedges with counterparties (primarily yen denominated forward contracts) were cancelled leaving SS/ L vulnerable to foreign currency fluctuations in the future. The inability to enter into forward contracts exposes SS/ L’s future revenues, costs and cash associated with anticipated yen denominated receipts and payments to currency fluctuations (see Note 16).
Stock-Based Compensation
As permitted by SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS 123”), Loral accounts for stock-based awards to employees using the intrinsic value method in accordance with APB 25, and its interpretations. The Company accounts for stock-based awards to non-employees in accordance with SFAS 123 and its interpretations.
In the fourth quarter of 2002, the Company adopted SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure (“SFAS 148”), an amendment of SFAS 123. SFAS 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to
LORAL SPACE & COMMUNICATIONS LTD., A DEBTOR IN POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results.
Under SFAS 123, the fair value of stock-based awards to employees is calculated through the use of option pricing models, even though such models were developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Company’s stock option awards. These models also require subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. The Company’s calculations were made using the Black-Scholes option pricing model with the following weighted average assumptions: expected life, six to twelve months following vesting; stock volatility, 90% in 2003, 90% in 2002, and 75% in 2001; risk free interest rate, 2.4% to 6.6% based on date of grant; and no dividends during the expected term. The Company’s calculations are based on a multiple option valuation approach and forfeitures are recognized as they occur. The following table summarizes what the Company’s pro forma net loss and pro forma loss per share would have been if the fair value method under SFAS 123 was used (in millions except per share amounts):
During the preparation of the Company’s 2003 consolidated financial statements, management revised the pro forma net loss and pro forma net loss per share for fiscal 2002 to appropriately include the effect of the reversal of the cumulative tax benefit of previous pro forma SFAS 123 charges of $30.4 million. This revision did not impact the Company’s consolidated balance sheet, consolidated statement of operations, net loss or net loss per share for any of the periods presented.
Income Taxes
As a Bermuda company, Loral Space & Communications Ltd. is subject to U.S. federal, state and local income taxation at regular corporate rates plus an additional 30% “branch profits” tax on any income that is
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effectively connected with the conduct of a U.S. trade or business. Loral’s U.S. subsidiaries are subject to regular corporate tax on their worldwide income.
Deferred income taxes reflect the future tax effect of temporary differences between the carrying amount of assets and liabilities for financial and income tax reporting and are measured by applying statutory tax rates in effect for the year during which the differences are expected to reverse. The deferred tax assets are reduced by a valuation allowance to the extent it is more likely than not that the deferred tax assets will not be realized. See Note 12.
Additional Cash Flow Information
The following represents non-cash activities and supplemental information to the consolidated statements of cash flows (in thousands):
New Accounting Pronouncements
SFAS 143
In June 2001, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 143, Accounting for Asset Retirement Obligations (“SFAS 143”). SFAS 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. It applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and the normal operation of a long-lived asset, except for certain obligations of lessees. The Company has determined that there was no effect on its consolidated financial position or results of operations upon the adoption of SFAS 143 on January 1, 2003.
FIN 45
In November 2002, the FASB issued FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees and Indebtedness of Others (“FIN 45”). FIN 45 elaborates on the disclosures to be made by the guarantor in its interim and annual
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financial statements about its obligations under certain guarantees that it has issued. It also requires that a guarantor recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial recognition and measurement provisions of this interpretation were applicable on a prospective basis to guarantees issued or modified after December 31, 2002; while the provisions of the disclosure requirements were effective for financial statements of interim or annual reports ending after December 15, 2002. The Company adopted the disclosure provisions of FIN 45 during the fourth quarter of 2002. The Company adopted the recognition provisions of FIN 45 on January 1, 2003 and determined that there was no effect on its consolidated financial position or its results of operation.
FIN 46
In January 2003 and revised in December 2003, the FASB issued FASB Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51 (“FIN 46”) and an amendment to FIN 46 entitled FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities (“FIN 46R”). FIN 46R requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46R will be applied by the Company for those entities that are considered variable interest entities as of March 31, 2004. The Company is currently evaluating the provisions of FIN 46R as it relates to variable interest entities.
SFAS 150
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity (“SFAS 150”). SFAS 150 establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity. SFAS 150 requires that an issuer classify a financial instrument that is within the scope as a liability (or an asset in some circumstances) because that financial instrument embodies an obligation of the issuer. As a result of the Company’s adoption of SFAS 150 on July 1, 2003, the Company reclassified its redeemable convertible preferred stock to liabilities and increased the recorded values to their redemption values (with an offsetting increase to other assets) and recorded a cumulative effect of accounting change of $2 million during the third quarter of 2003, which represents the amortization of expenses incurred on the issuance of the securities from their issuance dates through June 30, 2003, that were not previously amortized.
EITF 00-21
In May 2003, the Emerging Issues Task Force of the FASB (“EITF”) reached a consensus on Issue No. 00-21, Accounting for Revenue Arrangements with Multiple Deliverables (“EITF 00-21”). EITF 00-21 addresses determination of whether an arrangement involving more than one deliverable contains more than one unit of accounting and how the related revenues should be measured and allocated to the separate units of accounting. EITF 00-21 applies to revenue arrangements entered into after June 30, 2003; however, upon adoption, the EITF allows the guidance to be applied on a retroactive basis, with the change, if any, reported as a cumulative effect of accounting change in the statement of operations. Management determined that the adoption of EITF 00-21 did not have a significant impact on its consolidated financial position or its results of operations.
SFAS 132 Revised
In December 2003, the FASB issued SFAS No. 132, as revised, Employers’ Disclosures about Pensions and Other Postretirement Benefits, (“Revised SFAS 132”), which requires additional disclosures about
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assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans. The Company adopted the required revised disclosure provisions of Revised SFAS 132 as of December 31, 2003, except for the disclosure of estimated future benefit payments, which the Company is required to and will disclose as of December 31, 2004.
Reclassifications
Certain reclassifications have been made to conform prior year amounts to the current year’s presentation.
4.
Accumulated Other Comprehensive Loss
The components of accumulated other comprehensive loss are as follows (in thousands):
As of December 31, 2003, the Company anticipates reclassifying $2.2 million of the balance of derivatives classified as cash flow hedges (entered into prior to filing bankruptcy) in accumulated other comprehensive loss to earnings in the next year. The unrealized (loss) gain on available for sale securities at December 31, 2003 and 2002 includes a charge of $11.4 million related to deferred taxes on unrealized gains recorded prior to 2002, which pursuant to SFAS 109 will be deferred until the related investment is sold. See Note 12 for the related tax amounts for the table above.
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5.
Contracts-in-Process and Long-Term Receivables
Contracts-in-Process
Unbilled amounts include recoverable costs and accrued profit on progress completed, which have not been billed. Such amounts are billed in accordance with the contract terms, typically upon shipment of the product, achievement of contractual milestones, or completion of the contract and, at such time, are reclassified to billed receivables.
The Company has estimated that it will incur approximately $50 million to repair a satellite that was damaged during transit. The Company expects to recover a significant portion of these costs through insurance coverage. Management believes that the resolution of the insurance claim will not have a material adverse effect on its consolidated financial position or its results of operation.
Long-Term Receivables
Billed receivables relating to long-term contracts are expected to be collected within one year. Loral classifies billings deferred and the orbital component of unbilled receivables expected to be collected beyond one year as long-term. Receivable balances related to satellite orbital incentive payments and billings deferred as of December 31, 2003 are scheduled to be received as follows (in thousands):
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As of December 31, 2003, Loral owed orbital incentive obligations of $4 million to a subcontractor for which Loral has a corresponding long-term receivable from the customer. Payments of such amounts are due in 2004 and are contingent upon collection of the related receivable.
6.
Property, Plant and Equipment
Depreciation and amortization expense for property, plant and equipment was $182.3 million, $180.0 million and $190.0 million in 2003, 2002 and 2001, respectively. Accumulated depreciation and amortization as of December 31, 2003 and 2002 includes $91.5 million and $70.2 million, respectively, related to satellite transponders where Loral has the rights to transponders for the remaining life of the related satellite.
The transponder capacity on satellites in-orbit are either leased by customers or held for lease by the Company. Future minimum lease receipts due from customers under long-term operating leases for transponder capacity on the Company’s satellites in-orbit (including $446.2 million related to the satellites to be sold to Intelsat, see Note 2) and for service agreements as of December 31, 2003, are as follows (in thousands):
In January 2004, the Company’s Telstar 14/ Estrela do Sul-1 satellite was successfully launched, but after launch the satellite only partially deployed its North solar array. SS/ L, the manufacturer of the satellite, is raising the satellite to geostationary orbit. The book value of Telstar14/ Estrela do Sul-1 at December 31, 2003 was $253 million and is included in satellites under construction. It is insured for partial and total losses up to a maximum of $250 million.
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7.
Investments in and Advances to Affiliates
Investments in and Advances to Affiliates consists of (in thousands):
Equity in net losses of affiliates, net of taxes (Note 12) consists of (in thousands):
The consolidated statements of operations reflect the effects of the following amounts related to transactions with or investments in affiliates (in thousands):
XTAR
XTAR, a joint venture between Loral and Hisdesat Servicios Estrategicos, S.A. (“Hisdesat”), a consortium comprised of leading Spanish telecommunications companies, including Hispasat, S.A., and agencies of the Spanish government, is constructing and plans to launch an X-band satellite to provide X-band services to government users in the United States and Spain, as well as other friendly and allied nations. XTAR is owned 56% by Loral (accounted for under the equity method since the Company does not control certain significant operating decisions) and 44% by Hisdesat. In addition, XTAR has agreed to lease certain transponders on the Spainsat satellite, which is being constructed by SS/ L for Hisdesat. As of December 31, 2003, the partners in proportion to their respective ownership interests have contributed $87 million to XTAR.
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In October 2003, Loral and Hisdesat entered into an agreement (the “Contribution Agreement”) to contribute over time an additional $25.4 million and $20.0 million, respectively, into XTAR, with Loral’s contribution effected through the cancellation of amounts owed under XTAR’s satellite construction contract with SS/ L. The proceeds from Hisdesat’s capital contributions have been and will be largely used to fund the remaining amounts due under the satellite construction contract. XTAR has entered into a Launch Services Agreement with Arianespace, S.A. providing for launch of its satellite on Arianespace’s Ariane 5 ECA launch vehicle. This flight represents the resumption of the Ariane 5 ECA’s missions since the unsuccessful launch in late 2002. Arianespace has agreed to provide a one-year loan for a portion of the launch price, which loan is secured by certain of XTAR’s assets, including the satellite, ground equipment and rights to the orbital slot. The remainder of the launch price consists of a revenue-based fee to be paid over time following commencement of operations by XTAR. XTAR still requires additional funds to insure its satellite, complete the ground station system and fund its operations. XTAR is in discussions with its shareholders to try and obtain additional capital contributions and is seeking additional funds through other third-party financings.
Loral is seeking the approval of the Bankruptcy Court and its secured lenders to fund an additional $2.8 million to XTAR, which would be matched by $2.2 million of contributions to XTAR from Hisdesat. If XTAR is unable to raise the $5 million from Loral and Hisdesat or the substantial additional funds for launch insurance, the Company’s investment in XTAR of $43 million at December 31, 2003, and any additional investment effected as a result of the Contribution Agreement or otherwise, would be adversely affected. Moreover, if XTAR is unable to repay the Arianespace loan when due, Arianespace will have the right to foreclose on the XTAR assets pledged as collateral, which will also adversely affect the Company’s investment in XTAR.
Satmex
In connection with the privatization of Satmex by the Mexican Government of its satellite services business, Loral and Principia formed a joint venture, Firmamento Mexicano, S.A. de R.L. de C.V. (“Holdings”). In 1997, Holdings acquired 75% of the outstanding capital stock of Satmex. As part of the acquisition, Servicios Corporativos Satelitales, S.A. de C.V. (“Servicios”), a wholly owned subsidiary of Holdings, issued a seven-year Government Obligation (“Government Obligation”) to the Mexican Government in consideration for the assumption by Satmex of the debt incurred by Servicios in connection with the acquisition. The Government Obligation had an initial face amount of $125 million, which accretes at 6.03% and expires in December 2004. Under the terms of the Government Obligation, assets equal to 1.2 times the value of the Government Obligation are to be maintained in a collateral trust in favor of the Mexican government. Loral and Principia have pledged their respective shares in Holdings in this collateral trust. Because of the decline in the value of Satmex, the shares in Holdings are no longer sufficient to maintain the 1.2 collateral trust ratio requirement. As a result, a default has occurred under the Government Obligation and the government of Mexico could foreclose on the Company’s shares in the parent company of Servicios, which would result in the Company losing nearly all of its investment stake in Satmex.
