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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 27 Consolidated Operating Results Page 29 Liquidity and Capital Resources: Loral Page 36 Telesat Page 38 Contractual Obligations Page 40 Statement of Cash Flows Page 40 Affiliate Matters Page 41 Commitments and Contingencies Page 41 Other Matters Page 41 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. 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. 26 Overview Business 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 fixed satellite services operator, with facilities around the world. Telesat provides its satellite and communication services from a fleet of satellites that occupy Canadian andother orbital locations. Loral holds a 62.8% economic interest and a 32.7% voting interest in Telesat Holdco, the world's fourth largest satellite operator with approximately $4.1 billion of backlog as of September 30, 2014. At September 30, 2014, Telesat provided satellite services to customers from its fleet of 14 in-orbit satellites. In addition, Telesat owns the Canadian payload on the ViaSat-1 satellite and has another satellite, Telstar 12 VANTAGE, under construction. 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. 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 and contracted expansion satellites to strengthen the business. Telesat believes its satellite fleet offers a strong combination of existing revenue backlog and a strong foundation upon which it will seek to continue to grow its revenue and cash flows. The growth is expected to come from satellite services using the available capacity on its existing fleet of in-orbit satellites and its Telstar 12 VANTAGE satellite, which is expected to be launched in late 2015. 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 its business, combined with increasing demand for satellite services, will produce growth in operating income and cash flow. For the remainder of 2014, Telesat will remain focused on: increasing utilization on its existing satellites; the construction of Telstar 12 VANTAGE; 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. For the nine months ended September 30, 2014, approximately 49% of Telesat's revenues and a substantial portion of its expenses, indebtedness and capital expenditures were 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 September 30, 2014, Telesat's U.S. dollar denominated debt totaled $2.6 billion. As of September 30, 2014, a five percent increase (decrease) in the Canadian dollar against the U.S. dollar would have increased (decreased) Telesat's net income by approximately $124 million. This analysis assumes all other variables, in particular interest rates, remain constant. On September 22, 2014, Telesat entered into a forward foreign exchange contract to fix the exchange rate on cross-currency basis swaps settled on October 31, 2014. At September 30, 2014, Telesat had one outstanding forward foreign exchange contract requiring payment of $1.0 billion U.S. dollars to receive $1.1 billion Canadian dollars. This forward foreign exchange contract matured onOctober 31, 2014. 27 Sale of SS/L On November 2, 2012, Loral completed the sale (the "Sale") of its wholly-owned subsidiary, Space Systems/Loral, LLC (formerly known as Space Systems/Loral, Inc. ("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. Under the terms of the Purchase Agreement, Loral agreed to indemnify SS/L from certain damages in a lawsuit (the "ViaSat Suit") brought in 2012 by ViaSat, Inc. ("ViaSat") against Loral and SS/L. On September 5, 2014, Loral, SS/L and ViaSat entered into a settlement agreement (the "Settlement Agreement") pursuant to which the ViaSat Suit and an additional patent infringement and breach of contract lawsuit brought by ViaSat against SS/L in September 2013 were settled. Loral was also released from indemnification claims relating to the ViaSat lawsuits under the Purchase Agreement. The terms of the Settlement Agreement provide, among other things, for payment by Loral and SS/L to ViaSat on a joint and several basis of $100 million, $40 million of which was paid on September 9, 2014 in connection with entry into of the Settlement Agreement, and $60 million of which will be paid quarterly from October 15, 2014 through January 15, 2017 with interest accruing from the effective date of the Settlement Agreement at rate of 11.4% per year. The initial quarterly payment of $6.9 million was made by Loral and SS/L on October 15, 2014. In connection with entry into of the Settlement Agreement with ViaSat, Loral and MDA agreed to a mechanism for the allocation between Loral and SS/L of the payments due to ViaSat under the Settlement Agreement. Under that agreement, payments to ViaSat will initially be advanced equally by Loral and SS/L but will be subject to a further allocation between the parties. The parties will then, by way of mediation or arbitration (the "Dispute Resolution Agreement Proceedings"), allocate how much of the payment each party bears. The minimum payment to be borne by either party will be $15 million. The Dispute Resolution Agreement Proceedings are expected to occur in the fourth quarter of 2014. See Note 14 to the financial statements for additional information regarding the lawsuits brought by ViaSat, the Settlement Agreement and the Dispute Resolution Agreement Proceedings. The Land Note from MDA, as