**UNITEDSTATES SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON D.C. 20549**

 

**FORM 10-Q**

 

**QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15 (d) OF THESECURITIES EXCHANGE ACT OF 1934**

 

**FOR THE QUARTERLY PERIOD ENDED JUNE30, 2004**

 

**COMMISSION FILE NO. 0-22531**

 

**PANAMSATCORPORATION**

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

** **
| **DELAWARE**                                                    | ** ** | **95-4607698**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (STATE OR OTHER JURISDICTION OF INCORPORATION  OR ORGANIZATION) |       | (I.R.S. EMPLOYER IDENTIFICATION  NO.) |

 

**20 WESTPORT ROAD, WILTON, CT 06897**

(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)

 

REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE: **203-210-8000**

 

Indicate by checkmark whether the Registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the Registrant was required to filesuch reports) and (2) has been subject to such filing requirements for the past90 days.

 

Yes ýNo o

 

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act).

 

Yes ýNo o

 

As of July 26,2004, an aggregate of 150,299,954 shares of our common stock were outstanding.

 

 

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Unless the contextotherwise requires, in this Quarterly Report on Form 10-Q, the terms “we,” “our,”the “company” and “PanAmSat” refer to PanAmSat Corporation and itssubsidiaries.

 

CAUTIONARY STATEMENT FORPURPOSES OF THE “SAFE HARBOR” PROVISIONS OF THE PRIVATE SECURITIES LITIGATIONREFORM ACT OF 1995

 

This QuarterlyReport on Form 10-Q contains certain forward-looking statements. The PrivateSecurities Litigation Reform Act of 1995 provides a “safe harbor” for certainforward-looking statements so long as such information is identified asforward-looking and is accompanied by meaningful cautionary statementsidentifying important factors that could cause actual results to differmaterially from those projected in the information. When used in this QuarterlyReport on Form 10-Q, the words “estimate,” “project,” “plan,” “anticipate,”“expect,” “intend,” “outlook,” “believe” and other similar expressions areintended to identify forward-looking statements and information. Actual resultsmay differ materially from any results which might be projected, forecasted,estimated or budgeted due to certain risks and uncertainties, including withoutlimitation: (i) risks associated with operating our in-orbit satellites(ii) risks of launch failures, launch and construction delays and in-orbitfailures or reduced performance, (iii) risk that we may not be able to obtainnew or renewal satellite insurance policies on commercially reasonable terms orat all, (iv) risks related to possible future losses on satellites thatare not adequately covered by insurance, (v) risks related to domestic andinternational government regulation, (vi) risks related to the Company’scontracted backlog for future services, (vii) risks of doing businessinternationally, (viii) risks of inadequate access to capital for growth,(ix) risks related to competition, (x) risks related to customer defaults,(xi) risks relating to pricing pressure and overcapacity in markets in which weoperate, (xii) risks associated with the Company’s indebtedness,(xiii) risks related to control by our majority stockholder and(xiv) litigation.  PanAmSat cautionsthat the foregoing list of important factors is not exclusive, and PanAmSatundertakes no obligation to publicly update any forward-looking statement.   Such risks are more fully described underthe caption “Item 7. Management’s Discussion and Analysis of FinancialCondition and Results of Operations” in our Annual Report on Form 10-K for thefiscal year ended December 31, 2003. Reference is also made to such other risksand uncertainties detailed from time to time in our filings with the UnitedStates Securities and Exchange Commission.

 

WEBSITE ACCESS TO COMPANY’S REPORTS

 

PanAmSat’sInternet website address is WWW.PANAMSAT.COM. Our annual reports on Form 10-K,quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments tothose reports filed or furnished pursuant to section 13(a) or 15(d) of theExchange Act are available free of charge through our website as soon asreasonably practicable after they are electronically filed with, or furnishedto, the Securities and Exchange Commission.

 

2

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**PART I. FINANCIAL INFORMATION**

 

**ITEM1. FINANCIAL STATEMENTS.**

 

**PANAMSAT CORPORATION**

**CONSOLIDATED STATEMENTS OF INCOME(UNAUDITED)**

**FOR THE THREE MONTHS ENDED JUNE 30,2004 AND 2003**

**(IN THOUSANDS, EXCEPT SHARE DATA)**

 
| ** **                                                           | ** ** | **June 30,  2004** | ** ** | **June 30,  2003** | ** ** |
|----------------------------------------------------------------------|------------|--------------------|------------|--------------------|------------|
| REVENUES                                                             |       |               |       |               |       |
| Operating  leases, satellite services and other                      |       | $                  | 202,732    |               | $          | 199,400 |   |
| Outright sales  and sales-type leases                                |       | 4,093              |       | 4,193              |       |
| Total revenues                                                       |       | 206,825            |       | 203,593            |       |
|                                                                 |       |               |       |               |       |
| OPERATING COSTS  AND EXPENSES:                                       |       |               |       |               |       |
| Depreciation and  amortization                                       |       | 71,312             |       | 74,909             |       |
| Direct operating  costs (exclusive of depreciation and amortization) |       | 40,167             |       | 32,232             |       |
| Selling, general  and administrative expenses                        |       | 50,256             |       | 21,338             |       |
| Facilities  restructuring and severance costs                        |       | 573                |       | 663                |       |
| Total operating  costs and expenses                                  |       | 162,308            |       | 129,142            |       |
|                                                                 |       |               |       |               |       |
| INCOME FROM  OPERATIONS                                              |       | 44,517             |       | 74,451             |       |
| INTEREST EXPENSE  - NET                                              |       | 33,623             |       | 33,132             |       |
| INCOME BEFORE  INCOME TAXES                                          |       | 10,894             |       | 41,319             |       |
| INCOME TAX  EXPENSE                                                  |       | 228                |       | 11,021             |       |
| NET INCOME                                                           |       | $                  | 10,666     |               | $          | 30,298 |   |
| NET INCOME PER  COMMON SHARE - basic and diluted                     |       | $                  | 0.07       |               | $          | 0.20 |   |
| Weighted average  common shares outstanding                          |       | 150,256,000        |       | 150,054,000        |       |

 

The accompanying notes are an integral part of theseconsolidated financial statements.

 

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**PANAMSAT CORPORATION**

**CONSOLIDATED STATEMENTS OF INCOME(UNAUDITED)**

**FOR THE SIX MONTHS ENDED JUNE 30,2004 AND 2003**

**(IN THOUSANDS, EXCEPT SHARE DATA)**

 
| ** **                                                           | ** ** | **June 30,  2004** | ** ** | **June 30,  2003** | ** ** |
|----------------------------------------------------------------------|------------|--------------------|------------|--------------------|------------|
| REVENUES                                                             |       |               |       |               |       |
| Operating  leases, satellite services and other                      |       | $                  | 403,897    |               | $          | 394,820 |   |
| Outright sales  and sales-type leases                                |       | 8,358              |       | 8,529              |       |
| Total revenues                                                       |       | 412,255            |       | 403,349            |       |
|                                                                 |       |               |       |               |       |
| OPERATING COSTS  AND EXPENSES:                                       |       |               |       |               |       |
| Depreciation and  amortization                                       |       | 146,647            |       | 147,176            |       |
| Direct operating  costs (exclusive of depreciation and amortization) |       | 79,835             |       | 65,420             |       |
| Selling, general  and administrative expenses                        |       | 67,805             |       | 39,364             |       |
| PAS-6 impairment  loss                                               |       | 99,946             |       | ––       |       |
| Facilities  restructuring and severance costs                        |       | 2,428              |       | 663                |       |
| Total operating  costs and expenses                                  |       | 396,661            |       | 252,623            |       |
|                                                                 |       |               |       |               |       |
| INCOME FROM  OPERATIONS                                              |       | 15,594             |       | 150,726            |       |
| INTEREST EXPENSE  - NET                                              |       | 64,709             |       | 67,407             |       |
| INCOME (LOSS)  BEFORE INCOME TAXES                                   |       | (49,115            | )          | 83,319             |       |
| INCOME TAX  EXPENSE (BENEFIT)                                        |       | (27,852            | )          | 22,163             |       |
| NET INCOME  (LOSS)                                                   |       | $                  | (21,263    | )                  | $          | 61,156 |   |
| NET INCOME  (LOSS) PER COMMON SHARE - basic and diluted              |       | $                  | (0.14      | )                  | $          | 0.41 |   |
| Weighted average  common shares outstanding                          |       | 150,215,000        |       | 150,027,000        |       |

 

The accompanying notes are an integral part of theseconsolidated financial statements.

 

4

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**PANAMSAT CORPORATION**

**CONSOLIDATED BALANCE SHEETS**

**(IN THOUSANDS, EXCEPT SHARE DATA)**

 
| ** **                                                                                                                                                           | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|------------------------|------------|
| ** **                                                                                                                                                           | ** ** | **(UNAUDITED)**    | ** ** | ** **             | ** ** |
| ASSETS                                                                                                                                                               |       |               |       |                   |       |
| CURRENT ASSETS:                                                                                                                                                      |       |               |       |                   |       |
| Cash and cash  equivalents                                                                                                                                           |       | $                  | 627,751    |                   | $          | 511,248 |   |
| Short-term  investments                                                                                                                                              |       | 9,957              |       | 38,936                 |       |
| Accounts  receivable-net                                                                                                                                             |       | 72,206             |       | 77,006                 |       |
| Net investment  in sales-type leases                                                                                                                                 |       | 24,332             |       | 23,068                 |       |
| Prepaid expenses  and other current assets                                                                                                                           |       | 29,911             |       | 20,428                 |       |
| Insurance claim  receivable                                                                                                                                          |       | —             |       | 260,000                |       |
| Deferred income  taxes                                                                                                                                               |       | 6,933              |       | 7,688                  |       |
| Assets held for  sale                                                                                                                                                |       | 3,257              |       | ––           |       |
| Total current  assets                                                                                                                                                |       | 774,347            |       | 938,374                |       |
|                                                                                                                                                                 |       |               |       |                   |       |
| SATELLITES AND  OTHER PROPERTY AND EQUIPMENT-Net                                                                                                                     |       | 2,092,797          |       | 2,306,705              |       |
| NET INVESTMENT  IN SALES-TYPE LEASES                                                                                                                                 |       | 100,572            |       | 116,653                |       |
| GOODWILL                                                                                                                                                             |       | 2,244,553          |       | 2,243,611              |       |
| DEFERRED CHARGES  AND OTHER ASSETS-Net                                                                                                                               |       | 137,887            |       | 129,534                |       |
|                                                                                                                                                                 |       |               |       |                   |       |
| TOTAL ASSETS                                                                                                                                                         |       | $                  | 5,350,156  |                   | $          | 5,734,877 |   |
|                                                                                                                                                                 |       |               |       |                   |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                                           |       |               |       |                   |       |
| CURRENT  LIABILITIES:                                                                                                                                                |       |               |       |                   |       |
| Accounts payable  and accrued liabilities                                                                                                                            |       | $                  | 63,607     |                   | $          | 71,794 |   |
| Current portion  of long-term debt                                                                                                                                   |       | 275,000            |       | 3,500                  |       |
| Current portion  of satellite incentive obligations                                                                                                                  |       | 13,413             |       | 12,654                 |       |
| Accrued interest  payable                                                                                                                                            |       | 45,344             |       | 45,462                 |       |
| Deferred gains  and revenues                                                                                                                                         |       | 26,788             |       | 22,436                 |       |
| Total current  liabilities                                                                                                                                           |       | 424,152            |       | 155,846                |       |
|                                                                                                                                                                 |       |               |       |                   |       |
| LONG-TERM DEBT                                                                                                                                                       |       | 1,075,000          |       | 1,696,500              |       |
| DEFERRED INCOME  TAXES                                                                                                                                               |       | 399,755            |       | 430,512                |       |
| DEFERRED CREDITS  AND OTHER (principally customer deposits, satellite incentive obligations and  deferred revenue)                                                   |       | 287,648            |       | 273,261                |       |
|                                                                                                                                                                 |       |               |       |                   |       |
| TOTAL  LIABILITIES                                                                                                                                                   |       | 2,186,555          |       | 2,556,119              |       |
|                                                                                                                                                                 |       |               |       |                   |       |
| COMMITMENTS AND  CONTINGENCIES                                                                                                                                       |       |               |       |                   |       |
|                                                                                                                                                                 |       |               |       |                   |       |
| STOCKHOLDERS’  EQUITY:                                                                                                                                          |       |               |       |                   |       |
| Common stock,  $0.01 par value - 400,000,000 shares authorized; 150,292,411 and 150,120,864  shares outstanding at June 30, 2004 and December 31, 2003, respectively |       | 1,503              |       | 1,501                  |       |
| Additional  paid-in-capital                                                                                                                                          |       | 2,545,006          |       | 2,541,333              |       |
| Accumulated  other comprehensive loss                                                                                                                                |       | (396               | )          | (1,567                 | )          |
| Retained  earnings                                                                                                                                                   |       | 624,362            |       | 645,625                |       |
| Other  stockholders’ equity                                                                                                                                     |       | (6,874             | )          | (8,134                 | )          |
|                                                                                                                                                                 |       |               |       |                   |       |
| TOTAL  STOCKHOLDERS’ EQUITY                                                                                                                                     |       | 3,163,601          |       | 3,178,758              |       |
|                                                                                                                                                                 |       |               |       |                   |       |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                     |       | $                  | 5,350,156  |                   | $          | 5,734,877 |   |