To conserve cash, on August 1, 2003 Satmex stopped making interest payments on its high yield bonds and is currently in default. Although Satmex is current on interest due on its floating rate notes, the default on its high yield bonds triggered a cross-default provision under the indenture for its existing floating rate notes. In addition, on September 30, 2003, additional defaults occurred under Satmex’s existing floating rate notes as a result of its failure to complete certain proposed financings and the default by Servicios on the Government Obligation, as a result of its failure to maintain the minimum coverage ratio as discussed above. The occurrence of the events of default under each of the high yield bonds and the existing floating rate notes gives the holders of such notes the right to accelerate Satmex’s principal repayment obligations on such notes. Should this occur, Satmex may seek to reorganize under either Chapter 11 of the United States Bankruptcy Code or Mexican reorganization law or both.
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As of December 31, 2003, Loral had a 65% economic interest in Holdings and a 49% indirect economic interest in Satmex. Loral accounts for Satmex using the equity method. The covenants of Satmex’s debt instruments restrict the ability of Satmex to pay dividends to Loral. As a result of these recent events, under U.S. GAAP, Loral wrote-off its investment in Satmex of $29 million (as an increase to its equity loss) in the third quarter of 2003. Accordingly, there is no longer any requirement for Loral to provide for its allocated share of Satmex’s net losses subsequent to September 30, 2003. In addition, Loral recorded reductions in estimated contract revenues from Satmex resulting in an increase to the Company’s operating loss of approximately $24 million during 2003.
Satmex has two satellites in operation and a third satellite, Satmex 6, scheduled for launch this year. Satmex will require additional liquidity to complete the launch of Satmex 6. In order to fund the construction, insurance and launch of Satmex 6, Satmex pursued export credit agency financing and a proposed private placement of secured notes. The Export-Import Bank of the United States (“Ex-Im Bank”) has advised Satmex that it will not extend the commitment for the Ex-Im Bank loan guarantee for which Satmex had previously received approval.
The Ex-Im Bank financing was an important element in a financial restructuring of Satmex, which included an exchange offer for its high yield bonds, a prepayment of its secured floating rate notes and funding for the payments remaining for the launch of Satmex 6. Given the recent developments, Satmex is actively exploring, with its financial advisors, alternative means of restructuring its debt obligations and financing the remaining amount for Satmex 6.
The following table presents summary financial data for Satmex as of September 30, 2003 and December 31, 2002 and for the nine months ended September 30, 2003 and for each of the two years in the period ended December 31, 2002 (in thousands):
Europe*Star
Pursuant to a master settlement agreement on June 30, 2003 with Alcatel, Loral transferred to Alcatel its minority interest in Europe*Star, a joint venture between Loral and Alcatel that owns and operates the Europe*Star 1 satellite (see Note 17). In the fourth quarter of 2002, the Company’s investment in Europe*Star was reduced to zero, which resulted from the Company recording valuation allowances of $38 million on the vendor financing and the receivables advanced to Europe*Star due to collection concerns and recording an impairment charge relating to its investment in Europe*Star of $7 million. Accordingly,
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there is no longer any requirement for Loral to provide for its allocated share of Europe*Star’s net losses subsequent to December 31, 2002.
The following table presents summary financial data for Europe*Star as of December 31, 2002 and for each of the two years in the period ended December 31, 2002 (in thousands):
Globalstar
The Company accounts for its investment in Globalstar on the equity method due to its inability to control significant operating decisions at Globalstar. In 2000, Loral’s allocated share of Globalstar’s losses and Globalstar’s impairment charges reduced Loral’s investment in and advances to Globalstar to zero. Accordingly, there is no longer any requirement for Loral to provide for its allocated share of Globalstar’s net losses subsequent to December 31, 2000. The Company accounts for its investment in Globalstar’s $500 million credit facility at fair value, with changes in the value (net of tax) recorded as a component of other comprehensive loss (see Notes 4 and 16). The Company recorded unrealized net losses after taxes as a component of other comprehensive loss of $17 million, $13 million and $12 million in 2003, 2002 and 2001, respectively, in connection with this security.
During 2002, the Company recorded a $9 million charge to equity in net losses of affiliates relating to liabilities it had guaranteed in connection with a Globalstar service provider partnership, which were paid in 2002. In connection with recording its share of Globalstar’s operating losses in 2000, the Company recorded as a charge to equity in net losses of affiliates of $22.3 million representing the estimated probable uncollectible costs relating to subcontractor obligations to be incurred by the Company on Globalstar’s behalf. In 2002, the Company recovered a claim with a vendor on the Globalstar program. Of this recovery, $14 million ($8 million after taxes) is reflected in the statement of operations as equity income related to Globalstar, which, when combined with the recovery of $8.5 million ($5.5 million, after taxes) recorded in 2001, fully offset the probable uncollectible costs originally recorded. Globalstar or its creditors may assert a claim to some portion or all of the 2002 recovery. If so, the Company will vigorously dispute any such claim.
As of December 31, 2003, the remaining amount of SS/ L provided vendor financing to Globalstar that subcontractors assumed was $70 million (which is included in liabilities subject to compromise). The amount assumed by subcontractors includes $47 million which is non-recourse to SS/ L in the event of non-payment by Globalstar as a result of its bankruptcy.
On February 15, 2002, Globalstar and certain of its direct subsidiaries filed voluntary bankruptcy petitions under the Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware (the
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“Court”). In connection therewith, Loral/ Qualcomm Satellite Services, L.P., the managing general partner of Globalstar, its general partner, Loral/ Qualcomm Partnership, L.P. (“LQP”), and certain of Loral’s subsidiaries that serve as general partners of LQP also filed voluntary bankruptcy petitions with the Court.
During the pendency of the Globalstar bankruptcy cases, Loral entered into a settlement and release agreement with Globalstar and Globalstar’s official creditors committee to resolve certain issues related to Globalstar and Globalstar’s restructuring (the “Settlement”). This Settlement was approved on April 14, 2003 by the Court and closed on July 10, 2003. Among other things, the Settlement provided that Globalstar grants to Loral, subject to certain conditions, a general release of all claims Globalstar might have against Loral in exchange for certain consideration including, effective upon Globalstar’s emergence from Chapter 11 reorganization, an approximate 50% reduction in the amount of Loral’s unsecured claims against Globalstar of approximately $875 million. Loral does not expect any material impact on its results of operations or financial position as a result of this Settlement.
On April 24, 2003, one of Globalstar’s creditors filed with the bankruptcy court a motion seeking reconsideration by the bankruptcy court of the bankruptcy court’s approval of the Settlement. The Globalstar Court denied this motion for reconsideration on May 30, 2003, and, on June 9, 2003, the creditor filed a notice of appeal of the bankruptcy court’s order approving the Settlement. Although the Company believes that the appeal, which is currently pending, is without merit, no assurance can be given in this regard or as to what relief, if any, might be granted in the event the appeal were to be successful.
On December 8, 2003, Globalstar and Thermo Capital Partners, LLC (“Thermo”) reached an acquisition agreement for Thermo to acquire a majority interest in a reorganized Globalstar (the “Thermo Transaction”). The Court approved the sale of Globalstar’s assets to a new company (“New Globalstar”) to be controlled by Thermo in exchange for an investment of $43 million for which Thermo would receive an 81.25% equity stake in the new operating company. Following consummation of the Thermo Transaction and upon resolution of the Globalstar bankruptcy cases, Globalstar’s creditors will be allocated the remaining 18.75% equity interest. Loral’s share of any such equity interest allocation is estimated at approximately 2.5% of New Globalstar. Globalstar’s transaction with Thermo is subject to a number of material closing conditions. There can be no assurance that Globalstar will be successful in completing the Thermo Transaction or that Globalstar will be successfully reorganized.
The Company’s investment in Globalstar related activities on its balance sheet as of December 31, 2003 was $3 million, representing the fair value of its investment in Globalstar’s $500 million credit facility which was based on the trading values of Globalstar’s public debt at December 31, 2003. If Globalstar is unable to effectuate a successful restructuring, the Company’s investment in Globalstar would likely be worthless, which would have no effect on the Company’s results of operations.
Loral holds various indirect ownership interests in three foreign companies that currently serve as exclusive service providers for Globalstar service in Brazil, Mexico and Russia and an indirect ownership in a U.S.-based distributor that has the exclusive right to sell Globalstar services to certain agencies within the U.S. Government. In 2002, the Company paid $10 million it had guaranteed in connection with a Globalstar service provider partnership.
8.
Accounting for Goodwill and Other Acquired Intangible Assets
On January 1, 2002, the Company adopted SFAS 142, which addresses the initial recognition and measurement of intangible assets acquired outside of a business combination and the accounting for goodwill and other intangible assets subsequent to their acquisition. SFAS 142 provides that intangible assets with finite useful lives be amortized and that goodwill and intangible assets with indefinite lives not be amortized, but rather be tested at least annually for impairment. SFAS 142 also changed the evaluation criteria for testing goodwill for impairment from an undiscounted cash flow approach, which was previously utilized under the
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guidance in SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of (“SFAS 121”) and Accounting Principles Board Opinion No. 17, Intangible Assets (“APB 17”), to a test based on fair value. Fair value is determined by the amount at which an asset or liability could be bought or sold in a current transaction between willing parties, that is, other than in a forced or liquidation sale. Quoted market prices in active markets are the best evidence of fair value and must be used as the basis for the measurement, if available. If quoted market prices are not available, the estimate of fair value must be based on the best information available, including prices for similar assets and liabilities and the results of using other valuation techniques, such as public company trading multiples, future discounted cash flows and merger and acquisition transaction multiples.
Goodwill
In accordance with SFAS 142, the Company’s previously recognized cost in excess of net assets acquired (“goodwill”) of $892 million for business acquisitions accounted for under the purchase method of accounting completed prior to July 1, 2001, was reviewed under the new transitional guidance as of January 1, 2002. Goodwill had been previously assigned to the Company’s business segments as follows (based on the net book value at December 31, 2001): Satellite Services $606 million and Satellite Manufacturing $286 million. The Company hired professionals in the valuation consulting business to determine the fair value of each of the Company’s reporting units. Since there were no quoted market prices in active markets for the Company’s reporting units, the measurement of fair value for each reporting unit was based on the best information available for that reporting unit, including reasonable and supportable assumptions and projections, as follows: (1) Satellite Services - public company trading multiples and merger and acquisition transaction multiples and (2) Satellite Manufacturing - future discounted cash flows. Based on the fair values concluded on by those professionals, management determined that the goodwill for each of the Company’s reporting units under the new guidance in SFAS 142 was fully impaired. Accordingly, as of January 1, 2002, the Company recorded a non-cash charge for the cumulative effect of the change in accounting principle of $890 million.
The charge was the result of a change in the evaluation criteria for goodwill from an undiscounted cash flow approach, which was previously utilized under the guidance in SFAS 121 and APB 17, to the fair value approach which is stipulated in SFAS 142.
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The following table presents the actual financial results and as adjusted financial results without the amortization of goodwill for the Company for the year ended December 31, 2001 (in thousands, except per share amounts):
Other Acquired Intangible Assets
The Company evaluated the useful lives of its other acquired intangible assets in connection with the adoption of SFAS 142 and determined that no changes to the useful lives were necessary.
Other acquired intangible assets are included in other assets in the Company’s consolidated balance sheets as follows (in millions):
As of December 31, 2003, the weighted average remaining amortization period for satellite related intangibles was six years, 12 years for regulatory fees and two years for other intangibles.
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Total pre-tax amortization expense for other acquired intangible assets was $6.9 million for each of the three years in the period ended December 31, 2003. Annual pre-tax amortization expense for other acquired intangible assets for the five years ended December 31, 2008 is estimated to be as follows (in millions):
9.
