[May 09, 2013] DISH NETWORK CORP - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Tweet (Edgar Glimpses Via Acquire Media NewsEdge) You should read the following management's discussion and analysis of our financial condition and results of operations together with the condensed consolidated financial statements and notes to our financial statements included elsewhere in this quarterly report. This management's discussion and 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 our Annual Report on Form 10-K for the year ended December 31, 2012 and this Quarterly Report on Form 10-Q under the caption "Item 1A. Risk Factors." EXECUTIVE SUMMARY Overview DISH added approximately 36,000 net Pay-TV subscribers during the three months ended March 31, 2013, compared to the addition of approximately 104,000 net Pay-TV subscribers during the same period in 2012. The decrease versus the same period in 2012 primarily resulted from an increase in our Pay-TV churn rate and lower gross new Pay-TV subscriber activations. Our Pay-TV churn rate for the three months ended March 31, 2013 was 1.47% compared to 1.35% for the same period in 2012. Our Pay-TV churn rate was negatively impacted in part because we had a programming package price increase in the first quarter 2013 and did not during the same period in 2012. Churn continues to be adversely affected by the increased competitive pressures discussed below. Our Pay-TV 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. During the three months ended March 31, 2013, DISH added approximately 654,000 gross new Pay-TV subscribers compared to the addition of approximately 673,000 gross new Pay-TV subscribers during the same period in 2012, a decrease of 2.8%. 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. On September 27, 2012, we began marketing our satellite broadband service under the dishNET™ brand. This service leverages advanced technology and high-powered satellites launched by Hughes and ViaSat to provide broadband coverage nationwide. This service primarily targets approximately 15 million rural residents that are underserved, or unserved, by wireline broadband, and provides download speeds of up to 10 Mbps. We lease the customer premise equipment to subscribers and generally pay Hughes and ViaSat a wholesale rate per subscriber on a monthly basis. Currently, we generally utilize our existing DISH distribution channels under similar incentive arrangements as our pay-TV business to acquire new Broadband subscribers. In addition to the dishNET branded satellite broadband service, we also offer wireline voice and broadband services under the dishNET brand as a competitive local exchange carrier to consumers living in a 14-state region (Arizona, Colorado, Idaho, Iowa, Minnesota, Montana, Nebraska, New Mexico, North Dakota, Oregon, South Dakota, Utah, Washington and Wyoming). Our dishNET branded wireline broadband service provides download speeds of up to 20 Mbps. We primarily bundle our dishNET branded services with our DISH branded pay-TV service, to offer customers a single bill, payment and customer service option, which includes a discount for bundled services. In addition, we market and sell our dishNET branded services on a stand-alone basis. DISH added approximately 66,000 net Broadband subscribers during the three months ended March 31, 2013 compared to the addition of approximately 6,000 net Broadband subscribers during the same period in 2012. This 46 -------------------------------------------------------------------------------- Table of Contents Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued increase versus the same period in 2012 primarily resulted from higher gross new Broadband subscriber activations. During the three months ended March 31, 2013, DISH added approximately 83,000 gross new Broadband subscribers compared to the addition of approximately 14,000 gross new Broadband subscribers during the same period in 2012. This increase was driven by increased advertising related to the dishNET branded broadband services. Broadband services revenue was $40 million and $20 million for the three months ended March 31, 2013 and 2012, respectively, and 1.2% and 0.6% of our total "Subscriber-related revenue," respectively. "Net income (loss) attributable to DISH Network" for the three months ended March 31, 2013 was $216 million, compared to $360 million for the same period in 2012. During the three months ended March 31, 2013, "Net income (loss) attributable to DISH Network" decreased primarily due to an increase in subscriber-related expenses and subscriber acquisition costs, partially offset by the programming package price increase in February 2013. "Net income (loss) attributable to DISH Network" for the three months ended March 31, 2012 was favorably impacted by the non-cash gain of $99 million related to the conversion of our DBSD North America 7.5% Convertible Senior Secured Notes due 2009 in connection with the completion of the DBSD Transaction. See Note 8 in the Notes to the Condensed Consolidated Financial Statements for further information. Our ability to compete successfully will depend on our ability to continue to obtain desirable programming and deliver it to our subscribers at competitive prices, among other things. 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 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 47 -------------------------------------------------------------------------------- Table of Contents Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued 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 a consumer can use, at his or her option, to view recorded programming in HD in multiple rooms. 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 that a consumer can use, at his or her option, 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 Pay-TV subscriber activations. 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. Subsequently, Fox has alleged that the Sling placeshifting functionality and Hopper Transfers™ feature of our second generation Hopper set-top-box infringe its 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 12 in the Notes to our Condensed Consolidated Financial Statements for further information. Blockbuster On April 26, 2011, we completed the Blockbuster Acquisition for a net purchase price of $234 million. Blockbuster primarily offers movies and video games for sale and rental through multiple distribution channels such as retail stores, by-mail, the blockbuster.com website and the BLOCKBUSTER On Demand® service. The Blockbuster Acquisition is intended to complement our core business of delivering high-quality video entertainment to consumers. We are promoting our new Blockbuster offerings including the Blockbuster@Home™ service which provides movies, games and TV shows through Internet streaming, mail and in-store exchanges and online. This offering is only available to DISH subscribers. Blockbuster operations are included in our financial results beginning April 26, 2011. During the three months ended March 31, 2013, Blockbuster operations contributed $180 million in revenue and $1 million in operating income compared to $334 million in revenue and $14 million in operating income for the same period in 2012. The decrease in revenue during the three months ended March 31, 2013 primarily related to the deconsolidation of Blockbuster UK and Blockbuster domestic store closings during 2013 and 2012. During the first quarter 2013, we closed approximately 150 domestic retail stores, leaving us with approximately 650 domestic retail stores as of March 31, 2013. During the second quarter 2013 we plan to close approximately 150 additional stores. We continue to evaluate the impact of certain factors, including, among other things, competitive pressures, the ability of significantly fewer Blockbuster domestic retail stores to continue to support corporate administrative costs, and other issues impacting the store-level financial performance of our Blockbuster domestic retail stores. These factors, or other reasons, could lead us to close additional Blockbuster domestic retail stores. In addition, to reduce administrative expenses, we moved the Blockbuster headquarters to Denver during June 2012. 