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DISH DBS CORP - 10-K - MANAGEMENT'S NARRATIVE ANALYSIS OF RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) You should read the following narrative analysis of our financial condition and results of operations together with the audited consolidated financial statements and notes to our financial statements included elsewhere in this Annual Report. This management's narrative analysis is intended to help provide an understanding of our financial condition, changes in financial condition and results of our operations and contains forward-looking statements that involve risks and uncertainties. The forward-looking statements are not historical facts, but rather are based on current expectations, estimates, assumptions and projections about our industry, business and future financial results. Our actual results could differ materially from the results contemplated by these forward-looking statements due to a number of factors, including those discussed in this report, including under the caption "Item 1A. Risk Factors" in this Annual Report on Form 10-K. EXECUTIVE SUMMARY Overview DISH added approximately 89,000 net Pay-TV subscribers during the year ended December 31, 2012, compared to a loss of approximately 166,000 net Pay-TV subscribers during the same period in 2011. The increase versus the same period in 2011 primarily resulted from a decrease in our average monthly Pay-TV subscriber churn rate and higher gross new Pay-TV subscriber activations due primarily to increased advertising associated with our Hopper set-top box. During the year ended December 31, 2012, DISH added approximately 2.739 million gross new Pay-TV subscribers compared to approximately 2.576 million gross new Pay-TV subscribers during the same period in 2011, an increase of 6.3%. Our gross new Pay-TV subscriber activations continue to be negatively impacted by increased competitive pressures, including aggressive marketing and discounted promotional offers. In addition, our gross new Pay-TV subscriber activations continue to be adversely affected by sustained economic weakness and uncertainty. Our average monthly Pay-TV subscriber churn rate for the year ended December 31, 2012 was 1.57% compared to 1.63% for the same period in 2011. Our Pay-TV subscriber churn rate was positively impacted in part because we did not have a programming package price increase in the first quarter 2012, but did during the same period in 2011. While Pay-TV subscriber churn improved compared to the same period in 2011, churn continues to be adversely affected by the increased competitive pressures discussed above. Our Pay-TV subscriber churn rate is also impacted by, among other things, the credit quality of previously acquired subscribers, our ability to consistently provide outstanding customer service, the aggressiveness of competitor subscriber acquisition efforts, and our ability to control piracy and other forms of fraud. "Net income (loss)" for the year ended December 31, 2012 was $484 million, compared to $1.526 billion for the same period in 2011. During the year ended December 31, 2012, "Net income (loss)" decreased primarily due to $730 million of litigation expense related to the Voom Settlement Agreement, higher subscriber-related expenses primarily from higher programming costs, increased advertising associated with our Hopper set-top box and the reversal of our accrued expenses related to the TiVo Inc. settlement during 2011. Our ability to compete successfully will depend on, among other things, our ability to continue to obtain desirable programming and deliver it to our subscribers at competitive prices. Programming costs represent a large percentage of our "Subscriber-related expenses" and the largest component of our total expense. We expect these costs to continue to increase, especially for local broadcast channels and sports programming. Going forward, our margins may face pressure if we are unable to renew our long-term programming contracts on favorable pricing and other economic terms. In addition, increases in programming costs could cause us to increase the rates that we charge our subscribers, which could in turn cause our existing Pay-TV subscribers to disconnect our service or cause potential new Pay-TV subscribers to choose not to subscribe to our service. Additionally, our gross new Pay-TV subscriber activations and Pay-TV subscriber churn rate may be negatively impacted if we are unable to renew our long-term programming contracts before they expire or if we lose access to programming as a result of disputes with programming suppliers. As the pay-TV industry has matured, we and our competitors increasingly must seek to attract a greater proportion of new subscribers from each other's existing subscriber bases rather than from first-time purchasers of pay-TV services. Some of our competitors have been especially aggressive by offering discounted programming and services for both new and existing subscribers. In addition, programming offered over the Internet has become more 31 -------------------------------------------------------------------------------- Table of Contents Item 7. MANAGEMENT'S NARRATIVE ANALYSIS OF RESULTS OF OPERATIONS - Continued prevalent as the speed and quality of broadband networks have improved. Significant changes in consumer behavior with regard to the means by which they obtain video entertainment and information in response to digital media competition could materially adversely affect our business, results of operations and financial condition or otherwise disrupt our business. While economic factors have impacted the entire pay-TV industry, our relative performance has also been driven by issues specific to DISH. In the past, our Pay-TV subscriber growth has been adversely affected by signal theft and other forms of fraud and by operational inefficiencies at DISH. To combat signal theft and improve the security of our broadcast system, we completed the replacement of our Security Access Devices to re-secure our system during 2009. We expect that additional future replacements of these devices will be necessary to keep our system secure. To combat other forms of fraud, we continue to expect that our third party distributors and retailers will adhere to our business rules. While we have made improvements in responding to and dealing with customer service issues, we continue to focus on the prevention of these issues, which is critical to our business, financial position and results of operations. We implemented a new billing system as well as new sales and customer care systems in the first quarter 2012. To improve our operational performance, we continue to make significant investments in staffing, training, information systems, and other initiatives, primarily in our call center and in-home service operations. These investments are intended to help combat inefficiencies introduced by the increasing complexity of our business, improve customer satisfaction, reduce churn, increase productivity, and allow us to scale better over the long run. We cannot, however, be certain that our spending will ultimately be successful in improving our operational performance. We have been deploying receivers that utilize 8PSK modulation technology and receivers that utilize MPEG-4 compression technology for several years. These technologies, when fully deployed, will allow more programming channels to be carried over our existing satellites. Many of our customers today, however, do not have receivers that use MPEG-4 compression and a smaller but still significant number of our customers do not have receivers that use 8PSK modulation. We may choose to invest significant capital to accelerate the conversion of customers to MPEG-4 and/or 8PSK to realize the bandwidth benefits sooner. In addition, given that all of our HD content is broadcast in MPEG-4, any growth in HD penetration will naturally accelerate our transition to these newer technologies and may increase our subscriber acquisition and retention costs. All new receivers that we purchase from EchoStar have MPEG-4 technology. Although we continue to refurbish and redeploy MPEG-2 receivers, as a result of our HD initiatives and current promotions, we currently activate most new customers with higher priced MPEG-4 technology. This limits our ability to redeploy MPEG-2 receivers and, to the extent that our promotions are successful, will