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LORAL SPACE & COMMUNICATIONS INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis should be read in conjunction with our unaudited condensed consolidated financial statements (the "financialstatements") included in Item 1 and our latest Annual Report on Form 10-K filed with the Securities and Exchange Commission. INDEX Topic Location Overview Page 28 Consolidated Operating Results Page 30 Liquidity and Capital Resources: Loral Page 33 Telesat Page 35 Contractual Obligations Page 37 Statement of Cash Flows Page 38 Affiliate Matters Page 38 Commitments and Contingencies Page 38 Other Matters Page 39 Loral Space & Communications Inc., a Delaware corporation, together with its subsidiaries ("Loral", the "Company", "we", "our", and "us") is a leading satellite communications company engaged, through our ownership interests in affiliates, in satellite-based communications services. Prior to completion of the sale of our wholly-owned subsidiary, Space Systems/Loral, LLC (formerly known as Space Systems/Loral, Inc. ("SS/L")), we were also engaged in the satellite manufacturing business. 26 Table of Contents Disclosure Regarding Forward-Looking Statements Except for the historical information contained in the following discussion and analysis, the matters discussed below are not historical facts,but are "forward-looking statements" as that term is defined in the Private Securities Litigation Reform Act of 1995. In addition, we or our representatives have made and may continue to make forward-looking statements, orally or in writing, in other contexts. These forward-looking statements can be identified by the use of words such as "believes," "expects," "plans," "may," "will," "would," "could," "should," "anticipates," "estimates," "project," "intend," or "outlook" or other variations of these words. These statements, including without limitation, those relating to Telesat, are not guarantees of future performance and involve risks and uncertainties that are difficult to predict or quantify. Actual events or results may differ materially as a result of a wide variety of factors and conditions, many of which are beyond our control. For a detailed discussion of these and other factors and conditions, please refer to the Commitments and Contingencies section below and to our other periodic reports filed with the Securities and Exchange Commission ("SEC"). We operate in an industry sector in which the value of securities may be volatile and may be influenced by economic and other factors beyond our control. We undertake no obligation to updateany forward-looking statements. 27 Table of Contents Overview Business Sale of SS/L On November 2, 2012, Loral completed the sale (the "Sale") of its wholly-owned subsidiary, SS/L, to MDA Communications Holdings, Inc. ("MDA Holdings"), a subsidiary of MacDonald, Dettwiler and Associates Ltd. ("MDA"). Pursuant to the purchase agreement (the "Purchase Agreement"), dated as of June 26, 2012, as amended on October 30, 2012 and March 28, 2013, by and among Loral, SS/L, MDA and MDA Holdings, Loral received total cash payments of $967.9 million plus, for the sale of certain real estate used in connection with SS/L's business, a three-year promissory note in the principal amount of $101 million (the "Land Note"). Transaction costs related to the Sale were $35.2 million. Subsequent to the closing of the Sale and pursuant to the Purchase Agreement, Loral, in December 2012, paid MDA $6.5 million as a result of the resolution of a contingency (see Note 16 to the financial statements). The transaction was taxable, and, for tax purposes, treated as a sale of assets. Under the terms of the Purchase Agreement, Loral is obligated to indemnify SS/L for certain litigation costs and litigation damages, subject to certain capped cost-sharing by SS/L, and has retained control of the defense of the lawsuit against SS/L and Loral by ViaSat, Inc. as well as SS/L's counterclaims against ViaSat, Inc. in that lawsuit. Under the terms of the Purchase Agreement, following a change of control of Loral, the liability of Loral for certain litigation costs and litigation damages is subject to a dollar cap. In addition, Loral is obligated to indemnify SS/L from liabilities with respect to certain pre-closing taxes. The Land Note originally issued at closing provided for interest at the rate of 1% per annum with amortization in three equal annual installments on each March 31, commencing March 31, 2013. The Land Note was amended as described below and is backed by a letter of guarantee from Royal Bank of Canada. On November 7, 2012, in connection with the receipt of the proceeds from the Sale, our Board of Directors declared a special distribution of $29.00 per share for an aggregate distribution of $892.1 million. The special distribution was paid on December 4, 2012 to holders of record of Loral voting and non-voting common stock as of November 19, 2012. In accordance with Loral's stock incentive plan, an equitable adjustment was made to outstanding stock-based awards to reflect the special distribution. On March 28, 2013, Loral and MDA amended the Purchase Agreement to modify SS/L's capped cost sharing obligations related to Loral's indemnification of the certain litigation costs and litigation damages and also amended the Land Note to defer to March 31, 2014 the due date of the principal payment from MDA to Loral of $33.7 million due originally on March 31, 2013 with an increase in the interest rate applicable to this tranche of the Land Note from 1.0% to 1.5% effective as of April 1, 2013. Description of Business Subsequent to the Sale, Loral has one operating segment consisting of satellite-based communications services. Loral participates in satellite services operations through its ownership interest in Telesat Holdings Inc. ("Telesat Holdco") which owns Telesat Canada ("Telesat"), a leading global satellite operator, with offices and facilities around the world. Telesat provides its satellite and communication services