amended, provides for interest at the rate of 1% per annum on the remaining principal outstanding as of September 30, 2014 and is backed by a letter of guarantee from Royal Bank of Canada. Loral received a principal payment of $67.3 million on March 31, 2014 and is due to receive the remaining principal of $33.7 million on March 31, 2015. General Since the Sale, Loral's principal asset continues to be its majority ownership interest in Telesat. With the goal of maximizing shareholder value, we have been engaged in a process to explore potential strategic transactions involving the possible monetization of Loral's interest in Telesat. The exact structure of any such transaction has not yet been determined. As currently contemplated, such a transaction would be accomplished through the acquisition of Loral by a third party and would likely require the negotiation of a new shareholders agreement between the potential acquiror of Loral and Public Sector Pension Investment Board ("PSP"), our Canadian co-owner of Telesat. In connection with this process, we received non-binding indications of interest for the acquisition of Loral. Loral, the potential acquiror with the highest bid and PSP have not reached an agreement on the terms of a definitive transaction; the parties are, however, continuing efforts to reach a definitive agreement. There can be no assurance as to whether PSP or the potential acquiror will continue to pursue a transaction, or when or on what terms a strategic transaction involving Telesat or Loral may occur, or that any particular economic, tax, structural or other objectives or benefits with respect to any transaction involving Telesat or Loral's interest therein will be achieved. 28 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 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 nine months ended September 30, 2014. Three Months Ended September 30, 2014 Compared With Three Months Ended September 30, 2013 The following compares our consolidated results for the three months ended September 30, 2014 and 2013 as presented in our financial statements: General and Administrative Expenses Three Months Ended September 30, 2014 2013 (In thousands)General and administrative expenses $ 1,281 $ 3,452 General and administrative expenses decreased by $2.2 million for the three months ended September 30, 2014 as compared to the three months ended September 30, 2013, primarily from a decrease in pension expense of $1.6 million due to accelerated amortization in 2013 as a result of the termination of our supplemental executive retirement plan. Interest and Investment Income Three Months Ended September 30, 2014 2013 (In thousands)Interest and investment income $ 91 $ 307 Interest and investment income for the three months ended September 30, 2014 and 2013 is primarily comprised of interest on the Land Note. The decrease was primarily the result of the $67.3 million principal payment received on March 31, 2014. 29 Other Expense Three Months Ended September 30, 2014 2013 (In thousands) Other expense $ 450 $ 215 Other expense for the three months ended September 30, 2014 and 2013 was related to strategic initiatives. Income Tax (Provision) Benefit Three Months Ended September 30, 2014 2013 (In thousands)Income tax (provision) benefit $ (4,954 ) $ 7,589 For the three months ended September 30, our income tax provision is summarized as follows: (i) for 2014, we recorded a current tax provision of $4.2 million (which included a provision of $0.6 million to increase our liability for uncertain tax positions ("UTPs")) and a deferred tax provision of $0.7 million (which included a benefit of $0.1 million for UTPs), resulting in a total provision of $4.9 million on a pre-tax loss from continuing operations of $1.6 million and (ii) for 2013, we recorded a current tax benefit of $12.6 million (which included a benefit of $1.8 million to reduce our liability for UTPs) and a deferred tax provision of $5.0 million (which included a provision of $0.3 million for UTPs), resulting in a net benefit of $7.6 million on a pre-tax loss from continuing operations of $3.4 million. Our income tax provision for each period is computed by applying an expected effective annual tax rate against the pre-tax loss for the nine months ended September 30, 2014 and 2013 (after adjusting for certain tax items that are discrete to each period) less the provision recorded for the six months ended June 30, 2014 and 2013. The projected income tax provision for the full year used in the computation of our expected effective annual tax rate includes tax expense on the projected equity in net income of Telesat, which is included on the condensed consolidated statements of operations below the line for income tax provision. As a result, our statement of operations for the three months ended September 30, 2014 includes a tax provision rather than a tax benefiton the pretax loss. At September 30, 2014, income taxes receivable on our condensed consolidated balance sheet included $10.6 million from the carryback of our tax loss from 2013 against taxes previously paid for 2012. We expect to receive this tax refund in 2015. Subsequent to the Sale, to the extent that profitability from operations is not sufficient to realize the benefit from our remaining net deferred tax assets, we would generate sufficient taxable income from the appreciated value of our Telesat investment, which currently has a nominal tax basis, in order to prevent federal net operating losses from expiring and realize the benefit of all remaining deferred tax assets. 