Liabilities Subject to Compromise
As discussed in Note 2, the Company and its Debtor Subsidiaries have been operating as a debtor in possession under the jurisdiction of the Bankruptcy Court and in accordance with the provisions of the Bankruptcy Code.
In the consolidated balance sheet, the caption “liabilities subject to compromise” reflects Loral’s current estimate of the amount of prepetition claims that will be restructured in Loral’s and its Debtor Subsidiaries’ Chapter 11 Cases. Pursuant to court order, Loral has been authorized to pay certain prepetition operating liabilities incurred in the ordinary course of business (e.g. salaries and insurance). Since July 15, 2003, as permitted under the Bankruptcy Code, the Company has rejected certain of its prepetition obligations. Loral is in the process of calculating its estimated liability to the unsecured creditors affected by these contract rejections. The Bankruptcy Court established January 26, 2004 as the bar date in the Debtors’ Chapter 11 Cases, which is the date by which claims against Loral and its Debtor Subsidiaries were required to have been filed for claimants to receive any distribution in the Chapter 11 Cases. Differences between liability amounts estimated by the Company and claims filed by creditors are being investigated and the Bankruptcy Court will make a final determination of the allowable claim. The determination of how liabilities will ultimately be treated cannot be made until the Bankruptcy Court approves a Chapter 11 plan of reorganization. Loral and its Debtor Subsidiaries will continue to evaluate the amount and classification of their prepetition liabilities in general through the remainder of their Chapter 11 Cases. Should Loral or its Debtor Subsidiaries, through this ongoing evaluation, identify additional liabilities subject to compromise, such amounts will be recognized accordingly. As a result, “liabilities subject to compromise” are subject to change. Claims classified as “liabilities subject to compromise” represent secured as well as unsecured claims. Liabilities subject to compromise at December 31, 2003 consisted of the following (in thousands):
(1)
Includes $47 million of vendor financing that is non-recourse to SS/ L in the event of non-payment by Globalstar due to bankruptcy.
Preferred Stock
The Company’s 6% Series C convertible redeemable preferred stock (“the Series C Preferred Stock”) and 6% Series D convertible redeemable preferred stock (“the Series D Preferred Stock”) have mandatory redemption dates in 2006 and 2007, respectively. The Company has the right to make mandatory redemption payments to the holders in either cash or common stock, or a combination of the two. On July 1, 2003, the
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Company adopted SFAS 150. As a result of the adoption of SFAS 150, the Company reclassified its preferred stock to liabilities from shareholders’ deficit at June 30, 2003 and the related dividends since adoption have been included in interest expense (see Note 3).
In August 2002, Loral’s Board of Directors approved a plan to suspend indefinitely the future payment of dividends on its two series of preferred stock. Accordingly, Loral has deferred the payments of quarterly dividends due on its Series C and Series D preferred stock. On July 15, 2003, Loral stopped accruing dividends on the two series of its preferred stock in its consolidated financial statements, as a result of the Company’s Chapter 11 filing. Because Loral failed to pay dividends on the Series C and the Series D preferred stock for six quarters, holders of the majority of each class of such preferred stock are now entitled, subject to the applicable effects of the Chapter 11 Cases and Loral’s Bermuda insolvency proceedings, to elect two additional members, for a total of four, to Loral’s Board of Directors.
6% Series C Convertible Preferred Stock
The Series C Preferred Stock is non-voting unless Loral does not pay dividends for an aggregate of six quarters, and with respect to dividend rights and rights upon liquidation, winding up and dissolution, ranks pari passu with the Series D Preferred Stock and senior to or pari passu with all other existing and future series of preferred stock of Loral and senior to Loral common stock. Prior to redemption, the Series C Preferred Stock is redeemable in cash at any time, in whole or in part, at the option of the Company (at a premium which declines over time). The Series C Preferred Stock is redeemable in cash, Loral common stock or a combination thereof, at the option by the Company, on the mandatory redemption date. As a consequence of the Chapter 11 Cases, it is not likely that a mandatory redemption will occur.
6% Series D Convertible Preferred Stock
The Series D Preferred Stock is non-voting, unless Loral does not pay dividends for six consecutive quarters, and with respect to dividend rights and rights upon liquidation, winding up and dissolution, ranks pari passu with the Series C Preferred Stock and all other existing and future series of preferred stock of Loral and senior to Loral common stock. The Series D Preferred Stock is redeemable in cash, Loral common stock or a combination thereof, at the option by the Company, on the mandatory redemption date. As a consequence of the Chapter 11 Cases, it is not likely that a mandatory redemption will occur.
As of December 31, 2003, the Company had 12 million authorized shares of preferred stock for which the series had not been designated.
LORAL SPACE & COMMUNICATIONS LTD., A DEBTOR IN POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
10.
Debt
Loral currently has approximately $2.2 billion in debt (including future accrued interest of $214 million associated with the deferred gain on the Loral Orion debt exchanges). This debt includes $967 million of bank debt that is secured by liens on the assets of Loral SpaceCom and Loral Satellite, consisting primarily of Loral’s satellite manufacturing assets and satellites serving the North American market. As a result of the commencement of its Chapter 11 Cases, Loral continues to pay interest only on its bank debt, which has significantly reduced its cash interest payments. Loral expects to use the proceeds from the sale of the satellites serving the North American market to the Purchasers to repay its outstanding secured bank debt (see Note 2). From July 15, 2003 to December 31, 2003, Loral did not recognize $22.3 million of interest expense and $28.1 million of a reduction to its 10% senior notes as a result of the suspension of interest payments on its debt obligations.
As a result of Loral’s and the Debtor Subsidiaries’ voluntary petitions for reorganization, all of Loral’s prepetition debt obligations (aggregating approximately $2.2 billion at December 31, 2003) have been accelerated. On July 15, 2003, Loral suspended interest payments on the 9.50% Senior Notes due 2006, on the 10% Senior Notes due 2006, on the 11.25% Senior Notes due 2007 and on the 12.50% Senior Notes due 2007. A creditors’ committee has been appointed in the Chapter 11 Cases to represent all unsecured creditors, including all holders of Loral’s and Loral Orion’s senior unsecured notes, and, in accordance with the provisions of the Bankruptcy Code, it has the right to be heard on all matters that come before the Bankruptcy Court (see Note 2).
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Substantially all of the assets of Loral SpaceCom and Loral Satellite constitute collateral security for the obligations that are owed to their bank lenders. Under the provisions of the Bankruptcy Code, Loral SpaceCom and Loral Satellite are not authorized to use the existing cash or cash proceeds of this collateral (the “Cash Collateral”) without either an order of the Bankruptcy Court authorizing the use of the Cash Collateral or the consent of their bank lenders.
On the date the Chapter 11 cases were commenced, the Bankruptcy Court entered an order authorizing the Debtors to use the Cash Collateral to fund all operating expenses associated with their businesses in accordance with an agreed upon budget and in accordance with certain other terms set forth in the order. The use of the Cash Collateral can be terminated by the bank lenders upon the occurrence of certain events specified in the order. The bank lenders have granted the Debtors a number of waivers in the past. In fact, the Debtors currently are operating under a waiver that temporarily sets aside certain of the order’s requirements, among them, the requirement for an agreed upon business plan, certain financial tests, maintenance of in-orbit insurance at certain levels and delivery of financial statements. There can be no assurance that the bank lenders will grant future waivers. In the event the Debtors’ ability to use the Cash Collateral were terminated, the Debtors would still have the right to seek the authority of the Bankruptcy Court to use the Cash Collateral notwithstanding any objection by the bank lenders. There can be no assurance that the Bankruptcy Court would grant such request.
Satellite Credit Agreement
On December 21, 2001, Loral Satellite, a subsidiary of Loral Space & Communications Corporation, which in turn is a subsidiary of Loral, entered into the first amendment to the $500 million secured credit agreement dated as of November 17, 2000 by and among Loral Satellite, Bank of America as Administrative Agent, and the other lending parties thereto (the “Satellite Credit Agreement”). The first amendment provides for a $200 million revolving credit facility expiring January 7, 2005 and a term loan of which $226.5 million was outstanding as of December 31, 2003. During the first quarter of 2003, Loral had drawn down the full amount of the revolving credit facility. The first amendment also effected certain changes to provisions relating to the collateral pool provided to lenders under the Loral Satellite credit facility and imposed additional limitations on the application of proceeds from any sale of assets from this collateral pool.
Borrowings under the Satellite Credit Agreement bear interest, at Loral Satellite’s option, at various rates based on fixed margins over the lead bank’s base rate or the London Interbank Offer Rate for specified periods. Loral Satellite pays a commitment fee on the unused portion of the revolver. The Satellite Credit Agreement contains customary limitations, including those on indebtedness, fundamental changes, asset sales, dividends, investments, capital expenditures, creating liens (other than those created pursuant to the Satellite Credit Agreement), prepayments or amendments of indebtedness, and transactions with affiliates. During 2002, Loral Satellite paid dividends of $35 million to its parent.
The Satellite Credit Agreement is secured by certain assets of Loral Satellite, including the Telstar 6 and Telstar 7 satellites and the payments due to Loral Satellite under Globalstar’s $500 million credit facility (see Note 7). In addition, as part of the first amendment, lenders under the Satellite Credit Agreement received a junior lien on the assets of Loral SpaceCom and its subsidiaries pledged in favor of the banks under the LSC Amended Credit Agreement (as defined below). Loral has also agreed to guarantee Loral Satellite’s obligations under the Satellite Credit Agreement, which guarantee agreement contains a minimum net worth covenant.
On March 31, 2003, Loral Satellite amended the Satellite Credit Agreement to provide for certain modifications, including to its financial covenants (the “Loral Satellite Amendment”). Loral Satellite’s ability to dividend funds to its parent was substantially reduced in connection with this amendment.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The Loral guarantee was also amended in March 2003 to impose additional restrictions on Loral’s ability to pay dividends and to effect voluntary repayment or purchase of indebtedness. Moreover, under the amended guarantee, Loral’s ability to make investments or otherwise make payment to any of its subsidiaries is limited to a maximum amount of $5 million.
LSC Amended Credit Agreement
On December 21, 2001, Loral SpaceCom entered into an Amended and Restated Credit Agreement with Bank of America, N.A., as Administrative Agent, and the other lenders parties thereto (the “LSC Amended Credit Agreement”). The Loral SpaceCom Amended Credit Agreement provides for a $200 million revolving credit facility expiring January 7, 2005 and a term loan of which $350 million was outstanding at December 31, 2003. During the first quarter of 2003, Loral SpaceCom had substantially utilized the revolving credit facility through drawdowns and letters of credit. Borrowings under the LSC Amended Credit Agreement bear interest, at Loral SpaceCom’s option, at various rates based on margins over the lead bank’s base rate or the London Interbank Offered Rate for specified periods.
The Loral SpaceCom Amended Credit Agreement contains limitations on Loral SpaceCom and its subsidiaries, including those on indebtedness, liens, fundamental changes, asset sales, dividends, investments, capital expenditures, transactions with affiliates and certain other intercompany transactions.
The Loral SpaceCom Amended Credit Agreement is secured by substantially all of the assets of and the stock of Loral SpaceCom and its subsidiaries, including SS/ L. Loral SpaceCom’s obligations under the Loral SpaceCom Amended Credit Agreement have been guaranteed by certain of its subsidiaries, including SS/ L. As of December 31, 2003, the net book value of the assets that secure the Loral SpaceCom Amended Credit Agreement was approximately $250 million.
On March 31, 2003, Loral SpaceCom further amended the LSC Amended Credit Agreement to provide for additional modifications, including to Loral SpaceCom’s financial covenants (the “LSC Amendment”). The amendment imposed additional restrictions on Loral SpaceCom and its subsidiaries, including further restricting their ability to incur capital expenditures, sell assets, incur debt, provide vendor financing and make investments. The lenders under the Loral SpaceCom facilities also received a junior lien on the stock of Loral Satellite as part of this amendment.
In connection with the amendment of the Loral SpaceCom and the Loral Satellite credit facilities, Loral agreed to the continued retention of a financial advisor to assist it in various matters, including advising the Company on strategic alternatives, which may include asset sales and other actions to reduce indebtedness.