 

The accompanying notes are an integral part of theseconsolidated financial statements.

 

5

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**PANAMSAT CORPORATION**

**CONSOLIDATED STATEMENT OF CHANGES INSTOCKHOLDERS’ EQUITY**

**AND COMPREHENSIVE INCOME (LOSS)(UNAUDITED)**

**FOR THE SIX MONTHS ENDED JUNE 30,2004**

**(IN THOUSANDS, EXCEPT SHARE DATA)**

 
| ** **                                                        | ** ** | **Common  Stock**      | ** **  | **Additional  Paid-in  Capital** | ** ** | **Accumulated  Other  Comprehensive  Loss** | ** ** | **Retained  Earnings** | ** ** | **Other****Stockholders’****Equity** | ** ** | **Total**    | ** ** | **Comprehensive****Income  (Loss)** | ** ** |
|-------------------------------------------------------------------|------------|------------------------|-------------|----------------------------------|------------|---------------------------------------------|------------|------------------------|------------|-------------------------------------------|------------|--------------|------------|-------------------------------------|------------|
| **Shares**                                                        | ** ** | **Par  Value  Amount** |
| BALANCE,  JANUARY 1, 2004                                    |       | 150,120,864            |        | $                                | 1,501      |                                        | $          | 2,541,333              |       | $                                         | (1,567     | )            | $          | 645,625                             |       | $ | (8,134 | ) | $ | 3,178,758 |   |   |   |
| Additional  issuance  of common  stock                       |       | 171,547                |        | 2                                |       | 3,586                                       |       | —                 |       | —                                    |       | —       |       | 3,588                               |       |   |   |
| Realized and  unrealized  net gain on  cash  flow hedge |       | —                 |        | —                           |       | —                                      |       | 1,341                  |       | —                                    |       | —       |       | 1,341                               |       | $ | 791 |   |
| Unrealized gain  on  short-term  investments                 |       | —                 |        | —                           |       | —                                      |       | (27                    | )          | —                                    |       | —       |       | (27                                 | )          | (27 | ) |
| Foreign currency  translation adjustment                     |       | —                 |        | —                           |       | —                                      |       | (143                   | )          | —                                    |       | —       |       | (143                                | )          | (143 | ) |
| Deferred  compensation                                            |       | —                 |        | —                           |       | —                                      |       | —                 |       | —                                    |       | (197         | )          | (197                                | )          | — |   |
| Amortization of  deferred  compensation                      |       | —                 |        | —                           |       | 87                                          |       | —                 |       | —                                    |       | 1,457        |       | 1,544                               |       | — |   |
| Net loss                                                          |       | ––           |        | ––                     |       | ––                                |       | —                 |       | (21,263                                   | )          | –– |       | (21,263                             | )          | (21,263 | ) |
| BALANCE,  JUNE 30, 2004                                      |       | $                      | 150,292,411 |                             | $          | 1,503                                       |       | $                      | 2,545,006  |                                      | $          | (396         | )          | $                                   | 624,362    |   | $ | (6,874 | ) | $ | 3,163,601 |   | $ | (20,642 | ) |
|                                                                   |            |                        |             |                                  |            |                                             |            |                        |            |                                           |            |              |            |                                     |            |  |  |  |  |  |  |  |  |  |  |

 

**OtherStockholders’ Equity:**

 
| ** **                                                                  | ** ** | **June 30,  2004** | ** ** | **January  1,  2004** | ** ** |
|-----------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| Excess of  purchase price over historical cost basis of net assets acquired |       | $                  | (3,418     | )                     | $          | (3,418 | ) |
| Deferred  compensation, net                                                 |       | (3,456             | )          | (4,716                | )          |
| TOTAL OTHER  STOCKHOLDERS’ EQUITY                                      |       | $                  | (6,874     | )                     | $          | (8,134 | ) |

 

The accompanying notes are an integral part of theseconsolidated financial statements.

 

6

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**PANAMSAT CORPORATION**

**CONSOLIDATED STATEMENTS OF CASH FLOWS(UNAUDITED)**

**FOR THE SIX MONTHS ENDED JUNE 30,2004 AND 2003**

**(IN THOUSANDS)**

 
| ** **                                                                                | ** ** | **June 30,  2004** | ** ** | **June 30,  2003** | ** ** |
|-------------------------------------------------------------------------------------------|------------|--------------------|------------|--------------------|------------|
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                                    |       |               |       |               |       |
| Net income  (loss)                                                                        |       | $                  | (21,263    | )                  | $          | 61,156 |   |
| Adjustments to  reconcile net income (loss) to net cash provided by operating activities: |       |               |       |               |       |
| Depreciation and  amortization                                                            |       | 146,647            |       | 147,176            |       |
| Deferred income  taxes                                                                    |       | (30,528            | )          | 21,286             |       |
| Amortization of  debt issuance costs and other deferred charges                           |       | 3,962              |       | 4,971              |       |
| Provision for  uncollectible receivables                                                  |       | 30,456             |       | 2,112              |       |
| Loss on early  extinguishment of debt                                                     |       | 5,455              |       | —             |       |
| PAS-6 impairment  loss                                                                    |       | 99,946             |       | —             |       |
| Facilities  restructuring and severance costs                                             |       | 2,021              |       | 663                |       |
| Other non-cash  items                                                                     |       | (3,208             | )          | (1,400             | )          |
| Changes in  assets and liabilities:                                                       |       |               |       |               |       |
| Collections on  investments in sales-type leases                                          |       | 12,427             |       | 11,136             |       |
| Operating leases  and other receivables                                                   |       | (1,183             | )          | (2,565             | )          |
| Prepaid expenses  and other assets                                                        |       | (4,517             | )          | 16,971             |       |
| Accounts payable  and accrued liabilities                                                 |       | (22,308            | )          | (33,813            | )          |
| Deferred gains  and revenues                                                              |       | 4,352              |       | 1,473              |       |
|                                                                                      |       |               |       |               |       |
| NET CASH  PROVIDED BY OPERATING ACTIVITIES                                                |       | 222,259            |       | 229,166            |       |
|                                                                                      |       |               |       |               |       |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                                    |       |               |       |               |       |
| Capital  expenditures (including capitalized interest)                                    |       | (83,886            | )          | (54,744            | )          |
| Insurance  proceeds from satellite recoveries                                             |       | 286,915            |       | —             |       |
| Net sales of  short-term investments                                                      |       | 28,948             |       | 43,704             |       |
| Acquisitions,  net of cash acquired                                                       |       | (522               | )          | (8,352             | )          |
|                                                                                      |       |               |       |               |       |
| NET CASH  PROVIDED BY (USED IN) INVESTING ACTIVITIES                                      |       | 231,455            |       | (19,392            | )          |
|                                                                                      |       |               |       |               |       |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                                    |       |               |       |               |       |
| Repayments of  debt                                                                       |       | (350,000           | )          | (200,000           | )          |
| New incentive  obligations                                                                |       | 16,250             |       | 5,642              |       |
| Repayments of  incentive obligations                                                      |       | (6,818             | )          | (5,734             | )          |
| Stock issued in  connection with employee benefit plans                                   |       | 3,493              |       | 1,437              |       |
|                                                                                      |       |               |       |               |       |
| NET CASH USED IN  FINANCING ACTIVITIES                                                    |       | (337,075           | )          | (198,655           | )          |
|                                                                                      |       |               |       |               |       |
| EFFECT OF  EXCHANGE RATE CHANGES ON CASH                                                  |       | (136               | )          | 203                |       |
|                                                                                      |       |               |       |               |       |
| NET INCREASE IN  CASH AND CASH EQUIVALENTS                                                |       | 116,503            |       | 11,322             |       |
| CASH AND CASH  EQUIVALENTS, BEGINNING OF PERIOD                                           |       | 511,248            |       | 783,998            |       |
| CASH AND CASH  EQUIVALENTS, END OF PERIOD                                                 |       | $                  | 627,751    |               | $          | 795,320 |   |
|                                                                                      |       |               |       |               |       |
| SUPPLEMENTAL  DISCLOSURE OF CASH FLOW INFORMATION:                                        |       |               |       |               |       |
| Cash received  for interest                                                               |       | $                  | 4,752      |               | $          | 9,197 |   |
| Cash paid for  interest                                                                   |       | $                  | 64,882     |               | $          | 78,800 |   |
| Cash received  for taxes                                                                  |       | $                  | 109        |               | $          | 4,327 |   |
| Cash paid for  taxes                                                                      |       | $                  | 1,833      |               | $          | 1,101 |   |

 

The accompanying notes are an integral part of theseconsolidated financial statements.

 

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PANAMSAT CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

**(1)****         Basis of Presentation**

 

These unaudited consolidated financial statements havebeen prepared in accordance with generally accepted accounting principles forinterim financial information and with the instructions to Rule 10-01 ofRegulation S-X. Accordingly, they do not include all of the information andfootnotes required by accounting principles generally accepted in the UnitedStates of America for complete financial statements. In the opinion ofmanagement, all adjustments that are of a normal recurring nature necessary to present fairly the financialposition as of June 30, 2004, results of operations for the three and six monthperiods ended June 30, 2004 and 2003 and cash flows for the six months endedJune 30, 2004 and 2003 have been made. Certain prior period amounts have beenreclassified to conform to the current period’s presentation. Operating resultsfor the three and six months ended June 30, 2004 and 2003 are not necessarilyindicative of the operating results for the full year. For further information,refer to the consolidated financial statements and footnotes thereto includedin our Annual Report on Form 10-K for the year ended December 31, 2003 (the“Form 10-K”) filed with the Securities and Exchange Commission (“SEC”) on March15, 2004, all amendments thereto, and all of our other filings filed with theSEC from March 15, 2004 through the date of this report.