30 Equity in Net (Loss) Income of Affiliates Three Months Ended September 30, 2014 2013 (In thousands) Telesat Holdings Inc. $ (17,240 ) $ 34,242 XTAR, LLC (2,043 ) (1,569 ) Other - 685 $ (19,283 ) $ 33,358 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 amortization of profits eliminated, to the extent of our economic interest in Telesat, on satellites we constructed for Telesat while we owned SS/L and on Loral's sale to Telesat in April 2011 of its portion of the payload on the ViaSat-1 satellite and related assets. 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 September 30, 2014 and 2013 follows (in thousands): Three Months Three Months Ended September 30, Ended September 30, 2014 2013 2014 2013 (In Canadian dollars) (In U.S. dollars) Statement of Operations Data: Revenues 227,294 236,550 210,163 226,907 Operating expenses (46,348 ) (47,763 ) (42,827 ) (45,736 ) Depreciation, amortization and stock-based compensation (63,775 ) (65,642 ) (58,955 ) (62,946 ) Loss on disposition of long lived assets (178 ) (31 ) (164 ) (15 ) Operating income 116,993 123,114 108,217 118,210 Interest expense (51,458 ) (52,120 ) (47,573 ) (49,831 ) Foreign exchange (loss) gain (104,709 ) 57,817 (96,093 ) 58,171Gain (loss) on financial instruments 16,442 (25,086 ) 15,146 (25,471 ) Other income 908 338 841 420 Income tax provision (7,993 ) (19,192 ) (7,484 ) (18,485 ) Net (loss) income (29,817 ) 84,871 (26,946 ) 83,014 Average exchange rate for translating Canadian dollars to U.S. dollars ( 1 U.S. dollar equals) 1.0818 1.0443 Telesat's revenue decreased by $17 million for the three months ended September 30, 2014 as compared to the three months ended September 30, 2013 due primarily to the impact of the change in the U.S. dollar/Canadian dollar exchange rate on Canadian dollar denominated revenue, a decrease in revenue earned on Telesat's Nimiq 2 satellite as the satellite was returned by Telesat's customer in the third quarter of 2013, revenue from short-term services provided to another satellite operator in the third quarter of 2013 and completion of certain consulting contracts. Telesat's revenue excluding foreign exchange impact would have decreased by $13 million for the three months ended September 30, 2014 as compared to the three months ended September 30, 2013. 31 Telesat's operating income decreased by $10 million for the three months ended September 30, 2014 as compared to the three months ended September 30, 2013 primarily due to the revenue decrease described above, partially offset by the impact of the change in the U.S. dollar/Canadian dollar exchange rate on Canadian dollar denominated expenses, a decrease in share-based compensation expense related to stock options granted during the second quarter of 2013 and a decrease in the provision for variable compensation. Telesat's operating income excluding foreign exchange impact would have decreased by $9 million for the three months ended September 30, 2014 as compared to the three months ended September 30, 2013. The equity in losses of XTAR, LLC ("XTAR"), our 56% owned joint venture, represent our share of XTAR losses incurred in connection with its operations. Loss from Discontinued Operations, net of tax Three Months Ended September 30, 2014 2013 (In thousands)Loss from discontinued operations, net of tax $ (6,440 ) $ (1,987 ) Adjustments to amounts previously reported in discontinued operations that are directly related to the Sale are classified as discontinued operations in the statements of operations for the three months ended September 30, 2014 and 2013. We recorded a $10.3 million loss contingency less taxes thereon in third quarter of 2014 to increase our liability to the minimum liability under the Settlement Agreement and the mechanism for allocation of settlement payments between Loral and SS/L and to record related legal fees. Nine Months Ended September 30, 2014 Compared With Nine Months Ended September 30, 2013 The following compares our consolidated results for the nine months ended September 30, 2014 and 2013 as presented in our financial statements: General and Administrative Expenses Nine Months Ended September 30, 2014 2013 (In thousands)General and administrative expenses $ 3,957 $ 10,559 General and administrative expenses decreased by $6.6 million for the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013, primarily from a decrease in pension expense of $4.5 million due to accelerated amortization in 2013 as a result of the termination of our supplemental executive retirement plan, a $0.6 million reduction in compensation expense resulting from the restructuring of our corporate office functions, a $0.4 million decrease in expenses related to stock-based compensation, a $0.3 million decrease in professional fees and a $0.3 million decrease in rent expense. Interest and Investment Income Nine Months Ended September 30, 2014 2013 (In thousands)Interest and investment income $ 492 $ 939 Interest and investment income for the nine months ended September 30, 2014 and 2013 is primarily comprised of interest on the Land Note. The decrease was primarily the result of the $67.3 million principal payment received on March 31, 2014. 