accelerate the transition to MPEG-4 technology, resulting in an adverse effect on our acquisition costs per new subscriber activation. From time to time, we change equipment for certain subscribers to make more efficient use of transponder capacity in support of HD and other initiatives. We believe that the benefit from the increase in available transponder capacity outweighs the short-term cost of these equipment changes. To maintain and enhance our competitiveness over the long term, we introduced the Hopper set-top box, that allows, among other things, recorded programming to be viewed in HD in multiple rooms. During the second quarter 2012, the four major broadcast television networks filed lawsuits against us alleging, among other things, that the PrimeTime Anytime and AutoHop features of the Hopper set-top box infringe their copyrights. In the event a court ultimately determines that we infringe the asserted copyrights, we may be subject to, among other things, an injunction that could require us to materially modify or cease to offer these features. See Note 11 in the Notes to the Consolidated Financial Statements in Item 15 of this Annual Report on Form 10-K for further information. We recently introduced the Hopper set-top box with Sling, which promotes a suite of integrated products designed to maximize the convenience and ease of watching TV anytime and anywhere, which we refer to as DISH Anywhere™ that utilizes, among other things, online access and Slingbox "placeshifting" technology. In addition, the Hopper with Sling has several innovative features which allows customers to watch and record television programming through certain tablet computers and combines program-discovery tools, social media engagement and remote-control capabilities through the use of certain tablet computers. There can be no assurance that these integrated products will positively affect our results of operations or our gross new subscriber activations. 32 -------------------------------------------------------------------------------- Table of Contents Item 7. MANAGEMENT'S NARRATIVE ANALYSIS OF RESULTS OF OPERATIONS - Continued Operational Liquidity Like many companies, we make general investments in property such as satellites, set-top boxes, information technology and facilities that support our overall business. However, since we are a subscriber-based company, we also make subscriber-specific investments to acquire new subscribers and retain existing subscribers. While the general investments may be deferred without impacting the business in the short-term, the subscriber-specific investments are less discretionary. Our overall objective is to generate sufficient cash flow over the life of each subscriber to provide an adequate return against the upfront investment. Once the upfront investment has been made for each subscriber, the subsequent cash flow is generally positive. There are a number of factors that impact our future cash flow compared to the cash flow we generate at a given point in time. The first factor is how successful we are at retaining our current subscribers. As we lose subscribers from our existing base, the positive cash flow from that base is correspondingly reduced. The second factor is how successful we are at maintaining our subscriber-related margins. To the extent our "Subscriber-related expenses" grow faster than our "Subscriber-related revenue," the amount of cash flow that is generated per existing subscriber is reduced. The third factor is the rate at which we acquire new subscribers. The faster we acquire new subscribers, the more our positive ongoing cash flow from existing subscribers is offset by the negative upfront cash flow associated with new subscribers. Finally, our future cash flow is impacted by the rate at which we make general investments and any cash flow from financing activities. Our subscriber-specific investments to acquire new subscribers have a significant impact on our cash flow. While fewer subscribers might translate into lower ongoing cash flow in the long-term, cash flow is actually aided, in the short-term, by the reduction in subscriber-specific investment spending. As a result, a slow down in our business due to external or internal factors does not introduce the same level of short-term liquidity risk as it might in other industries. Availability of Credit and Effect on Liquidity The ability to raise capital has generally existed for us despite the weak economic conditions. Modest fluctuations in the cost of capital will not likely impact our current operational plans. Future Liquidity Wireless Spectrum On March 2, 2012, the FCC approved the transfer of 40 MHz of 2 GHz wireless spectrum licenses held by DBSD North America and TerreStar to DISH Network. On March 9, 2012, DISH Network completed the DBSD Transaction and the TerreStar Transaction, pursuant to which DISH Network acquired, among other things, certain satellite assets and wireless spectrum licenses held by DBSD North America and TerreStar. The total consideration to acquire these assets was approximately $2.860 billion. This amount includes $1.364 billion for the DBSD Transaction, $1.382 billion for the TerreStar Transaction, and the net payment of $114 million to Sprint pursuant to the Sprint Settlement Agreement. DISH Network's consolidated FCC applications for approval of the license transfers from DBSD North America and TerreStar were accompanied by requests for waiver of the FCC's Mobile Satellite Service ("MSS") "integrated service" and spare satellite requirements and various technical provisions. The FCC denied DISH Network's requests for waiver of the integrated service and spare satellite requirements but did not initially act on DISH Network's request for waiver of the various technical provisions. On March 21, 2012, the FCC released a Notice of Proposed Rule Making ("NPRM") proposing the elimination of the integrated service, spare satellite and various technical requirements attached to the 2 GHz licenses. On December 11, 2012, the FCC approved rules that eliminated these requirements and gave notice of its proposed modification of DISH Network's 2 GHz authorizations to, among other things, allow DISH Network to offer single-mode terrestrial terminals to customers who do not desire satellite functionality. On February 15, 2013, the FCC issued an order, which will become effective on March 7, 2013, modifying DISH Network's 2 GHz licenses to add terrestrial operating authority. The FCC's order of modification has imposed certain limitations on the use of a portion of this spectrum, including 33 -------------------------------------------------------------------------------- Table of Contents Item 7. MANAGEMENT'S NARRATIVE ANALYSIS OF RESULTS OF OPERATIONS - Continued interference protections for other spectrum users and power and emission limits that DISH Network presently believes could render 5 MHz of its uplink spectrum effectively unusable for terrestrial services and limit its ability to fully utilize the remaining 15 MHz of its uplink spectrum for terrestrial services. These limitations could, among other things, impact the finalization of technical standards associated with DISH Network's wireless business, and may have a material adverse effect on DISH Network's ability to commercialize these licenses. The new rules also mandate certain interim and final build-out requirements for the licenses. By March 2017, DISH Network must provide terrestrial signal coverage and offer terrestrial service to at least 40% of the aggregate population represented by all of the areas covered by the licenses (the "2 GHz Interim Build-out Requirement"). By March 2020, DISH Network must provide terrestrial signal coverage and offer terrestrial service to at least 70% of the population in each area covered by an individual license (the "2 GHz Final Build-out Requirement"). If DISH Network fails to meet the 2 GHz Interim Build-out Requirement, the 2 GHz Final Build-out Requirement will be accelerated by one year, from March 2020 to March 2019. If DISH Network fails to meet the 2 GHz Final Build-out Requirement, DISH Network's terrestrial authorization for each license area in which it fails to meet the requirement will terminate. In addition, the FCC is currently considering rules for a spectrum band that is adjacent to DISH Network's 2 GHz licenses, known as the "H Block." If the FCC adopts rules for the H block that do