 

The DIRECTV Group, Inc. (“The DIRECTV Group,” formerlyknown as Hughes Electronics Corporation) owns 80.4% of our outstanding commonstock.  Fox Entertainment Group, Inc.(“Fox Entertainment”),a subsidiary of The News Corporation Limited (“News Corporation”), ownsapproximately 34% of The DIRECTV Group’s outstanding common stock.

 

**(2)****         PanAmSat Merger,Subsequent Sale and Related Transactions**

 

On April 20, 2004, we entered into a definitivetransaction agreement with The DIRECTV Group, PAS Merger Sub, Inc.(“Merger Sub”), a wholly-owned subsidiary of The DIRECTV Group, andConstellation, LLC (“Constellation”), an affiliate of Kohlberg KravisRoberts & Co. L.P. (“KKR”) for the merger of our company with PASMerger Sub (“Merger”) and subsequent sale to Constellation (the “PanAmSatSale”). On May 17, 2004, Constellation assigned the right to purchase aportion of the shares of our common stock beneficially held by The DIRECTVGroup to limited liability companies affiliated with The Carlyle Group(“Carlyle”) and Providence Equity Partners, Inc. (“Providence”)(collectively the “Sponsors”).  Thesetransactions, the related financing transactions and the anticipated newcontractual arrangements with The DIRECTV Group or its affiliates describedbelow are referred to collectively as the “Transactions”.

 

Pursuant to the terms of the transaction agreement,Merger Sub will merge with and into us, with us being the surviving entity inthe Merger. As of the effective time of the Merger, holders of shares of ourcommon stock (other than The DIRECTV Group, members of management who haveagreed not to have certain of their equity interests cashed out in the Mergerand holders who perfect their appraisal rights under Delaware law) will have nofurther ownership interest in us. Instead, each holder of our common stockoutstanding immediately prior to the effective time of the Merger (other thanThe DIRECTV Group, members of management who have agreed not to have certain oftheir equity interests cashed out in the Merger and holders who perfect theirappraisal rights under Delaware law) will be entitled to receive $23.50 in cashper share of our common stock.

 

Subject to the satisfaction of certain closingconditions set forth in the transaction agreement, two business days after theeffective time of the Merger, a portion of the shares of our common stockbeneficially owned by The DIRECTV Group will be repurchased by us at a purchaseprice of $23.50 in cash per share. Following the repurchase, The DIRECTV Groupwill sell all of the remaining shares of our common stock that it owns to theSponsors at a purchase price of $23.50 in cash per share, less any amountswithheld in accordance with the transaction agreement.

 

Immediately following the PanAmSat Sale, each stockoption issued and outstanding under our 1997 Long-Term Incentive Plan, whetheror not then vested, will be canceled and converted into the right to receive apayment from us (subject to any applicable withholding taxes) equal to theproduct of (a) the total number of shares of our common stock subject tosuch stock option and (b) the excess of $23.50 over the option exerciseprice for such stock option, payable in cash. Immediately before the effectivetime of the Merger, all restrictions on restricted shares and restricted stockunits granted under our 1997 Long-Term Incentive Plan will lapse, and theunvested restricted shares and restricted stock units will vest and will becanceled and the holders of those securities will be entitled to receive $23.50per share, less applicable withholding taxes. Certain members of our management

 

8

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have agreed not to have certain of their equityinterests cashed out in the Merger and PanAmSat Sale; existing options,restricted shares and restricted stock units granted to such individuals areexpected to remain outstanding as options and shares of the survivingcorporation.

 

The Transactions are expected to be accounted for as aleveraged recapitalization, whereby the historical basis of the assets andliabilities of PanAmSat will be maintained.

 

The transaction agreement contains various covenantsregarding the conduct of our business prior to the closing of the Transactions.In addition, the Transactions are subject to a number of conditions, includingreceipt of certain regulatory approvals and the consummation of the debtfinancings described in the following paragraphs, or other satisfactoryfinancing.

 

In connection with the PanAmSat Sale, we intend toenter into new senior secured credit facilities, consisting of a$800.0 million Term Loan A Facility, a $1,860.0 million Term Loan BFacility and a $250.0 million revolving credit facility, and incur$1,010.0 million aggregate principal amount of senior unsecured indebtedness.

 

We have commenced tender offers to purchase any andall of the outstanding $800.0 million aggregate principal amount of our8 1/2% Senior Notes due 2012 and any and all of the outstanding$275.0 million aggregate principal amount of our 6 1/8% Senior Notes due2005 for cash. The tender offers are conditioned upon, among other things, theincurrence of the $1,010.0 million aggregate principal amount of seniorunsecured indebtedness.

 

Concurrently with the execution of the transactionagreement, we entered into a tax separation agreement with The DIRECTV Groupthat will supersede four earlier tax-related agreements among ourselves, The DIRECTVGroup and certain of its affiliates. We and The DIRECTV Group have agreed tohandle tax matters with respect to the tax periods covered by the taxseparation agreement, including tax return preparation, audits, appeals andlitigation, in a manner consistent with the past practice of The DIRECTV Groupand ourselves before the acquisition. In addition, we and The DIRECTV Grouphave agreed to cooperate in any tax audits, litigation or appeals that involve,directly or indirectly, periods ending on or prior to the day of the closing ofthe PanAmSat Sale.

 

Pursuant to the tax separation agreement, The DIRECTVGroup has agreed to indemnify us for all federal and consolidated state andlocal income taxes a taxing authority may attempt to collect from us regardingany liability for the federal or consolidated state or local income taxes ofGeneral Motors Corporation (“GM”) and The DIRECTV Group, except those incometaxes we are required to pay under the tax separation agreement. In addition,The DIRECTV Group has agreed to indemnify us for any taxes (other than thosetaxes described in the preceding sentence) related to any periods or portionsof such periods ending on or prior to the day of the closing of the PanAmSatSale in amounts equal to 80% of the first $75 million of such other taxesand 100% of any other taxes in excess of the first $75 million. Inaddition, our tax liability related to these periods is capped at$15 million.

 

The tax separation agreement will be effective fromthe day of the closing of the Transactions until the expiration of the statuteof limitations with respect to all taxes to which the tax separation agreementrelates.

 

In connection with the transaction agreement, TheDIRECTV Group has agreed to, or to cause its affiliates to, enter into, amendor in some cases extend certain commercial arrangements with us.  These commercial arrangements include theextension of transponder lease agreements with Hughes Network Systems, Inc.(“HNS”), the extension of The DIRECTV Group guarantees of our transponder leaseagreements with DIRECTV Latin America LLC (“DTVLA”), entering into an agreementfor additional transponder capacity for direct-to-home (“DTH”) services inLatin America, and the extension of telemetry, tracking and control (“TT&C”)services agreements with DIRECTV Operations LLC.  In addition, in connection with theTransactions (as defined below), we expect The DIRECTV Group or NewsCorporation to pay us for certain past due receivables from, and guaranteecertain future obligations of, our customer Sky Multi-Country Partners, anaffiliate of News Corporation. Management believes that these anticipated guarantees and othercontractual arrangements will, when executed, substantially reduce credit risksassociated with the two Latin American DTH platforms in our contracted backlogand protect us against the possible impact of future consolidation of thoseplatforms.

 

Certain of the new contractual arrangements we expectto enter into in connection with the Transactions would have increased ourcontracted backlog as of June 30, 2004 by approximately $659 million.  Of this incremental contracted backlog,approximately $450 million related to a contractual arrangement that is notrequired to be in place at the time of the completion of the Transactions or atall.  However, in the event thisagreement is not entered into, the amount payable to The DIRECTV Group underthe transaction agreement would be reduced by $250 million, we would not borrowan equal amount under our new Term

 

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Loan A Facility, we would not be required to make anyof the related capital expenditures and the related backlog would notmaterialize.  If this agreement isentered into by March 31, 2005, we would pay $250 million to The DIRECTV Group,funded by borrowings under our new Term Loan A Facility.  If this agreement is not executed, inaddition to reducing our indebtedness by $250 million, we would not be requiredto make any of the related capital expenditures.

 

Certain of our executives have change-in-controlseverance agreements, which provide for, among other things, the payment ofseverance and other benefits upon the termination of the executive withoutcause or for good reason within three years after a change in control ofPanAmSat, as defined in their respective agreements. In addition, our SeverancePay Plan allows for the payment of enhanced severance to employees laid off orwho resign for good reason (as defined in such plan) as a result of, and withintwo years after, a change-in-control (See Note 11 “Commitments andContingencies”).

 

**(3)****         Customer Termination**

 

In July of 2004, we terminated our transponder leaseagreements with one of our customers due to non-payment of the customer’sobligations to us through June 30, 2004. As a result, in the secondquarter of 2004 we recorded a pre-tax charge of approximately$29.6 million related to the write-off of current and long-term receivablebalances due from this customer. Prior to the termination, contracted futurebacklog and remaining 2004 revenues related to this customer were$80.4 million and $5.0 million, respectively.

 

**(4)****         PAS-6 Impairment Loss**

 

On March 17, 2004, ourPAS-6 satellite, an FS 1300 model satellite built by Space Systems/Loral,suffered an anomaly resulting in a loss of power.  Following that event, we moved the satelliteto a storage orbit while we evaluated the problem with the manufacturer.  On April 1, 2004, this satellite experiencedanother anomaly and more significant loss of power.  Neither of these losses was anticipated.  We maintained communications with, andcontrol of, this satellite and, as a result of the second anomaly, took thenecessary steps to de-orbit it.

 

PAS-6 had previously beentaken out of primary service and was used as a backup for another satellite,PAS-6B.  Accordingly, these events didnot affect service to any of our customers and we anticipate that they will notaffect our revenues in 2004.  We do notplan to replace this satellite.** **As a result of the March 17 event,we recorded a non-cash impairment charge within income from operations ofapproximately $99.9 million in the first quarter of 2004.  This resulted in a non-cash charge to netincome after taxes of approximately $63.3 million.  PAS-6 was uninsured and we will not collectinsurance proceeds as a result of these events.

 

**(5)****         Satellite DeploymentPlans**

 

In January 2004, we and Horizons LLC (“Horizons”)commenced service on the Galaxy 13/Horizons 1 satellite.  The satellite is a Boeing 601HP with 24C-band and 24 Ku-band transponders and is operated at 127 degrees westlongitude.  Horizons, a 50-50 jointventure between us and JSAT International Inc. (“JSAT”), the U.S. subsidiary ofa Japanese satellite services provider, owns the Ku-band payload on the satellite,which is separately designated Horizons 1. Using this capacity, Horizons offers a variety of digital video, Internet anddata services.  Effective upon thein-service date of Galaxy 13/Horizons 1, JSAT and us contributed ourinvestments in the Ku-band transponders to Horizons.  Our investment in Horizons of $43.7 millionas of June 30, 2004 is classified within “Deferred Charges and OtherAssets-Net” on our Consolidated Balance Sheet as of such date and is being accountedfor under the equity method.

 

The C-band capacity on this satellite is designated asGalaxy 13.  It is owned, developed andmarketed solely by us and is utilized to provide High-Definition Television(“HDTV”), as well as other services within the United States.  This satellite is a part of our “Power ofFive” antenna program, which provides qualified cable operators with simultaneous access to five Galaxyneighborhood satellites.  The spacecrafttook over for Galaxy 9, which is now utilized as a domestic C-band in-orbitspare.