32 Other Expense Nine Months Ended September 30, 2014 2013 (In thousands) Other expense $ 2,026 $ 586 Other expense for the nine months ended September 30, 2014 and 2013 was related to strategic initiatives. Income Tax (Provision) Benefit Nine Months Ended September 30, 2014 2013 (In thousands)Income tax (provision) benefit $ (25,106 ) $ 2,604 For the nine months ended September 30, our income tax provision is summarized as follows: (i) for 2014, we recorded a current tax provision of $5.0 million (which included a provision of $0.2 million to increase our liability for UTPs) and a deferred tax provision of $20.1 million (which included a benefit of $0.1 million for UTPs), resulting in a total provision of $25.1 million on a pre-tax loss from continuing operations of $5.5 million and (ii) for 2013, we recorded a current tax benefit of $18.9 million (which included a benefit of $1.1 million to reduce our liability for UTPs) and a deferred tax provision of $16.3 million (which included a provision of $0.1 million for UTPs), resulting in a net benefit of $2.6 million on a pre-tax loss from continuing operations of $10.2 million. Our income tax provision for each period is computed by applying an expected effective annual tax rate against the pre-tax loss for the nine months ended September 30, 2014 and 2013 (after adjusting for certain tax items that are discrete to each period). The projected income tax provision for the full year used in the computation of our expected effective annual tax rate includes tax expense on the projected equity in net income of Telesat, which is included on the condensed consolidated statements of operations below the line for income tax provision. As a result, our statement of operations for the nine months ended September 30, 2014 includes a tax provision rather than a tax benefiton the pretax loss. At September 30, 2014, income taxes receivable on our condensed consolidated balance sheet included $10.6 million from the carryback of our tax loss from 2013 against taxes previously paid for 2012. We expect to receive this tax refund in 2015. Subsequent to the Sale, to the extent that profitability from operations is not sufficient to realize the benefit from our remaining net deferred tax assets, we would generate sufficient taxable income from the appreciated value of our Telesat investment, which currently has a nominal tax basis, in order to prevent federal net operating losses from expiring and realize the benefit of all remaining deferred tax assets. Equity in Net (Loss) Income of Affiliates Nine Months Ended September 30, 2014 2013 (In thousands) Telesat Holdings Inc. $ 48,226 $ 34,242 XTAR, LLC (5,315 ) (5,068 ) Other - (2,965 ) $ 42,911 $ 26,209 33 The following is a reconciliation of the changes in our investment in Telesat for the nine months ended September 30, 2014: Nine Months Ended September 30, 2014 (In thousands)Opening Balance, January 1, 2014 $ 60,157 Equity in net income of Telesat 49,167 Eliminations of affiliate transactions and related amortization (941 ) Settlement of tax indemnification (4,963 ) Proportionate share of Telesat other comprehensive income 3,815 Ending balance, September 30, 2014 $ 107,235 Summary financial information for Telesat in accordance with U.S. GAAP and in Canadian dollars ("CAD") and U.S. dollars ("$") for the nine months ended September 30, 2014 and 2013 and as of September 30, 2014 and December 31, 2013 follows (in thousands): Nine Months Nine Months Ended September 30, Ended September 30, 2014 2013 2014 2013 (In Canadian dollars) (In U.S. dollars) Statement of Operations Data: Revenues 693,885 669,706 636,552 654,413 Operating expenses (133,426 ) (143,342 ) (122,402 ) (140,068 ) Depreciation, amortization and stock-based compensation (191,540 ) (187,900 ) (175,713 ) (183,609 ) Loss on disposition of long lived assets (246 ) (1,593 ) (226 ) (1,557 ) Operating income 368,673 336,871 338,211 329,179 Interest expense (155,432 ) (164,356 ) (142,589 ) (160,603 ) Expense of refinancing - (20,225 ) - (19,763 ) Foreign exchange losses (114,650 ) (113,142 ) (105,177 ) (110,558 )Gains on financial instruments 34,356 72,799 31,517 71,137 Other income 3,278 11,314 3,007 11,055 Income tax provision (50,841 ) (46,541 ) (46,640 ) (45,478 ) Net income (loss) 85,384 76,720 78,329 74,969 Average exchange rate for translating Canadian dollars to U.S. dollars ( 1 U.S. dollar equals) 1.0903 1.0233 Telesat's revenue decreased by $18 million for the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013 due primarily to the impact of the change in the U.S. dollar/Canadian dollar exchange rate on Canadian dollar denominated revenue, a decrease in revenue earned on Telesat's Nimiq 2 satellite as the satellite was returned by Telesat's customer in the third quarter of 2013 and lower equipment sales. These revenue decreases were partially offset by increased revenue on the Anik G1 satellite which entered commercial service in May 2013. Telesat's revenue excluding foreign exchange impact would have increased by $3 million for the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013. 