not adequately protect DISH Network's 2 GHz licenses, there could be a material adverse effect on DISH Network's ability to commercialize the 2 GHz licenses. As a result of the completion of the DBSD Transaction and the TerreStar Transaction, DISH Network will likely be required to make significant additional investments or partner with others to, among other things, finance the commercialization and build-out requirements of these licenses and DISH Network's integration efforts including compliance with regulations applicable to the acquired licenses. Depending on the nature and scope of such commercialization, build-out, and integration efforts, any such investment or partnership could vary significantly. We have made cash distributions to DISH Network to finance these acquisitions and may make additional cash distributions to, among other things, finance the commercialization of these licenses and DISH Network's integration efforts including compliance with regulations applicable to the acquired licenses. Additionally, recent consolidation in the wireless telecommunications industry, may, among other things, limit DISH Network's available options, including DISH Network's ability to partner with others. There can be no assurance that DISH Network will be able to develop and implement a business model that will realize a return on these spectrum licenses or that DISH Network will be able to profitably deploy the assets represented by these spectrum licenses. In 2008, DISH Network paid $712 million to acquire certain 700 MHz wireless spectrum licenses, which were granted to DISH Network by the FCC in February 2009. These licenses mandate certain interim and final build-out requirements. By June 2013, DISH Network must provide signal coverage and offer service to at least 35% of the geographic area in each area covered by each individual license (the "700 MHz Interim Build-out Requirement"). By the end of DISH Network's license term (June 2019), DISH Network must provide signal coverage and offer service to at least 70% of the geographic area in each area covered by each individual license (the "700 MHz Final Build-out Requirement"). DISH Network recently notified the FCC of its plans to commence signal coverage in select cities within certain of these areas, but DISH Network has not yet developed plans for providing signal coverage and offering service in all of these areas. If DISH Network fails to meet the 700 MHz Interim Build-out Requirement, the term of DISH Network's licenses will be reduced, from June 2019 to June 2017, and DISH Network could face possible fines and the reduction of license area(s). If DISH Network fails to meet the 700 MHz Final Build-out Requirement, DISH Network's authorization for each license area in which it fails to meet the requirement will terminate. To commercialize these licenses and satisfy the associated FCC build-out requirements, DISH Network will be required to make significant additional investments or partner with others. Depending on the nature and scope of such commercialization and build-out, any such investment or partnership could vary significantly. We may make cash distributions to, among other things, finance the commercialization of these licenses and DISH Network's integration efforts including compliance with regulations applicable to the acquired licenses. There can be no assurance that DISH Network will be able to develop and implement a business model that will realize a return on these investments and profitably deploy the spectrum represented by the 700 MHz licenses. DISH Network has recently been engaged in discussions regarding a potential strategic transaction with Clearwire. On January 8, 2013, Clearwire issued a press release summarizing the proposed transaction at that time. Later that day, DISH Network confirmed that it had formally approached Clearwire with respect to a potential strategic transaction on the terms and conditions generally outlined in Clearwire's press release. The terms and conditions for a potential strategic transaction at that time disclosed by Clearwire generally provided for the following, among others: (i) DISH Network would acquire approximately 24% of Clearwire's total spectrum, for approximately $2.2 billion; and (ii) DISH Network would make an offer to purchase up to all of Clearwire's outstanding shares at a price of $3.30 per share in cash. This offer would be subject to certain conditions, including that DISH Network acquire no less than 25% of the fully-diluted shares of Clearwire and receive certain governance and minority protection rights. There is no assurance that DISH Network will continue discussions with Clearwire or that DISH Network will ultimately be able to conclude a transaction with Clearwire upon the terms outlined above or at all. 34 -------------------------------------------------------------------------------- Table of Contents Item 7. MANAGEMENT'S NARRATIVE ANALYSIS OF RESULTS OF OPERATIONS - Continued To the extent that DISH Network is able to conclude a transaction with Clearwire, it may be required to commit a significant portion of its cash and marketable securities to fund these arrangements, and these commitments may cause DISH Network to defer or curtail investments in its core business, strategic investments, share repurchases or other transactions that it otherwise may have made. Furthermore, Clearwire has experienced significant operating and financial challenges in its recent history. Therefore, any investment DISH Network may make in Clearwire will be speculative, and it may lose all of the investment. In addition, we may be required to raise additional capital to support DISH Network's investment in Clearwire's business, if any, and to build out a network to utilize the spectrum acquired, which may not be available on acceptable terms or at all. We may make cash distributions to, among other things, finance these arrangements, the commercialization of this spectrum and DISH Network's integration efforts including compliance with regulations applicable to the acquired spectrum. There can be no assurance that DISH Network will be able to develop and implement a business model that will realize a return on a possible transaction with Clearwire or that DISH Network will be able to profitably deploy the spectrum assets. If DISH Network is unable to successfully address these challenges and risks, our business, financial condition or results of operations will likely suffer. Covenants and Restrictions Related to our Senior Notes The indentures related to our outstanding senior notes contain restrictive covenants that, among other things, impose limitations on our ability to: (i) incur additional indebtedness; (ii) enter into sale and leaseback transactions; (iii) pay dividends or make distributions on our capital stock or repurchase our capital stock; (iv) make certain investments; (v) create liens; (vi) enter into certain transactions with affiliates; (vii) merge or consolidate with another company; and (viii) transfer or sell assets. Should we fail to comply with these covenants, all or a portion of the debt under the senior notes could become immediately payable. The senior notes also provide that the debt may be required to be prepaid if certain change-in-control events occur. As of the date of filing, we were in compliance with the covenants. EXPLANATION OF KEY METRICS AND OTHER ITEMS Subscriber-related revenue. "Subscriber-related revenue" consists principally of revenue from basic, premium movie, local, HD programming, pay-per-view, Latino and international subscription television services, broadband services, equipment rental fees and other hardware related fees, including fees for DVRs, fees for broadband equipment, equipment upgrade fees and additional outlet fees from subscribers with receivers with multiple tuners, advertising services, fees earned from our in-home service operations and other subscriber revenue. Certain of the amounts included in "Subscriber-related revenue" are not recurring on a monthly basis. On October 1, 2012, the assets and liabilities associated with the satellite broadband business were distributed to DISH Network. As a result, beginning in the fourth quarter 2012, we no longer have revenue related to the satellite broadband business. See Note 15 in the Notes to our Consolidated Financial Statements in Item 15 of this Annual Report on Form 10-K for further discussion. Equipment