from a fleet of satellites that occupy Canadian and other orbital locations. Loral holds a 62.8% economic interest and a 33 % voting interest in Telesat, the world's fourth largest satellite operator with approximately $4.9 billion of backlog as of March 31, 2013. Telesat provides satellite services to customers from its state-of-the-art fleet of 14 satellites, including the recently launched Anik G1 satellite which began commercial service on May 8, 2013. In addition, Telesat owns the Canadian payload on ViaSat-1. The satellite services business is capital intensive and the build-out of a satellite fleet requires substantial time and investment. Once the investment in a satellite is made, the incremental costs to maintain and operate the satellite are relatively low over the life of the satellite, with the exception of in-orbit insurance. Telesat has been able to generate a large contracted revenue backlog by entering into long-term contracts with some of its customers for all or substantially all of a satellite's life. Historically, this has resulted in revenue from the satellite services business being fairly predictable. 28 Table of Contents Telesat's commitment to providing strong customer service and its focus on innovation and technical expertise has allowed it to successfully build its business to date. Building on its existing contractual revenue backlog, Telesat's focus is on taking disciplined steps to grow its core business and sell newly launched and existing in-orbit satellite services, and, in a disciplined manner, use the cash flow generated by existing business, contracted expansion satellites and cost savings to strengthen the business. Telesat believes its satellite fleet produces a strong combination of ongoing revenue from backlog, continuing revenue growth and an effective foundation upon which it will seek to continue to grow its revenue and cash flows. The growth is expected to come from the sale of available capacity on its existing in-orbit satellites, including the recently launched Anik G1 satellite. Telesat believes that it is well-positioned to serve its customers and the markets in which it participates. Telesat actively pursues opportunities to develop new satellites, particularly in conjunction with current or prospective customers who will commit to long term service agreements prior to the time the satellite construction contract is signed. Although Telesat regularly pursues opportunities to develop new satellites, it does not procure additional or replacement satellites until it believes there is a demonstrated need and a sound business plan for such satellite capacity. Telesat anticipates that the relatively fixed cost nature of the business, combined with contracted revenue growth and other growth opportunities, will produce growth in operating income and cash flow. For the remainder of 2013, Telesat will remain focused on: increasing utilization of its existing satellites, including the recently launched Anik G1 satellite, identifying and pursuing opportunities to expand its satellite fleet and maintaining cost and operating discipline. Telesat's operating results are subject to fluctuations as a result of exchange rate variations. Approximately 45% of Telesat's revenues received in Canada for the three months ended March 31, 2013, and a substantial portion of its expenses, indebtedness and capital expenditures are denominated in U.S. dollars. The most significant impact of variations in the exchange rate is on the U.S. dollar denominated debt financing. As of March 31, 2013, Telesat's U.S. dollar denominated debt totaled CAD 2.9 billion. As of March 31, 2013, a five percent increase (decrease) in the Canadian dollar against the U.S. dollar would have increased (decreased) Telesat's net income by approximately CAD 149 million. This analysis assumes all other variables, in particular interest rates, remain constant. General Subsequent to the Sale, Loral's remaining assets, primarily its ownership interests in Telesat, will continue to have substantial value. With the goal of maximizing shareholder value, we have previously explored, and expect in the future to continue to explore, potential strategic transactions involving Telesat, including transactions that could result in public ownership of a portion of Telesat. There can be no assurance as to whether, when or on what terms a strategic transaction involving Telesat or Loral may occur. Loral may, from time to time, explore and evaluate other possible strategic transactions and alliances which may include joint ventures and strategic relationships as well as business combinations or the acquisition or disposition of assets. In order to pursue certain of these opportunities, additional funds are likely to be required. There can be no assurance that we will enter into additional strategic transactions or alliances, nor do we know if we will be able to obtain the necessary financing for transactions that require additional funds on favorable terms, if at all. In connection with the Sale, Loral has developed a plan for restructuring its corporate functions. Through mid-2013, Loral will reduce the number of employees at its headquarters. During 2012, Loral charged approximately $11.8 million to general and administrative expenses, mainly for severance and related costs, and paid approximately $8.0 million. During the three months ended March 31, 2013 we paid approximately $0.2 million in restructuring costs and at March 31, 2013, the liability recorded in the condensed consolidated balance sheet for the restructuring was $3.6 million which includes all expected future payments under the restructuring plan relating to the Sale. In connection with the corporate office restructuring as a result of the Sale, on December 13, 2012, Loral's Board of Directors approved termination of Loral's supplemental retirement plan (the "SERP"). The Company expects to make lump sum payments to the participants in the SERP between December 16, 2013 and December 31, 2013 in accordance with the requirements of Section 409A of the Internal Revenue Code and the regulations promulgated thereunder. Our unfunded benefit obligations include approximately $18.2 million for future SERP payments based on benefits earned as of March 31, 2013. 