34 Telesat's operating income increased by $9 million for the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013 primarily due to the impact of the change in the U.S. dollar/Canadian dollar exchange rate on Canadian dollar denominated expenses, a decrease in share-based compensation expense related to stock options granted during the second quarter of 2013, a decrease in the provision for variable compensation, lower cost of sales as a result of lower equipment sales, lower in-orbit insurance expenses and lower amortization of intangible assets. These increases to operating income were partially offset by increased depreciation on Telesat's Anik G1 satellite which entered commercial service in May 2013 and the revenue decrease described above. Telesat's operating income excluding foreign exchange impact would have increased by $14 million for the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013. On March 28, 2013, Telesat announced the redemption of the outstanding 12.5% senior subordinated notes which took place on May 1, 2013. As a result, an expense of refinancing of $20 million was recorded for the nine months ended September 30, 2013, representing the unamortized deferred financing costs and the redemption premium associated with the 12.5% senior subordinated notes. 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 September 30, 2014 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 September 30, 2014, Telesat's U.S. dollar denominated debt totaled $2.6 billion. As of September 30, 2014, a five percent increase (decrease) in the Canadian dollar against the U.S. dollar would have increased (decreased) Telesat's net income by approximately $124 million. This analysis assumes all other variables, in particular interest rates, remain constant.The equity in losses of 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 performed an impairment test for our investment in XTAR as of September 30, 2014, using XTAR's most recent forecast, and concluded that our investment in XTAR was not impaired. In connection with the sale in 2008 by Loral and certain of its subsidiaries and DASA Globalstar LLC to Globalstar Inc. of their respective interests in Globalstar do Brasil S.A. ("GdB"), the Globalstar Brazilian service provider, Loral agreed to indemnify Globalstar Inc. and GdB for certain GdB pre-closing liabilities, primarily related to Brazilian taxes. As a result of an April 2013 adverse court decision in Brazil relating to a potential tax liability, an adverse outcome for which was previously believed to be remote, Loral recorded a loss contingency of $4.8 million in the first quarter of 2013. A payment of $3.7 million related to this loss contingency was made in the second quarter of 2013, and, in the third quarter of 2013, this loss was adjusted to $3.7 million, primarily due to a favorable court decision. During the nine months ended September 30, 2013, we recorded a gain of $1.1 million related to the sale of our ownership interests in an affiliate with no carrying value. Loss from Discontinued Operations, net of tax Nine Months Ended September 30, 2014 2013 (In thousands)Loss from discontinued operations, net of tax $ (6,448 ) $ (4,352 ) Adjustments to amounts previously reported in discontinued operations that are directly related to the Sale are classified as discontinued operations in the statements of operations for the nine months ended September 30, 2014 and 2013. We recorded a $10.3 million loss contingency less taxes thereon in third quarter of 2014 to increase our liability to the minimum liability under the Settlement Agreement and the mechanism for allocation of settlement payments between Loral and SS/L and to record related legal fees. Backlog Telesat's backlog as of September 30, 2014 and December 31, 2013 was $4.1 billion and $4.7 billion, respectively. 35 Liquidity and Capital Resources Loral As described above, 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 $33.7 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. Loral 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 September 30, 2014, Loral had $44.3 million of cash and cash equivalents, a note receivable from MDA for $33.7 million and no debt. The Company's cash and cash equivalents as of September 30, 2014 increased by $38.3 million from December 31, 2013 due primarily to a $67.3 million principal payment received from MDA under the Land Note related to the Sale, reimbursement by SS/L of its $5.4 million final share of litigation costs related to the ViaSat Suit and a $5.4 million tax indemnification recovery received from Telesat (see Note 15 to our financial statements), partially offset by a $20 million payment to ViaSat pursuant to the Settlement Agreement and Dispute Resolution Agreement, payment of litigation costs of $10.7 million relating to the ViaSat Suit, pension funding of $3.6 million and Corporate expenses net of consulting fees and revenue share from Telesat of $3.5 million. A discussion of cash changes by activity is set forth in the sections, "Net Cash Used In Operating Activities," "Net Cash Provided By Investing Activities" and "Net Cash Provided by (Usedin) Financing Activities." Loral did not have a credit facility as of September 30, 2014 and December 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 We believe that our cash and cash equivalents will be sufficient to fund projected expenditures for the next 12 months. We expect that our existing cash balance plus cash receipts including payments under the Land Note will be sufficient to fund any required payments under the Dispute Resolution Agreement as well as normal operating expenditures for the next 12 months. 