sales and other revenue. "Equipment sales and other revenue" principally includes the non-subsidized sales of DBS accessories to retailers and other third-party distributors of our equipment domestically and to Pay-TV subscribers. Equipment sales, services and other revenue - EchoStar. "Equipment sales, services and other revenue - EchoStar" includes revenue related to equipment sales, services, and other agreements with EchoStar. Subscriber-related expenses. "Subscriber-related expenses" principally include programming expenses, which represent a substantial majority of these expenses. "Subscriber-related expenses" also include costs for pay-TV and broadband services incurred in connection with our in-home service and call center operations, billing costs, refurbishment and repair costs related to receiver systems, subscriber retention, other variable subscriber expenses and monthly wholesale fees paid to broadband providers. During the fourth quarter 2012, certain expenses related to the acquisition of new broadband subscribers for the period beginning January 1, 2012 through September 30, 2012 that were previously included in "Subscriber-related expenses" were reclassified to "Subscriber acquisition costs." These amounts associated with our broadband services for 2011 were immaterial. On October 1, 2012, the assets and liabilities associated with the satellite broadband business were distributed to DISH Network. As a result, beginning in the fourth quarter 2012, we no longer have costs related to the satellite broadband business. See Note 15 in the Notes to our Consolidated Financial Statements in Item 15 of this Annual Report on Form 10-K for further discussion. Satellite and transmission expenses - EchoStar. "Satellite and transmission expenses - EchoStar" includes the cost of leasing satellite and transponder capacity from EchoStar and the cost of digital broadcast operations provided 35 -------------------------------------------------------------------------------- Table of Contents Item 7. MANAGEMENT'S NARRATIVE ANALYSIS OF RESULTS OF OPERATIONS - Continued to us by EchoStar, including satellite uplinking/downlinking, signal processing, conditional access management, telemetry, tracking and control, and other professional services. Satellite and transmission expenses - other. "Satellite and transmission expenses - other" includes executory costs associated with capital leases and costs associated with transponder leases and other related services. Cost of sales - equipment, services and other. "Cost of sales - equipment, services and other" principally includes the cost of non-subsidized sales of DBS accessories to retailers and other third-party distributors of our equipment domestically and to Pay-TV subscribers. In addition, this category includes costs related to equipment sales, services, and other agreements with EchoStar. Subscriber acquisition costs. In addition to leasing receivers, we generally subsidize installation and all or a portion of the cost of our receiver systems to attract new Pay-TV subscribers. Our "Subscriber acquisition costs" include the cost of subsidized sales of receiver systems to retailers and other third-party distributors of our equipment, the cost of subsidized sales of receiver systems directly by us to subscribers, including net costs related to our promotional incentives, costs related to our direct sales efforts and costs related to installation and acquisition advertising. During the fourth quarter 2012, certain expenses related to the acquisition of new broadband subscribers for the period beginning January 1, 2012 through September 30, 2012 that were previously included in "Subscriber-related expenses" were reclassified to "Subscriber acquisition costs." These amounts associated with our broadband services for 2011 were immaterial. We exclude the value of equipment capitalized under our lease program for new Pay-TV and broadband subscribers from "Subscriber acquisition costs." On October 1, 2012, the assets and liabilities associated with the satellite broadband business were distributed to DISH Network. As a result, beginning in the fourth quarter 2012, we no longer have costs related to the satellite broadband business. See Note 15 in the Notes to our Consolidated Financial Statements in Item 15 of this Annual Report on Form 10-K for further discussion. Pay-TV SAC. Subscriber acquisition cost measures are commonly used by those evaluating companies in the Pay-TV industry. We are not aware of any uniform standards for calculating the "average subscriber acquisition costs per new Pay-TV subscriber activation," or Pay-TV SAC, and we believe presentations of Pay-TV SAC may not be calculated consistently by different companies in the same or similar businesses. Our Pay-TV SAC is calculated as "Subscriber acquisition costs," excluding "Subscriber acquisition costs" associated with our broadband services, plus the value of equipment capitalized under our lease program for new Pay-TV subscribers, divided by gross new Pay-TV subscriber activations. We include all the costs of acquiring Pay-TV subscribers (e.g., subsidized and capitalized equipment) as we believe it is a more comprehensive measure of how much we are spending to acquire subscribers. We also include all new Pay-TV subscribers in our calculation, including Pay-TV subscribers added with little or no subscriber acquisition costs. During the fourth quarter 2012, we have elected to provide Pay-TV SAC rather than SAC, defined below, as we believe Pay-TV SAC provides a more meaningful metric. SAC. Historically, we have calculated SAC as "Subscriber acquisition costs," plus the value of equipment capitalized under our lease program for new subscribers, divided by gross new subscriber activations. This metric included the cost (e.g., subsidized and capitalized equipment) of acquiring Pay-TV subscribers and certain costs of acquiring broadband subscribers. We also included all new Pay-TV subscribers in our calculation, including Pay-TV subscribers added with little or no subscriber acquisition costs. During the fourth quarter 2012, we have elected to discontinue providing SAC as we believe Pay-TV SAC, which excludes broadband subscriber acquisition costs, provides a more meaningful metric. General and administrative expenses. "General and administrative expenses" consists primarily of employee-related costs associated with administrative services such as legal, information systems, accounting and finance, including non-cash, stock-based compensation expense. It also includes outside professional fees (e.g., legal, information systems and accounting services) and other items associated with facilities and administration. Litigation expense. "Litigation expense" primarily consists of legal settlements, judgments or accruals associated with certain significant litigation. Interest expense, net of amounts capitalized. "Interest expense, net of amounts capitalized" primarily includes interest expense, prepayment premiums and amortization of debt issuance costs associated with our senior debt (net of capitalized interest), and interest expense associated with our capital lease obligations. Other, net. The main components of "Other, net" are gains and losses realized on the sale of investments, impairment of marketable and non-marketable investment securities, unrealized gains and losses from changes in 36 -------------------------------------------------------------------------------- Table of Contents Item 7. MANAGEMENT'S NARRATIVE ANALYSIS OF RESULTS OF OPERATIONS - Continued fair value of marketable and non-marketable investments accounted for at fair value, and equity in earnings and losses of our affiliates. Earnings before interest, taxes, depreciation and amortization ("EBITDA"). EBITDA is defined as "Net income (loss)" plus "Interest expense, net of amounts capitalized" net of "Interest income," "Income tax (provision) benefit, net" and "Depreciation and amortization." This "non-GAAP measure" is reconciled to "Net income (loss)" in our discussion of "Results of Operations" below. "Pay-TV subscribers." We include customers obtained through direct sales, third-party retailers and other third-party distribution relationships in our Pay-TV subscriber count. We also provide pay-TV service to hotels, motels and other commercial accounts. For certain of these commercial accounts, we divide our total revenue for these commercial accounts by an