 

We expect to launch three satellites by the end of2006. We are scheduled to launch Galaxy 14 in the fourth quarter of 2004 toreplace Galaxy 12 as an in-orbit spare at 74 degrees west longitude. We plan toreplace Galaxy 5 at 125 degrees west longitude with Galaxy 12. We plan tolaunch Galaxy 15 in the first quarter of 2005 to replace Galaxy 1R at 133degrees west longitude.

 

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This satellite will include an additional L-band payload.  We plan to launch Galaxy 16 in the secondquarter of 2006 to replace Galaxy 4R at 99 degrees west longitude.  In addition, we plan to construct and launcha replacement satellite for PAS-6B prior to the end of its useful life,although no commitment has been made for the procurement of this satellite atthis time.

 

In April 2004, we committed to acquire a new satellitefrom Space Systems/Loral, which would replace our Galaxy 4R satellite and wouldbe known as Galaxy 16. In June 2004, we paid The DIRECTV Group $28.5 million toreimburse them in full for amounts previously paid on our behalf to themanufacturer of this satellite.  Also inJune 2004, we committed to purchase Galaxy 17, an on-ground spare for Galaxy11, which will also serve as a spare to protect against launch failure of Galaxy16. The aggregate commitment related to these construction agreements isapproximately $200 million and will be paid over the next two years (See Note11 “Commitments and Contingencies” below).

 

**(6)****         Long-term Debt**

 

At June 30, 2004, we had total debt outstanding ofapproximately $1.35 billion, including current maturities of $275 millionrelated to our 6 1/8% Senior Notes due 2005.

 

In June 2004, we repaid the $349.1 millionoutstanding balance under our Term B-1 Facility from available cash on hand. Inconjunction with this repayment, we recorded a charge of $5.5 millionwithin interest expense as a result of the write-off of unamortized debtissuance costs related to the Term B-1 Facility and a charge of$0.5 million within interest expense representing the amount accumulatedwithin other comprehensive income related to our $100.0 million interestrate hedge on our Term B-1 Facility. The hedge liability was not impactedby the repayment of the Term B-1 Facility. The fair value of the outstanding interest-rate hedgeagreement as of June 30, 2004, based upon quoted market prices from thecounterparty, reflected a hedge liability of approximately $0.8 million.  Upon expiration of the current agreement onAugust 30, 2005, we will not be required to enter into an interest rate hedgeagreement under the Senior Secured Credit Facility.

 

Our Senior Secured Credit Facility is comprised of a$250.0 million revolving credit facility, which is currently undrawn and will terminate onDecember 31, 2007 (the “Revolving Facility”). We are also required to pay acommitment fee for the unused commitments under the Revolving Facility, which,as of June 30, 2004, on an annualized basis was 0.375%.  We had outstanding letters of credit totaling$1.1 million, which reduce ourability to borrow against the Revolving Facility by such amount.  Any amounts borrowed under the RevolvingFacility would bear interest at LIBOR plus 2.25% as of June 30, 2004, althoughthis interest rate is subject to adjustment based on our total leverage ratio.

 

As of June 30, 2004, we also had outstanding $800million 8 1⁄2% Senior Notes due 2012. Obligations under the 8 1⁄2% Senior Notes due 2012 are, or will be, as thecase may be, unconditionally guaranteed by each of our existing andsubsequently acquired or organized domestic and, to the extent no adverse taxconsequences would result therefrom, foreign restricted subsidiaries.  See condensed consolidating financial information in Note 16, asrequired by the SEC’s Regulation S-X, Rule 3-10(f).

 

We also had outstanding seven, ten and thirty-yearfixed rate notes totaling $550 million issued in January 1998. The outstandingprincipal balances, interest rates and maturity dates for these notes as of June 30, 2004 were $275million at 6 1/8% due January 2005, $150 million at 6 3/8% due 2008 and $125million at 6 7/8% due 2028, respectively. Principal on these notes is payable at maturity, while interest ispayable semi-annually.

 

In connection with the PanAmSat Sale, we intend toenter into new senior secured credit facilities, consisting of an $800.0million Term Loan A Facility, a $1,860.0 million Term Loan B Facility and a$250.0 million revolving credit facility, and to incur $1,010.0 millionaggregate principal amount of senior unsecured indebtedness.

 

We have commenced tender offers to purchase any andall of the outstanding $800.0 million aggregate principal amount of our 81⁄2%Senior Notes due 2012 and any and all of the outstanding $275.0 millionaggregate principal amount of our 6 1/8% Senior Notes due 2005 for cash. Thetender offers are conditioned upon, among other things, the incurrence of the$1,010.0 million aggregate principal amount of senior unsecured indebtedness.

 

We are required to maintain certain financialcovenants and arealso subject to restrictive covenants under our borrowings.  As of June 30, 2004, we were in compliancewith all such covenants.

 

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**(7)****         Acquisitions**

 

On March 7, 2003, we acquired substantially all of theassets of Hughes Global Services, Inc. (“HGS”) from our affiliate, The DIRECTVGroup, for approximately $8.4 million in cash and the assumption of certainliabilities.   On August 27, 2003, weacquired Esatel Communications, Inc. (“Esatel”) and its related entity, SilverSprings Teleport,LC.  In November 2003, we purchasedsubstantially all of the assets of Sonic Telecommunications International Ltd.(“Sonic”).  The aggregate purchase pricefor the Esatel and Sonic acquisitions was approximately $12.3 million, of which$0.5 million was paid in the first quarter of 2004.

 

The results of these acquisitions are included withinour consolidated income statements from the date of each respective acquisition.

 

**(8)****         Stock-Based Compensation**

 

Effective January 1, 2003, we adopted the fair valuerecognition provision of FASB Statement No. 123, “Accounting for Stock BasedCompensation,” prospectively, to all employee awards granted on or afterJanuary 1, 2003, pursuant to FASB Statement No. 148, “Accounting forStock-Based Compensation - Transition and Disclosure.”  During 2004 and 2003, we issued the followingawards under our Long-Term Incentive Plan:

 
| **Grant date:**     | ** ** | **Employee Stock  Options Granted** | ** ** | **Restricted Stock  Units Granted** | ** ** |
|---------------------|------------|-------------------------------------|------------|-------------------------------------|------------|
| March 31, 2003      |       | 11,900                              |       | —                              |       |
| June 30, 2003       |       | 11,550                              |       | 398,500                             |       |
| September 30,  2003 |       | 21,350                              |       | —                              |       |
| December 31,  2003  |       | 4,400                               |       | 2,000                               |       |
| March 31, 2004      |       | 48,350                              |       | 2,000                               |       |
| June 30, 2004       |       | —                              |       | —                              |       |

 

The employee stock options granted in 2004 and 2003vest ratably over three years. Compensation expense for these nonqualified stock options is based onthe fair value of the options at the respective grant dates utilizing theBlack-Scholes model for estimating fair value. We recorded compensation expenserelated to these options of approximately $63 thousand and $82 thousand for thethree and six months ended June 30, 2004, respectively and $5 thousand duringthe three and six month periods ended June 30, 2003, respectively.  Under the intrinsic value method used forreporting prior to January 1, 2003, no compensation expense had been recognizedon options granted through December 31, 2002, as the exercise price of theoptions granted equaled the market price of our common stock on the date ofgrant for allprior grants.

 

The restricted stock units granted in 2004 and 2003vest 50% on the second anniversary of the grant date and the remaining 50% onthe third anniversary.  Stockcompensation expense is being recognized over the vesting period based on our stockprice on the grant date.  We recordedcompensation expense related to the restricted stock units of approximately$0.7 million and $1.3 million for the three and six months ended June 30, 2004,respectively, and $0.5 million during the three and six month periods endedJune 30, 2003, respectively.

 

See Note 11 “Commitments and Contingencies –Change-in-Control Obligations” for the impact the Transactions will have onemployee stock options and restricted stock units.

 

The following table illustrates the effect on netincome and earnings per share as if the fair value based method had beenapplied to all outstanding and unvested awards in each period (in thousandsexcept per share amounts):

 

 
| ** **                                                                                                                                     | ** ** | **Three Months Ended:** | ** ** | **Six Months Ended:** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                     | ** ** | **June 30,  2004**      | ** ** | **June 30,  2003**    | ** ** | **June 30,  2004** | ** ** | **June 30,  2003** | ** ** |
| Net income  (loss), as reported                                                                                                                |       | $                       | 10,666     |                  | $          | 30,298 |   | $ | (21,263 | ) | $ | 61,156 |   |
| Add: Stock-based  employee compensation expense included in reported net income, net of related  tax effects                                   |       | 449                     |       | 300                   |       | 892 |   | 300 |   |
| Deduct: Total  stock-based employee compensation expense determined under fair value based  methods for all awards, net of related tax effects |       | (1,766                  | )          | (2,647                | )          | (3,301 | ) | (5,416 | ) |
| Pro forma net  income (loss)                                                                                                                   |       | $                       | 9,349      |                  | $          | 27,951 |   | $ | (23,672 | ) | $ | 56,040 |   |
| Earnings (loss)  per share:                                                                                                                    |       |                    |       |                  |       |   |   |   |   |
| Basic and  Diluted - as reported                                                                                                               |       | $                       | 0.07       |                  | $          | 0.20 |   | $ | (0.14 | ) | $ | 0.41 |   |
| Basic and  Diluted - pro forma                                                                                                                 |       | $                       | 0.06       |                  | $          | 0.19 |   | $ | (0.16 | ) | $ | 0.37 |   |

 

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The pro forma amounts for compensation cost may notnecessarily be indicativeof the effects on operating results for future periods.

 

**(9)****         Facilities Restructuringand Severance Costs**

 

Facilities restructuring and severance costs were $0.6million and $0.7 million for the three months ended June 30, 2004 and 2003,respectively, and $2.4 million and $0.7 million for the six month periods endedJune 30, 2004 and 2003, respectively.

 

In January 2003, our management approved a plan toconsolidate certain of our teleports in order to improve customer service andreduce operating costs. Under this plan, our Homestead, Florida teleport wasclosed in 2003 and in June 2004 we closed our Spring Creek, New York teleport.We expect to sell our Spring Creek Teleport later in 2004 (see below). Thisteleport consolidation planwill include the disposal of land, buildings and equipment located at theseteleports and severance related costs for approximately 40 employees that willbe required to perform services through the date of closure. During the yearended December 31, 2003 and for the six months ended June 30, 2004, we recordedcharges of $4.2 million and $1.0 million, respectively, related to thisteleport consolidation plan, primarily representing severance costs.

 

In the second quarter of 2004, we reached agreementwith one of our customers to move their teleport service from our Spring Creekteleport facility to one of our other teleport facilities. This agreementallowed us to close the Spring Creek teleport facility at the end of the secondquarter of 2004 and proceed with its planned sale. We plan on selling thisteleport facility and related assets for approximately $14.4 million, net ofassociated selling costs. As a result, we have reflected the assets of theSpring Creek Teleport of $3.3 million as “Assets Held for Sale” on our balancesheet as of June 30, 2004. The sale of this teleport is expected to close laterin 2004 and is expected to result in a pre-tax gain of approximately $11.2million, which will be recorded during that period. The Spring Creek Teleportis not significant to the consolidated operating results or financial positionof the Company.