29 Table of Contents In connection with the acquisition of our ownership interest in Telesat in 2007, Loral has agreed that, subject to certain exceptions described in Telesat's shareholders agreement, for so long as Loral has an interest in Telesat, it will not compete in the business of leasing, selling or otherwise furnishing fixed satellite service, broadcast satellite service or audio and video broadcast direct to home service using transponder capacity in the C-band, Ku-band and Ka-band (including in each case extended band) frequencies and the business of providing end-to-end data solutions on networks comprised of earth terminals, space segment, and, where appropriate, networking hubs. Consolidated Operating Results See Critical Accounting Matters in our latest Annual Report on Form 10-K filed with the SEC and Note 2 to the financial statements. Changes in Critical Accounting Policies - There have been no changes in our critical accounting policies during the three months ended March 31, 2013. Consolidated Operating Results Three Months Ended March 31, 2013 Compared With Three Months Ended March 31, 2012 The following compares our consolidated results for the three months ended March 31, 2013 and 2012 as presented in our financial statements (in millions): General and Administrative Expenses Three Months Ended March 31, 2013 2012General and administrative expenses $ 3.7 $ 4.6 General and administrative expenses decreased by $0.9 million for the three months ended March 31, 2013 as compared to the three months ended March 31, 2012, primarily due to a $1.4 million reduction in compensation resulting from the restructuring of our corporate functions and $0.5 million of income earned from supplemental capacity on the ViaSat-1 satellite, partially offset by a $1.0 million increase in pension expense due to the termination of our supplemental retirement plan. Interest and Investment Income Three Months Ended March 31, 2013 2012Interest and investment income $ 0.3 $ 0.5 Interest and investment income, which consists primarily of interest on our cash balance and notes receivable decreased by $0.2 million for the three months ended March 31, 2013 as compared to the three months ended March 31, 2012 primarily due to the reduction in the balance of notes receivable from Telesat in 2013, partially offset by the increase due to the interest on the Land Note in 2013. Other Expense Other expense for the three months ended March 31, 2012 is primarily comprised of expenses related to the evaluation of strategic alternatives for SS/L. Income Tax Provision For the three months ended March 31, our income tax provision is summarized as follows: (i) for 2013, we recorded a current tax provision of $0.8 million (which included a provision of $0.4 million to increase our liability for uncertain tax positions ("UTPs")) and a deferred tax provision of $2.0 million (which included a benefit of $0.1 million for UTPs), resulting in a total provision of $2.8 million on a pre-tax loss of $3.5 million and (ii) for 2012, we recorded a current tax benefit of $1.9 million to decrease our liability for UTPs and a deferred tax provision of $5.1 million (which included a provision of $0.5 million for UTPs), resulting in a total provision of $3.2 million on apre-tax loss of $4.5 million. 30 Table of Contents Our income tax provision for each period is computed by applying an expected effective annual tax rate against the pre-tax loss for the three months ended March 31, 2013 and 2012 (before adjusting for certain tax items that are discrete to each period). The income tax provision includes our tax expense on equity in net (loss) income of affiliates, which is included on the condensed consolidated statements of operations below the line for income tax provision. For 2013 and 2012, the impact of taxes provided on our projected equity in net income of Telesat for the full year relative to the projected pre-tax loss from continuing operations for each respective period caused our expected effective annual tax rate (projected provision for the full year as a percentage of our projected pre-tax loss for the full year) to be negative and in excess of 100%. Subsequent to the Sale, to the extent that Loral's profitability from operations is not sufficient to realize the benefit from our remaining net deferred tax assets, the Company would generate sufficient taxable income from the appreciated value of its Telesat investment, which currently has a nominal tax basis, in order to prevent its federal net operating losses from expiring and realize the benefit of all the remaining deferred tax assets. The increase of $2.7 million in the current provision for the three months ended March 31, 2013 as compared to the three months ended March 31, 2012 primarily relates to the discrete benefit recorded of $0.6 million and $3.2 million for the three months ended March 31, 2013 and 2012, respectively, related to settlement of various state and local UTPs. The decrease of $3.1 million in the deferred provision for the three months ended March 31, 2013 as compared with the three months ended March 31, 2012 is primarily due to a discrete benefit of $1.8 million in 2013 related to the loss recorded from Loral's sale of GdB in 2008 (see Note 7 to the financial statements), a $0.6 million reduction in our provision for UTPs and a $0.4 million reduction of our provision attributable to equity in net income of Telesat. Equity in Net (Loss) Income of Affiliates Equity in net (loss) income of affiliates consists of (in millions): Three Months Ended March 31, 2013 2012 Telesat $ (0.7 ) $ 7.4 XTAR, LLC (1.8 ) (0.5 ) Other (4.8 ) - $ (7.3 ) $ 6.9 The following is a reconciliation of the changes in our investment in Telesat for the three months ended March 31, 2013 (in millions): Three Months Ended March 31, 2013Ending