amount approximately equal to the retail price of our DISH America programming package, and include the resulting number, which is substantially smaller than the actual number of commercial units served, in our Pay-TV subscriber count. Effective during the first quarter 2011, we made two changes to this calculation methodology compared to prior periods. Beginning February 1, 2011, the retail price of our DISH America programming package was used in the calculation rather than America's Top 120 programming package, which had been used in prior periods. We also determined that two of our commercial business lines, which had previously been included in the described calculation, could be more accurately reflected through actual subscriber counts. The net impact of these two changes was to increase our subscriber count by approximately 6,000 subscribers in the first quarter 2011. Prior period Pay-TV subscriber counts have not been adjusted for this revised commercial accounts calculation as the impacts were immaterial. Pay-TV average monthly revenue per subscriber ("Pay-TV ARPU"). We are not aware of any uniform standards for calculating ARPU and believe presentations of ARPU may not be calculated consistently by other companies in the same or similar businesses. We calculate Pay-TV average monthly revenue per subscriber, or Pay-TV ARPU, by dividing average monthly "Subscriber-related revenue," excluding revenue from broadband services, for the period by our average number of Pay-TV subscribers for the period. The average number of Pay-TV subscribers is calculated for the period by adding the average number of Pay-TV subscribers for each month and dividing by the number of months in the period. The average number of Pay-TV subscribers for each month is calculated by adding the beginning and ending Pay-TV subscribers for the month and dividing by two. During the fourth quarter 2012, we have elected to provide Pay-TV ARPU rather than APRU, defined below, as we believe Pay-TV ARPU provides a more meaningful metric. Average monthly revenue per subscriber ("ARPU"). Historically, we have calculated ARPU by dividing average monthly "Subscriber-related revenue" for the period by our average number of Pay-TV subscribers for the period. The average number of Pay-TV subscribers was calculated for the period by adding the average number of Pay-TV subscribers for each month and dividing by the number of months in the period. The average number of Pay-TV subscribers for each month was calculated by adding the beginning and ending Pay-TV subscribers for the month and dividing by two. During the fourth quarter 2012, we have elected to discontinue providing ARPU as we believe Pay-TV ARPU, which excludes revenue from broadband services, provides a more meaningful metric. Pay-TV average monthly subscriber churn rate ("Pay-TV churn rate"). We are not aware of any uniform standards for calculating subscriber churn rate and believe presentations of subscriber churn rates may not be calculated consistently by different companies in the same or similar businesses. We calculate Pay-TV churn rate for any period by dividing the number of Pay-TV subscribers who terminated service during the period by the average number of Pay-TV subscribers for the same period, and further dividing by the number of months in the period. When calculating Pay-TV subscriber churn, the same methodology for calculating average number of Pay-TV subscribers is used as when calculating Pay-TV ARPU. 37 -------------------------------------------------------------------------------- Table of Contents Item 7. MANAGEMENT'S NARRATIVE ANALYSIS OF RESULTS OF OPERATIONS - Continued RESULTS OF OPERATIONS Year Ended December 31, 2012 Compared to the Year Ended December 31, 2011. For the Years Ended December 31, Variance Statements of Operations Data 2012 2011 Amount % (In thousands) Revenue: Subscriber-related revenue $ 13,038,349 $ 12,959,025 $ 79,324 0.6 Equipment sales and other revenue 96,185 64,547 31,638 49.0 Equipment sales, services and other revenue - EchoStar 17,066 36,474 (19,408 ) (53.2 ) Total revenue 13,151,600 13,060,046 91,554 0.7 Costs and Expenses: Subscriber-related expenses 7,246,104 6,841,760 404,344 5.9 % of Subscriber-related revenue 55.6 % 52.8 % Satellite and transmission expenses - EchoStar 419,888 441,613 (21,725 ) (4.9 ) % of Subscriber-related revenue 3.2 % 3.4 % Satellite and transmission expenses - Other 40,392 39,341 1,051 2.7 % of Subscriber-related revenue 0.3 % 0.3 % Cost of sales - equipment, services and other 96,240 79,563 16,677 21.0 Subscriber acquisition costs 1,660,685 1,503,476 157,209 10.5 General and administrative expenses 666,217 615,887 50,330 8.2 % of Total revenue 5.1 % 4.7 % Litigation expense 730,457 (316,949 ) 1,047,406 * Depreciation and amortization 898,682 904,955 (6,273 ) (0.7 ) Total costs and expenses 11,758,665 10,109,646 1,649,019 16.3 Operating income (loss) 1,392,935 2,950,400 (1,557,465 ) (52.8 ) Other Income (Expense): Interest income 22,431 13,209 9,222 69.8 Interest expense, net of amounts capitalized (647,298 ) (552,036 ) (95,262 ) (17.3 ) Other, net 2,124 10,957 (8,833 ) (80.6 ) Total other income (expense) (622,743 ) (527,870 ) (94,873 ) (18.0 ) Income (loss) before income taxes 770,192 2,422,530 (1,652,338 ) (68.2 ) Income tax (provision) benefit, net (285,926 ) (896,847 ) 610,921 68.1 Effective tax rate 37.1 % 37.0 % Net income (loss) $ 484,266 $ 1,525,683 $ (1,041,417 ) (68.3 ) Other Data: Pay-TV subscribers, as of period end (in millions) 14.056 13.967 0.089 0.6 Pay-TV subscriber additions, gross (in millions) 2.739 2.576 0.163 6.3 Pay-TV subscriber additions, net (in millions) 0.089 (0.166 ) 0.255 * Pay-TV average monthly subscriber churn rate 1.57 % 1.63 % (0.06 )% (3.7 ) Pay-TV average subscriber acquisition cost per subscriber ("Pay-TV SAC") $ 784 $ 770 $ 14 1.8 Pay-TV average monthly revenue per subscriber ("Pay-TV ARPU") $ 77.10 $ 76.45 $ 0.65 0.9 EBITDA $ 2,293,741 $ 3,866,312 $ (1,572,571 ) (40.7 ) -------------------------------------------------------------------------------- * Percentage is not meaningful. 38 -------------------------------------------------------------------------------- Table of Contents Item 7. MANAGEMENT'S NARRATIVE ANALYSIS OF RESULTS OF OPERATIONS - Continued Pay-TV subscribers. DISH added approximately 89,000 net Pay-TV subscribers during the year ended December 31, 2012, compared to a loss of approximately 166,000 net Pay-TV subscribers during the same period in 2011. The increase versus the same period in 2011 primarily resulted from a decrease in our average monthly Pay-TV subscriber churn rate and higher gross new Pay-TV subscriber activations due primarily to increased advertising associated with our Hopper set-top box. During the year ended December 31, 2012, DISH added approximately 2.739 million gross new Pay-TV subscribers compared to approximately 2.576 million gross new Pay-TV subscribers during the same period in 2011, an increase of 6.3%. Our gross new Pay-TV subscriber activations continue to be negatively impacted by increased competitive pressures, including aggressive marketing and discounted promotional offers. Telecommunications companies have continued to grow their pay-TV customer bases. In addition, our gross new Pay-TV subscriber activations continue to be adversely affected by sustained economic weakness and uncertainty. Our average monthly Pay-TV subscriber churn rate for the year ended December 31, 2012 was 1.57% compared to 1.63% for the same period in 2011. Our Pay-TV subscriber churn rate was positively impacted in part because we did not have a programming package price increase in the first quarter 2012, but did during the same period in 2011. While Pay-TV subscriber churn improved compared to the same period in 2011, churn continues to be adversely affected by the increased competitive pressures discussed above. Our Pay-TV subscriber churn rate is also impacted by, among other things, the credit quality of previously acquired subscribers, our ability to consistently provide outstanding customer service, the aggressiveness of competitor subscriber acquisition efforts, and our ability to control piracy and other forms of fraud. We have not always met our own standards for performing high-quality installations, effectively resolving subscriber issues when they arise, answering subscriber calls in an acceptable timeframe, effectively communicating with our subscriber