 

On March 29, 2002, our management approved a plan torestructure several of our United States locations and close certainfacilities, some of which are currently being leased through 2011.  In an effort to further streamline ouroperations, in the six months ended June 30, 2004 we consolidated our ManhattanBeach, El Segundoand Long Beach, California facilities. As a result, we recorded a non-cash charge of $1.4 million reflectingfuture lease costs related to approximately 18,000 square feet of unusedfacilities in Manhattan Beach.

 

During the six months ended June 30, 2004 we made cashpayments of $0.4 million related to the 2003 reduction in workforce.

 

The following table summarizes the recorded accrualsand activityrelated to our teleport consolidation, facilities restructuring and severancecharges (in millions):

 
| ** **                            | ** ** | **Facilities  Restructuring** | ** ** | **Teleport  Consolidation** | ** ** | **Severance  Costs** | ** ** | **Total** | ** ** |
|---------------------------------------|------------|-------------------------------|------------|-----------------------------|------------|----------------------|------------|-----------|------------|
| Balance as of  January 1, 2003        |       | $                             | 7.6        |                        | $          | —               |       | $         | —     |   | $ | 7.6 |   |
| 2003  restructuring charges (credits) |       | (1.4                          | )          | 4.2                         |       | 1.4                  |       | 4.2       |       |
| Less: net cash  payments in 2003      |       | (1.6                          | )          | (2.4                        | )          | (0.7                 | )          | (4.7      | )          |
| Balance as of  December 31, 2003      |       | $                             | 4.6        |                        | $          | 1.8                  |       | $         | 0.7        |   | $ | 7.2 |   |
| 2004  restructuring charges           |       | 1.4                           |       | 1.0                         |       | —               |       | 2.4       |       |
| Less: net cash  payments in 2004      |       | (0.5                          | )          | (0.9                        | )          | (0.4                 | )          | (1.9      | )          |
| Balance as of  June 30, 2004          |       | $                             | 5.5        |                        | $          | 1.9                  |       | $         | 0.3        |   | $ | 7.7 |   |

 

**(10)****  Interest Expense – Net**

 

Interest expense for the three months ended June 30,2004 and 2003 isrecorded net of capitalized interest of $1.9 million and $3.6 million,respectively, and interest income of $3.2 million and $5.7 million,respectively. Interest expense for the six months ended June 30, 2004 and 2003is recorded net of capitalized interest of $2.2 million and $8.5 million,respectively, and interest income of $5.1 million and $9.0 million,respectively. Included in interest expense for the three and six months endedJune 30, 2004 is approximately $5.5 million of unamortized debt issuance costsrelated to the June 2004 prepayment under our Term B-1 Facility of $349.1million.

 

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**(11)****  Commitments and Contingencies**

 

***Satellite IncentiveObligations***

 

Satellite contractstypically require that we make progress payments during the period of thesatellite’s construction and orbital incentive payments (plus interest) overthe orbital life of the satellite. The incentive obligations may be subject toreduction or refund if the satellite fails to meet specific technical operatingstandards. As of June 30, 2004, we had $134.7 million of liabilities recordedin relation to these satellite incentive obligations.

 

***SatelliteCommitments***

 

As of June 30, 2004, we had approximately $163.8million of expenditures remaining under existing satellite constructioncontracts and $36.3 million remaining under existing satellite launchcontracts.  Satellite launch and in-orbitinsurance contracts related to future satellites to be launched are cancelable up to thirty days prior tothe satellite’s launch. As of June 30, 2004, we did not have any non-cancelablecommitments related to existing launch insurance or in-orbit insurancecontracts for satellites to be launched.

 

Through June 30, 2004, we had made approximately$154.8 million of capital expenditures in relation to Galaxy 14 and Galaxy 15.We also spent $65.8 million for launch costs originally intended forGalaxy 8-iR and $6.0 million for another future launch. As a result of thetermination of the Galaxy 8-iR construction contract, we now expect to use thislaunch in early 2006 to replace our Galaxy 4R satellite.

 

In April 2004, we committed to acquire a newsatellite from Space Systems/Loral, which would replace our Galaxy 4R satelliteand would be known as Galaxy 16. In June 2004, we paid The DIRECTV Group$28.5 million to reimburse them in full for amounts they previously paidon our behalf to the manufacturer of this satellite. Also in June 2004, weexecuted a definitive agreement for the procurement of Galaxy 17 an on-groundspare for Galaxy 11, which will also serve as a spare to protect against launchfailure of Galaxy 16. The aggregate commitment related to these constructionagreements is approximately $200 million, which will be paid over the nexttwo years.

 

***Satellite Insurance***

 

On February 19, 2003, we filed proofs of loss underthe insurance policies for two of our BSS 702 spacecraft, Galaxy 11 and PAS-1R,for constructive total losses based on degradation of the solar panels. OnDecember 29, 2003, we reached a settlement of these insurance claims forpayment of $260 million with no future revenue share.  We offsetthe proceeds from this settlement against the carrying value of the satellites.In the first quarter of 2004, we received the $260 million settlement amount.

 

On July 31, 2003, we filed a proof of loss under theinsurance policyfor our Galaxy 4R spacecraft after the secondary Xenon Ion Propulsion System(“XIPS”) on this satellite ceased working. In 2003, we settled with and received $102.6 million from insurersrepresenting approximately 83 percent of the insurance coverage on thesatellite.  In March 2004, we reached anagreement with and received $26.9 million from the insurer representing theremaining 17 percent of the insurance coverage on this satellite.  The settlement with the insurer representing17 percent coverage includes a future sharing of revenues actually receivedfrom the satellite.  We proportionatelyoffset the proceeds from these settlements against the insured carrying valueof the satellite and the net investment in sales-type lease.  We are planning on replacing this satellitewith Galaxy 16 prior to the end of its useful life using the insurance proceedsand a prepaid launch service contract that we had purchased previously.

 

During the first quarter of 2004 we received $286.9million of insurance proceeds under the insurance policies for Galaxy 11,PAS-1R and Galaxy 4R satellites.  Theseproceeds were held in a collateral account and were classified as restrictedcash pursuant to the terms of our existing senior secured credit facilitiesuntil restrictions were lifted in June 2004.

 

As of June 30, 2004, we had in effect launch andin-orbit insurance policies covering seven satellites in the aggregate amountof approximately $846.1 million.  As ofsuch date, these insured satellites had an aggregate net book value and otherinsurable costs of $927.2 million.  Wehave 17 uninsured satellites in orbit. The uninsured satellites are: PAS-4, which is used as a backupsatellite; PAS-5 and PAS-7, for which we received insurance proceeds for constructive total losses; Galaxy 1R,Galaxy 3R, Galaxy 5 and SBS-6, which are approaching the ends of their usefullives; Galaxy 11 and PAS-1R, for which we received insurance proceeds forpartial losses; PAS-2, PAS-3R, PAS-6B, PAS-8 and Galaxy 9, for which wedetermined that insurance was not available on commercially reasonable terms;and HGS-3, HGS-5 and Leasat, which have an aggregate book value of less

 

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than $1.0 million. Our Galaxy 12 and Galaxy 9 satellites currently serve as in-orbitbackups for the C-band portions of Galaxy 1R, Galaxy 4R, Galaxy 5, Galaxy 10R,Galaxy 11 and Galaxy 13/Horizons 1 (See Note 5 “Satellite Deployment Plans”above).

 

Of the insured satellites, as of June 30, 2004, threewere covered by policies with substantial exclusions or exceptions to coveragefor failures of specific components identified by the underwriters as at riskfor possible failure (“Significant Exclusion Policies”).  The exclusions reduce the probability of aninsurance recovery in the event of a loss on these satellites.  One of the satellites, PAS-9, has operationalredundancies available for the systems on which exclusions have been imposed.  We believe that this redundancy allows foruninterrupted operation of the satellite in the event of a failure of thecomponent subject to the insurance exclusion. The second such satellite, Galaxy 4R, for which we have receivedinsurance proceeds, has a remaining policy covering $20.0 million ofinvestments in sales-type leases that also has a policy exclusion for XIPSrelated anomalies. Galaxy 4R is currently operating on its backup bi-propellantpropulsion system.  The third satellite,Galaxy 13/Horizons 1, which was placed in service in January 2004 and isinsured by a policy with an exclusion for XIPS related anomalies, continues tohave fully redundant XIPS as its primary propulsion system.  Certain enhancements have been made to theXIPS on this satellite to make the systems more robust.  In addition, this satellite has availablebackup bi-propellant of approximately 11.9 years.

 

At June 30, 2004, the uninsured satellites and thesatellites insured by Significant Exclusion Policies had a total net book valueand other insurable costs of approximately $1.1 billion. Of this amount, $800.0million related to uninsured satellites and $281.7 million related tosatellites insured by Significant Exclusion Policies.

 

***Change-in-ControlObligations***

 

Upon consummation of the PanAmSat Sale, all outstandingemployee stock options which have not yet vested will vest and becomeexercisable, and all outstanding restricted shares and restricted stock unitswill vest immediately prior to the Merger. We currently estimate that upon the consummation of the PanAmSat Sale,we will be required to record a charge of approximately $6 million in relationto the acceleration of vesting of these options, restricted shares andrestricted stock units. Holders of options and restricted stock units will beentitled to receive (i) with respect to in-the-money options, cash equal to thedifference between the exercise price and the $23.50 per share price to be paidin the PanAmSat Sale, and (ii) with respect to restricted shares and restrictedstock units cash in the amount of $23.50 per share, except for any stockoptions, restricted shares and restricted stock units held by certain employeeswho have agreed not to have their equity interests cashed out in the Merger orthe PanAmSat Sale, as applicable.  Allout-of-the-money stock options will be cancelled without payment.  In addition, our Severance Pay Plan allowsfor the payment of enhanced severance to employees laid off or who resign forgood reason (as defined in such plan) as a result of, and within two yearsafter, a change-in-control.

 

One of our executives is party to an employmentagreement which provides for, among other things, the payment of severance andother benefits upon the termination of the executive without cause or for goodreason (as defined in such agreement) or if we decline to extend suchagreement.  Certain other seniorexecutives are party to change-in-control severance agreements, which provide for payment of severance andother benefits in the event of an involuntary termination of the executive’semployment (as defined in such agreements) within three years after a change incontrol of The DIRECTV Group.  As achange in control of The DIRECTV Group occurred on December 22, 2003, theseagreements will apply if an involuntary termination of the executive occurs onor before December 22, 2006.  Based uponcurrent compensation levels, if all of these executives receive the terminationrelated benefits as specified by their respective agreements, the aggregate costto us would be in the range of $9.0 million to $11.0 million.

 

Certain of our other executives have change-in-controlseverance agreements which provide for, among other things, the payment ofseverance and other benefits upon the termination of the executive withoutcause or for good reason within three years after a change in control ofPanAmSat, as defined in their respective agreements. The PanAmSat Sale would result in a change-in-controlunder these agreements.  Based uponcurrent compensation levels, if all of these executives receive the terminationrelated benefits as specified by their respective agreements, the aggregatecost to us would be approximately $5 million in addition to the costs describedabove with respect to our senior executives. These agreements expire if no change in control of PanAmSat has occurredby December 31, 2004.

 

In addition, our Severance Pay Plan allows for thepayment of enhanced severance to employees laid off or who resign for goodreason (as defined in such plan) as a result of, and within two years after, achange-in-control.