Loral Orion Indentures
On December 21, 2001, Loral Orion issued $613 million principal amount of 10% senior notes due 2006 and guaranteed by Loral, in exchange for the extinguishment of $841 million principal amount of Loral Orion 11.25% senior notes due 2007 and 12.5% senior discount notes due 2007 as discussed below.
As part of the exchange, Loral issued to the new note holders 604,299 five-year warrants to purchase Loral common stock at a price of $23.70 per share. The warrants were valued at $7 million using the Black Scholes option pricing model with the following assumptions: stock volatility, 75%, risk free interest rate, 4.36%, and no dividends during the expected term. As of December 31, 2003, principal amount of $37 million of the existing 11.25% senior notes and principal amount of $49 million of the existing 12.5% senior discount notes remain outstanding at their original maturities and interest rates.
The interest rate on the 10% senior notes is a reduction from the 11.25% interest rate on the existing senior notes and the 12.5% rate on the existing senior discount notes. Interest is payable semi-annually on July 15 and January 15, beginning July 15, 2002. Under U.S. GAAP dealing with debt restructurings, in 2001 the Company recorded a gain of $34 million on the exchange, after expenses of $8 million. The carrying value of the 10% senior notes on the balance sheet at December 31, 2003 was $827 million, although the actual
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
principal amount of the 10% senior notes is $613 million. The difference between this carrying value and the actual principal amount of the 10% senior notes is being amortized over the remaining life of the 10% senior notes, fully offsetting interest expense through maturity of the 10% senior notes. The indenture relating to the 10% senior notes contains covenants, including, without limitation, restrictions on Loral Orion’s ability to pay dividends or make loans to Loral.
In connection with the consummation of the exchange offer, LSC canceled its $79.7 million intercompany note issued to it by Loral Orion, which ranked pari passu to the senior debt, in exchange for the transfer of Loral Orion’s data services business and the issuance of a new note to LSC in the principal amount of $29.7 million due 2006, having an interest rate of 10% per annum payable in kind, subordinated to Loral Orion’s 10% senior notes.
The Loral Orion 11.25% senior notes are due in 2007 and require interest payments semi-annually. The 12.5% senior discount notes are due in 2007 and require interest payments semi-annually commencing on July 15, 2002. In connection with the Loral Orion acquisition in 1998, the carrying value of the senior notes and senior discount notes were increased to reflect a fair value adjustment based on quoted market prices at the date of acquisition. Such adjustment resulted in effective interest rates of 8.69% and 9.69% on the senior notes and senior discount notes, respectively, through maturity. Along with the issuance of each 11.25% senior note and 12.5% senior discount note, one warrant was originally issued to purchase shares of common stock. Upon the acquisition of Loral Orion, each warrant was converted so that it could purchase shares of Loral common stock. As of December 31, 2003, exercisable warrants for 4,530 shares of Loral common stock at an exercise price of $0.23 per share under the Loral Orion 11.25% senior notes and 8,397 shares of Loral common stock at an exercise price of $0.30 per share under the Loral Orion 12.5% senior discount notes are yet to be exercised.
Loral Senior Notes
In 1999, Loral sold $350 million principal amount of 9.5% Senior Notes due 2006 (“Senior Notes”). The Senior Notes are general unsecured obligations of Loral that: (1) are structurally junior in right of payment to all existing and future indebtedness of Loral’s subsidiaries; (2) are equal in right of payment with all existing and future senior indebtedness of Loral (except as to assets pledged to secure such indebtedness); and (3) are senior in right of payment to any future indebtedness which is by its terms junior in right of payment to any senior indebtedness of Loral. Interest on the Senior Notes accrues at the rate of 9.5% per annum and is payable semi-annually on January 15 and July 15. The Senior Notes were scheduled to mature on January 15, 2006. Upon a change of control (as defined), each holder of Senior Notes will have the right to require Loral to repurchase such holder’s Senior Notes at a price equal to 101% of the principal amount thereof plus accrued interest to the date of repurchase.
11.
Reorganization Expenses Due to Bankruptcy
Reorganization expenses due to bankruptcy for the period from July 15, 2003 (filing date) to December 31, 2003, include professional fees associated with bankruptcy services, employee retention costs, lease rejection claims, vendor settlement gains and interest income earned, excluding interest earned related to satellite activities, and were as follows (in thousands):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
12.
Income Taxes
The provision for income taxes on the loss before income taxes, equity in net losses of affiliates, minority interest, cumulative effect of change in accounting principle and extraordinary gain on acquisition of minority interest consists of the following (in thousands):
The above income tax provision excludes the following (in thousands):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The provision for income taxes on the loss before income taxes, equity in net losses of affiliates, minority interest, cumulative effect of change in accounting principle and extraordinary gain on acquisition of minority interest differs from the amount computed by applying the statutory U.S. Federal income tax rate because of the effect of the following items (in thousands):
For the years ended December 31, 2003, 2002 and 2001, loss before income taxes includes approximately $22 million, $49 million and $71 million, respectively, of non-U.S. source loss. As of December 31, 2003, the Company had net operating loss carryforwards or NOLs of approximately $1.8 billion, which includes $203 million related to foreign partner interests in Globalstar and CyberStar L.P. (“Cyberstar”), as well as tax credit carryforwards of approximately $11.7 million, which expire at varying dates from 2012 through 2023. While the NOLs can be used to offset future taxable income, including the tax gain that will be recognized upon the sale of the satellite assets to Intelsat (see Note 2), future use may be impaired depending upon various factors relating to the Company’s plan of reorganization such as how creditor claims are satisfied, how the equity interests in the reorganized company are distributed, the extent of any capital infusion by new investors and the Company’s value and level of debt at the time the Company emerges from bankruptcy, which are unknown at this time. Moreover, if it is determined that an “ownership change” occurred in the three-year period preceding the emergence from bankruptcy, future use of these NOLs would be severely limited. An ownership change would be triggered if shareholders owning 5% or more of the Company’s total equity value change their holdings during this three-year period by more than 50% in the aggregate. On August 22, 2003, the Bankruptcy Court entered an order to assist the Company in protecting the NOLs by establishing procedures that require certain proposed acquirers of the Company’s securities to notify the Company about a prospective acquisition, thus giving the Company an opportunity to file an objection with the Bankruptcy Court if deemed necessary. While there is no guarantee that the Bankruptcy Court will rule in the Company’s favor in the event of a dispute between a proposed acquirer and the Company, a ruling against the Company could jeopardize a substantial portion of its NOLs.
The Company assesses the recoverability of its NOLs and other deferred tax assets and based upon this analysis, records a valuation allowance to the extent recoverability does not satisfy the “more likely than not” recognition criteria in SFAS No. 109. Based upon this analysis, management concluded during the fourth quarter of 2002 that, due to insufficient positive evidence substantiating recoverability, a 100% valuation allowance should be established for the entire balance of the Company’s net deferred tax assets. During 2003, Loral continued to maintain the valuation allowance increasing the reserve by $94.4 million to a balance of $670.9 million. Of this net increase, $7.8 million represented deferred tax assets applied directly to shareholders’ deficit for other comprehensive loss items, $12.0 million was applied to equity in net losses of
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
affiliates and $21.0 million represented a reduction to the allowance which was applied directly against the deferred tax asset. The balance of $95.6 million was charged to the 2003 results.
During 2002, the valuation allowance was increased by $390.4 million to a balance of $576.5 million. Of this net increase, $31.9 million represented deferred tax assets applied directly to shareholders’ deficit for other comprehensive loss items, $18.7 million primarily related to the cumulative effect of a change in accounting principles on the adoption of SFAS 142 and $55.9 million represented a reduction to the allowance which was applied directly against the deferred tax asset. Included in the reduction was the elimination of the benefit for NOLs related to certain foreign partners interests in Globalstar that will expire unrealized. The balance of $395.7 million was charged to the 2002 results. The valuation allowance was $186.1 million at December 31, 2001.
As of December 31, 2003 and 2002, valuation allowances of $670.9 million and $576.5 million, respectively, have been established for the entire balances of the Company’s net deferred tax assets. Loral will maintain the valuation allowance until sufficient positive evidence exists to support its reversal. Until such time, we expect to report no income tax provision net of valuation allowance adjustments, except for potential alternative minimum taxes and minor state, local and foreign tax provisions. When Loral determines that it will be able to realize its deferred tax assets, an adjustment to the valuation allowance will increase income in the period such determination is made.
The significant components of the net deferred income tax asset (liability) are (in thousands):
The net deferred income tax liability is included in other long-term liabilities.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
13.
Shareholders’ Deficit
Common Stock
On June 4, 2003, the Company’s Board of Directors approved a reverse stock split of the Company’s common stock at a ratio of one-for-ten, resulting in a new par value of $0.10 per common share (previously $0.01 par value per common share). The reverse stock split became effective after the close of business on June 13, 2003 and reduced the number of shares of common stock then outstanding from 440 million to 44 million. All share and per share amounts for all periods presented have been retroactively restated to reflect the reverse stock split.
At its annual shareholders’ meeting on May 29, 2003, the Company obtained shareholder approval to increase the authorized number of shares of its common stock from 75,000,000 to 125,000,000 (as adjusted for the above-mentioned reverse stock split).
Series B Preferred Stock
The Series B Preferred Stock will, if issued, be junior to any other series of preferred stock which may be authorized and issued. The Series B Preferred Stock becomes issuable upon exercise by holders of rights issued under the Company’s rights plan. The rights are issued with the Company’s common stock and become detachable, and thus exercisable, only upon the occurrence of certain events. Each right, when it becomes exercisable, entitles the holder to purchase from the Company a unit consisting initially of one-thousandth of a share of Series B Preferred Stock at a purchase price of $50 per unit, subject to adjustment.
6% Series C and Series D Convertible Redeemable Preferred Stock
Based upon the price of the Company’s common stock at December 31, 2002, the Company did not have available a sufficient number of authorized shares of its common stock to effect payment of the total mandatory redemptions of its preferred stock into common stock in 2006 and 2007. Accordingly, as of December 31, 2002, the Company classified an aggregate of $125 million of its Series C Preferred Stock and Series D Preferred Stock outside the shareholders’ deficit section of the balance sheet, based on the average of the volume weighted average daily price of the Company’s common stock as defined. As a consequence of the Chapter 11 Cases, it is not likely that a mandatory redemption will occur. See Note 9.
Series C and Series D Preferred Stock Conversions
In connection with the conversions of the Company’s preferred stock for common stock in 2002 and 2001 detailed below, the Company retired preferred stock with mandatory redemptions in 2006 and 2007 aggregating $921 million (representing 80% of the aggregate redemption values prior to these exchanges).
On October 8, 2002, Loral completed exchange offers for its Series C and Series D preferred stock and converted 4.3 million shares of its Series C Preferred Stock and 2.7 million shares of its Series D Preferred Stock for 4.6 million shares of its common stock and $13.4 million in cash. In connection with the exchange offers, Loral incurred $21.6 million of dividend charges, comprised of the $13.4 million in cash and non-cash dividend charges of $8.2 million. The non-cash dividend charges relate to the difference between the value of the common stock issued in the exchanges and the value of the shares that were issuable under the stated conversion terms of the preferred stock and will have no impact on Loral’s total shareholders’ deficit as the offset was an increase in common stock and paid-in capital.
During the second quarter of 2002, in privately negotiated exchange transactions, Loral converted 1.8 million shares of its Series C Preferred Stock and 2.7 million shares of its Series D Preferred Stock into 3.1 million shares of its common stock. In connection with these transactions, Loral incurred non-cash dividend charges of $38 million, which primarily relate to the difference between the value of the common
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
stock issued in the exchanges and the value of the shares that were issuable under the stated conversion terms of the preferred stock. The non-cash dividend charges had no impact on Loral’s total shareholders’ deficit, as the offset was an increase in common stock and paid-in capital.
On April 16, 2001, the Company completed exchange offers for its Series C Preferred Stock and its Series D Preferred Stock. As a result, 3.7 million shares of its Series C Preferred Stock and 1.9 million shares of its Series D Preferred Stock were tendered and exchanged into 3.1 million shares of the Company’s common stock. Loral incurred non-cash dividend charges in the second quarter of 2001 of $29 million, which primarily relate to the difference between the value of the common stock issued in the exchanges and the value of the shares that were issuable under the stated conversion terms of the preferred stock. The non-cash dividend charges had no impact on Loral’s total shareholders’ deficit, as the offset was an increase in common stock and paid-in capital.