48 -------------------------------------------------------------------------------- Table of Contents Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued Blockbuster Entertainment Limited and Blockbuster GB Limited, our Blockbuster operating subsidiaries in the United Kingdom (collectively, the "Blockbuster UK Operating Entities"), entered into administration proceedings in the United Kingdom on January 16, 2013 (the "Administration"). Administrators were appointed by the English courts to sell or liquidate the assets of the Blockbuster UK Operating Entities for the benefit of their creditors. Since we no longer exercise control over operating decisions for the Blockbuster UK Operating Entities, we were required to deconsolidate our Blockbuster entities in the United Kingdom (collectively, "Blockbuster UK") on January 16, 2013. As a result of the Administration, we wrote down the assets of Blockbuster UK to their estimated net realizable value on our Consolidated Balance Sheets as of December 31, 2012, and we recorded a charge to "Cost of sales - equipment, merchandise, services, rental and other" of $21 million during the year ended December 31, 2012 on our Consolidated Statements of Operations and Comprehensive Income (Loss). As of December 31, 2012, we had intercompany receivables due from Blockbuster UK of approximately $37 million that were previously eliminated in consolidation on our Consolidated Balance Sheets. As a result of deconsolidation of Blockbuster UK on January 16, 2013, the intercompany receivables are no longer eliminated in consolidation. We believe we will not receive the entire amount for these intercompany receivables in the Administration and accordingly, we recorded a $25 million impairment charge related to these intercompany receivables, to adjust these amounts to their estimated net realizable value for the year ended December 31, 2012. This impairment charge was recorded in "Other, net" within "Other Income (Expense)" on our Consolidated Statements of Operations and Comprehensive Income (Loss) and the resulting liability was recorded in "Other accrued expenses" on our Consolidated Balance Sheets as of December 31, 2012. In total, we recorded charges described above of approximately $46 million on a pre-tax basis on our Consolidated Statements of Operations and Comprehensive Income (Loss) for the year ended December 31, 2012 related to the Administration. As of December 31, 2012, Blockbuster UK had total assets and liabilities as follows (in thousands): Cash $ 14,072 Trade accounts receivable 1,153 Inventory 34,937 Other current assets 10,243 Restricted cash and marketable securities 484 Property and equipment 186 Trade accounts payable (13,081 ) Intercompany payable (36,676 ) Deferred revenue and other (1,369 ) Other accrued expenses (9,949 ) Total net assets $ - Upon deconsolidation on January 16, 2013, the above amounts were combined into one net asset and the intercompany receivables of $37 million, net of the impairment liability of $25 million described above, were recorded in "Other noncurrent assets, net" on our Condensed Consolidated Balance Sheets as a component of our investment in Blockbuster UK. On March 25, 2013, Gordon Brothers Europe purchased certain assets and assumed certain liabilities of the Blockbuster UK Operating Entities through the Administration. As a result, we recorded an additional $2 million impairment charge related to the intercompany receivables, to adjust these amounts to their estimated net realizable value. This impairment charge was recorded in "Other, net" within "Other Income (Expense)" on our Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the three months ended March 31, 2013. In total, as of March 31, 2013, we have recorded charges of approximately $48 million on a pre-tax basis related to the Administration. The proceeds that we actually receive from the Administration and the actual impairment charge may differ from our estimates. For the three months ended March 31, 2012, Blockbuster UK had $71 million of revenue and an operating loss of $4 million. Upon deconsolidation on January 16, 2013, the revenue and expenses related to Blockbuster UK are no longer recorded in our Condensed Consolidated Financial Statements. 49 -------------------------------------------------------------------------------- Table of Contents Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued Wireless Spectrum In 2008, we paid $712 million to acquire certain 700 MHz wireless spectrum licenses, which were granted to us by the FCC in February 2009 subject to certain interim and final build-out requirements. On March 2, 2012, the FCC approved the transfer of 40 MHz of 2 GHz wireless spectrum licenses held by DBSD North America, Inc. ("DBSD North America") and TerreStar Networks, Inc. ("TerreStar") to us. On March 9, 2012, we completed the acquisition of 100% of the equity of reorganized DBSD North America (the " DBSD Transaction") and substantially all of the assets of TerreStar (the "TerreStar Transaction"), pursuant to which we acquired, among other things, certain satellite assets and wireless spectrum licenses held by DBSD North America and TerreStar. The total consideration to acquire the DBSD North America and TerreStar assets was approximately $2.860 billion. The financial results of DBSD North America and TerreStar are included in our results beginning March 9, 2012. We generated $1 million and less than $1 million of revenue for the three months ended March 31, 2013 and 2012, respectively from our wireless segment. In addition, we incurred an $18 million and $8 million operating loss for the three months ended March 31, 2013 and 2012, respectively. We incur general and administrative expenses associated with certain satellite operations and regulatory compliance matters from our wireless spectrum assets. We also incur depreciation and amortization expenses associated with certain assets of DBSD North America and TerreStar. As we review our options for the commercialization of this wireless spectrum, we may incur significant additional expenses and may have to make significant investments related to, among other things, research and development, wireless testing and construction of a wireless network. 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 primarily 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. 50 -------------------------------------------------------------------------------- Table of Contents Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued Future Liquidity 4 1/4% Senior Notes due 2018 On April 5, 2013, we issued $1.2 billion aggregate principal amount of our five-year, 4 1/4% Senior Notes due April 1, 2018 at an issue price of 100.0%. Interest accrues at an annual rate of 4 1/4% and is payable semi-annually in cash, in arrears on April 1 and October 1 of each year, commencing on October 1, 2013. 5 1/8% Senior Notes due 2020 On April 5, 2013, we issued $1.1 billion aggregate principal amount of our seven-year, 5 1/8% Senior Notes due May 1, 2020 at an issue price of 100.0%. Interest accrues at an annual rate of 5 1/8% and is payable semi-annually in cash, in arrears on May 1 and November 1 of each year, commencing on November 1, 2013. 