 

15

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***Foreign WithholdingTaxes***

 

We have outstanding tax claims related to withholdingtaxes assessed on revenues derived from broadcasters inside and outside ofIndia who broadcast from or into India. The Indian government has assessed approximately $7.3 million (reducedfrom an initial assessment of $15.2 million) against one of our subsidiariesfor the Indian tax year ended March 31, 1997. This assessment is being appealed to the Income Tax AppealsTribunal.  For Indian tax years endedMarch 31, 1996, 1998, 1999, 2000 and 2001, the Indian government has assessedapproximately $34.5 million in the aggregate against us.  This assessment has been appealed to theCommissioner of Income Tax (Appeals).  Weare contesting the imposition of such taxes. While this contest proceeds, we may be required to advance cash orprovide a bank guarantee for amounts up to the total assessment.  If unsuccessful in our contest, we could besubject to comparable claims for subsequent years. The DIRECTV Group has agreedto indemnify us for certain of our tax obligations, including foreignwithholding tax obligations (See Note 2 “PanAmSat Merger, Subsequent Sale andRelated Transactions” above).

 

**(12) RelatedParty Transactions**

 

***Transactions with The DIRECTV Groupand its Affiliates***

 

We provide satellite capacity, TT&C and otherrelated services and facilities to several subsidiaries of The DIRECTV Groupand purchase certain services and equipment from a subsidiary of The DIRECTV Group.Additionally, we reimburse The DIRECTV Group for the allocated costs of certainexpense items we jointly incur with The DIRECTV Group, principally relating toadministrative and other expenses. Revenues derived from The DIRECTV Group and its affiliates were $33.3million and $63.8 million for the three and six month periods ended June 30,2004, or 16% and 15% of our revenues, respectively.  As of June 30, 2004, we had receivables duefrom The DIRECTV Group and its affiliates of approximately $12.5 million.

 

During the fourth quarter of 2003, we agreed to amendour transponder lease agreements with DTVLA. This amendment became effective in February 2004 upon DTVLA’s emergence from theChapter 11 bankruptcy process.  Inconjunction with these amendments we agreed to accept reduced cash payments inthe early years, most of which we expect to recapture in later years, and TheDIRECTV Group has agreed to guarantee all of the transponder lease agreementswith DTVLA for a period of five years.

 

We expect to enter into new contractual arrangementswith affiliates of The DIRECTV Group in connection with the Transactions. Thesecontractual arrangements include the extension of transponder lease agreementswith HNS, the extension of The DIRECTV Group guarantees of our transponderlease agreements with DTVLA, entering into an agreement for additionaltransponder capacity for DTH services in Latin America, and the extension ofTT&C services agreements with DIRECTV Operations LLC. In addition, inconnection with the Transactions, we expect The DIRECTV Group or NewsCorporation to pay us for certain past due receivables from, and guaranteecertain future obligations of, our customer Sky Multi-Country Partners, anaffiliate of News Corporation (See Note 2 “PanAmSat Merger, Subsequent Sale andRelated Transactions” above).

 

During 2003, we transferred an authorization for aKa-band orbital slot to HNS, an affiliate, in exchange for a contingent paymentof approximately $2.1 million.  The payment is payable upon the launch of asatellite by HNS to such orbital slot. The Federal Communications Commission has approved the transfer of thisauthorization.

 

On April 20, 2004,we entered into a definitive transaction agreement with The DIRECTV Group, MergerSub, a wholly-owned subsidiary of The DIRECTV Group, and Constellation, anaffiliate of KKR for the Merger and the PanAmSat Sale. On May 17, 2004,Constellation assigned the right to purchase a portion of the shares of ourcommon stock beneficially held by The DIRECTV Group to limited liabilitycompanies affiliated with Carlyle and Providence (See Note 2 “PanAmSat Merger,Subsequent Sale and Related Transactions” above).

 

In June 2004, we paid The DIRECTV Group $28.5 millionto reimburse them in full for amounts they previously paid on our behalf to themanufacturer of the Galaxy 16 satellite (See Note 5 “Satellite DeploymentPlans” above).

 

Concurrently with theexecution of the transaction agreement, we entered into a tax separationagreement with The DIRECTV Group that will supersede four earlier tax-relatedagreements among ourselves, The DIRECTV Group and certain of its affiliates. Weand The DIRECTV Group have agreed to handle tax matters with respect to the taxperiods covered by the tax separation agreement, including tax returnpreparation, audits, appeals and litigation, in a manner consistent with thepast practice of The 

 

16

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DIRECTV Group andourselves before the acquisition. In addition, we and The DIRECTV Group haveagreed to cooperate in any tax audits, litigation or appeals that involve,directly or indirectly, periods ending on or prior to the day of the closing ofthe PanAmSat Sale.

 

Pursuant to the taxseparation agreement, The DIRECTV Group has agreed to indemnify us for allfederal and consolidated state and local income taxes a taxing authority mayattempt to collect from us regarding any liability for the federal orconsolidated state or local income taxes of GM and The DIRECTV Group, exceptthose income taxes we are required to pay under the tax separation agreement.In addition, The DIRECTV Group has agreed to indemnify us for any taxes (otherthan those taxes described in the preceding sentence) related to any periods orportions of such periods ending on or prior to the day of the closing of thePanAmSat Sale in amounts equal to 80% of the first $75 million of such othertaxes and 100% of any other taxes in excess of the first $75 million. Inaddition, our tax liability related to these periods is capped at $15 million.

 

The tax separationagreement will be effective from the day of the closing of the transactionsuntil the expiration of the statute of limitations with respect to all taxes towhich the tax separation agreement relates.

 

***Transactions withNews Corporation and its Affiliates (Other than The DIRECTV Group)***

 

We are a party to agreements with News Corporation andcertain of its subsidiaries and affiliates pursuant to which we providesatellite capacity, TT&C and other related services. Revenues derived fromthe News Corporation and its affiliates, other than The DIRECTV Group, were$21.6 million and $42.3 million for the three and six month periods ended June30, 2004, or 10% of our revenues for each of the periods, respectively.  As of June 30, 2004, we had receivables duefrom News Corporation and its affiliates of approximately $28.3 million.  This receivable balance is primarilycomprised of a long-term receivable related to an operating lease withescalating payment terms that is being recognized on a straight-line basis intorevenue over the lease term.

 

In January 2004, Fox Entertainment and we signed amulti-year, multi-satellite agreement, the terms of which provide that FoxEntertainment will consolidate its entire suite of U.S. cable and broadcast programming onto our globalfleet for 15 years and move a significant portion of its international trafficonto the fleet for the next decade.  FoxEntertainment will now be one of our largest media customers and one of our topfive global customers.

 

Included in our total backlog of $4.52 billion as ofJune 30, 2004 is $1.50 billion of backlog from The DIRECTV Group, NewsCorporation and their affiliates. Backlog represents future cash payments expected from customers underall long-term contractual agreements.

 

**(13)Other Assets-Net**

 

Our Other Assets-net are recorded within deferredcharges and other assets-net on our consolidated balance sheet. Otherassets-net consists of prepayments of installation at the facilities of thirdparties that provide TT&C services to us under long-term serviceagreements, as well as other miscellaneous deferred charges and other assets.The prepaid installation costs are necessary for third parties to provideservices to us over the term of the related services agreement. These prepaidcosts are amortized on a straight-line basis over the respective contractperiods. Included in other assets-net as of June 30, 2004 and December 31, 2003are $2.5 million and $3.2 million, respectively of customer lists. As ofJune 30, 2004 and December 31, 2003, customer lists are net of accumulatedamortization of $1.3 million and $0.6 million, respectively.

 

**(14)Evaluation of Long-Lived Assets**

 

We periodically evaluate potential impairment lossrelating to long-lived assets, including satellites, when a change incircumstances occurs, by assessing whether the unamortized carrying amount canbe recovered over the remaining life through undiscounted future expected cashflows generated by the underlying assets (excluding interest payments). If theundiscounted future cash flows were less than the carrying value of the assetor group of assets, an impairment charge would be recorded. We assess therecoverability of certain of our deferred charges and other assets by comparingthe remaining net book value of the deferred charges and other assets at eachperiod end with the expected future undiscounted cash flows to be generatedpursuant to the customer contract that gave rise to the deferred charges. Therecoverability analysis is performed for each individual deferred charge andthe undiscounted cash flows are the cash flows associated with the specificcustomer contract that gave rise to the deferred charges. The undiscounted cashflows, as determined within the specific contractual arrangement with thatcustomer, would be utilized to assess the recoverability of the deferredcharge. The impairment charge would be measured as the excess of the carryingvalue of the asset or group of assets over

 

17

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the present value of estimated expected future cashflows related to the asset or asset group using a discount rate commensuratewith the risks involved.

 

We also assess the recoverability of our long-livedassets pursuant to paragraph 10 of Financial Accounting Standards Board(“FASB”) Statement No. 144 (“SFAS No. 144”). The costs of specificsatellites are grouped together with other associated assets when assessingrecoverability. Periodically and when a change in circumstances occurs, thisgroup of assets is compared with the expected future undiscounted cash flows tobe generated by us from the related satellite. Any excess of the net book valuefor this group of assets over the expected future undiscounted cash flows of therelated satellite would result in an impairment charge that would be recordedwithin our statement of income in the period the determination is made. Theimpairment charge would be measured as the excess of the carrying value of theasset or group of assets over the present value of estimated expected futurecash flows related to the asset or asset group using a discount ratecommensurate with the risks involved.

 

In theevent a portion of a satellite was rendered inoperative and/or incapable ofperforming its intended function, we would apply the concepts of SFAS No.144, in the determination of whether an impairment loss had occurred. If animpairment loss was indicated, such amount would be recognized in the period ofoccurrence, net of any insurance proceeds to be received so long as suchamounts are determinable and receipt is probable. If no impairment loss wasindicated in accordance with SFAS No. 144 and we received insuranceproceeds, the proceeds would offset the carrying value of the satellite. In theevent that the insurance proceeds received exceeded the carrying value of thesatellite, the excess of the proceeds over the carrying value of the satellitewould be recognized in the income statement.

 

In the event a portion of a satellite was renderedinoperative and/or incapable of performing its intended function and thesatellite was not insured, we would apply the concepts of SFAS 144 in thedetermination of whether an impairment loss had occurred. In the event animpairment loss had occurred, such amount would be recognized in the period ofoccurrence.

 

**(15) Operating Segments**

 

Statement of Financial Accounting Standards No. 131,“Disclosures About Segments of an Enterprise and Related Information” (“SFASNo. 131”) establishes standards for reporting information about operatingsegments in annual financial statements of public business enterprises andrequires that those enterprises report selected information about operatingsegments in interim financial reports issued to shareholders.  Operating segments are components of an enterprise aboutwhich separate financial information is available and regularly evaluated bythe chief operating decision maker(s) of an enterprise.  We have organized our company into twooperating segments based upon the types of customers served, services providedand the economic characteristics of each segment.  Our operating segments are:

 

Fixed Satellite Services(“FSS”):  Through FSS, we leasetransponder capacity to customers for various applications, including broadcasting,news gathering, Internet access and transmission, private voice and datanetworks, business television, distance learning and DTH television and provideTT&C and network services to customers.

 

Government Services (“G2Satellite Solutions or “G2”):  ThroughG2, we provide global satellite and related telecommunications services to thefederal government, international government entities, and their contractors.