Stock Plans
On April 18, 2000, the Board of Directors of Loral approved a new stock option plan (the “2000 Plan”) in order to provide an inducement to attract and retain the services of qualified employees. The 2000 Plan is intended to constitute a “broadly-based plan” as defined in Section 312.04(h) of the NYSE Listed Company Manual, which provides that at least 50% of grants thereunder exclude senior management. The 2000 Plan provides for the grant of non-qualified stock options only. As of December 31, 2003, up to 3.7 million shares of common stock may be issued under the 2000 Plan, of which approximately 1.6 million options at a weighted average exercise price of $20.30 per share were outstanding as of December 31, 2003.
In April 1996, Loral established the 1996 Stock Option Plan. An aggregate of 1.8 million shares of common stock have been reserved for issuance, of which approximately 0.8 million options at a weighted average exercise price of $95.63 per share were outstanding as of December 31, 2003.
In connection with the acquisition of Loral Orion, Loral assumed the unvested employee stock options of Loral Orion.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
A summary of the status of the Company’s stock option plans as of December 31, 2003, 2002 and 2001 and changes during the periods then ended is presented below:
The following table summarizes information about Loral’s outstanding stock options at December 31, 2003:
All options granted during 2002 and 2001 were non-qualified stock options. As of December 31, 2003, 2,996,265 shares of common stock were available for future grant under the plans.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
In connection with its exchange offer for certain outstanding stock options completed on March 7, 2003, Loral accepted and cancelled existing stock options to purchase an aggregate of 1,488,440 shares of common stock that were tendered in the exchange offer and agreed to grant in exchange new stock options to purchase an aggregate of 602,149 shares of common stock. The new options were to be granted, subject to the terms and conditions of the exchange offer, on September 8, 2003. As a result of Loral’s Chapter 11 filing, however, Loral will not be able to grant the new stock options. Any claims or rights that option holders whose options were cancelled may have will be addressed in the context of the Chapter 11 Cases. These cancellations have been reflected as forfeitures in 2003.
14.
Loss Per Share
Basic loss per share is computed based upon the weighted average number of shares of common stock outstanding. Diluted loss per share excludes the assumed conversion of the Series C Preferred Stock and the Series D Preferred Stock (see Note 13), as their effect would have been antidilutive in 2003, 2002 and 2001, respectively. For 2003, 2002 and 2001, weighted options equating to zero, 151,632 and 38,966 shares of common stock, respectively, as calculated using the treasury stock method, were excluded from the calculation of diluted loss per share, as the effect would have been antidilutive.
The following table sets forth the computation of basic and diluted loss per share:
15.
Pensions and Other Employee Benefits
Pensions
The Company maintains a pension plan and a supplemental retirement plan. These plans are defined benefit pension plans and members in certain locations may contribute to the pension plan in order to receive enhanced benefits. Eligibility for participation in these plans vary and benefits are based on members’
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
compensation and/or years of service. The Company’s funding policy is to fund the pension plan in accordance with the Internal Revenue Code and regulations thereon and to fund the supplemental retirement plan on a discretionary basis. Plan assets are generally invested in U.S. government and agency obligations and listed stocks and bonds.
Other Benefits
In addition to providing pension benefits, the Company provides certain health care and life insurance benefits for retired employees and dependents. Participants are eligible for these benefits when they retire from active service and meet the eligibility requirements for the Company’s pension plan. These benefits are funded primarily on a pay-as-you-go basis, with the retiree generally paying a portion of the cost through contributions, deductibles and coinsurance provisions.
The following tables provide a reconciliation of the changes in the plans’ benefit obligations and fair value of assets for 2003 and 2002, and a statement of the funded status as of December 31, 2003 and 2002, respectively. The Company uses a December 31 measurement date for the pension plans and other post retirement benefit plans.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table provides the details of the net pension liability recognized in the balance sheet as of December 31, 2003 and 2002, respectively (in thousands):
Included in liabilities subject to compromise (Note 9) is $131 million of the accrued benefit liability for pensions and the net amount recognized for other benefits.
The accumulated pension benefit obligation was $321.0 million and $281.1 million at December 31, 2003 and 2002, respectively.
For 2003, the Company’s qualified pension plan, under the Internal Revenue Code and regulations thereunder, was considered fully funded (i.e. assets are greater than liabilities) and there was no contribution required for 2003. During 2004, based on current estimates, the Company expects to contribute $13 million to the qualified pension plan. The significant declines experienced in the financial markets in previous years have unfavorably impacted pension plan asset performance. This, coupled with historically low interest rates (a key factor when estimating pension plan liabilities), caused the Company to recognize an additional $4.5 million during 2003, for a total of $69.2 million of non-cash charges to other comprehensive income (loss) as of December 31, 2003. Market conditions and interest rates significantly impact future assets and liabilities of the Company’s pension plans, and this charge to equity will be revalued in the future based upon plan assets and the measurement of plan obligations which is completed at the end of each fiscal year.
The following table provides the components of net periodic cost for the plans for 2003, 2002 and 2001, respectively (in thousands):
The principal actuarial assumptions were:
Assumptions used to determine net periodic cost:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Assumptions used to determine the benefit obligation:
The expected long-term rate of return on pension plan assets is selected by taking into account the expected duration of the projected benefit obligation for the plans, the asset mix of the plans and the fact that the plan assets are actively managed to mitigate risk. Allowable investment types include equity investments and fixed income investments. Pension plan assets are managed by Russell Investment Corp., which allocates the assets into specified Russell designed funds as per the Company’s directed asset allocation. Each specified Russell fund is then managed by investment managers chosen by Russell. The targeted allocation of the Company’s pension plan assets is 60% in equity investments and 40% in fixed income investments. Based on this target allocation, the fifteen year historical return of the Company’s investment managers has been 10.9%. The Company believes that its long-term asset allocation will approximate 60% in equity investments and 40% in fixed income investments. The expected long-term rate of return on plan assets determined on this basis was 9.0% for 2003, a decline of 50 basis points from 2002.
The Company’s pension and other employee benefits plan asset allocations by asset category as of December 31, 2003 and 2002 are as follows:
Actuarial assumptions used a health care cost trend rate of 11.0% decreasing gradually to 4.50% by 2010. Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A 1% change in assumed health care cost trend rates for 2003 would have the following effects (in thousands):
On December 8, 2003, President Bush signed the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (DIMA). The Act introduces a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. In accordance with the FASB Staff Position No. 106-1, Loral is electing to defer recognition of any potential savings on the measure of accumulated postretirement benefit obligation or net periodic benefit cost as a result of DIMA until specific authoritative guidance on the accounting of the federal subsidy is issued. Therefore, the consolidated financial statements do not reflect the effects of the Act on the plan.
Employee Savings Plan
The Company has an employee savings plan, which provides that the Company match the contributions of participating employees up to a designated level. Under this plan, the matching contributions in Loral common stock or cash were $5.3 million, $6.6 million and $6.7 million in 2003, 2002 and 2001, respectively. Employees vested in the savings plan are able to redirect the Company match to any available fund. In addition, employees are able to direct their individual contributions to any available fund.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
16.
Financial Instruments, Derivative Instruments and Hedging
Financial Instruments
The estimated fair values of the Company’s financial instruments are as follows (in thousands):
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate fair value:
The carrying amount of cash and cash equivalents approximates fair value because of the short maturity of those instruments. The fair value of the investments in available-for-sale securities are based on market quotations or, for the Company’s investment in Globalstar’s $500 million credit facility (as adjusted for the settlement agreement), the quoted market price of Globalstar’s public debt securities (see Note 7). The fair value of the Company’s debt is based on the carrying value for those obligations that have short-term variable interest rates on the outstanding borrowings and quoted market prices for obligations with long-term or fixed interest rates (the fair value for the Loral Orion 11.25% and 12.5% senior notes was based on the quoted market price of the Loral Orion 10% senior notes, as there was no active market for those senior notes). The fair value of the Company’s preferred stock is based on market quotations.
The fair value of the investments in available-for-sale securities includes unrealized gains of $3 million and $20 million as of December 31, 2003 and 2002, respectively, which relates to the Company’s investment in Globalstar’s $500 million credit facility (see Note 4). Approximately $214 million and $245 million of the carrying amount of debt as of December 31, 2003 and 2002, respectively, is attributable to the accounting for the Loral Orion exchange offer (see Note 10).
Foreign Currency
The Company, in the normal course of business, is subject to the risks associated with fluctuations in foreign currency exchange rates. Prior to filing Chapter 11, the Company entered into forward exchange contracts to establish with certainty the U.S. dollar amount of future anticipated cash receipts and payments and firm commitments for cash payments denominated in a foreign currency. The primary business objective of this hedging program is to minimize the gains and losses resulting from exchange rate changes. As of December 31, 2002, the Company had foreign currency exchange contracts (forwards) with several banks to purchase and sell foreign currencies, primarily Japanese yen, with aggregate notionals of $101.8 million. Such contracts were designated as hedges of certain foreign contracts and subcontracts to be performed by SS/ L through May 2006. The fair value of these foreign currency hedges and forward contracts based on quoted market prices as of December 31, 2002 was $11.7 million and were included in cash (foreign currency cash balances designated as hedges) and other current assets (forward contracts) on the consolidated balance sheets.
Ineffectiveness from all hedging activity was immaterial for the years ended December 31, 2003, 2002 and 2001. For the year ended December 31, 2001, SS/ L recognized charges of $0.7 million, for hedges that no
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longer qualified as fair value hedges and $1.5 million for excluded forward points on accelerated or delayed cash flows, which were recorded as interest expense.
Upon filing Chapter 11, SS/ L’s hedges with counterparties (primarily yen denominated forward contracts) were cancelled leaving SS/ L vulnerable to foreign currency fluctuations in the future. The inability to enter into forward contracts exposes SS/ L’s future revenues, costs and cash associated with anticipated yen denominated receipts and payments to currency fluctuations. As of December 31, 2003, SS/ L had the following amounts denominated in Japanese Yen that were unhedged (in millions):
At December 31, 2003, SS/ L also had future expenditures in EURO’s of $1.5 million ($1.8 million U.S.) that were unhedged.
Derivative Instruments and Hedging
On January 1, 2001, the Company adopted SFAS 133, which requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of derivatives that do not qualify, or are not effective as hedges, must be recognized currently in earnings. Upon adoption, the Company recorded a $1.7 million reduction in net income, net of tax, and a $1.2 million increase in other comprehensive income (“OCI”), net of tax, relating to the cumulative effect of the change in adopting this new accounting principle. The Company recorded these adjustments to recognize the fair value of foreign currency forward contracts that qualify as derivatives under SFAS 133 and to recognize the fair value of firm commitments designated as hedged items in fair value hedge relationships. Furthermore, the transition adjustments reflect the derecognition of any deferred gains or losses recorded on the balance sheet prior to the effective date of SFAS No. 133 on foreign exchange contracts designated as hedges of foreign currency exposures on long-term construction contracts in process.
17.
Commitments and Contingencies
The Company had outstanding letters of credit of approximately $6 million as of December 31, 2003.
Due to the long lead times required to produce purchased parts and launch vehicles, the Company has entered into various purchase commitments with suppliers. These commitments aggregated approximately $108 million as of December 31, 2003, and primarily relate to satellite backlog. The Company’s commitments for unassigned launch vehicles were immaterial as of December 31, 2003. The Company is also obligated to pay $10 million over the next five years pursuant to a consent agreement with the U.S. Department of State, which can be reduced by the Company incurring certain costs as required under the consent agreement.