base, reducing calls driven by the complexity of our business, improving the reliability of certain systems and subscriber equipment, and aligning the interests of certain third party retailers and installers to provide high-quality service. Most of these factors have affected both gross new Pay-TV subscriber activations as well as existing Pay-TV churn rate. Our future gross new Pay-TV subscriber activations and Pay-TV churn rate may be negatively impacted by these factors, which could in turn adversely affect our revenue growth. Subscriber-related revenue. "Subscriber-related revenue" totaled $13.038 billion for the year ended December 31, 2012, an increase of $79 million or 0.6% compared to the same period in 2011. The change in "Subscriber-related revenue" from the previous year was primarily related to the increase in Pay-TV ARPU discussed below. On October 1, 2012, the assets and liabilities associated with the satellite broadband business were distributed to DISH Network. As a result, beginning in the fourth quarter 2012, we no longer have revenue related to the satellite broadband business. Included in Subscriber-related revenue" is $55 million and $72 million of revenue related to our broadband services for the years ended December 31, 2012 and 2011, respectively. See Note 15 in the Notes to our Consolidated Financial Statements in Item 15 of this Annual Report on Form 10-K for further discussion. Pay-TV ARPU. "Pay-TV average monthly revenue per subscriber" was $77.10 during the year ended December 31, 2012 versus $76.45 during the same period in 2011. The $0.65 or 0.9% increase in Pay-TV ARPU was primarily attributable to higher hardware related revenue. The following table details Pay-TV ARPU by quarter for the year ended December 31, 2012. Pay-TV Pay-TV ARPU ARPU First Quarter, 2012 $ 76.24 Second Quarter, 2012 77.59 Third Quarter, 2012 76.99 Fourth Quarter, 2012 77.59 Year-to-date, 2012 77.10 39 -------------------------------------------------------------------------------- Table of Contents Item 7. MANAGEMENT'S NARRATIVE ANALYSIS OF RESULTS OF OPERATIONS - Continued Subscriber-related expenses. "Subscriber-related expenses" totaled $7.246 billion during the year ended December 31, 2012, an increase of $404 million or 5.9% compared to the same period in 2011. The increase in "Subscriber-related expenses" was primarily attributable to higher programming costs. The increase in programming costs was driven by rate increases in certain of our programming contracts, including the renewal of certain contracts at higher rates. "Subscriber-related expenses" represented 55.6% and 52.8% of "Subscriber-related revenue" during the year ended December 31, 2012 and 2011, respectively. The change in this expense to revenue ratio primarily resulted from higher programming costs, discussed above. During the fourth quarter 2012, $6 million of expenses related to the acquisition of new broadband subscribers for the period beginning January 1, 2012 through September 30, 2012 that were previously included in "Subscriber-related expenses" were reclassified to "Subscriber acquisition costs." These amounts associated with our broadband services for 2011 were immaterial. On October 1, 2012, the assets and liabilities associated with the satellite broadband business were distributed to DISH Network. As a result, beginning in the fourth quarter 2012, we no longer have costs related to the satellite broadband business. Included in "Subscriber-related expenses" is $24 million and $27 million of costs related to our broadband services for the years ended December 31, 2012 and 2011, respectively. See Note 15 in the Notes to our Consolidated Financial Statements in Item 15 of this Annual Report on Form 10-K for further discussion. In the normal course of business, we enter into contracts to purchase programming content in which our payment obligations are fully contingent on the number of subscribers to whom we provide the respective content. Our programming expenses will continue to increase to the extent we are successful in growing our subscriber base. In addition, our "Subscriber-related expenses" may face further upward pressure from price increases and the renewal of long-term programming contracts on less favorable pricing terms. Subscriber acquisition costs. "Subscriber acquisition costs" totaled $1.661 billion for the year ended December 31, 2012, an increase of $157 million or 10.5% compared to the same period in 2011. This increase was primarily attributable to the increase in gross new subscriber activations and SAC described below. The $1.661 billion of subscriber acquisition costs includes $6 million of expenses related to the acquisition of new broadband subscribers for the period beginning January 1, 2012 through September 30, 2012 that were previously included in "Subscriber-related expenses" and were reclassified to "Subscriber acquisition costs." These amounts associated with our broadband services for 2011 were immaterial. On October 1, 2012, the assets and liabilities associated with the satellite broadband business were distributed to DISH Network. As a result, beginning in the fourth quarter 2012, we no longer have costs related to the satellite broadband business. Included in "Subscriber acquisition costs" is $18 million and zero of costs related to our broadband services for the years ended December 31, 2012 and 2011, respectively. See Note 15 in the Notes to our Consolidated Financial Statements in Item 15 of this Annual Report on Form 10-K for further discussion. Pay-TV SAC. Pay-TV SAC was $784 during the year ended December 31, 2012 compared to $770 during the same period in 2011, an increase of $14 or 1.8%. This increase was primarily attributable to increased advertising associated with our Hopper set-top box. The following table details Pay-TV SAC by quarter for the year ended December 31, 2012. Pay-TV Pay-TV SAC SAC First Quarter, 2012 $ 747 Second Quarter, 2012 800 Third Quarter, 2012 797 Fourth Quarter, 2012 791 Year-to-date, 2012 784 During the years ended December 31, 2012 and 2011, the amount of equipment capitalized under our lease program for new Pay-TV subscribers totaled $506 million and $480 million, respectively. This increase in capital expenditures under our lease program for new Pay-TV subscribers resulted primarily from an increase in gross new Pay-TV subscribers. Capital expenditures resulting from our equipment lease program for new Pay-TV subscribers were partially mitigated by the redeployment of equipment returned by disconnecting lease program Pay-TV subscribers. To remain competitive we upgrade or replace subscriber equipment periodically as technology changes, and the costs associated with these upgrades may be substantial. To the extent technological changes render a portion of our existing equipment obsolete, we would be unable to redeploy all returned equipment and consequently would realize less benefit from the Pay-TV SAC reduction associated with redeployment of that returned lease equipment. Our Pay-TV SAC calculation does not reflect any benefit from payments we received in connection with equipment not returned to us from disconnecting lease subscribers and returned equipment that is made available for sale or used in our existing customer lease program rather than being redeployed through our new customer lease program. 