 

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Selected information for our operating segments is as follows (inthousands):

 
| ** **                                   | ** ** | **Three Months Ended:** | ** ** | **Six Months Ended:** | ** ** |
|----------------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                                   | ** ** | **June 30,  2004**      | ** ** | **June 30,  2003**    | ** ** | **June 30,  2004** | ** ** | **June 30,  2003** | ** ** |
| Revenues:                                    |       |                    |       |                  |       |   |   |   |   |
| FSS                                          |       | $                       | 188,782    |                  | $          | 193,582 |   | $ | 378,209 |   | $ | 389,254 |   |
| G2                                           |       | 22,605                  |       | 15,402                |       | 44,421 |   | 25,033 |   |
| Eliminations                                 |       | (4,562                  | )          | (5,391                | )          | (10,375 | ) | (10,938 | ) |
| Total Revenues                               |       | $                       | 206,825    |                  | $          | 203,593 |   | $ | 412,255 |   | $ | 403,349 |   |
|                                         |       |                    |       |                  |       |   |   |   |   |
| Depreciation and  Amortization Expense:      |       |                    |       |                  |       |   |   |   |   |
| FSS                                          |       | $                       | 70,970     |                  | $          | 74,867 |   | $ | 145,867 |   | $ | 147,124 |   |
| G2                                           |       | 342                     |       | 42                    |       | 780 |   | 52 |   |
| Eliminations                                 |       | —                  |       | —                |       | — |   | — |   |
| Total  Depreciation and Amortization Expense |       | $                       | 71,312     |                  | $          | 74,909 |   | $ | 146,647 |   | $ | 147,176 |   |
|                                         |       |                    |       |                  |       |   |   |   |   |
| Income from  Operations:                     |       |                    |       |                  |       |   |   |   |   |
| FSS                                          |       | $                       | 40,942     |                  | $          | 72,205 |   | $ | 10,269 |   | $ | 146,619 |   |
| G2                                           |       | 3,575                   |       | 2,246                 |       | 5,325 |   | 4,107 |   |
| Eliminations                                 |       | —                  |       | —                |       | — |   | — |   |
| Total Income  from Operations                |       | $                       | 44,517     |                  | $          | 74,451 |   | $ | 15,594 |   | $ | 150,726 |   |
|                                         |       |                    |       |                  |       |   |   |   |   |
| EBITDA (a):                                  |       |                    |       |                  |       |   |   |   |   |
| FSS                                          |       | $                       | 111,912    |                  | $          | 147,072 |   | $ | 156,136 |   | $ | 293,743 |   |
| G2                                           |       | 3,917                   |       | 2,288                 |       | 6,105 |   | 4,159 |   |
| Eliminations                                 |       | —                  |       | —                |       | — |   | — |   |
| Total EBITDA                                 |       | $                       | 115,829    |                  | $          | 149,360 |   | $ | 162,241 |   | $ | 297,902 |   |
|                                         |       |                    |       |                  |       |   |   |   |   |
| Capital  Expenditures:                       |       |                    |       |                  |       |   |   |   |   |
| FSS                                          |       | $                       | 62,202     |                  | $          | 21,663 |   | $ | 83,886 |   | $ | 54,744 |   |
| G2                                           |       | —                  |       | —                |       | — |   | — |   |
| Eliminations                                 |       | —                  |       | —                |       | — |   | — |   |
| Total Capital  Expenditures                  |       | $                       | 62,202     |                  | $          | 21,663 |   | $ | 83,886 |   | $ | 54,744 |   |

 
| ** **   | ** ** | ** ** | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** | ** ** | ** ** |
|--------------|------------|------------|------------|--------------------|------------|------------------------|------------|------------|------------|
| Assets:      |       |       |       |               |       |                   |       |       |       |
| FSS          |       |       |       | $                  | 5,332,383  |                   | $          | 5,716,365  |       |   |   |
| G2           |       |       |       | 39,873             |       | 39,859                 |       |       |       |
| Eliminations |       |       |       | (22,100            | )          | (21,347                | )          |       |       |
| Total Assets |       |       |       | $                  | 5,350,156  |                   | $          | 5,734,877  |       |   |   |

 

**NON-GAAP FINANCIAL RECONCILIATION SCHEDULE**

 

Thefollowing table sets forth a reconciliation of Income from operations to EBITDAfor our FSS Operating Segment and our G2 Operating Segment for the periodsindicated. Management encourages readers to use GAAP disclosures within thisForm 10-Q to evaluate the Company’s results of operations.  These non-GAAP tables are included to aid thereader in understanding our GAAP financial statements.

 

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| ** **                                               | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                               | ** ** | **2004**                             | ** ** | **2003**                           | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                               | ** ** | **(In thousands)**                   | ** ** |
| **Reconciliation of Income from operations to  EBITDA:** | ** ** | ** **                           | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** |
|                                                     |       |                                 |       |                               |       |   |   |   |   |
| **FSS  Operating Segment:**                              | ** ** | ** **                           | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Income from  operations                                  |       | $                                    | 40,942     |                               | $          | 72,205 |   | $ | 10,269 |   | $ | 146,619 |   |
| Depreciation and  amortization                           |       | 70,970                               |       | 74,867                             |       | 145,867 |   | 147,124 |   |
| EBITDA (a)                                               |       | $                                    | 111,912    |                               | $          | 147,072 |   | $ | 156,136 |   | $ | 293,743 |   |
|                                                     |       |                                 |       |                               |       |   |   |   |   |
| **G2  Operating Segment:**                               | ** ** | ** **                           | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Income from  operations                                  |       | $                                    | 3,575      |                               | $          | 2,246 |   | $ | 5,325 |   | $ | 4,107 |   |
| Depreciation and  amortization                           |       | 342                                  |       | 42                                 |       | 780 |   | 52 |   |
| EBITDA (a)                                               |       | $                                    | 3,917      |                               | $          | 2,288 |   | $ | 6,105 |   | $ | 4,159 |   |

 

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(a)  EBITDA, a measure used bymanagement to measure operating performance, is defined as net income plus netinterest expense, income tax expense (benefit) and depreciation andamortization. EBITDA is not a presentation made in accordance with GAAP, and isnot a measure of financial condition or profitability, and should not beconsidered as an alternative to (1) net income (loss) or income fromoperations determined in accordance with GAAP or (2) operating cash flowsdetermined in accordance with GAAP. Our management uses EBITDA to evaluate theoperating performance of its operating segments, and as a measure ofperformance for incentive compensation purposes.  We believe EBITDA is a measure of performanceused by some investors, equity analysts and others to make informed investmentdecisions. Our management also uses this metric to measure income generatedfrom operations that could be used to service debt, fund future capitalexpenditures or pay taxes.  In addition,multiples of current or projected EBITDA are used to estimate current orprospective enterprise value. Additionally, EBITDA is not intended to be a measure of free cash flowfor management’s discretionary use, as it does not consider certain cashrequirements such as interest payments, tax payments and debt servicerequirements. Because not all companies use identical calculations, thispresentation of EBITDA may not be comparable to other similarly titled measuresof other companies.

 

**(16)****  Condensed Consolidating Financial Statements**

 

Obligations under our 8 1⁄2% Senior Notes due 2012 are,or will be, as the case may be, fully and unconditionally guaranteed on a jointand several basis by us (PanAmSat Corporation, the issuer of the 8 1⁄2% SeniorNotes due 2012) and certainof our existing and subsequently acquired or organized domestic subsidiaries(the “Guarantor Subsidiaries,” each a “Guarantor”).

 

In the first quarter of 2004, we reorganized portionsof our subsidiary structure so that certain of our government sales activitiesoperate through a wholly-owned subsidiary, G2. As a result, we are now required to present consolidating financialinformation for our company and our subsidiaries within the notes to ourconsolidated financial statements in accordance with the criteria establishedfor parent companies in the SEC’s Regulation S-X, Rule 3-10(f).  During the current period we determined thatour non-guarantor subsidiaries, which include our foreign subsidiaries which donot guarantee the Senior Notes, were no longer minor (as defined in the SEC’sRegulation S-X, Rule 3-10 (h)) and therefore they are included within theattached consolidating financial statements.

 

The following condensed consolidating financialinformation present the results of operations, financial position and cashflows of PanAmSat Corporation, the Guarantor Subsidiaries, the Non-guarantorSubsidiaries, which are our international subsidiaries, and the eliminations necessary to arrive at theinformation for our company on a consolidated basis as of and for the three andsix month periods ended June 30, 2004. The principal elimination entrieseliminate investments in subsidiaries and intercompany balances andtransactions.

 

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**PANAMSAT CORPORATION**

**CONDENSED CONSOLIDATING STATEMENTS OFINCOME**

**FOR THE THREE MONTHS ENDED JUNE 30,2004 (UNAUDITED)**

**(IN THOUSANDS, EXCEPT SHARE DATA)**

 

** **
| ** **                                                           | ** ** | **PanAmSat  Corporation** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------------------------------|------------|---------------------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| REVENUES:                                                            |       |                      |       |                        |       |                            |       |             |       |             |       |
| Operating leases, satellite services and other                       |       | $                         | 184,141    |                        | $          | 23,544                          |       | $                | 6,559      |             | $          | (11,512 | ) | $ | 202,732 |   |
| Outright sales and sales-type leases                                 |       | 4,093                     |       | ––                |       | —                          |       | —           |       | 4,093            |       |
| Total revenues                                                       |       | 188,234                   |       | 23,544                      |       | 6,559                           |       | (11,512          | )          | 206,825          |       |
| OPERATING COSTS AND EXPENSES:                                        |       |                      |       |                        |       |                            |       |             |       |             |       |
| Depreciation and amortization                                        |       | 70,820                    |       | 425                         |       | 67                              |       | —           |       | 71,312           |       |
| Direct operating costs (exclusive of depreciation and  amortization) |       | 32,613                    |       | 18,221                      |       | 845                             |       | (11,512          | )          | 40,167           |       |
| Selling, general and administrative expenses                         |       | 46,447                    |       | 1,489                       |       | 2,320                           |       | —           |       | 50,256           |       |
| Facilities  restructuring and severance cost                         |       | 573                       |       | —                      |       | —                          |       | —           |       | 573              |       |
| Total operating costs and expenses                                   |       | 150,453                   |       | 20,135                      |       | 3,232                           |       | (11,512          | )          | 162,308          |       |
|                                                                 |       |                      |       |                        |       |                            |       |             |       |             |       |
| INCOME FROM OPERATIONS                                               |       | 37,781                    |       | 3,409                       |       | 3,327                           |       | —           |       | 44,517           |       |
| INTEREST EXPENSE (INCOME) - NET                                      |       | 33,694                    |       | (68                         | )          | (3                              | )          | —           |       | 33,623           |       |
| INCOME BEFORE INCOME TAXES                                           |       | 4,087                     |       | 3,477                       |       | 3,330                           |       | —           |       | 10,894           |       |
| INCOME TAX EXPENSE (BENEFIT)                                         |       | (1,191                    | )          | 1,287                       |       | 132                             |       | —           |       | 228              |       |
| NET INCOME                                                           |       | $                         | 5,278      |                        | $          | 2,190                           |       | $                | 3,198      |             | $          | — |   | $ | 10,666 |   |

 