SS/ L has deferred revenue for performance warranty obligations relating to satellites sold to customers which could be impacted by future performance. SS/ L accounts for satellite performance warranties in accordance with the product warranty provisions of FIN 45 which requires disclosure, but not initial recognition and measurement, of performance guarantees. SS/ L estimates the deferred revenue for its warranty obligation based on historical satellite performance. Management periodically reviews and adjusts the deferred revenue for warranty reserves based on the actual performance of each satellite and remaining
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warranty period. A reconciliation of such deferred amounts for each of the three years in the period ended December 31, 2003, is as follows (in millions):
Loral Skynet has in the past entered into prepaid leases, sales contracts and other arrangements relating to transponders on its satellites. Under the terms of these agreements, Loral Skynet continues to operate the satellites which carry the transponders and originally provided for a warranty for a period of 10 to 14 years, in the case of sales contracts and other arrangements (19 transponders), and the lease term, in the case of the prepaid leases (six transponders). Depending on the contract, Loral Skynet may be required to replace transponders which do not meet operating specifications. Substantially all customers are entitled to a refund equal to the reimbursement value if there is no replacement, which is normally covered by insurance. In the case of the sales contracts, the reimbursement value is based on the original purchase price plus an interest factor from the time the payment was received to acceptance of the transponder by the customer, reduced on a straight-line basis over the warranty period. In the case of prepaid leases, the reimbursement value is equal to the unamortized portion of the lease prepayment made by the customer. In the case of other arrangements, in the event of transponder failure where replacement capacity is not available on the satellite, one customer is not entitled to reimbursement, and the other customer’s reimbursement value is based on contractually prescribed amounts that decline over time. As a result of the Telstar 4 failure, during the third quarter of 2003 Loral Skynet established warranty liabilities of $11 million for previously sold transponders to customers who were restored and who were not restored (three transponders) on other Loral satellites (see Note 2).
Fourteen of the satellites built by SS/ L and launched since 1997, six of which are owned and operated by Loral’s subsidiaries or affiliates, have experienced minor losses of power from their solar arrays. Although to date, neither the Company nor any of the customers using the affected satellites have experienced any degradation in performance, there can be no assurance that one or more of the affected satellites will not experience additional power loss that could result in performance degradation, including loss of transponder capacity or reduction in power transmitted. In the event of additional power loss, the extent of the performance degradation, if any, will depend on numerous factors, including the amount of the additional power loss, the level of redundancy built into the affected satellite’s design, when in the life of the affected satellite the loss occurred and the number and type of use being made of transponders then in service. It is also possible that one or more transponders on a satellite may need to be removed from service to accommodate the power loss and to preserve full performance capabilities of the remaining transponders. In the case of one satellite, Loral Skynet has removed one transponder from service in order to maintain proper power balance for the remaining transponders, none of which have been degraded in performance as a result of the power loss. A complete or partial loss of satellites could result in a loss of orbital incentive payments and, in the case of satellites owned by Loral subsidiaries and affiliates, a loss of revenues and profits. With respect to satellites under construction and construction of new satellites, based on its investigation of the matter, SS/ L has identified and has implemented remediation measures that SS/ L believes will prevent newly launched
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satellites from experiencing similar anomalies. SS/ L does not expect that implementation of these measures will cause any significant delay in the launch of satellites under construction or construction of new satellites. Based upon information currently available, including design redundancies to accommodate small power losses and that no pattern has been identified as to the timing or specific location within the solar arrays of the failures, the Company believes that this matter will not have a material adverse effect on the consolidated financial position or results of operations of Loral.
In September 2001, the PAS 7 satellite built by SS/ L for PanAmSat experienced an electrical power failure on its solar arrays that resulted in the loss of use of certain transponders on the satellite. Also, the PAS 8 satellite has experienced minor losses of power from its solar arrays, the cause of which is unrelated to the loss of power on the PAS 7 satellite. On June 30, 2003, PanAmSat commenced an arbitration claiming that under its contract with SS/ L it is entitled to $23.7 million as a result of these losses. As a result of SS/ L’s Chapter 11 filing, this arbitration is subject to the automatic stay, and further proceedings in the matter have been suspended. In March 2004, the Company reached an agreement in principle to settle this matter with PanAmSat, which is subject to documentation and Bankruptcy Court approval and has recorded a charge to operations of $8 million in the fourth quarter of 2003. In addition, a Loral Skynet satellite has experienced a minor loss of power from its solar arrays, the cause of which may be similar to the cause of the PAS 7 anomaly. SS/ L believes, however, that these failures are isolated events and do not reflect a systemic problem in either the satellite design or manufacturing process. Accordingly, SS/ L does not believe that these anomalies will affect other on-orbit satellites built by SS/ L.
SS/ L has contracted to build a spot beam, Ka-band satellite for a customer planning to offer broadband data services directly to the consumer. SS/ L had suspended work on this program since December 2001 while the customer and SS/ L were in discussions to resolve a dispute under the contract. In March 2003, SS/ L and the customer reached an agreement in principle to restart the satellite construction program, and in June 2003, SS/ L and the customer executed a definitive agreement. As of December 31, 2003, SS/ L had billed and unbilled accounts receivable and vendor financing arrangements of $51 million (including accrued interest of $9 million) with this customer. Under the agreement, the customer will pay the remainder of the purchase price under the contract of $65 million plus accrued interest (including $51 million owed to SS/ L at December 31, 2003) in installments over time, most of which will be due subsequent to completion of the satellite.
SS/ L was a party to an Operational Agreement with Alcatel Space Industries, pursuant to which the parties had agreed to cooperate on certain satellite programs, and an Alliance Agreement with Alcatel Space (together with Alcatel Space Industries, “Alcatel”), pursuant to which Alcatel had certain rights with respect to SS/ L. On June 30, 2003, Loral, SS/ L and Alcatel entered into a master settlement agreement in settlement of all claims among the parties, including arbitration claims brought by Alcatel against Loral alleging breaches of the Operational Agreement and Alliance Agreement. Pursuant to the master settlement agreement, Loral paid Alcatel $5 million and agreed to pay an additional $8 million within one year, resulting in a charge to operations of $13 million. In addition, Alcatel transferred to Loral its minority interest in CyberStar, and Loral transferred to Alcatel its minority interests in Europe*Star and SkyBridge Limited Partnership that Loral had previously written off. As a result of receiving Alcatel’s minority interest in CyberStar, Loral recognized an extraordinary gain of $14 million, which represents the extinguishment of the minority interest liability less the fair value of the acquired net assets. Under the terms of the master settlement agreement, the arbitration and a related court proceeding to confirm the arbitral tribunal’s January partial award were suspended, with termination to occur on the date of confirmation of a plan of reorganization or a liquidation, provided that if any action is commenced in the Chapter 11 Cases seeking the repayment, disgorgement or turnover of the transfers made in connection with the master settlement agreement, because of the commencement of the Chapter 11 Cases, the arbitration and related court confirmation proceeding would not be terminated until such repayment, disgorgement or turnover action had been dismissed. The master settlement agreement also provides that Alcatel is entitled to reinstate the arbitration if it is required by
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judicial order to repay, disgorge or turn over the consideration paid to it under the agreement in the context of the Chapter 11 Cases.
SS/ L is required to obtain licenses and enter into technical assistance agreements, presently under the jurisdiction of the State Department, in connection with the export of satellites and related equipment, as well as disclosure of technical data to foreign persons. Due to the relationship between launch technology and missile technology, the U.S. government has limited, and is likely in the future to limit, launches from China and other foreign countries. Delays in obtaining the necessary licenses and technical assistance agreements have in the past resulted in, and may in the future result in, the delay of SS/ L’s performance on its contracts, which could result in the cancellation of contracts by its customers, the incurrence of penalties or the loss of incentive payments under these contracts.
The launch of ChinaSat 8 has been delayed pending SS/ L’s obtaining the approvals required for the launch. SS/ L is continuing to seek the State Department approvals required for the launch of ChinaSat 8. If ChinaSat were to terminate its contract with SS/ L for ChinaSat 8 as a result of these delays, ChinaSat may seek a refund of $82 million for payments made to SS/ L as well as penalties of up to $11 million. The Company does not believe that ChinaSat is entitled to such a refund or penalties and would vigorously contest any such claims by ChinaSat. If ChinaSat were to terminate the contract, SS/ L estimates that it would incur costs of approximately $38 million to refurbish and retrofit the satellite so that it could be sold to another customer, which resale cannot be guaranteed. In addition, subject to approval of the launch vehicle provider and approval of the Bankruptcy Court, the receipt of which cannot be assured, ChinaSat has agreed to release SS/ L from any claim ChinaSat might have to recover some or all of the $52 million deposit that ChinaSat paid to SS/ L, and SS/ L paid to the launch vehicle provider, for a Chinese launch vehicle.
On September 20, 2002, and as further amended in March 2003, Loral agreed with APT Satellite Company Limited (“APT”) to jointly acquire the Apstar V satellite, a satellite then under construction by SS/ L for APT pursuant to which Loral and APT agreed to share, on a 50/50 basis, the project cost of constructing, launching and insuring the satellite. Under this agreement, Loral was to initially acquire 23% of the satellite in return for paying 25% of the project cost, and was to pay to APT over time an additional 25% of the project cost to acquire an additional 23% interest in the satellite. At December 31, 2003, the project cost of the satellite was estimated at $230 million.
In August 2003, in order to expedite the receipt of necessary export licenses from the U.S. government, Loral and APT amended their various agreements to convert their arrangement from a joint ownership arrangement to a lease arrangement, but leaving unchanged the cost allocation between the parties relating to the project cost of the satellite. Under this arrangement, Loral retains title to the entire satellite, now known as Telstar 18, and will lease to APT transponders representing initially 77% of the transponder capacity on the satellite. The number of transponders leased to APT would be reduced over time upon repayment by Loral of the second 25% of the satellite’s project cost, ultimately to 54% of the satellite’s transponder capacity. As a result of this conversion from joint ownership to a lease arrangement in the third quarter of 2003, Loral (a) reversed the cumulative sales of $83 million and cost of satellite manufacturing of $73 million and (b) recorded an increase to self constructed assets of $73 million and recorded long-term obligations of $80 million which, in addition to the $34 million received from APT and subject to repayment, is included in long-term liabilities as of December 31, 2003.
In November 2003, Loral and APT agreed to further revise their existing arrangement. Under this revised arrangement, Loral agreed, among other things, to accelerate the termination of APT’s leasehold interest in 4.5 transponders by assuming $20.4 million of project cost which otherwise would have been initially paid by APT, decreasing APT’s initial leased transponder capacity from 77% to 69%. In addition, Loral will provide to APT, free of charge, available capacity on Telstar 10/ Apstar IIR, during an interim period, and provide APT with certain rights to exchange Ku-band transponder capacity on Telstar 18 for equivalent Ku-band transponder capacity on Telstar 10/ Apstar IIR.
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SS/ L has entered into several long-term launch services agreements with various launch providers to secure future launches for its customers, including Loral and its affiliates. SS/ L had launch services agreements with International Launch Services (“ILS”) which covered three launches. In November 2002, SS/ L terminated one of those future launches, which had a termination liability equal to SS/ L’s deposit of $5 million. Subsequently, SS/ L received a letter from ILS alleging SS/ L’s breach of the agreements and purporting to terminate all three launches. Despite ILS’s termination of all three launches, to protect its interest SS/ L also terminated a second launch, which had a termination liability equal to its deposit of $5 million. As a result, SS/ L recognized a non-cash charge to earnings of $10 million in the fourth quarter of 2002 with respect to the two terminated launches. In June 2003, to protect its interest, SS/ L also terminated a third launch, which had a termination liability equal to $23.5 million, and SS/ L recognized a non-cash charge to earnings of $23.5 in the second quarter of 2003 with respect to this launch. ILS has asserted that it is entitled to termination charges of up to $54.75 million with respect to the three terminated launches. SS/ L believes that ILS’s claims are without merit and intends to defend against them vigorously and to seek recovery of its deposits and termination liabilities. The Company does not believe that this matter will have a material adverse effect on its consolidated financial position and its results of operations, although no assurances can be provided.