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 us. On March 9, 2012, we completed the DBSD Transaction and the TerreStar Transaction, pursuant to which we acquired, among other things, certain satellite assets and wireless spectrum licenses held by DBSD North America and TerreStar. The total consideration to acquire the DBSD North America and TerreStar assets was approximately $2.860 billion. On February 15, 2013, the FCC issued an order, which became effective on March 7, 2013, modifying our 2 GHz licenses to expand our terrestrial operating authority. The FCC's order of modification has imposed certain limitations on the use of a portion of this spectrum, including interference protections for other spectrum users and power and emission limits that we presently believe could render 5 MHz of our uplink spectrum effectively unusable for terrestrial services and limit our ability to fully utilize the remaining 15 MHz of our uplink spectrum for terrestrial services. These limitations could, among other things, impact ongoing development of technical standards associated with our wireless business, and may have a material adverse effect on our ability to commercialize these licenses. The new rules also mandate certain interim and final build-out requirements for the licenses. By March 2017, we 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, we 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 we fail 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 we fail to meet the 2 GHz Final Build-out Requirement, our terrestrial authorization for each license area in which we fail to meet the requirement will terminate. In addition, the FCC is currently considering rules for a spectrum band that is adjacent to our 2 GHz licenses, known as the "H Block." If the FCC adopts rules for the H block that do not adequately protect our 2 GHz licenses, there could be a material adverse effect on our ability to commercialize the 2 GHz licenses. See Note 8 in the Notes to the Condensed Consolidated Financial Statements for further information. We 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 our 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. Additionally, recent consolidation in the wireless telecommunications industry, may, among other things, limit our available options, including our ability to partner with others. There can be no assurance that we will be able to develop and implement a business model that will realize a return on these spectrum licenses or that we will be able to profitably deploy the assets represented by these spectrum licenses, which may affect the carrying value of these assets and our future financial condition or results of operations. In 2008, we paid $712 million to acquire certain 700 MHz wireless spectrum licenses, which were granted to us by the FCC in February 2009. These licenses mandate certain interim and final build-out requirements. By June 2013, we must provide signal coverage and offer service to at least 35% of the geographic area in each area covered by 51 -------------------------------------------------------------------------------- Table of Contents Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued each individual license (the "700 MHz Interim Build-out Requirement"). By the end of our license term (June 2019), we 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"). We have recently notified the FCC of our plans to commence signal coverage in select cities within certain of these areas, but we have not yet developed plans for providing signal coverage and offering service in all of these areas. If we fail to meet the 700 MHz Interim Build-out Requirement, the term of our licenses will be reduced, from June 2019 to June 2017, and we could face possible fines and the reduction of license area(s). If we fail to meet the 700 MHz Final Build-out Requirement, our authorization for each license area in which we fail to meet the requirement will terminate. To commercialize these licenses and satisfy the associated FCC build-out requirements, we 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. Sprint Merger Proposal On April 15, 2013, we announced that we had submitted a merger proposal to the Board of Directors of Sprint Nextel Corporation ("Sprint") for a total consideration of $25.5 billion, consisting of $17.3 billion in cash and $8.2 billion in stock. Under this proposal, Sprint shareholders would receive $7.00 per share, based upon the closing price of DISH Network shares on April 12, 2013, consisting of $4.76 per share in cash and 0.05953 DISH Network shares per Sprint share. The equity portion would represent approximately 32% ownership in the combined DISH Network/Sprint. There is no assurance that our proposal will be accepted by Sprint or that we will ultimately be able to complete a transaction with Sprint upon terms acceptable to us. The proposed merger would be subject to, among other things, certain regulatory approvals, approval by Sprint's shareholders and other customary closing conditions. To the extent that we complete the proposed merger with Sprint, we will be required to commit a majority of our cash and marketable securities, and we will incur significant additional indebtedness, to finance the cash consideration and possibly to refinance certain existing debt. These commitments may cause us to defer or curtail other strategic investments, investments in our pay-TV business or other transactions. The incurrence of indebtedness to finance the proposed merger with Sprint, together with Sprint's existing indebtedness, will increase the leverage of the combined company. In addition, we may be required to spend additional capital or raise additional capital to support investment in Sprint's business and to continue the build-out of a wireless network, which may not be available on acceptable terms. There can be no assurance that we will be able to achieve our business and financial goals following the proposed merger with Sprint, which may affect the carrying value of our assets and our future financial condition and/or results of operations. If we are unable to successfully address these challenges and risks, among others, our business, financial condition and/or results of operations may suffer. For additional information, see Item 1A, "Risk Factors - Risks Relating to our Proposed Merger with Sprint." Clearwire Proposal On January 8, 2013, Clearwire Corporation ("Clearwire") issued a press release summarizing a strategic transaction that we had proposed at that time. Later that day, we confirmed that we 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 disclosed by Clearwire generally provided for the following, among others things: (i) we would acquire approximately 24% of Clearwire's total spectrum, for approximately $2.2 billion; and (ii) we 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 we 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 we will continue discussions with Clearwire or that we will ultimately be able to complete a transaction with Clearwire upon the terms outlined above or at all. In connection with our merger proposal for Sprint, we have stated that we expect Sprint's pending merger with Clearwire to be completed if our proposal is accepted. 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 52 -------------------------------------------------------------------------------- Table of Contents Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued 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. Equipment and merchandise sales, rental and other revenue. "Equipment and merchandise sales, rental 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. Effective April 26, 2011, revenue from merchandise sold to customers including movies, video games and other items, and revenue from the rental of movies and video games and the sale of previously rented titles related to our Blockbuster operations are included in this category. Effective March 9, 2012, revenue related to our wireless segment is included in this category. 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. 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 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. Effective March 9, 2012, expenses related to our wireless segment are included in this category. Cost of sales - equipment, merchandise, services, rental and other. "Cost of sales - equipment, merchandise, services, rental 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. Effective April 26, 2011, the cost of movies and video games including rental title purchases or revenue sharing to studios, packaging and online delivery costs and cost of merchandise sold including movies, video games and other items related to our Blockbuster operations are included in this category. In addition, "Cost of sales - equipment, merchandise, services, rental and other" 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. In addition, our "Subscriber acquisition costs" include the cost of sales, direct sales efforts and costs related to installations associated with our broadband services. We exclude the value of equipment capitalized under our lease program for new Pay-TV and Broadband subscribers from "Subscriber acquisition costs." 