balance, December 31, 2012 $ - Equity in net loss of Telesat (6.7 ) Proportionate share of Telesat other comprehensive income 0.7 Eliminations of affiliate transactions and related amortization (0.8 ) Additional unrecognized loss for the three months ended March 31, 2013 6.8 Ending balance, March 31, 2013 $ - As of March 31, 2013 and December 31, 2012, we held a 62.8% economic interest in Telesat. Our economic interest decreased from 64% to 62.8% in December 2012 when certain executives of Telesat exercised share appreciation rights related to a total of 5,311,568 stock options granted under Telesat's share based compensation plan and received 2,249,747 non-voting participating preferred shares. In March 2012, Telesat completed a refinancing and recapitalization transaction which resulted in special cash distributions to Loral of CAD 375 million ($376 million) in the first quarter of 2012 and CAD 45 million ($44 million) in July 2012 (see Note 7 to the financial statements). As of March 31, 2013 and December 31, 2012, the special cash distributions received from Telesat exceeded our recorded cumulative equity in net income of Telesat and our initial investment by approximately $14 million and $7 million, respectively. In following the equity method of accounting, our investment balance in Telesat was reduced to zero as of March 31, 2013 and December 31, 2012, and we will not record equity in net income of Telesat until our share of Telesat's future net income exceeds $14 million. 31 Table of Contents Loral's equity in net income of Telesat is based on our proportionate share of Telesat's results in accordance with U.S. GAAP and in U.S. dollars. The amortization of Telesat fair value adjustments applicable to the Loral Skynet assets and liabilities acquired by Telesat in 2007 is proportionately eliminated in determining our share of the net income of Telesat. Our equity in net income of Telesat also reflects the elimination of our profit, to the extent of our beneficial interest, on satellites we constructed for Telesat while we owned SS/L. Summary financial information for Telesat in accordance with U.S. GAAP and in Canadian dollars ("CAD") and U.S. dollars ("$") for the three months ended March 31, 2013 and 2012 follows (in millions): Three Months Three Months Ended March 31, Ended March 31, 2013 2012 2013 2012 (In Canadian dollars) (In U.S. dollars) Statement of Operations Data: Revenues 218.9 196.3 217.5 196.0 Operating expenses (50.5 ) (83.8 ) (50.2 ) (83.7 ) Depreciation, amortization and stock-based compensation (58.2 ) (60.6 ) (57.8 ) (60.5 ) Loss on disposition of long lived assets 0.5 (0.1 ) 0.5 (0.1 ) Operating income 110.7 51.8 110.0 51.7 Interest expense (60.1 ) (51.8 ) (59.7 ) (51.7 ) Expense of refinancing (20.1 ) (21.9 ) (20.0 ) (21.8 )Foreign exchange (losses) gains (70.8 ) 62.6 (70.3 ) 62.5 Gains (losses) on financial instruments 37.1 (26.4 ) 36.9 (26.4 ) Other income 0.4 0.7 0.4 0.7Income tax (provision) benefit (7.9 ) 2.4 (7.9 ) 2.4 Net (loss) income (10.7 ) 17.4 (10.6 ) 17.4 Average exchange rate for translating Canadian dollars to U.S. dollars 1.0063 1.0012 March 31, December 31, March 31, December 31, 2013 2012 2013 2012 (In Canadian dollars) (In U.S. dollars) Balance Sheet Data: Current assets 361.9 287.3 356.1 289.6 Total assets 5,342.5 5,300.1 5,257.3 5,342.3 Current liabilities 502.3 235.8 494.3 237.7 Long-term debt, including current portion 3,549.0 3,492.1 3,492.4 3,519.9 Total liabilities 4,785.8 4,733.3 4,709.5 4,771.0 Shareholders' equity 556.7 566.8 547.8 571.3 Period end exchange rate for translating Canadian dollars to U.S. dollars 1.0162 0.9921 Expense of refinancing for the three months ended March 31, 2013 primarily represents the premium paid and the write-off of deferred financing costs related to the redemption of Telesat's 12.5% senior subordinated notes. Telesat's operating expense for the three months ended March 31, 2012 included a $37 million expense related to special payments to executives and certain employees of Telesat in connection with the cash distribution made to Telesat's shareholders. Expense of refinancing for the three months ended March 31, 2012 represents deferred financing costs on the previous credit facilities which were charged to expense as a result of the refinancing. Telesat's operating results are subject to fluctuations as a result of exchange rate variations to the extent that transactions are made in currencies other than Canadian dollars. Telesat's main currency exposures as of March 31, 2013 lie in its U.S. dollar denominated cash and cash equivalents, accounts receivable, accounts payable and debt financing. The most significant impact of variations in the exchange rate is on the U.S. dollar denominated debt financing. As of March 31, 2013, Telesat's U.S. dollar denominated debt totaled CAD 2.9 billion. As of March 31, 2013, a five percent change in the value of the Canadian dollar against the U.S. dollar would have increased or decreased Telesat's net income for the three months ended March 31, 2013 by approximately $149 million. This analysis assumes all other variables, in particular interest rates, remain constant. 