While the Company has in the past, consistent with industry practice and the requirements in the Company’s debt agreements, typically obtained in-orbit insurance for its satellites, the Company cannot assure that, upon a policy’s expiration, the Company will be able to renew the insurance on acceptable terms, especially on satellites that have, or that are part of a family of satellites that have, experienced problems in the past. Five satellites owned by Loral Skynet and Loral Orion have the same solar array configuration as one other 1300-class satellite manufactured by SS/ L that has experienced an event with a large loss of solar power. SS/ L believes that this failure is an isolated event and does not reflect a systemic problem in either the satellite design or manufacturing process. Accordingly, the Company does not believe that this anomaly will affect the Company’s satellites with the same solar array configuration. The insurance coverage for three of the Company’s satellites, however, provides for coverage of losses due to solar array failures only in the event of a capacity loss of between 75% and 80% or more. The Company believes that the insurers will require either exclusions of, or limitations on, coverage due to solar array failures in connection with renewals of insurance of its five satellites each year. An uninsured loss of a satellite would have a material adverse effect on the Company’s consolidated financial position and its results of operations. Moreover, the Company is required under the terms of its bank facilities and cash collateral order to use the insurance proceeds from any launch or in-orbit failure of a satellite owned by Loral SpaceCom or Loral Satellite to prepay the bank loans (see Note 2), and as a result, these insurance proceeds would not be available to Loral to build a replacement for the lost satellite, which would result in an adverse effect on its future revenue.
Loral Orion did not renew its in-orbit insurance policy on Telstar 11 due to the high cost of such insurance and the relative age of the satellite. As of December 31, 2003, the net book value of Telstar 11 was $42 million and its end of life, as determined in the fourth quarter of 2003, was June 2004.
In an order released on August 8, 2003, the FCC added Telstar 13 to the “Permitted Space Station List” in the C-Band frequency at 121 degrees W.L. As a result of this action, earth stations located in the U.S. will be able to communicate with the Telstar 13 satellite, which was successfully launched on August 7, 2003, and Telstar 13 will be permitted to operate in the U.S. using a non-U.S. ITU filing. The order contains several conditions on this authorization, including (1) a requirement that Telstar 13 be in compliance with all applicable current and future operational requirements as a result of coordination agreements reached with other satellite systems; and (2) that, in the absence of a coordination agreement with a satellite network with higher ITU priority, Telstar 13 must cease service to the U.S. market immediately upon launch and operation of the higher ITU priority satellite, or be subject to further conditions designed to address potential harmful interference to a satellite with ITU date precedence. New Skies Satellites has asserted that its non-U.S. ITU filing at 120.8 degrees W.L. has ITU priority over Telstar 13. Loral Skynet is continuing its international
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coordination of the 121 degrees W.L. slot. There can be no assurance, however, that coordination discussions will be successful (see Note 2).
On October 21, 2002, National Telecom of India Ltd. (“Natelco”) filed suit against Loral and a subsidiary in the United States District Court for the Southern District of New York. The suit relates to a joint venture agreement entered into in 1998 between Natelco and ONS Mauritius, Ltd., a Loral Orion subsidiary, the effectiveness of which was subject to express conditions precedent. In 1999, ONS Mauritius had notified Natelco that Natelco had failed to satisfy those conditions precedent. In Natelco’s amended complaint filed in March 2003, Natelco has alleged wrongful termination of the joint venture agreement, has asserted claims for breach of contract and fraud in the inducement and is seeking damages and expenses in the amount of $97 million. Loral believes that the claims are without merit and intends to vigorously defend against them. As a result of the commencement of the Chapter 11 Cases, this lawsuit is subject to the automatic stay and further proceedings in the matter have been suspended.
Lawsuits against our Directors and Officers
In August 2003, plaintiffs Robert Beleson and Harvey Matcovsky filed a purported class action complaint against Bernard Schwartz in the United States District Court for the Southern District of New York. The complaint alleges (a) that Mr. Schwartz violated Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder, by making material misstatements or failing to state material facts about Loral’s financial condition relating to the sale of assets to Intelsat and Loral’s Chapter 11 filing and (b) that Mr. Schwartz is secondarily liable for these alleged misstatements and omissions under Section 20(a) of the Exchange Act as an alleged “controlling person” of Loral. The class of plaintiffs on whose behalf the lawsuit has been asserted consists of all buyers of Loral common stock during the period from June 30, 2003 through July 15, 2003, excluding the defendant and certain persons related to or affiliated with them. In November 2003, three other complaints against Mr. Schwartz with substantially similar allegations were consolidated into the Beleson case. In February 2004, a motion to dismiss the complaint in its entirety was denied by the court. Defendant filed an answer on March 2, 2004, and discovery has commenced.
In November 2003, plaintiffs Tony Christ, individually and as custodian for Brian and Katelyn Christ, Casey Crawford, Thomas Orndorff and Marvin Rich filed a purported class action complaint against Bernard Schwartz and Richard J. Townsend in the United States District Court for the Southern District of New York. The complaint alleges (a) that defendants violated Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder, by making material misstatements or failing to state material facts about Loral’s financial condition relating to the restatement in 2003 of the financial statements for the second and third quarters of 2002 to correct accounting for certain general and administrative expenses and the alleged improper accounting for a satellite transaction with APT Satellite Company Ltd. and (b) that defendants are secondarily liable for these alleged misstatements and omissions under Section 20(a) of the Exchange Act as an alleged “controlling person” of Loral. The class of plaintiffs on whose behalf the lawsuit has been asserted consists of all buyers of Loral common stock during the period from July 31, 2002 through June 29, 2003, excluding the defendants and certain persons related to or affiliated with them. This case is in its preliminary stages, and, on March 11, 2004, a conference was held with the court concerning selection of a lead plaintiff.
In December 2003, plaintiff Wendy Koch, a former employee, filed a purported class action complaint against the Loral Space & Communications Ltd. Savings Plan Administrative Committee, all Loral directors, Richard J. Townsend and certain other Loral officers and employees in the United States District Court for the Southern District of New York. The complaint alleges (a) that defendants violated Section 404 of the Employee Retirement Income Security Act (“ERISA”), by breaching their fiduciary duties to prudently and loyally manage the assets of the Loral Savings Plan (the “Plan”) by including Loral common stock as an investment alternative and by providing matching contributions under the Plan in Loral stock, (b) that the director defendants violated Section 404 of ERISA by breaching their fiduciary duties to monitor the
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committee defendants and (c) that defendants violated Sections 404 and 405 of ERISA by failing to provide complete and accurate information to Plan participants and beneficiaries. The class of plaintiffs on whose behalf the lawsuit has been asserted consists of all participants in or beneficiaries of the Plan at any time between November 4, 1999 and the present and whose accounts included investments in Loral stock. One other similar complaint against the defendants with substantially similar allegations has been filed, and a motion to consolidate the cases is pending.
Loral is obligated to indemnify its directors and officers for any losses or costs they may incur as a result of these lawsuits. Loral is unable to estimate the maximum potential impact of these obligations on its future results of operations.
Other
The Company is subject to various other legal proceedings and claims, either asserted or unasserted, that arise in the ordinary course of business. Although the outcome of these claims cannot be predicted with certainty, the Company does not believe that any of these other existing legal matters will have a material adverse effect on its consolidated financial position or results of operations. These claims against the Company are subject to the automatic stay as a result of the commencement of the Chapter 11 Cases.
Globalstar Related Matters
On September 26, 2001, the nineteen separate purported class action lawsuits filed in the United States District Court for the Southern District of New York by various holders of securities of Globalstar Telecommunications Limited (“GTL”) and Globalstar against GTL, Loral, Bernard L. Schwartz and other defendants were consolidated into one action titled In re: Globalstar Securities Litigation. In November 2001, plaintiffs in the consolidated action filed a consolidated amended class action complaint against Globalstar, GTL, Globalstar Capital Corporation, Loral and Bernard L. Schwartz alleging (a) that all defendants (except Loral) violated Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”) and Rule 10b-5 promulgated thereunder, by making material misstatements or failing to state material facts about Globalstar’s business and prospects, (b) that defendants Loral and Mr. Schwartz are secondarily liable for these alleged misstatements and omissions under Section 20(a) of the Exchange Act as alleged “controlling persons” of Globalstar, (c) that defendants GTL and Mr. Schwartz are liable under Section 11 of the Securities Act of 1933 (the “Securities Act”) for untrue statements of material facts in or omissions of material facts from a registration statement relating to the sale of shares of GTL common stock in January 2000, (d) that defendant GTL is liable under Section 12(2)(a) of the Securities Act for untrue statements of material facts in or omissions of material facts from a prospectus and prospectus supplement relating to the sale of shares of GTL common stock in January 2000, and (e) that defendants Loral and Mr. Schwartz are secondarily liable under Section 15 of the Securities Act for GTL’s primary violations of Sections 11 and 12(2)(a) of the Securities Act as alleged “controlling persons” of GTL. The class of plaintiffs on whose behalf the lawsuit has been asserted consists of all buyers of securities of Globalstar, Globalstar Capital and GTL during the period from December 6, 1999 through October 27, 2000, excluding the defendants and certain persons related to or affiliated with them. Loral and Mr. Schwartz have filed a motion to dismiss the amended complaint in its entirety as to Loral and Mr. Schwartz, which motion is pending before the court. Loral believes that it has meritorious defenses to this class action lawsuit and intends to pursue them vigorously. As a result of the commencement of the Chapter 11 Cases, however, this lawsuit is subject to the automatic stay and further proceedings in the matter have been suspended insofar as Loral is concerned but are proceeding as to GTL and Mr. Schwartz. Loral is obligated to indemnify Mr. Schwartz for any losses or costs he may incur as a result of this lawsuit. Loral is unable to estimate the maximum potential impact of these obligations on its future results of operations. In December 2003, a motion to dismiss the amended complaint in its entirety was denied by the court insofar as GTL and Mr. Schwartz are concerned, and discovery has commenced.
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On March 2, 2002, the seven separate purported class action lawsuits filed in the United States District Court for the Southern District of New York by various holders of Loral common stock against Loral, Bernard L. Schwartz and Richard Townsend were consolidated into one action titled In re: Loral Space & Communications Ltd. Securities Litigation. On May 6, 2002, plaintiffs in the consolidated action filed a consolidated amended class action complaint alleging (a) that all defendants violated Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder, by making material misstatements or failing to state material facts about Loral’s financial condition and its investment in Globalstar and (b) that Mr. Schwartz is secondarily liable for these alleged misstatements and omissions under Section 20(a) of the Exchange Act as an alleged “controlling person” of Loral. The class of plaintiffs on whose behalf the lawsuit has been asserted consists of all buyers of Loral common stock during the period from November 4, 1999 through February 1, 2001, excluding the defendants and certain persons related to or affiliated with them. Loral and Messrs. Schwartz and Townsend have filed a motion to dismiss the complaint in its entirety. After oral argument on a motion to dismiss filed by Loral and Messrs. Schwartz and Townsend, in June 2003, the plaintiffs filed an amended complaint alleging essentially the same claims as in the original amended complaint. Loral believes that it has meritorious defenses to this class action lawsuit and intends to pursue them vigorously. As a result of the commencement of the Chapter 11 Cases, however, this lawsuit is subject to the automatic stay, and further proceedings in the matter have been suspended, insofar as Loral is concerned but are proceeding as to the other defendants. Loral is obligated to indemnify Messrs. Schwartz and Townsend for any losses or costs they may incur as a result of this lawsuit. Loral is unable to estimate the maximum potential impact of these obligations on its future results of operations. On February 23, 2004, a motion to dismiss the amended complaint was granted by the court insofar as Messrs. Schwartz and Townsend are concerned.
In addition, the primary insurer under Loral’s directors and officers liability insurance policy has denied coverage for the case filed by Loral shareholders under the policy and, on March 24, 2003, filed a lawsuit in the Supreme Court of New York county seeking a declaratory judgment upholding their coverage position. In May 2003, Loral and the other defendants served their answer and filed counterclaims seeking a declaration that the insurer is obligated to provide coverage and damages for breach of contract and the implied covenant of good faith. In May 2003, Loral and the other defendants also filed a third party complaint against the excess insurers seeking a declaration that they are obligated to provide coverage. Loral believes that the insurers have wrongfully denied coverage and intends to defend against the denial vigorously. As a result of the commencement of the Chapter 11 Cases, however, this lawsuit is subject to the automatic stay and further proceedings in the matter have been suspended insofar as Loral is concerned but are proceeding as to the other defendants.
Lease Arrangements
The Company leases certain facilities, equipment and transponder capacity under agreements expiring at various dates. Certain leases covering facilities contain renewal and or purchase options which may be exercised by the Company. Rent expense, net of sublease income of $1.0 million, $2.0 million and $4.3 million, was $41.6 million, $61.7 million and $62.9 million in 2003, 2002 and 2001 respectively.