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. 53 -------------------------------------------------------------------------------- Table of Contents Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued 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 and/or conversion of investments, impairment of marketable and non-marketable investment securities, unrealized gains and losses from changes in fair value of marketable and non-marketable strategic investments accounted for at fair value, unrealized gains and losses from changes in fair value of derivative financial instruments, and equity in earnings and losses of our affiliates. Earnings before interest, taxes, depreciation and amortization ("EBITDA"). EBITDA is defined as "Net income (loss) attributable to DISH Network" 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) attributable to DISH Network" 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. "Broadband subscribers." During the fourth quarter 2012, we elected to provide certain Broadband subscriber data. Each broadband customer is counted as one Broadband subscriber, regardless of whether they are also a Pay-TV subscriber. A subscriber of both our pay-TV and broadband services is counted as one Pay-TV subscriber and one Broadband subscriber. 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 Pay-TV 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. 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 churn rate, the same methodology for calculating average number of Pay-TV subscribers is used as when calculating Pay-TV ARPU. Free cash flow. We define free cash flow as "Net cash flows from operating activities" less "Purchases of property and equipment," as shown on our Condensed Consolidated Statements of Cash Flows. 54 -------------------------------------------------------------------------------- Table of Contents Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued RESULTS OF OPERATIONS Three Months Ended March 31, 2013 Compared to the Three Months Ended March 31, 2012. For the Three Months Ended March 31, Variance Statements of Operations Data 2013 2012 Amount % (In thousands) Revenue: Subscriber-related revenue $ 3,352,550 $ 3,224,465 $ 128,085 4.0 Equipment and merchandise sales, rental and other revenue 200,534 350,737 (150,203 ) (42.8 ) Equipment sales, services and other revenue - EchoStar 2,140 6,667 (4,527 ) (67.9 ) Total revenue 3,555,224 3,581,869 (26,645 ) (0.7 ) Costs and Expenses: Subscriber-related expenses 1,911,593 1,761,252 150,341 8.5 % of Subscriber-related revenue 57.0 % 54.6 % Satellite and transmission expenses - EchoStar 112,933 109,854 3,079 2.8 % of Subscriber-related revenue 3.4 % 3.4 % Satellite and transmission expenses - Other 10,248 11,679 (1,431 ) (12.3 ) % of Subscriber-related revenue 0.3 % 0.4 % Cost of sales - equipment, merchandise, services, rental and other 99,526 142,262 (42,736 ) (30.0 ) Subscriber acquisition costs 463,900 399,538 64,362 16.1 General and administrative expenses 270,444 376,175 (105,731 ) (28.1 ) % of Total revenue 7.6 % 10.5 % Depreciation and amortization 234,327 208,698 25,629 12.3 Total costs and expenses 3,102,971 3,009,458 93,513 3.1 Operating income (loss) 452,253 572,411 (120,158 ) (21.0 ) Other Income (Expense): Interest income 37,494 7,089 30,405 * Interest expense, net of amounts capitalized (161,386 ) (138,013 ) (23,373 ) (16.9 ) Other, net 9,740 110,282 (100,542 ) (91.2 ) Total other income (expense) (114,152 ) (20,642 ) (93,510 ) * Income (loss) before income taxes 338,101 551,769 (213,668 ) (38.7 ) Income tax (provision) benefit, net (127,425 ) (191,643 ) 64,218 33.5 Effective tax rate 37.7 % 34.7 % Net income (loss) 210,676 360,126 (149,450 ) (41.5 ) Less: Net income (loss) attributable to noncontrolling interest (4,922 ) (184 ) (4,738 ) * Net income (loss) attributable to DISH Network $ 215,598 $ 360,310 $ (144,712 ) (40.2 ) Other Data: Pay-TV subscribers, as of period end (in millions) 14.092 14.071 0.021 0.1 Pay-TV subscriber additions, gross (in millions) 0.654 0.673 (0.019 ) (2.8 ) Pay-TV subscriber additions, net (in millions) 0.036 0.104 (0.068 ) (65.4 ) Pay-TV average monthly subscriber churn rate 1.47 % 1.35 % 0.12 % 8.9 Pay-TV average subscriber acquisition cost per subscriber ("Pay-TV SAC") $ 882 $ 747 $ 135 18.1 Pay-TV average monthly revenue per subscriber ("Pay-TV ARPU") $ 78.54 $ 76.24 $ 2.30 3.0 Broadband subscribers, as of period end (in millions) 0.249 0.111 0.138 * Broadband subscriber additions, gross (in millions) 0.083 0.014 0.069 * Broadband subscriber additions, net (in millions) 0.066 0.006 0.060 * EBITDA (in thousands) $ 701,242 $ 891,575 $ (190,333 ) (21.3 ) -------------------------------------------------------------------------------- * Percentage is not meaningful. 55 -------------------------------------------------------------------------------- Table of Contents Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued Pay-TV subscribers. DISH added approximately 36,000 net Pay-TV subscribers during the three months ended March 31, 2013, compared to the addition of approximately 104,000 net Pay-TV subscribers during the same period in 2012. The decrease versus the same period in 2012 primarily resulted from an increase in our Pay-TV churn rate and lower gross new Pay-TV subscriber activations. Our Pay-TV churn rate for the three months ended March 31, 2013 was 1.47% compared to 1.35% for the same period in 2012. Our Pay-TV churn rate was negatively impacted in part because we had a programming package price increase in the first quarter 2013 and did not during the same period in 2012. Churn continues to be adversely affected by the increased competitive pressures discussed below. Our Pay-TV 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. During the three months ended March 31, 2013, DISH added approximately 654,000 gross new Pay-TV subscribers compared to the addition of approximately 673,000 gross new Pay-TV subscribers during the same period in 2012, a decrease of 2.8%. 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. 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. Broadband subscribers. DISH added approximately 66,000 net Broadband subscribers during the three months ended March 31, 2013 compared to the addition of approximately 6,000 net Broadband subscribers during the same period in 2012. This increase versus the same period in 2012 primarily resulted from higher gross new Broadband subscriber activations driven by increased advertising related to the dishNET branded broadband services. During the three months ended March 31, 2013, DISH added approximately 83,000 gross new Broadband subscribers compared to approximately 14,000 gross new Broadband subscribers during the same period in 2012. Subscriber-related revenue. "Subscriber-related revenue" totaled $3.353 billion for the three months ended March 31, 2013, an increase of $128 million or 4.0% compared to the same period in 2012. The change in "Subscriber-related revenue" from the same period in 2012 was primarily related to the increase in Pay-TV ARPU discussed below. Included in "Subscriber-related revenue" is $40 million and $20 million of revenue related to our broadband services for the three months ended March 31, 2013 and 2012, respectively. Pay-TV ARPU. "Pay-TV average monthly revenue per subscriber" was $78.54 during the three months ended March 31, 2013 versus $76.24 during the same period in 2012. The $2.30 or 3.0% increase in Pay-TV ARPU was primarily attributable