32 Table of Contents Telesat's revenue increased by $22 million for the three months ended March 31, 2013 as compared to the three months ended March 31, 2012 due primarily to revenue on the Nimiq 6 satellite which entered commercial service in June 2012, increased enterprise services revenues from higher equipment sales and growth in international activities. Foreign exchange rate changes had no net impact on the change in revenue for the three months ended March 31, 2013 as compared to the three months ended March 31, 2012. Telesat's operating income increased by $58 million for the three months ended March 31, 2013 as compared to the three months ended March 31, 2012 primarily due to the $37 million expense related to the special payments to executives and certain employees of Telesat in connection with the cash distribution to shareholders in 2012 and the revenue increase described above. Foreign exchange rate changes had no net impact on the change in operating income for the three months ended March 31, 2013 as compared to the three months ended March 31, 2012. The equity losses in XTAR, LLC ("XTAR"), our 56% owned joint venture, represent our share of XTAR losses incurred in connection with its operations. We regularly evaluate our investment in XTAR to determine whether there has been a decline in fair value that is other than temporary. We have performed an impairment test for our investment in XTAR as of March 31, 2013, using the most recent forecast, and concluded that our investment in XTAR was not impaired. Any further declines in XTAR's projected revenues may result in a future impairment charge. Backlog Telesat's backlog as of March 31, 2013 and December 31, 2012 was $4.9 billion and $5.2 billion, respectively. The decrease in Telesat's backlog as of March 31, 2013 compared with December 31, 2012 was the result of exchange rate changes and the realization of a portion of previous backlog as revenues, partially offset by additional bookings. Liquidity and Capital Resources Loral As of March 31, 2013, Loral's principal asset is a 62.8% economic interest in Telesat. In addition, we have a 56% economic interest in XTAR and a note receivable of $101 million related to the Sale. The operations of Telesat and XTAR are not consolidated but are presented using the equity method of accounting. Loral has no debt. Telesat has third party debt with financial institutions. XTAR has no external debt other than to its LLC member, Hisdesat, for restructured lease payments on the Spainsat satellite. XTAR makes payments of $5 million per year to pay down the outstanding restructured lease balance. The Company has not provided a guarantee for the debt of Telesat or XTAR. Cash is maintained at Loral, Telesat and XTAR to support the operating needs of each respective entity. The ability of Telesat to pay dividends or certain other restricted payments as well as consulting fees in cash to Loral is governed by applicable covenants relating to its debt and its shareholder agreement. The ability of XTAR to pay dividends and management fees in cash to Loral is governed by its operating agreement. Cash and Available Credit At March 31, 2013, Loral had $44 million of cash and cash equivalents, the Land Note of $101 million and no debt. The Company's cash and cash equivalents decreased by $43 million from December 31, 2012. The cash decrease during the first quarter of 2013 consisted primarily of a payment of $35 million for income taxes on the gain related to the Sale. A discussion of cash changes by activity is set forth in the sections, "Net Cash (Used In) Provided By Operating Activities," "Net Cash (Used In) Provided By Investing Activities," and "Net Cash Used In Financing Activities." 33 Table of Contents The Company did not have a credit facility as of March 31, 2013. Cash Management We have a cash management investment program that seeks a competitive return while maintaining a conservative risk profile. Our cash management investment policy establishes what we believe to be conservative guidelines relating to the investment of surplus cash. The policy allows us to invest in commercial paper, money market funds and other similar short term investments but does not permit us to engage in speculative or leveraged transactions, nor does it permit us to hold or issue financial instruments for trading purposes. The cash management investment policy was designed to preserve capital and safeguard principal, to meet all of our liquidity requirements and to provide a competitive rate of return for similar risk categories of investment. The policy addresses dealer qualifications, lists approved securities, establishes minimum acceptable credit ratings, sets concentration limits, defines a maturity structure, requires all firms to safe keep securities on our behalf, requires certain mandatory reporting activity and discusses review of the portfolio. We operate the cash management investment program under the guidelines of our investment policy and continuously monitor the investments to avoid risks. We currently invest our cash in several liquid Prime AAA money market funds. The dispersion across funds reduces the exposure of a default at one fund. Liquidity On March 28, 2013, Loral entered into Amendment No. 2 to the Purchase Agreement in connection with the sale of SS/L. Under the terms of the Purchase Agreement, Loral is obligated to indemnify SS/L for certain litigation costs and litigation damages relating to the lawsuit with ViaSat, Inc., subject to certain capped cost-sharing by SS/L. Pursuant to Amendment No. 2, the parties agreed to modify SS/L's capped cost-sharing obligations and also to defer to March 31, 2014 the due date of the principal payment from MDA to Loral of $33.7 million due originally on March 31, 2013 under the $101 million Land Note. With this amendment, we still expect that our cash and cash equivalents will be sufficient to fund projected expenditures for the next 12 months though we may decide to borrow on a short-term basis to allow more efficient cash management. These borrowings, if any, would most likely occur in late 2013. If necessary, we plan to obtain a short-term credit facility that may be used until we receive the initial Land Note payment of $67.3 million on March 31, 2014. The substantial fair value of our assets, which include our 62.8% economic interest in Telesat, should permit us to access the financial markets for this facility. Given the continuously changing financial environment, however, there can be no assurance that Loral would be able to obtain such financing on acceptable terms. We expect that our major cash outlays for the next 12 months will be payments under our supplemental retirement plan of $19 million including the final lump sum distribution resulting from termination of the plan. Other cash outlays will include additional severance payments associated with reductions of the corporate staff and funding of long-term