40 -------------------------------------------------------------------------------- Table of Contents Item 7. MANAGEMENT'S NARRATIVE ANALYSIS OF RESULTS OF OPERATIONS - Continued During the years ended December 31, 2012 and 2011, these amounts totaled $140 million and $96 million, respectively. We have been deploying receivers that utilize 8PSK modulation technology and receivers that utilize MPEG-4 compression technology for several years. These technologies, when fully deployed, will allow more programming channels to be carried over our existing satellites. Many of our customers today, however, do not have receivers that use MPEG-4 compression and a smaller but still significant number do not have receivers that use 8PSK modulation. We may choose to invest significant capital to accelerate the conversion of customers to MPEG-4 and/or 8PSK to realize the bandwidth benefits sooner. In addition, given that all of our HD content is broadcast in MPEG-4, any growth in HD penetration will naturally accelerate our transition to these newer technologies and may increase our subscriber acquisition and retention costs. All new receivers that we purchase from EchoStar have MPEG-4 technology. Although we continue to refurbish and redeploy MPEG-2 receivers, as a result of our HD initiatives and current promotions, we currently activate most new customers with higher priced MPEG-4 technology. This limits our ability to redeploy MPEG-2 receivers and, to the extent that our promotions are successful, will accelerate the transition to MPEG-4 technology, resulting in an adverse effect on our SAC. Our "Subscriber acquisition costs" and "Pay-TV SAC" may materially increase in the future to the extent that we transition to newer technologies, introduce more aggressive promotions, or provide greater equipment subsidies. Litigation expense. "Litigation expense" related to legal settlements, judgments or accruals associated with certain significant litigation totaled $730 million during the year ended December 31, 2012 related to the Voom Settlement Agreement. During the year ended December 31, 2011, "Litigation expense" totaled a negative $317 million. During the year ended December 31, 2011, we reversed $341 million related to the April 29, 2011 settlement agreement with TiVo, which was previously recorded as an expense. See Note 11 and Note 15 in the Notes to our Consolidated Financial Statements in Item 15 of this Annual Report on Form 10-K for further discussion. Depreciation and amortization. "Depreciation and amortization" expense totaled $899 million during the year ended December 31, 2012, a $6 million or 0.7% decrease compared to the same period in 2011. This change in "Depreciation and amortization" expense was primarily due to a decrease in depreciation expense on equipment leased to subscribers, partially offset by $68 million of depreciation expense related to the 148 degree orbital location in 2012 and an increase in depreciation expense associated with additional assets which were placed in service to support DISH Network. See Note 6 in the Notes to the Consolidated Financial Statements in Item 15 of this Annual Report on Form 10-K for further discussion. Interest expense, net of amounts capitalized. "Interest expense, net of amounts capitalized" totaled $647 million during the year ended December 31, 2012, an increase of $95 million or 17.3% compared to the same period in 2011. This change primarily resulted from an increase in net interest expense associated with the issuances and redemption of our senior notes during 2012 and 2011. 41 -------------------------------------------------------------------------------- Table of Contents Item 7. MANAGEMENT'S NARRATIVE ANALYSIS OF RESULTS OF OPERATIONS - Continued Earnings before interest, taxes, depreciation and amortization. EBITDA was $2.294 billion during the year ended December 31, 2012, a decrease of $1.573 billion or 40.7% compared to the same period in 2011. EBITDA for year ended December 31, 2012 was unfavorably impacted by $730 million of litigation expense related to the Voom Settlement Agreement and an increase in "Subscriber-related expense." EBITDA for the year ended December 31, 2011 was favorably impacted by the reversal of $341 million of "Litigation expense" related to the April 29, 2011 settlement agreement with TiVo, which had been previously recorded as an expense prior to the first quarter 2011. The following table reconciles EBITDA to the accompanying financial statements. For the Years Ended December 31, 2012 2011 (In thousands) EBITDA $ 2,293,741 $ 3,866,312 Interest expense, net (624,867 ) (538,827 ) Income tax (provision) benefit, net (285,926 ) (896,847 ) Depreciation and amortization (898,682 ) (904,955 ) Net income (loss) $ 484,266 $ 1,525,683 EBITDA is not a measure determined in accordance with accounting principles generally accepted in the United States ("GAAP") and should not be considered a substitute for operating income, net income or any other measure determined in accordance with GAAP. EBITDA is used as a measurement of operating efficiency and overall financial performance and we believe it to be a helpful measure for those evaluating companies in the pay-TV industry. Conceptually, EBITDA measures the amount of income generated each period that could be used to service debt, pay taxes and fund capital expenditures. EBITDA should not be considered in isolation or as a substitute for measures of performance prepared in accordance with GAAP. Income tax (provision) benefit, net. Our income tax provision was $286 million during the year ended December 31, 2012, a decrease of $611 million compared to the same period in 2011. The decrease in the provision was primarily related to the decrease in "Income (loss) before income taxes." Net income (loss). "Net income (loss)" was $484 million during the year ended December 31, 2012, a decrease of $1.042 billion compared to $1.526 billion for the same period in 2011. The decrease was primarily attributable to the changes in revenue and expenses discussed above. 42 -------------------------------------------------------------------------------- Table of Contents Item 7. MANAGEMENT'S NARRATIVE ANALYSIS OF RESULTS OF OPERATIONS - Continued Year Ended December 31, 2011 Compared to the Year Ended December 31, 2010. For the Years Ended December 31, Variance Statements of Operations Data 2011 2010 Amount % (In thousands) Revenue: Subscriber-related revenue $ 12,959,025 $ 12,538,950 $ 420,075 3.4 Equipment sales and other revenue 64,547 59,607 4,940 8.3 Equipment sales, services and other revenue - EchoStar 36,474 37,180 (706 ) (1.9 ) Total revenue 13,060,046 12,635,737 424,309 3.4 Costs and Expenses: Subscriber-related expenses 6,841,760 6,675,095 166,665 2.5 % of Subscriber-related revenue 52.8 % 53.2 % Satellite and transmission expenses - EchoStar 441,613 418,286 23,327 5.6 % of Subscriber-related revenue 3.4 % 3.3 % Satellite and transmission expenses - Other 39,341 39,776 (435 ) (1.1 ) % of Subscriber-related revenue 0.3 % 0.3 % Cost of sales - equipment, services and other 79,563 76,295 3,268 4.3 Subscriber acquisition costs 1,503,476 1,652,992 (149,516 ) (9.0 ) General and administrative expenses 615,887 620,924 (5,037 ) (0.8 ) % of Total revenue 4.7 % 4.9 % Litigation expense (316,949 ) 225,456 (542,405 ) * Depreciation and amortization 904,955 983,360 (78,405 ) (8.0 ) Total costs and expenses 10,109,646 10,692,184 (582,538 ) (5.4 ) Operating income (loss) 2,950,400 1,943,553 1,006,847 51.8 Other Income (Expense): Interest income 13,209 13,744 (535 ) (3.9 ) Interest expense, net of amounts capitalized (552,036 ) (470,890 ) (81,146 ) (17.2 ) Other, net 10,957 581 10,376 * Total other income (expense) (527,870 ) (456,565 ) (71,305 ) (15.6 ) Income (loss) before income taxes 2,422,530 1,486,988 935,542 62.9 Income tax (provision) benefit, net (896,847 ) (538,312 ) (358,535 ) (66.6 ) Effective tax rate 37.0 % 36.2 % Net income (loss) $ 1,525,683 $ 948,676 $ 577,007 60.8 Other Data: Pay-TV subscribers, as of period end (in millions) 13.967 14.133 (0.166 ) (1.2 ) Pay-TV subscriber additions, gross (in millions) 2.576 3.052 (0.476 ) (15.6 ) Pay-TV subscriber additions, net (in millions) (0.166 ) 0.033 (0.199 ) * Average monthly subscriber churn rate 1.63 % 1.76 % (0.13 )% (7.4 ) Average subscriber acquisition cost per subscriber ("SAC") $ 771 $ 776 $ (5 ) (0.6 ) Average monthly revenue per subscriber ("ARPU") $ 76.93 $ 73.32 $ 3.61 4.9 EBITDA $ 3,866,312 $ 2,927,494 $ 938,818 32.1 -------------------------------------------------------------------------------- * Percentage is not meaningful. 