36 We expect that our major cash outlays for the next 12 months will include possible additional payments under the Dispute Resolution Agreement, payments under employee benefit programs, including a possible contribution to our qualified pension plan to reduce the unfunded obligation, and general corporate expenses net of consulting fees and revenue share from Telesat. Offsetting these expenditures are the remaining Land Note receipt, possible receipts from SS/L if our indemnification liability for the ViaSat Suit is ultimately determined in the Dispute Resolution Agreement Proceedings to be less than amounts we have already paid and the receipt of income tax refunds. 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; and (2) certain litigation costs and litigation damages relating to the ViaSat Suit. The amounts of indemnification claims relating to pre-closing taxes have not yet been determined. Where appropriate, we intend vigorously to contest the underlying tax assessments, but there can be no assurance that we will be successful. Although no assurance can be provided, we do not believe that these tax-related matters will have a material adverse effect on our financial position or results of operations. On September 5, 2014, Loral, SS/L and ViaSat entered into the Settlement Agreement pursuant to which the patent infringement and breach of contract lawsuits brought by ViaSat in the United States District Court for the Southern District of California against Loral and SS/L in February 2012 and against SS/L in September 2013 were settled. Pursuant to the Settlement Agreement, on September 10, 2014, the court entered an order dismissing the lawsuits with prejudice. The terms of the Settlement Agreement provide, among other things, for (1) mutual releases of claims asserted in the lawsuits; (2) payment by Loral and SS/L to ViaSat on a joint and several basis of $100 million, $40 million of which was paid in connection with entry into of the Settlement Agreement, and $60 million of which will be paid quarterly from October 15, 2014 through January 15, 2017 with interest accruing from the effective date of the Settlement Agreement at rate of 11.4% per year; (3) agreement by ViaSat not to sue any of Loral, SS/L or their customers and suppliers on the Covered ViaSat Patents (as defined in the Settlement Agreement) or for breach of the contracts asserted in the lawsuits to the extent such breach relates to claims asserted in the lawsuits; and (4) agreement by Loral and SS/L not to sue ViaSat or its customers and suppliers on the Covered SSL Patents (as defined in the Settlement Agreement) or for breach of the contracts asserted in the lawsuits to the extent such breach relates to claims asserted in the lawsuits. MDA, the parent company of SS/L, agreed to guarantee SS/L's payment obligations under the Settlement Agreement. Also on September 5, 2014, Loral, on the one hand, and SS/L, MDA and MDA Holdings, on the other hand (collectively, the "MDA Parties") entered into a Release Agreement pursuant to which the MDA Parties released Loral, and Loral released the MDA Parties, from their respective indemnification claims relating to the ViaSat lawsuits under the Purchase Agreement pursuant to which Loralsold SS/L to MDA in 2012. Pursuant to a document titled "MDA/Loral Dispute Resolution," dated August 14, 2014 (the "Dispute Resolution Agreement"), Loral and MDA agreed that the payments to ViaSat will initially be advanced equally by Loral and SS/L but will be subject to a further allocation between the parties. The parties will then, by way of the Dispute Resolution Agreement Proceedings, allocate how much of the payment each party bears. In the Dispute Resolution Agreement Proceedings, the arbitrator will value ViaSat's covenant not to sue with respect to the Covered ViaSat Patents. An amount of the payment due to ViaSat under the Settlement Agreement equal to such value will be allocated to SS/L. The remaining payments under the Settlement Agreement will be allocated fifty percent (50%) to the first ViaSat lawsuit, with Loral being responsible for that portion of the payment, and the other fifty percent (50%) will be allocated to the second ViaSat lawsuit. Payment of the amount allocated to the second ViaSat lawsuit will be borne by SS/L, unless the arbitrator decides that Loral shall bear some portion of that allocation. The minimum payment to be borne by either party will be $15 million. The Dispute Resolution Agreement Proceedings are expected to occur in December 2014. Because of the pending Dispute Resolution Agreement Proceedings, we are unable to estimate the loss related to the ViaSat settlement. We did, however, as a result of the Settlement Agreement and the Dispute Resolution Agreement, increase in the third quarter of 2014 our indemnification liabilities related to the ViaSat Suit to $15.4 million using the probability threshold approach, representing approximately Loral's minimum liability under the Dispute Resolution Agreement. Loral's maximum liability under the Dispute Resolution Agreement is $85 million plus interest, and it is possible that, as a result of the Dispute Resolution Agreement Proceedings, we may incur liability up to that amount. Loral paid $20 million to ViaSat on September 9, 2014 which represents Loral's share of the initial $40 million payment to ViaSat required by theSettlement Agreement. 