to the programming package price increase in February 2013 and higher hardware related revenue. Equipment and merchandise sales, rental and other revenue. "Equipment and merchandise sales, rental and other revenue" totaled $201 million for the three months ended March 31, 2013, a decrease of $150 million or 42.8% compared to the same period in 2012. This change was primarily related to the deconsolidation of Blockbuster UK on January 16, 2013 and Blockbuster domestic store closings during 2013 and 2012. See Note 9 in the Notes to the Condensed Consolidated Financial Statements for further information. Subscriber-related expenses. "Subscriber-related expenses" totaled $1.912 billion during the three months ended March 31, 2013, an increase of $150 million or 8.5% compared to the same period in 2012. The increase in "Subscriber-related expenses" was primarily attributable to higher pay-TV programming and retention costs and higher Broadband subscriber-related expenses due to the increase in our Broadband subscriber base. The increase in 56 -------------------------------------------------------------------------------- Table of Contents Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued programming costs was driven by rate increases in certain of our programming contracts, including the renewal of certain contracts at higher rates. Included in "Subscriber-related expenses" is $28 million and $10 million of expense related to our broadband services for the three months ended March 31, 2013 and 2012, respectively. "Subscriber-related expenses" represented 57.0% and 54.6% of "Subscriber-related revenue" during the three months ended March 31, 2013 and 2012, respectively. The change in this expense to revenue ratio primarily resulted from higher programming costs, discussed above. 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. Cost of sales - equipment, merchandise, services, rental and other. "Cost of sales - equipment, merchandise, services, rental and other" totaled $100 million for the three months ended March 31, 2013, a decrease of $43 million or 30.0% compared to the same period in 2012. This change was primarily related to the deconsolidation of Blockbuster UK on January 16, 2013 and Blockbuster domestic store closings during 2013 and 2012. See Note 9 in the Notes to the Condensed Consolidated Financial Statements for further information. Subscriber acquisition costs. "Subscriber acquisition costs" totaled $464 million for the three months ended March 31, 2013, an increase of $64 million or 16.1% compared to the same period in 2012. This increase was primarily attributable to the increase in gross new subscriber activations and SAC described below. The $464 million and $400 million of subscriber acquisition costs for first quarter 2013 and 2012, respectively, include $34 million and $4 million of expenses related to our broadband services for the three months ended March 31, 2013 and 2012, respectively. Pay-TV SAC. Pay-TV SAC was $882 during the three months ended March 31, 2013 compared to $747 during the same period in 2012, an increase of $135 or 18.1%. This increase was primarily attributable to increased advertising and equipment costs. Advertising costs were up $44 per activation reflecting increased brand spending related to the launch of our new Hopper with Sling set-top box in February 2013. Other non-capitalized subscriber acquisition costs increased $25 per activation primarily due to increases in the level of inventory subsidies provided to third party sales channels. Capitalized equipment costs increased $66 per activation, primarily due to three factors. First, the percentage of new subscriber activations with new Hopper receiver systems increased. Second, the Hopper with Sling set-top box cost per unit is currently higher than the original Hopper set-top box. Finally, for new subscriber activations with set-top boxes other than the Hopper set-top boxes, we disproportionately deployed new rather than remanufactured set-top boxes during the first quarter 2013. During the three months ended March 31, 2013 and 2012, the amount of equipment capitalized under our lease program for new Pay-TV subscribers totaled $147 million and $107 million, respectively. This increase in capital expenditures under our lease program for new Pay-TV subscribers resulted primarily from the factors described above. 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. During the three months ended March 31, 2013 and 2012, these amounts totaled $45 million and $30 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 57 -------------------------------------------------------------------------------- Table of Contents Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued 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 certain 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. See further discussion under "Other Liquidity Items - Subscriber Acquisition and Retention Costs." General and administrative expenses. "General and administrative expenses" totaled $270 million during the three months ended March 31, 2013, a $106 million or 28.1% decrease compared to the same period in 2012. This decrease was primarily related to the deconsolidation of Blockbuster UK on January 16, 2013 and Blockbuster domestic store closings during 2013 and 2012. See Note 9 in the Notes to the Condensed Consolidated Financial Statements for further information. Depreciation and amortization. "Depreciation and amortization" expense totaled $234 million during the three months ended March 31, 2013, a $26 million or 12.3% increase compared to the same period in 2012. This change in "Depreciation and amortization" expense was primarily due to additional assets which were placed in service to support DISH Network and increased depreciation expense related to equipment leased to subscribers. Interest income. "Interest income" totaled $37 million during the three months ended March 31, 2013, an increase of $30 million compared to the same period in 2012. This increase principally resulted from higher average cash and marketable investment securities balances during the three months ended March 31, 2013 and higher percentage returns earned on our cash and marketable investment securities. Interest expense, net of amounts capitalized. "Interest expense, net of amounts capitalized" totaled $161 million during the three months ended March 31, 2013, an increase of $23 million or 16.9% compared to the same period in 2012. This change primarily resulted from an increase in interest expense associated with the issuance of debt during 2012, partially offset by an increase in capitalized interest in 2013 of $35 million primarily related to our wireless spectrum. Other, net. "Other, net" income totaled $10 million during the three months ended March 31, 2013, a decrease of $101 million compared to the same period in 2012. This change primarily resulted from a decrease in unrealized gains on the sale and/or conversion of marketable investment securities during 2013 compared to 2012. The three months ended March 31, 2012 was favorably impacted by the non-cash gain of $99 million related to the conversion of our DBSD North America 7.5% Convertible Senior Secured Notes due 2009 in connection with the completion of the DBSD Transaction. See Note 8 in the Notes to the Condensed Consolidated Financial Statements for further information. 