43 -------------------------------------------------------------------------------- Table of Contents Item 7. MANAGEMENT'S NARRATIVE ANALYSIS OF RESULTS OF OPERATIONS - Continued Pay-TV subscribers. DISH lost approximately 166,000 net Pay-TV subscribers during the year ended December 31, 2011, compared to a gain of approximately 33,000 net new Pay-TV subscribers during the same period in 2010. The change versus the prior year primarily resulted from a decline in gross new Pay-TV subscriber activations. During the year ended December 31, 2011, DISH added approximately 2.576 million gross new Pay-TV subscribers compared to approximately 3.052 million gross new Pay-TV subscribers during the same period in 2010, a decrease of 15.6%. Our gross activations and net Pay-TV subscriber additions were negatively impacted during the year ended December 31, 2011 compared to the same period in 2010 as a result of increased competitive pressures, including aggressive marketing and the effectiveness of certain competitors' promotional offers, which included an increased level of programming discounts. In addition, telecommunications companies continue to grow their respective customer bases. Our gross activations and net Pay-TV subscriber additions continue to be adversely affected during the year ended December 31, 2011 by sustained economic weakness and uncertainty, including, among other things, the weak housing market in the United States combined with lower discretionary spending. Our Pay-TV churn rate for the year ended December 31, 2011 was 1.63%, compared to 1.76% for the same period in 2010. While our Pay-TV churn rate improved compared to the same period in 2010, our Pay-TV churn rate continues to be adversely affected by the increased competitive pressures discussed above. In general, our Pay-TV churn rate is impacted by the quality of Pay-TV subscribers acquired in past quarters, our ability to provide outstanding customer service, and our ability to control piracy. Subscriber-related revenue. DISH "Subscriber-related revenue" totaled $12.959 billion for the year ended December 31, 2011, an increase of $420 million or 3.4% compared to the same period in 2010. This change was primarily related to the increase in "ARPU" discussed below. ARPU. "Average monthly revenue per subscriber" was $76.93 during the year ended December 31, 2011 versus $73.32 during the same period in 2010. The $3.61 or 4.9% increase in ARPU was primarily attributable to price increases during the past year, higher hardware related revenue and fees earned from our in-home service operations, partially offset by decreases in premium and pay per view revenue. Subscriber-related expenses. "Subscriber-related expenses" totaled $6.842 billion during the year ended December 31, 2011, an increase of $167 million or 2.5% compared to the same period in 2010. The increase in "Subscriber-related expenses" was primarily attributable to higher programming costs and an increase in customer retention expense, partially offset by reduced costs related to our call centers. The increase in programming costs was driven by rate increases in certain of our programming contracts, including the renewal of certain contracts at higher rates. "Subscriber-related expenses" represented 52.8% and 53.2% of "Subscriber-related revenue" during the year ended December 31, 2011 and 2010, respectively. The improvement in this expense to revenue ratio primarily resulted from an increase in "Subscriber-related revenue," partially offset by higher programming costs, discussed above. Subscriber acquisition costs. "Subscriber acquisition costs" totaled $1.503 billion for the year ended December 31, 2011, a decrease of $150 million or 9.0% compared to the same period in 2010. This decrease was primarily attributable to a decline in gross new subscriber activations. SAC. SAC was $771 during the year ended December 31, 2011 compared to $776 during the same period in 2010, a decrease of $5 or 0.6%. This decrease was primarily attributable to an increase in the percentage of redeployed receivers that were installed. During the years ended December 31, 2011 and 2010, the amount of equipment capitalized under our lease program for new subscribers totaled $480 million and $716 million, respectively. This decrease in capital expenditures under 44 -------------------------------------------------------------------------------- Table of Contents Item 7. MANAGEMENT'S NARRATIVE ANALYSIS OF RESULTS OF OPERATIONS - Continued our lease program for new subscribers resulted primarily from a decrease in gross new subscriber activations and an increase in the percentage of redeployed receivers that were installed. Capital expenditures resulting from our equipment lease program for new subscribers were partially mitigated by the redeployment of equipment returned by disconnecting lease program subscribers. To remain competitive we upgrade or replace subscriber equipment periodically as technology changes, and the costs associated with these upgrades may be substantial. To the extent technological changes render a portion of our existing equipment obsolete, we would be unable to redeploy all returned equipment and consequently would realize less benefit from the SAC reduction associated with redeployment of that returned lease equipment. Our SAC calculation does not reflect any benefit from payments we received in connection with equipment not returned to us from disconnecting lease subscribers and returned equipment that is made available for sale or used in our existing customer lease program rather than being redeployed through our new customer lease program. During the years ended December 31, 2011 and 2010, these amounts totaled $96 million and $108 million, respectively. Litigation expense. "Litigation expense" totaled a negative $317 million during the year ended December 31, 2011, a reduction in expense of $542 million compared to the same period in 2010. See Note 15 in the Notes to our Consolidated Financial Statements in Item 15 of this Annual Report on Form 10-K for further discussion. Depreciation and amortization. "Depreciation and amortization" expense totaled $905 million during the year ended December 31, 2011, a $78 million or 8.0% decrease compared to the same period in 2010. This change in "Depreciation and amortization" expense was primarily due to a decrease in depreciation on equipment leased to subscribers principally related to less equipment capitalization during 2011 compared to the same period in 2010 and less equipment write-offs from disconnecting subscribers. This decrease was partially offset by an increase in depreciation on satellites as a result of EchoStar XIV and EchoStar XV being placed into service during the second and third quarters 2010, respectively. Interest expense, net of amounts capitalized. "Interest expense, net of amounts capitalized" totaled $552 million during the year ended December 31, 2011, an increase of $81 million or 17.2% compared to the same period in 2010. This change primarily resulted from an increase in interest expense related to the issuance of our 6 3/4% Senior Notes due 2021 during the second quarter 2011, partially offset by a decrease in interest expense as a result of the repurchases and redemptions of our 6 3/8% Senior Notes due 2011. Earnings before interest, taxes, depreciation and amortization. EBITDA was $3.866 billion during the year ended December 31, 2011, an increase of $939 million or 32.1% compared to the same period in 2010. The following table reconciles EBITDA to the accompanying financial statements. For the Years Ended December 31, 2011 2010 (In thousands) EBITDA $ 3,866,312 $ 2,927,494 Interest expense, net (538,827 ) (457,146 ) Income tax (provision) benefit, net (896,847 ) (538,312 ) Depreciation and amortization (904,955 ) (983,360 ) Net income (loss) $ 1,525,683 $ 948,676 EBITDA is not a measure determined in accordance with GAAP and should not be considered a substitute for operating income, net income or any other measure determined in accordance with GAAP. EBITDA is used as a measurement of operating efficiency and overall financial performance and we believe it to be a helpful measure for those evaluating companies in the pay-TV industry. Conceptually, EBITDA measures the amount of income generated each period that could be used to service debt, pay taxes and fund capital expenditures. EBITDA should not be considered in isolation or as a substitute for measures of performance prepared in accordance with GAAP. 45 -------------------------------------------------------------------------------- Table of Contents Item 7. MANAGEMENT'S NARRATIVE ANALYSIS OF RESULTS OF OPERATIONS - Continued Income tax (provision) benefit, net. Our income tax provision was $897 million during the year ended December 31, 2011, an increase of $359 million compared to the same period in 2010. The increase in the provision was primarily related to the increase in "Income (loss) before income taxes." Net income (loss). "Net income (loss)" was $1.526 billion during the year ended December 31, 2011, an increase of $577 million compared to $949 million for the same period in 2010. The increase was primarily attributable to the changes in revenue and expenses discussed above. 46 -------------------------------------------------------------------------------- Table of Contents |