incentive-compensation, employee benefit programs, ViaSat litigation costs, indemnification of the tax liabilities for Globalstar do Brasil and general corporate expenses. We expect the Sale will enable us to reduce the annual run rate of corporate expenses, after a transition period, to approximately $6 million, excluding costs related to the SS/L transaction and net of consulting fees from Telesat of $5 million per year. We are also considering an additional contribution to our qualified pension plan to reduce the unfunded obligation. Offsetting these expenditures will be the receipt of cash from Telesat for the outstanding notes receivable associated with the consulting fee and the income sharing arrangement for certain Canadian transponders on the ViaSat-1 satellite, reimbursement of ViaSat litigation costs from SS/L under the terms of the Purchase Agreement, as amended and receipt of $67.3 million from MDA in March 2014 under the Land Note. Risks to Cash Flow In the fourth quarter of 2012, we sold our former subsidiary, SS/L, to MDA pursuant to the Purchase Agreement. Under the terms of the Purchase Agreement, we are obligated to indemnify MDA from (1) liabilities with respect to certain pre-closing taxes; (2) certain litigation costs and litigation damages relating to the ViaSat lawsuit, subject to certain sharing formulas and caps; and (3) certain breaches of representations, warranties and covenants, subject to certain limitations on survival of claims, deductibles and caps. In March 2013, we and MDA agreed, among other things, to modify SS/L's capped cost-sharing obligations. To date, other than with respect to sharing of litigation costs (see below), MDA has submitted one claim for indemnification, which relates to pre-closing taxes. The amount of this claim has not yet been determined. We intend to vigorously contest the underlying tax assessment, but there can be no assurance that we will be successful. Although no assurance can be provided, we do not believe that this matter will have a material adverse effect on our financial position or results of operations. Our condensed consolidated balance sheets include liabilities of $14.8 million and $16.5 million as of March 31, 2013 and December 31, 2012, respectively, representing the estimated fair value of all potential indemnification liabilities relating to the Sale. 34 Table of Contents ViaSat, Inc. and ViaSat Communications, Inc. (formerly known as WildBlue Communications, Inc.) (collectively, "ViaSat") have sued SS/L and Loral in the United States District Court for the Southern District of California. ViaSat's amended complaint alleges, among other things, that SS/L and Loral directly and indirectly infringed, that SS/L and Loral induced infringement, and that SS/L contributed to the infringement of, certain ViaSat patents in connection with the manufacture of satellites by SS/L for customers other than ViaSat. The amended complaint also alleges that each of SS/L and Loral breached non-disclosure obligations in certain contracts with ViaSat. ViaSat's amended complaint seeks, among other things, damages (including treble damages with respect to the patent infringement claims) in amounts to be determined at trial and to enjoin SS/L and Loral from further infringement of the ViaSat patents and breach of contract. SS/L and Loral have answered ViaSat's complaint and asserted defenses to ViaSat's claims and counterclaims seeking a declaratory judgment that neither SS/L nor Loral has infringed and that they are not infringing the ViaSat patents, that ViaSat's patents are invalid and that at least certain of ViaSat's patents are unenforceable due to inequitable conduct. SS/L has also asserted counterclaims against ViaSat for patent infringement, alleging, among other things, that ViaSat infringed certain SS/L patents in connection with its manufacture and sale of certain satellite communication products and services. SS/L's counterclaims seek, among other things, damages (including treble damages with respect to at least one of the patent infringement claims) in amounts to be determined at trial and to enjoin ViaSat from further infringement of the SS/L patents. In March 2013, ViaSat renewed its previously denied motion for summary judgment seeking an order declaring that the claims in two of SS/L's patents are invalid. In April 2013, SS/L and Loral filed a motion seeking an order declaring that certain of the claims in one of ViaSat's patents are invalid as indefinite or, in the alternative, summary judgment of non-infringement of such claims. These motions are pending before the court. We believe that each of SS/L and Loral has, and we intend vigorously to pursue, meritorious defenses and counterclaims to ViaSat's claims. There can be no assurance, however, that SS/L's and Loral's defenses and counterclaims will be successful with respect to all or some of ViaSat's claims or that SS/L will prevail with respect to its assertion that ViaSat has infringed SS/L patents. We believe that SS/L's and Loral's conduct was consistent with, and in due regard for, any applicable and valid intellectual property rights of ViaSat. Although no assurance can be provided, we do not believe that this matter will have a material adverse effect on our financial position or results of operations. Under the terms of the Purchase Agreement, as amended, Loral is obligated to indemnify SS/L for certain litigation costs and litigation damages, subject to certain capped cost-sharing by SS/L, and has retained control of the defense of the lawsuit by ViaSat against SS/L and Loral as well as SS/L's counterclaims against ViaSat in the lawsuit. Under the terms of the Purchase Agreement, following a change of control of Loral, the liability of Loral for certain litigation costs and litigation damages is subject to a dollar cap. Telesat Cash and Available Credit As of March 31, 2013, Telesat had CAD 260 million of cash and short-term investments as well as approximately CAD 140 million of borrowing availability under its revolving facility. Telesat