58 -------------------------------------------------------------------------------- Table of Contents Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued Earnings before interest, taxes, depreciation and amortization. EBITDA was $701 million during the three months ended March 31, 2013, a decrease of $190 million or 21.3% compared to the same period in 2012. EBITDA for the three months ended March 31, 2012 was favorably impacted by the non-cash gain of $99 million related to the conversion of our DBSD North America 7.5% Convertible Senior Secured Notes due 2009 in connection with the completion of the DBSD Transaction. The following table reconciles EBITDA to the accompanying financial statements. For the Three Months Ended March 31, 2013 2012 (In thousands) EBITDA $ 701,242 $ 891,575 Interest expense, net (123,892 ) (130,924 ) Income tax (provision) benefit, net (127,425 ) (191,643 ) Depreciation and amortization (234,327 ) (208,698 ) Net income (loss) attributable to DISH Network $ 215,598 $ 360,310 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 $127 million during the three months ended March 31, 2013, a decrease of $64 million compared to the same period in 2012. The change was primarily related to the decrease in "Income (loss) before income taxes," partially offset by the increase in our effective tax rate. Our effective tax rate for 2012 was favorably impacted by the change in our valuation allowances against certain deferred tax assets that are capital in nature. Net income (loss) attributable to DISH Network. "Net income (loss) attributable to DISH Network" was $216 million during the three months ended March 31, 2013, a decrease of $145 million compared to $360 million for the same period in 2012. This decrease was primarily attributable to the changes in revenue and expenses discussed above. LIQUIDITY AND CAPITAL RESOURCES Cash, Cash Equivalents and Current Marketable Investment Securities We consider all liquid investments purchased within 90 days of their maturity to be cash equivalents. See "Item 3. - Quantitative and Qualitative Disclosures About Market Risk" for further discussion regarding our marketable investment securities. As of March 31, 2013, our cash, cash equivalents and current marketable investment securities totaled $7.095 billion compared to $7.238 billion as of December 31, 2012, a decrease of $143 million. This decrease in cash, cash equivalents and current marketable investment securities was primarily related to purchases and prepaid funding of derivative financial instruments of $550 million and capital expenditures of $312 million, partially offset by cash generated from operations of $686 million. Cash Flow The following discussion highlights our cash flow activities during the three months ended March 31, 2013. Cash flows from operating activities For the three months ended March 31, 2013, we reported "Net cash flows from operating activities" of $686 million primarily attributable to $492 million of net income adjusted to exclude non-cash charges for "Depreciation and 59 -------------------------------------------------------------------------------- Table of Contents Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued amortization" expense and "Deferred tax expense (benefit)." In addition, "Net cash flows from operating activities" benefited from sources of cash related to the changes in operating assets and liabilities related to timing differences between book expense and cash payments. Cash flows from investing activities For the three months ended March 31, 2013, we reported net cash outflows from investing activities of $1.365 billion primarily related to purchases and prepaid funding of derivative financial instruments of $550 million, net purchases of marketable investment securities of $499 million and capital expenditures of $312 million. The capital expenditures included $212 million for new and existing pay-TV subscriber equipment, $15 million for new Broadband subscriber equipment, $1 million for existing Broadband subscriber equipment, $17 million for satellites and $67 million of other corporate capital expenditures. Cash flows from financing activities For the three months ended March 31, 2013, we reported net cash inflows from financing activities of $3 million primarily related to $11 million of proceeds from the issuance of stock related to stock option exercises and our employee stock purchase plan, partially offset by $9 million of repayments of debt and capital lease obligations. Free Cash Flow We define free cash flow as "Net cash flows from operating activities" less "Purchases of property and equipment," as shown on our Condensed Consolidated Statements of Cash Flows. We believe free cash flow is an important liquidity metric because it measures, during a given period, the amount of cash generated that is available to repay debt obligations, make investments, fund acquisitions and for certain other activities. Free cash flow is not a measure determined in accordance with GAAP and should not be considered a substitute for "Operating income," "Net income," "Net cash flows from operating activities" or any other measure determined in accordance with GAAP. Since free cash flow includes investments in operating assets, we believe this non-GAAP liquidity measure is useful in addition to the most directly comparable GAAP measure "Net cash flows from operating activities." During the three months ended March 31, 2013 and 2012, free cash flow was significantly impacted by changes in operating assets and liabilities and in "Purchases of property and equipment" as shown in the "Net cash flows from operating activities" and "Net cash flows from investing activities" sections, respectively, of our Condensed Consolidated Statements of Cash Flows included herein. Operating asset and liability balances can fluctuate significantly from period to period and there can be no assurance that free cash flow will not be negatively impacted by material changes in operating assets and liabilities in future periods, since these changes depend upon, among other things, management's timing of payments and control of inventory levels, and cash receipts. In addition to fluctuations resulting from changes in operating assets and liabilities, free cash flow can vary significantly from period to period depending upon, among other things, subscriber growth, subscriber revenue, subscriber churn, subscriber acquisition costs including amounts capitalized under our equipment lease programs, operating efficiencies, increases or decreases in purchases of property and equipment, and other factors. The following table reconciles free cash flow to "Net cash flows from operating activities." For the Three Months Ended March 31, 2013 2012 (In thousands) Free cash flow $ 374,935 $ 689,622 Add back: Purchases of property and equipment 311,527 168,928 Net cash flows from operating activities $ 686,462 $ 858,550 60 -------------------------------------------------------------------------------- Table of Contents Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued Subscriber Base DISH added approximately 36,000 net Pay-TV subscribers during the three months ended March 31, 2013, compared to the addition of approximately 104,000 net Pay-TV subscribers during the same period in 2012. The decrease versus the same period in 2012 primarily resulted from an increase in our average monthly Pay-TV subscriber churn rate and lower gross new Pay-TV subscriber activations. See "Results of Operations" above for further discussion. There are a number of factors that impact our future cash flow compared to the cash flow we generate at any given point in time, including our Pay-TV churn rate and how successful we are at retaining our current Pay-TV subscribers. As we lose Pay-TV subscribers from our existing base, the positive cash flow from that base is correspondingly reduced. Satellites Operation of our pay-TV service requires that we have adequate satellite transmission capacity for the programming we offer. Moreover, current competitive conditions require that we continue to expand our offering of new programming. While we generally have had in-orbit satellite capacity sufficient to transmit our existing channels and some backup capacity to recover the transmission of certain critical programming, our backup capacity is limited. In the event of a failure or loss of any of our satellites, we may need to acquire or lease additional satellite capacity or relocate one of our other satellites and use it as a replacement for the failed or lost satellite. Such a failure could result in a prolonged loss of critical programming or a significant delay in our plans to expand programming