37 Telesat Cash and Available Credit As of September 30, 2014, Telesat had CAD 498 million of cash and short-term investments as well as approximately CAD 140 million of borrowing availability under its revolving credit facility. Cash Flows from Operating Activities Cash generated from Telesat's operating activities for the nine months ended September 30, 2014 was CAD 321 million, a CAD 59 million decrease from the same period in the prior year. The decrease was primarily due to higher income taxes paid, lower interest paid and the impact of changes in Telesat's working capital. Cash Flows used in Investing Activities Cash used in Telesat's investing activities for the nine months ended September 30, 2014 was CAD 65 million. Telesat's investing activities included cash outflows related to the on-going construction of Telstar 12 VANTAGE and other property and equipment.Cash used in Telesat's investing activities for the nine months ended September 30, 2013, was CAD 48 million. These investing activities included cash outflows related to the launch of Anik G1 in April 2013 and other property and equipment. Cash Flows used in Financing Activities Cash used in Telesat's financing activities for the nine months ended September 30, 2014 was CAD 57 million. This was primarily the result of mandatory principal payments made on its senior secured credit facilities, as well as satellite performance incentive payments.Cash used in Telesat's financing activities for the nine months ended September 30, 2013 was CAD 278 million. This was primarily the result of the redemption of Telesat's 12.5% senior subordinated notes and the associated premiums paid for early redemption, as well as mandatory principal payments made on its senior secured credit facilities and satellite performance incentive payments. 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 and short-term investments as of September 30, 2014, cash flow from operating activities and drawings on the available lines of credit under its senior secured credit facilities will be adequate to meet Telesat's expected cash requirements for at least the next 12 months for activities in the normal course of business, including capital requirements and required interest and principal payments on debt. 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 credit facility. In addition, Telesat may sell certain satellite assets, and in accordance with the terms and conditions of Telesat's senior secured credit facilities, reinvest the proceeds in replacement satellites or pay down indebtedness under Telesat's senior secured credit facilities. Subject to market conditions and subject to compliance with the terms and conditions of its senior secured 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 or new satellite construction programs. 38 Debt Telesat's debt as of September 30, 2014 and December 31, 2013 was as follows: September 30, December 31, Maturity Currency 2014 2013 (In CAD thousands) Senior Secured Credit Facilities: Revolving credit facility March 28, 2017 CAD or USD - - Term Loan A March 28, 2017 CAD 437,500 475,000 Term Loan B - U.S. facility March 28, 2019 USD 1,925,567 1,840,601Term Loan B - Canadian facility March 28, 2019 CAD 137,900 138,950 6.0% Senior notes May 15, 2017 USD 1,007,820 956,070 3,508,787 3,410,621 Less: Deferred financing costs, interest rate floors and prepayment options (59,237 ) (68,755 ) Total debt under international financial reporting standards 3,449,550 3,341,866 U.S. GAAP adjustments 63,515 74,311 Total debt under U.S. GAAP 3,513,065 3,416,177 Current portion 72,682 71,641 Long term portion 3,440,383 3,344,536 Senior Secured Credit Facilities The obligations under the credit agreement and the guarantees of those obligations are secured, subject to certain exceptions, by a first priority security interest in the assets of Telesat and certain of its subsidiaries ("Guarantors"). The credit agreement contains covenants that restrict the ability of Telesat and the Guarantors 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 also requires Telesat and the Guarantors to comply with a maximum senior secured leverage ratio and contains customary affirmative covenants and events of default. 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 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. 6.0% Senior Notes due May 15, 2017 The senior notes, in the amount of $900 million, bear interest at an annual rate of 6.0% and are due May 15, 2017. They include covenants or terms that restrict Telesat's ability to, among other things, incur additional indebtedness, (incur liens, pay dividends or make certain other restricted payments, investments or acquisitions, enter into certain transactions with affiliates, modify or cancel its satellite insurance, effect mergers with another entity, and redeem the senior notes without penalty between May 15, 2014 and May 15, 2016, in each case subject to exceptions provided in the senior notes indenture. As of September 30, 2014, Telesat was in compliance with the financial covenants of its senior secured credit facilities and the indenture governing its 6.0% senior notes. 