believes that cash and short-term investments as of March 31, 2013, cash flow from operating activities, including amounts from customer prepayments, and drawings on the available lines of credit under the Telesat credit facility will be adequate to meet its expected cash requirements for at least the next 12 months for activities in the normal course of business, including interest and required principal payments on debt as well as the redemption of the 12.5% senior subordinated notes. Cash Flows from Operating Activities Cash generated from operating activities for the three months ended March 31, 2013, was CAD 120 million, a CAD 8 million increase over the same period in the prior year. The increase was primarily due to revenue earned from Telesat's Nimiq 6 satellite, higher equipment sales and growth in its international enterprise activities. These increases were partially offset by lower customer prepayments on future satellite services and a higher cost of sales resulting from higher equipment sales. 35 Table of Contents Cash Flows used in Investing Activities Cash used in investing activities for the three months ended March 31, 2013 was CAD 30 million. This was primarily the result of capital expenditures of CAD 29 million related to Telesat's Anik G1 satellite which launched in April 2013. Cash Flows used in Financing Activities Cash used in financing activities for the three months ended March 31, 2013, was CAD 12 million. This was primarily the result of mandatory repayments made on its term loan A and term loan B credit facilities. Liquidity A large portion of Telesat's annual cash receipts are reasonably predictable because they are primarily derived from an existing backlog of long-term customer contracts and high contract renewal rates. Telesat believes its cash flow from operating activities, in addition to cash on hand and available credit facilities, will be sufficient to provide for its capital requirements and to fund its interest and debt payment obligations for the next 12 months. The construction of any satellite replacement or expansion program will require significant capital expenditures. Telesat may choose to invest in new satellites to further grow its business. Cash required for current and future satellite construction programs will be funded from some or all of the following: cash and short-term investments, cash flow from operating activities, cash flow from customer prepayments or through borrowings on available lines of credit under Telesat's revolving facility. In addition, Telesat may sell certain satellite assets, and in accordance with the terms and conditions of the Telesat senior secured credit facilities, reinvest the proceeds in replacement satellites or pay down indebtedness under the Telesat senior secured credit facilities. Subject to market conditions and subject to compliance with the terms and conditions of the Telesat credit facilities and the financial leverage covenant tests therein, Telesat may also have the ability to obtain additional secured or unsecured financing to fund current or future satellite construction. Telesat's ability to access these sources of funding, however, is not guaranteed and, therefore, Telesat may not be able to fully fund additional replacement and new satellite construction programs. Debt Telesat's debt as of March 31, 2013 and December 31, 2012 was as follows: March 31, December 31, Maturity Currency 2013 2012 (In CAD millions) Senior Credit Facilities:Revolving credit facility March 28, 2017 CAD or USD equivalent Term Loan A March 28, 2017 CAD 494 500 Term Loan B - U.S. Facility March 28, 2019 USD 1,740 1,703 Term Loan B - Canadian facility March 28, 2019 CAD 174 174 6.0% Senior notes May 15, 2017 USD 914 893 12.5% Senior subordinated notes November 1, 2017 USD 221 215 CAD 3,543 3,485 Less: deferred financing costs, interest rate floors and prepayment options (71 ) (78 ) 3,472 3,407 Current portion CAD (260 ) (32 ) Long term portion CAD 3,212 3,375 The obligations under the credit agreement and the guarantees of those obligations are secured, subject to certain exceptions, by first priority liens and security interest in the assets of Telesat and the guarantors. The credit agreement contains covenants that restrict the ability of Telesat and certain of its subsidiaries to take specified actions, including, among other things and subject to certain significant exceptions: creating liens, incurring indebtedness, making investments, engaging in mergers, selling property, paying dividends, entering into sales-leaseback transactions, creating subsidiaries, repaying subordinated debt or amending organizational documents. The credit agreement requires Telesat to comply with a maximum senior secured leverage ratio. The credit agreement also contains customary affirmative covenants and events of default. 36 Table of Contents Each of the Telesat senior secured credit facilities is subject to mandatory principal repayment requirements. The maturity date for each of the Telesat senior secured credit facilities described above will be accelerated if Telesat's existing 6.0% senior notes due in 2017 or certain refinancing thereof are not repurchased, redeemed, refinanced or deferred before the date that is 91 days prior to the maturity date of such notes. The senior notes include covenants or terms that restrict Telesat's ability to, among other things, (i) incur additional indebtedness, (ii) incur liens, (iii) pay dividends or make certain other restricted payments, investments or acquisitions, (iv) enter into certain transactions with affiliates, (v) modify or cancel the Company's satellite insurance, (vi) effect mergers with another entity, and (vii) redeem the senior notes prior to May 15, 2014, in each case subject to exceptions provided in the senior notes indenture. On March 28, 2013, Telesat announced its intention to redeem all outstanding 12.5% senior subordinated notes, and on May 1, 2013, the notes were redeemed at a price equal to 106.25% of the principal amount. On April 2, 2013, Telesat re-priced