as necessary to remain competitive and cause us to expend a significant portion of our cash to acquire or lease additional satellite capacity. Security Systems Increases in theft of our signal or our competitors' signals could, in addition to reducing new subscriber activations, also cause subscriber churn to increase. We use microchips embedded in credit card sized access cards, called "smart cards," or security chips in our receiver systems to control access to authorized programming content ("Security Access Devices"). Our signal encryption has been compromised in the past and may be compromised in the future even though we continue to respond with significant investment in security measures, such as Security Access Device replacement programs and updates in security software, that are intended to make signal theft more difficult. It has been our prior experience that security measures may only be effective for short periods of time or not at all and that we remain susceptible to additional signal theft. During 2009, we completed the replacement of our Security Access Devices and re-secured our system. We expect additional future replacements of these devices will be necessary to keep our system secure. We cannot ensure that we will be successful in reducing or controlling theft of our programming content and we may incur additional costs in the future if our system's security is compromised. Stock Repurchases Our Board of Directors previously authorized the repurchase of up to $1.0 billion of our Class A common stock. On November 2, 2012, our Board of Directors extended this authorization such that we are currently authorized to repurchase up to $1.0 billion of outstanding shares of our Class A common stock through and including December 31, 2013. As of March 31, 2013, we may repurchase up to $1.0 billion of our Class A common stock under this plan. Subscriber Acquisition and Retention Costs We incur significant upfront costs to acquire subscribers, including advertising, retailer incentives, equipment subsidies, installation services, and new customer promotions. While we attempt to recoup these upfront costs over the lives of their subscription, there can be no assurance that we will. We employ business rules such as minimum credit requirements and we strive to provide outstanding customer service, to increase the likelihood of customers keeping their DISH service over longer periods of time. Our subscriber acquisition costs may vary significantly from period to period. 61 -------------------------------------------------------------------------------- Table of Contents Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued We incur significant costs to retain our existing customers, mostly by upgrading their equipment to HD and DVR receivers. As with our subscriber acquisition costs, our retention spending includes the cost of equipment and installation services. In certain circumstances, we also offer free programming and/or promotional pricing for limited periods for existing customers in exchange for a commitment to receive service for a minimum term. A component of our retention efforts includes the installation of equipment for customers who move. Our subscriber retention costs may vary significantly from period to period. Seasonality Historically, the first half of the year generally produces fewer gross new subscriber activations than the second half of the year, as is typical in the pay-TV service industry. In addition, the first and fourth quarters generally produce a lower churn rate than the second and third quarters. However, we cannot provide assurance that this will continue in the future. 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 the ability of DISH DBS Corporation ("DISH DBS") and its restricted subsidiaries to: (i) incur additional indebtedness; (ii) enter into sale and leaseback transactions; (iii) pay dividends or make distributions on DISH DBS' capital stock or repurchase DISH DBS' 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, DISH DBS was in compliance with the covenants. Other We are also vulnerable to fraud, particularly in the acquisition of new subscribers. While we are addressing the impact of subscriber fraud through a number of actions, there can be no assurance that we will not continue to experience fraud, which could impact our subscriber growth and churn. Sustained economic weakness may create greater incentive for signal theft and subscriber fraud, which could lead to higher subscriber churn and reduced revenue. Obligations and Future Capital Requirements Future Capital Requirements We expect to fund our future working capital, capital expenditures and debt service requirements from cash generated from operations, existing cash and marketable investment securities balances, and cash generated through raising additional capital. The amount of capital required to fund our future working capital and capital expenditure needs varies, depending on, among other things, the rate at which we acquire new subscribers and the cost of subscriber acquisition and retention, including capitalized costs associated with our new and existing subscriber equipment lease programs. The amount of capital required will also depend on the levels of investment necessary to support potential strategic initiatives, including our plans to expand our national HD offerings and other strategic opportunities that may arise from time to time. Our capital expenditures vary depending on the number of satellites leased or under construction at any point in time, and could increase materially as a result of increased competition, significant satellite failures, or sustained economic weakness. These factors could require that we raise additional capital in the future. Volatility in the financial markets has made it more difficult at times for issuers of high-yield indebtedness, such as us, to access capital markets at acceptable terms. These developments may have a significant effect on our cost of financing and our liquidity position. 62 -------------------------------------------------------------------------------- Table of Contents Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued 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 us. On March 9, 2012, we completed the DBSD Transaction and the TerreStar Transaction, pursuant to which we acquired, among other things, certain satellite assets and wireless spectrum licenses held by DBSD North America and TerreStar. The total consideration to acquire the DBSD North America and TerreStar assets was approximately $2.860 billion. On February 15, 2013, the FCC issued an order, which became effective on March 7, 2013, modifying our 2 GHz licenses to expand our terrestrial operating authority. The FCC's order of modification has imposed certain limitations on the use of a portion of this spectrum, including interference protections for other spectrum users and power and emission limits that we presently believe could render 5 MHz of our uplink spectrum effectively unusable for terrestrial services and limit our ability to fully utilize the remaining 15 MHz of our uplink spectrum for terrestrial services. These limitations could, among other things, impact ongoing development of technical standards associated with our wireless business, and may have a material adverse effect on our ability to commercialize these licenses. The new rules also mandate certain interim and final build-out requirements for the licenses. By March 2017, we 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, we 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 we fail 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 we fail to meet the 2 GHz Final Build-out Requirement, our terrestrial authorization for each license area in which we fail to meet the requirement will terminate. In addition, the FCC is currently considering rules for a spectrum band that is adjacent to our 2 GHz licenses, known as the "H Block." If the FCC adopts rules for the H block that do not adequately protect our 