39 Debt Service Cost An estimate of interest expense is based upon assumptions of foreign exchange rates, LIBOR and Bankers Acceptance rates and the applicable margins of Telesat's senior secured credit facilities and senior notes. Telesat's interest expense for the year ending December 31, 2014 is expected to be approximately CAD 191 million. Derivatives Telesat uses interest rate and currency derivatives to manage its exposure to changes in interest rates and foreign exchange rates. In order to manage its currency risk, Telesat had cross-currency basis swaps to synthetically convert $1.0 billion of future U.S. dollar denominated payment obligations to CAD 1.1 billion. These swaps matured on October 31, 2014. On September 22, 2014, Telesat entered into a forward foreign exchange contract to fix the exchange rate on the cross-currency basis swaps settled on October 31, 2014. At September 30, 2014, Telesat had one outstanding forward foreign exchange contract requiring payment of $1.0 billion U.S. dollars to receive $1.1 billion Canadian dollars. This forward foreign exchange contract matured on October 31, 2014. At September 30, 2014, 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 related to a prepayment option included in Telesat's 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 maturity dateof March 28, 2019. Capital Expenditures Telesat has entered into contracts for the construction and launch of the Telstar 12 VANTAGE satellite and other capital expenditures. The outstanding commitments relating to these capital expenditures were approximately CAD 152 million as of September 30, 2014. These expenditures may be funded from some or all of the following: cash and cash equivalents, cash flow from operating activities, cash flow from customer prepayments or through borrowings on available lines of credit under the revolving facility. Contractual Obligations On September 5, 2014, we entered into the Settlement Agreement related to the ViaSat Suit. Loral's portion of the payments due to ViaSat under the Settlement Agreement will be determined by way of the Dispute Resolution Agreement Proceedings which are expected to occur in December 2014. Other than obligations relating to settlement of the ViaSat Suit, 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 with the SEC. Statement of Cash Flows Net Cash Used in Operating Activities Net cash used in operations was $36.3 million for the nine months ended September 30, 2014. Net cash used in operating activities by continuing operations was $10.4 million for the nine months ended September 30, 2014, consisting primarily of a $10.1 million cash use attributable to income from continuing operations adjusted for non-cash operating items and a $3.5 million decrease in pension and other post retirement liabilities, partially offset by a $2.7 million reduction to income taxes receivable (net) and a $0.4 million increase in accrued expenses andother current liabilities. 40 Net cash used by operating activities from discontinued operations was $25.9 million for the nine months ended September 30, 2014 consisting primarily of an advance of $20 million to ViaSat pursuant to the Settlement Agreement and payment of $10.7 million of indemnified litigation costs related to the ViaSat Suit, partially offset by reimbursement by SS/L of its $5.4 million final share of litigation costs related to the ViaSat Suit. Net cash used in operations was $56 million for the nine months ended September 30, 2013. Net cash used in operating activities by continuing operations was $13 million for the nine months ended September 30, 2013, consisting primarily of an increase in income taxes receivable of $19 million and a $7 million decrease in accrued expenses and other current liabilities of which $4 million relates to payment of the GdB indemnification liability, partially offset by $14 million from income from continuing operations adjusted for non-cash operating items. Net cash used in operating activities by discontinued operations was $43 million for the nine months ended September 30, 2013, consisting primarily of income tax payments of $35 million relating to the gain on the Sale and payment of $7 million of indemnification liabilities related to the Sale. Net Cash Provided by Investing Activities Net cash provided by investing activities for the nine months ended September 30, 2014 was $72.8 million. Net cash provided by investing activities from continuing operations for the nine months ended September 30, 2014 was $5.4 million consisting primarily of a tax indemnification recovery received from Telesat. Net cash provided by investing activities from discontinued operations for the nine months ended September 30, 2014 was $67.3 million consisting primarily of the receipt of principal under the Land Note. Net cash provided by investing activities from continuing operations for the nine months ended September 30, 2013 was $1.1 million relating to the proceeds from the sale of our ownership interests in an affiliate. Net Cash Provided by (Used in) Financing Activities Net cash provided by financing activities for the nine months ended September 30, 2014 was $1.9 million relating to excess tax benefits associated with stock-based compensation. Net cash used in financing activities for the nine months ended September 30, 2013 was $8 million which includes funding of $9 million of withholding taxes relating to stock-based compensation, partially offset by $1 million of excess tax benefits associated with stock-based compensation. 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 5 to our condensed consolidated 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 14 to our condensed consolidated financial statements. 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. 41 |