and amended its existing credit agreement, dated March 28, 2012. The amendment converted CAD 34 million from Canadian to U.S. dollars and decreased the interest rates on Telesat's Canadian and U.S. term loan B facilities by 0.50%. The amendment also decreased the interest rate floors on the debt to 1.00% and 0.75% for the Canadian term loan B facility and U.S. term loan B facility, respectively. The permitted leverage ratio to incur first lien debt is now 4.25:1.00 which represents a change from the prior 4.00:1.00 senior secured leverage ratio in the credit agreement. As of March 31, 2013, Telesat was in compliance with the financial covenants of its senior secured credit facilities and the indentures governing its 6.0% senior notes and 12.5% senior subordinated notes. Debt Service Cost An estimate of the interest expense on the facilities is based upon assumptions of LIBOR and Bankers Acceptance rates and the applicable margin for the Telesat senior secured credit facilities, the senior notes and the senior subordinated notes. Telesat's estimated interest expense for the year ended December 31, 2013 is approximately CAD 206 million. Derivatives Telesat has used interest rate and currency derivatives to hedge its exposure to changes in interest rates and foreign exchange rates. In order to hedge its currency risk, Telesat has cross-currency basis swaps to synthetically convert $1.0 billion of the U.S. term loan facility debt into CAD 1.2 billion of debt. The cross-currency basis swaps are being amortized on a quarterly basis at 1/4 of 1% of the original amount. As of March 31, 2013, the balance of the swaps was CAD 1.2 billion and bears interest at a floating rate of Bankers Acceptance plus an applicable margin of approximately 387 basis points. Any non-cash loss will remain unrealized until this contract is settled. The contract matures on October 31, 2014. At March 31, 2013, Telesat had a series of five interest rate swaps to fix interest on CAD 1.5 billion of Canadian dollar denominated debt at a weighted average fixed rate of 2.63% (excluding applicable margins) and one interest rate swap to pay a fixed rate of 1.46% (excluding applicable margins) on CAD 300 million of U.S. dollar denominated debt.. These contracts mature between October 31, 2014 and September 30, 2016. Telesat also has embedded derivatives. These embedded derivatives are related to a prepayment option included in its senior notes as well as interest rate floors included in its Canadian and U.S. term loan B facilities. The prepayment option on the senior notes will expire on its maturity date of May 15, 2017. The interest rate floors on the Canadian and U.S. term loan B facilities will expire on their respective maturity dates. Contractual Obligations There have not been any significant changes to Loral's contractual obligations as previously disclosed in our latest Annual Report on Form 10-K filed withthe SEC. 37 Table of Contents Statement of Cash Flows Net Cash (Used in) Provided by Operating Activities Net cash used in operations was $ 43 million for the three months ended March 31, 2013. Net cash used in operating activities by continuing operations was $6 million for the three months ended March 31, 2013, consisting primarily of $3 million from the loss from continuing operations adjusted for non-cash operating items, a $2 million increase in other current assets and other assets, a $1 million decrease in accrued expenses and other current liabilities and a $1 million decrease in pension and other postretirement liabilities. Net cash used in operating activities by discontinued operations was $37 million for the three months ended March 31, 2013, consisting primarily of income tax payments of $35 million relating to the gain on the Sale and a $2 million decrease in indemnification liabilities related to the Sale. Net cash provided by operations was $6 million for the three months ended March 31, 2012. Net cash used in operating activities by continuing operations was $6 million for the three months ended March 31, 2012, consisting primarily of $2 million from the loss from continuing operations adjusted for non-cash operating items, a $2 million decrease in long-term liabilities and a $2 million decrease in accrued expenses and other current liabilities. Net cash provided by operating activities from discontinued operations was $11 million for the three months ended March 31, 2012. Net Cash (Used in) Provided by Investing Activities Net cash used in investing activities for the three months ended March 31, 2013 was not significant. Net cash provided by investing activities for the three months ended March 31, 2012 was $312 million. Net cash provided by investing activities from continuing operations for the three months ended March 31, 2012 was $376 million relating to a special cash distribution by Telesat. Net cash used in investing activities by discontinued operations was $64 million for the three months ended March 31, 2012. Net Cash Used in Financing Activities No cash was provided by or used in financing activities for the three months ended March 31, 2013. Net cash used in financing activities for the three months ended March 31, 2012 was $5 million, all from continuing operations, mainly relating to funding by the Company of withholding taxes on employee cashless stock option exercises. Affiliate Matters Loral has made certain investments in joint ventures in the satellite services business that are accounted for under the equity method of accounting. See Note 7 to the financial statements for further information on affiliate matters.Commitments and Contingencies Our business and operations are subject to a number of significant risks, the most significant of which are summarized in Part II, Item 1A - Risk Factors and also in Note 16 to the financial statements. 38 Table of Contents Other Matters Recent Accounting Pronouncements There are no accounting pronouncements that have been issued but not yet adopted that we believe will have a significant impact on our financial statements. |