2 GHz licenses, there could be a material adverse effect on our ability to commercialize the 2 GHz licenses. See Note 8 in the Notes to the Condensed Consolidated Financial Statements for further information. We 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 our 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. Additionally, recent consolidation in the wireless telecommunications industry, may, among other things, limit our available options, including our ability to partner with others. There can be no assurance that we will be able to develop and implement a business model that will realize a return on these spectrum licenses or that we will be able to profitably deploy the assets represented by these spectrum licenses, which may affect the carrying value of these assets and our future financial condition or results of operations. In 2008, we paid $712 million to acquire certain 700 MHz wireless spectrum licenses, which were granted to us by the FCC in February 2009. These licenses mandate certain interim and final build-out requirements. By June 2013, we 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 our license term (June 2019), we 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"). We have recently notified the FCC of our plans to commence signal coverage in select cities within certain of these areas, but we have not yet developed plans for providing signal coverage and offering service in all of these areas. If we fail to meet the 700 MHz Interim Build-out Requirement, the term of our licenses will be reduced, from June 2019 to June 2017, and we could face possible fines and the reduction of license area(s). If we fail to meet the 700 MHz Final Build-out Requirement, our authorization for each license area in which we fail to meet the requirement will terminate. To commercialize these licenses and satisfy the associated FCC build-out requirements, we 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. 63 -------------------------------------------------------------------------------- Table of Contents Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued Sprint Merger Proposal On April 15, 2013, we announced that we had submitted a merger proposal to the Board of Directors of Sprint for a total consideration of $25.5 billion, consisting of $17.3 billion in cash and $8.2 billion in stock. Under this proposal, Sprint shareholders would receive $7.00 per share, based upon the closing price of DISH Network shares on April 12, 2013, consisting of $4.76 per share in cash and 0.05953 DISH Network shares per Sprint share. The equity portion would represent approximately 32% ownership in the combined DISH Network/Sprint. There is no assurance that our proposal will be accepted by Sprint or that we will ultimately be able to complete a transaction with Sprint upon terms acceptable to us. The proposed merger would be subject to, among other things, certain regulatory approvals, approval by Sprint's shareholders and other customary closing conditions. To the extent that we complete the proposed merger with Sprint, we will be required to commit a majority of our cash and marketable securities, and we will incur significant additional indebtedness, to finance the cash consideration and possibly to refinance certain existing debt. These commitments may cause us to defer or curtail other strategic investments, investments in our pay-TV business or other transactions. The incurrence of indebtedness to finance the proposed merger with Sprint, together with Sprint's existing indebtedness, will increase the leverage of the combined company. In addition, we may be required to spend additional capital or raise additional capital to support investment in Sprint's business and to continue the build-out of a wireless network, which may not be available on acceptable terms. There can be no assurance that we will be able to achieve our business and financial goals following the proposed merger with Sprint, which may affect the carrying value of our assets and our future financial condition and/or results of operations. If we are unable to successfully address these challenges and risks, among others, our business, financial condition and/or results of operations may suffer. For additional information, see Item 1A, "Risk Factors - Risks Relating to our Proposed Merger with Sprint." Clearwire Proposal On January 8, 2013, Clearwire issued a press release summarizing a strategic transaction that we had proposed at that time. Later that day, we confirmed that we 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 disclosed by Clearwire generally provided for the following, among others things: (i) we would acquire approximately 24% of Clearwire's total spectrum, for approximately $2.2 billion; and (ii) we 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 we 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 we will continue discussions with Clearwire or that we will ultimately be able to complete a transaction with Clearwire upon the terms outlined above or at all. In connection with our merger proposal for Sprint, we have stated that we expect Sprint's pending merger with Clearwire to be completed if our proposal is accepted. 64 -------------------------------------------------------------------------------- Table of Contents Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued Other Future Capital Requirements Our 7% Senior Notes with an aggregate principal balance of $500 million mature on October 1, 2013. We expect to fund this obligation from existing cash and marketable investment securities balances. 4 1/4% Senior Notes due 2018. On April 5, 2013, we issued $1.2 billion aggregate principal amount of our five-year, 4 1/4% Senior Notes due April 1, 2018 at an issue price of 100.0%. Interest accrues at an annual rate of 4 1/4% and is payable semi-annually in cash, in arrears on April 1 and October 1 of each year, commencing on October 1, 2013. 5 1/8% Senior Notes due 2020. On April 5, 2013, we issued $1.1 billion aggregate principal amount of our seven-year, 5 1/8% Senior Notes due May 1, 2020 at an issue price of 100.0%. Interest accrues at an annual rate of 5 1/8% and is payable semi-annually in cash, in arrears on May 1 and November 1 of each year, commencing on November 1, 2013. Strategic Investments or Acquisitions From time to time we evaluate opportunities for strategic investments or acquisitions that may complement our current services and products, enhance our technical capabilities, improve or sustain our competitive position, or otherwise offer growth opportunities. We may make investments in or partner with others to, among other things, expand our business into mobile and portable video, IPTV and wireline and wireless data and voice services. Future material investments or acquisitions may require that we obtain additional capital, assume third party debt or incur other long-term obligations. Investments in ARS A portion of our investment portfolio is invested in auction rate securities ("ARS"), and other strategic investments, and as a result a portion of our portfolio has restricted liquidity. Liquidity in the markets for these investments has been adversely impacted. If the credit ratings of these securities deteriorate or the lack of liquidity in the marketplace continues, we may be required to record impairment charges. Moreover, the sustained uncertainty of domestic and global financial markets has greatly affected the volatility and value of our marketable investment securities. To the extent we require access to funds, we may need to sell these securities under unfavorable market conditions, record further impairment charges and fall short of our financing needs. Off-Balance Sheet Arrangements Other than the "Guarantees" disclosed in Note 12 in the Notes to our Condensed Consolidated Financial Statements, we generally do not engage in off-balance sheet financing activities. 65 -------------------------------------------------------------------------------- Table of Contents [ Back To TMCnet.com's Homepage ]