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Future minimum payments, by year and in the aggregate, under operating leases with initial or remaining terms of one year or more consisted of the following as of December 31, 2003 (in thousands):
Future minimum payments have been reduced by minimum sublease rentals of $2.0 million due in the future under non-cancelable subleases.
18.
Segments
Loral is organized into two operating segments: Satellite Services and Satellite Manufacturing (see Note 1 and Note 2 regarding the sale of the Company’s satellite assets to Intelsat).
The common definition of EBITDA is “Earnings Before Interest, Taxes, Depreciation and Amortization”. In evaluating financial performance, management uses revenues and operating income (loss) before depreciation and amortization, including amortization of unearned stock compensation, and reorganization expenses due to bankruptcy (“Adjusted EBITDA”) as the measure of a segment’s profit or loss. Adjusted EBITDA is equivalent to the common definition of EBITDA before amortization of stock compensation; reorganization expenses due to bankruptcy; gain (loss) on investments and debt exchanges; equity in net losses of affiliates, net of tax; minority interest, net of tax; cumulative effect of change in accounting principle, net of tax, and extraordinary gain on acquisition of minority interest, net of tax. Adjusted EBITDA should be used in conjunction with U.S. GAAP financial measures and is not presented as an alternative to cash flow from operations as a measure of the Company’s liquidity or as an alternative to net income as an indicator of the Company’s operating performance.
The Company believes the use of Adjusted EBITDA along with GAAP financial measures enhances the understanding of the Company’s operating results and is useful to investors in comparing performance with competitors, estimating enterprise value and making investment decisions. Adjusted EBITDA allows investors to compare operating results of competitors exclusive of depreciation and amortization, net losses of affiliates and minority interest, a useful tool given the significant variation that can result from the timing of capital expenditures, the amount of intangible assets recorded, the differences in assets’ lives, the timing and amount of investments, and effects of investments not managed by the Company. Adjusted EBITDA as used here may not be comparable to similarly titled measures reported by other companies. The Company also uses Adjusted EBITDA to evaluate operating performance, to allocate resources and capital, to measure performance for incentive compensation programs, and to evaluate future growth opportunities.
Intersegment revenues primarily consist of satellites under construction by Satellite Manufacturing for Satellite Services and the leasing of transponder capacity by Satellite Manufacturing from Satellite Services. In the first quarter of 2003, management changed its basis of evaluating and reporting the financial performance of the Satellite Manufacturing segment to conform it to U.S. GAAP principles for commercial contracts and has restated the segment information for 2002 and 2001, accordingly. Previously the segment was evaluated and reported by management in accordance with accounting principles applicable to government contracts whereby all costs incurred, including G&A were allocated to customer programs.
LORAL SPACE & COMMUNICATIONS LTD., A DEBTOR IN POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Summarized financial information concerning the reportable segments is as follows (in millions):
2003 Segment Information
(1)
Represents corporate expenses incurred in support of the Company’s operations.
(2)
Includes revenues from affiliates of $28.7 million, $85.9 million and $100.9 million in 2003, 2002 and 2001, respectively.
(3)
Represents the elimination of intercompany sales and Adjusted EBITDA, primarily for satellites under construction by SS/ L for wholly owned subsidiaries and the reversal of sales of $83 million and $73 million of cost of satellite manufacturing on a satellite program with a customer where the contract was changed to a lease arrangement in 2003 (see Note 17).
(4)
Includes amortization of unearned stock compensation charges.
(5)
The amounts are presented after the elimination of intercompany profit.
LORAL SPACE & COMMUNICATIONS LTD., A DEBTOR IN POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
2002 Segment Information
2001 Segment Information
LORAL SPACE & COMMUNICATIONS LTD., A DEBTOR IN POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Revenue by Customer Location
The following table presents revenues by country based on customer location for each of the three years in the period ended December 31, 2003 (in thousands).
(1)
The 2003 amount includes the reversal of $83 million of sales on a satellite program with a customer where the contract was changed to a lease arrangement (see Note 17).
During 2003, two customers of Loral accounted for approximately 15% and 10% of its consolidated revenues. During 2002, two customers of Loral accounted for approximately 12% and 10% of its consolidated revenues. During 2001, one customer of Loral accounted for approximately 14% of its consolidated revenues.
With the exception of the Company’s satellites in-orbit (see Note 6), the Company’s long-lived assets are primarily located in the United States.
19.
Related Party Transactions
In connection with contract performance, Loral acquired services from Lockheed Martin. A summary of such transactions and balances as of December 31, 2003 and 2002, and for the three years in the period ended December 31, 2003, respectively, is as follows (in thousands):
In 2002, Alcatel ceased being a related party of Loral. Loral’s sales to, purchases from, and balances with Alcatel as of December 31, 2002, and for the two years in the period ended December 31, 2002, respectively, were as follows (in thousands):
LORAL SPACE & COMMUNICATIONS LTD., A DEBTOR IN POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
20.
Financial Information for Subsidiary Issuer, Guarantor Subsidiaries and Non-Guarantor Subsidiaries
Loral is a holding company (the “Parent Company”), which is the ultimate parent of all Loral subsidiaries. In December 2001, the Company’s wholly owned subsidiary, Loral Orion (the “Subsidiary Issuer”), issued new senior notes in an exchange offer (see Note 10) which are fully and unconditionally guaranteed, on a joint and several basis, by the Parent Company and several of Loral Orion’s wholly-owned subsidiaries (the “Guarantor Subsidiaries”). The Parent Company, the Subsidiary Issuer and the Guarantor Subsidiaries, as well as certain other non-guarantor subsidiaries of the Parent Company (including the Sellers and SS/ L) filed voluntary petitions for reorganization under Chapter 11 of the Bankruptcy Code on July 15, 2003.
Presented below is condensed consolidating financial information for the Parent Company, the Subsidiary Issuer, the Guarantor Subsidiaries and the other wholly-owned subsidiaries of the Parent Company (the “Non-Guarantor Subsidiaries”) as of December 31, 2003 and 2002 and for the years ended December 31, 2003, 2002 and 2001. The condensed consolidating financial information has been presented to show the nature of assets held, results of operations and cash flows of the Parent Company, Subsidiary Issuer, Guarantor Subsidiaries and Non-Guarantor Subsidiaries.
The supplemental condensed consolidating financial information reflects the investments of the Parent Company in the Subsidiary Issuer, the Guarantor Subsidiaries and the Non-Guarantor Subsidiaries using the equity method of accounting. The Company’s significant transactions with its subsidiaries other than the investment account and related equity in net loss of unconsolidated subsidiaries are intercompany payables and receivables between its subsidiaries resulting primarily from the funding of the construction of satellites for the Satellite Services segment and the management fee charged by Loral SpaceCom to the Parent Company (in 2001). Loral’s $200 million note receivable from unconsolidated subsidiaries is due from Loral Space & Communications Corporation (“LSCC”) and bears interest at 8.2% per annum. Loral SpaceCom (a non-guarantor subsidiary) holds a $29.7 million subordinated note receivable from the subsidiary issuer. The note is subordinated to all existing and future indebtedness of the subsidiary issuer and guaranteed by the Parent Company. The note bears interest at a rate of 10% per annum. Loral Satellite has provided $59.8 million to Loral as of December 31, 2003, in the form of a note receivable which bears no interest and is payable upon maturity of the Loral Satellite Credit Agreement. As a result of filing Chapter 11, the accrual of interest on all related party notes in the following condensed consolidating financial statements was suspended.
LORAL SPACE & COMMUNICATIONS LTD., A DEBTOR IN POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
20.
Financial Information for Subsidiary Issuer, Guarantor Subsidiaries and Non-Guarantor Subsidiaries
CONDENSED CONSOLIDATING BALANCE SHEET
December 31, 2003
(in thousands)
LORAL SPACE & COMMUNICATIONS LTD., A DEBTOR POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
20.
Financial Information for Subsidiary Issuer, Guarantor Subsidiaries and Non-Guarantor Subsidiaries
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Year ended December 31, 2003
(in thousands)
LORAL SPACE & COMMUNICATIONS LTD., A DEBTOR IN POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
20.
Financial Information for Subsidiary Issuer, Guarantor Subsidiaries and Non-Guarantor Subsidiaries
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
Year Ended December 31, 2003
(in thousands)
LORAL SPACE & COMMUNICATIONS LTD., A DEBTOR IN POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
20.
Financial Information for Subsidiary Issuer, Guarantor Subsidiaries and Non-Guarantor Subsidiaries
CONDENSED CONSOLIDATING BALANCE SHEET
December 31, 2002
(in thousands)
LORAL SPACE & COMMUNICATIONS LTD., A DEBTOR IN POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
20.
Financial Information for Subsidiary Issuer, Guarantor Subsidiaries and Non-Guarantor Subsidiaries
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Year ended December 31, 2002
(in thousands)
LORAL SPACE & COMMUNICATIONS LTD., A DEBTOR IN POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
20.
Financial Information for Subsidiary Issuer, Guarantor Subsidiaries and Non-Guarantor Subsidiaries
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
Year ended December 31, 2002
(in thousands)
LORAL SPACE & COMMUNICATIONS LTD., A DEBTOR IN POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
20.
Financial Information for Subsidiary Issuer, Guarantor Subsidiaries and Non-Guarantor Subsidiaries
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Year ended December 31, 2001
(in thousands)
LORAL SPACE & COMMUNICATIONS LTD., A DEBTOR IN POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
20.
Financial Information for Subsidiary Issuer, Guarantor Subsidiaries and Non-Guarantor Subsidiaries
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
Year ended December 31, 2001
(in thousands)
LORAL SPACE & COMMUNICATIONS LTD., A DEBTOR IN POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
21.
Selected Quarterly Financial Information (unaudited, in thousands, except per share amounts)
(1)
The quarterly earnings per share information is computed separately for each period. Therefore, the sum of such quarterly per share amounts may differ from the total for the year.
(2)
Represents the reported high and low closing prices of Loral’s common stock as reported on the Pink Sheets and the NYSE for 2003 and the intra-day high and low sales prices for 2002.
INDEPENDENT AUDITORS’ REPORT ON SUPPLEMENTAL SCHEDULE
To the Board of Directors and Stockholders of Loral Space & Communications Ltd. (a Debtor In Possession):
We have audited the consolidated financial statements of Loral Space & Communications Ltd. (a Bermuda Company) and its subsidiaries (collectively, the “Company”) (a Debtor In Possession) as of December 31, 2003 and 2002, and for each of the three years in the period ended December 31, 2003 and have issued our report thereon dated March 15, 2004 included elsewhere in this Annual Report on Form 10-K. Our audits also included the consolidated financial statement schedule of the Company listed in Item 15 (a) (2) of this Annual Report on Form 10-K. Our audits were conducted for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. This consolidated schedule is the responsibility of the Company’s management. Such consolidated schedule has been subjected to the auditing procedures applied in our audits of the basic consolidated financial statements and, in our opinion, is fairly stated in all material respects when considered in relation to the basic consolidated financial statements taken as a whole. The basic consolidated financial statements have been prepared assuming the Company will continue as a going concern; our report thereon, included elsewhere in this Annual Report on Form 10-K, includes explanatory paragraphs which indicate that (1) the Company changed its methods of accounting to adopt the provisions of Statement of Financial Accounting Standards No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity, effective July 1, 2003, and Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, effective January 1, 2002 and (2) the Company has filed for reorganization under Chapter 11 of the Federal Bankruptcy Code and that (i) the consolidated financial statements do not purport to reflect or provide for the consequences of the bankruptcy proceedings and (ii) the aforementioned matter, among others, raises substantial doubt about its ability to continue as a going concern.
DELOITTE & TOUCHE LLP
San Jose, California
March 15, 2004
SCHEDULE II
LORAL SPACE & COMMUNICATIONS LTD., A DEBTOR IN POSSESSION
VALUATION AND QUALIFYING ACCOUNTS
For the Years Ended December 31, 2003, 2002 and 2001
(in thousands)
(1)Write-offs of uncollectible accounts.