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**PANAMSAT CORPORATION**

**CONDENSED CONSOLIDATING STATEMENTS OFINCOME**

**FOR THE SIX MONTHS ENDED JUNE 30,2004 (UNAUDITED)**

**(IN THOUSANDS, EXCEPT SHARE DATA)**

 
| ** **                                                           | ** ** | **PanAmSat  Corporation** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------------------------------|------------|---------------------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| REVENUES:                                                            |       |                      |       |                        |       |                            |       |             |       |             |       |
| Operating leases, satellite services and other                       |       | $                         | 368,348    |                        | $          | 46,450                          |       | $                | 9,615      |             | $          | (20,516 | ) | $ | 403,897 |   |
| Outright sales and sales-type leases                                 |       | 8,358                     |       | ––                |       | —                          |       | ––     |       | 8,358            |       |
| Total revenues                                                       |       | 376,706                   |       | 46,450                      |       | 9,615                           |       | (20,516          | )          | 412,255          |       |
| OPERATING COSTS AND EXPENSES:                                        |       |                      |       |                        |       |                            |       |             |       |             |       |
| Depreciation and amortization                                        |       | 145,485                   |       | 947                         |       | 215                             |       | —           |       | 146,647          |       |
| Direct operating costs (exclusive of depreciation and  amortization) |       | 61,610                    |       | 37,529                      |       | 1,212                           |       | (20,516          | )          | 79,835           |       |
| Selling, general and administrative expenses                         |       | 59,807                    |       | 3,809                       |       | 4,189                           |       | —           |       | 67,805           |       |
| PAS-6 impairment loss                                                |       | 99,946                    |       | —                      |       | —                          |       | —           |       | 99,946           |       |
| Facilities  restructuring and severance cost                         |       | 2,428                     |       | —                      |       | —                          |       | —           |       | 2,428            |       |
| Total operating costs and expenses                                   |       | 369,276                   |       | 42,285                      |       | 5,616                           |       | (20,516          | )          | 396,661          |       |
|                                                                 |       |                      |       |                        |       |                            |       |             |       |             |       |
| INCOME FROM OPERATIONS                                               |       | 7,430                     |       | 4,165                       |       | 3,999                           |       | —           |       | 15,594           |       |
| INTEREST EXPENSE (INCOME) - NET                                      |       | 64,844                    |       | (130                        | )          | (5                              | )          | ––     |       | 64,709           |       |
| INCOME (LOSS) BEFORE INCOME TAXES                                    |       | (57,414                   | )          | 4,295                       |       | 4,004                           |       | —           |       | (49,115          | )          |
| INCOME TAX EXPENSE (BENEFIT)                                         |       | (29,664                   | )          | 1,562                       |       | 250                             |       | ––     |       | (27,852          | )          |
| NET INCOME (LOSS)                                                    |       | $                         | (27,750    | )                           | $          | 2,733                           |       | $                | 3,754      |             | $          | — |   | $ | (21,263 | ) |

 

22

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**PANAMSATCORPORATION**

**CONDENSED CONSOLIDATING BALANCESHEETS**

**JUNE 30, 2004 (UNAUDITED)**

**(IN THOUSANDS)**

 
| ** **                                                                                                         | ** ** | **PanAmSat  Corporation** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| ASSETS                                                                                                             |       |                      |       |                        |       |                            |       |             |       |             |       |
| CURRENT ASSETS:                                                                                                    |       |                      |       |                        |       |                            |       |             |       |             |       |
| Cash and cash  equivalents                                                                                         |       | $                         | 624,692    |                        | $          | 500                             |       | $                | 2,559      |             | $          | — |   | $ | 627,751 |   |
| Short-term  investments                                                                                            |       | 9,957                     |       | —                      |       | —                          |       | —           |       | 9,957            |       |
| Accounts  receivable-net                                                                                           |       | 44,368                    |       | 23,106                      |       | 4,732                           |       | —           |       | 72,206           |       |
| Net investment  in sales-type leases                                                                               |       | 24,332                    |       | —                      |       | —                          |       | —           |       | 24,332           |       |
| Prepaid expenses  and other current assets                                                                         |       | 20,050                    |       | 9,613                       |       | 248                             |       | —           |       | 29,911           |       |
| Deferred income  taxes                                                                                             |       | 6,933                     |       | ––                |       | —                          |       | ––     |       | 6,933            |       |
| Assets held for  sale                                                                                              |       | 3,257                     |       | —                      |       | —                          |       | —           |       | 3,257            |       |
| Total current  assets                                                                                              |       | 733,589                   |       | 33,219                      |       | 7,539                           |       | —           |       | 774,347          |       |
|                                                                                                               |       |                      |       |                        |       |                            |       |             |       |             |       |
| SATELLITES AND  OTHER PROPERTY AND EQUIPMENT-NET                                                                   |       | 2,087,054                 |       | 5,010                       |       | 733                             |       | —           |       | 2,092,797        |       |
| NET INVESTMENT  IN SALES-TYPE LEASES                                                                               |       | 100,572                   |       | —                      |       | —                          |       | —           |       | 100,572          |       |
| GOODWILL                                                                                                           |       | 2,238,659                 |       | 5,894                       |       | —                          |       | —           |       | 2,244,553        |       |
| DEFERRED CHARGES  AND OTHER ASSETS - NET                                                                           |       | 137,704                   |       | 2,545                       |       | 5,690                           |       | (8,052           | )          | 137,887          |       |
|                                                                                                               |       |                      |       |                        |       |                            |       |             |       |             |       |
| TOTAL ASSETS                                                                                                       |       | $                         | 5,297,578  |                        | $          | 46,668                          |       | $                | 13,962     |             | $          | (8,052 | ) | $ | 5,350,156 |   |
|                                                                                                               |       |                      |       |                        |       |                            |       |             |       |             |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                         |       |                      |       |                        |       |                            |       |             |       |             |       |
| CURRENT  LIABILITIES:                                                                                              |       |                      |       |                        |       |                            |       |             |       |             |       |
| Accounts payable  and accrued liabilities                                                                          |       | $                         | 53,154     |                        | $          | 8,826                           |       | $                | 1,627      |             | $          | — |   | $ | 63,607 |   |
| Current portion  of long-term debt                                                                                 |       | 275,000                   |       | —                      |       | —                          |       | —           |       | 275,000          |       |
| Current portion  of satellite incentives                                                                           |       | 13,413                    |       | —                      |       | —                          |       | —           |       | 13,413           |       |
| Accrued interest  payable                                                                                          |       | 45,344                    |       | —                      |       | —                          |       | —           |       | 45,344           |       |
| Deferred  revenues                                                                                                 |       | 23,409                    |       | 3,379                       |       | —                          |       | ––     |       | 26,788           |       |
| Total current  liabilities                                                                                         |       | 410,320                   |       | 12,205                      |       | 1,627                           |       | —           |       | 424,152          |       |
|                                                                                                               |       |                      |       |                        |       |                            |       |             |       |             |       |
| LONG-TERM DEBT                                                                                                     |       | 1,075,000                 |       | —                      |       | —                          |       | —           |       | 1,075,000        |       |
| DEFERRED INCOME  TAXES                                                                                             |       | 399,688                   |       | 67                          |       | —                          |       | —           |       | 399,755          |       |
| DEFERRED CREDITS  AND OTHER (principally customer deposits, satellite incentive obligations and  deferred revenue) |       | 292,002                   |       | 12,548                      |       | 206                             |       | (17,108          | )          | 287,648          |       |
|                                                                                                               |       |                      |       |                        |       |                            |       |             |       |             |       |
| TOTAL  LIABILITIES                                                                                                 |       | 2,177,010                 |       | 24,820                      |       | 1,833                           |       | (17,108          | )          | 2,186,555        |       |
|                                                                                                               |       |                      |       |                        |       |                            |       |             |       |             |       |
| COMMITMENTS AND  CONTINGENCIES                                                                                     |       |                      |       |                        |       |                            |       |             |       |             |       |
|                                                                                                               |       |                      |       |                        |       |                            |       |             |       |             |       |
| STOCKHOLDERS’  EQUITY:                                                                                        |       |                      |       |                        |       |                            |       |             |       |             |       |
| Common Stock,  $0.01 par value                                                                                     |       | 1,503                     |       | —                      |       | —                          |       | ––     |       | 1,503            |       |
| Additional  paid-in-capital                                                                                        |       | 2,526,894                 |       | 10,069                      |       | (1,013                          | )          | 9,056            |       | 2,545,006        |       |
| Accumulated  other comprehensive loss                                                                              |       | (396                      | )          | —                      |       | —                          |       | —           |       | (396             | )          |
| Retained  earnings                                                                                                 |       | 596,023                   |       | 15,197                      |       | 13,142                          |       | —           |       | 624,362          |       |
| Other  stockholders’ equity                                                                                   |       | (3,456                    | )          | (3,418                      | )          |                            |       | ––     |       | (6,874           | )          |
|                                                                                                               |       |                      |       |                        |       |                            |       |             |       |             |       |
| TOTAL  STOCKHOLDERS’ EQUITY                                                                                   |       | 3,120,568                 |       | 21,848                      |       | 12,129                          |       | 9,056            |       | 3,163,601        |       |
|                                                                                                               |       |                      |       |                        |       |                            |       |             |       |             |       |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                   |       | $                         | 5,297,578  |                        | $          | 46,668                          |       | $                | 13,962     |             | $          | (8,052 | ) | $ | 5,350,156 |   |

 

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**PANAMSAT CORPORATION**

**CONSOLIDATING STATEMENTS OF CASHFLOWS**

**FOR THE SIX MONTHS ENDED JUNE 30,2004 (UNAUDITED)**

**(IN THOUSANDS)**

 
| ** **                                                                         | ** ** | **PanAmSat  Corporation** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                             |       |                      |       |                        |       |                              |       |             |       |             |       |
| Net income  (loss)                                                                 |       | $                         | (27,750    | )                           | $          | 2,733                             |       | $                | 3,754      |             | $          | — |   | $ | (21,263 | ) |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                      |       |                        |       |                              |       |             |       |             |       |
| Depreciation and  amortization                                                     |       | 145,485                   |       | 947                         |       | 215                               |       | —           |       | 146,647          |       |
| Deferred income  taxes                                                             |       | (30,528                   | )          | —                      |       | —                            |       | —           |       | (30,528          | )          |
| Amortization of  debt issuance costs and other deferred charges                    |       | 3,962                     |       | —                      |       | —                            |       | —           |       | 3,962            |       |
| Provision for  uncollectible receivables                                           |       | 30,456                    |       | —                      |       | —                            |       | —           |       | 30,456           |       |
| Loss on early  extinguishment of debt                                              |       | 5,455                     |       | —                      |       | —                            |       | —           |       | 5,455            |       |
| PAS-6 impairment  loss                                                             |       | 99,946                    |       | —                      |       | —                            |       | —           |       | 99,946           |       |
| Facilities  restructuring and severance costs                                      |       | 2,021                     |       | —                      |       | —                            |       | —           |       | 2,021            |       |
| Other non-cash  items                                                              |       | (3,001                    | )          | (139                        | )          | (68                               | )          | —           |       | (3,208           | )          |
| Changes in  assets and liabilities:                                                |       |                      |       |                        |       |                              |       |             |       |             |       |
| Collections on  investments in sales-type leases                                   |       | 12,427                    |       | —                      |       | —                            |       | —           |       | 12,427           |       |
| Operating leases  and other receivables                                            |       | (5,379                    | )          | 6,902                       |       | (2,706                            | )          | —           |       | (1,183           | )          |
| Prepaid expenses  and other assets                                                 |       | 90                        |       | (7,203                      | )          | 12                                |       | 2,584            |       | (4,517           | )          |
| Accounts payable  and accrued liabilities                                          |       | (20,991                   | )          | 1,297                       |       | (30                               | )          | (2,584           | )          | (22,308          | )          |
| Deferred gains  and revenues                                                       |       | 8,209                     |       | (3,857                      | )          | —                            |       | —           |       | 4,352            |       |
|                                                                               |       |                      |       |                        |       |                              |       |             |       |             |       |
| NET CASH  PROVIDED BY OPERATING ACTIVITIES                                         |       | 220,402                   |       | 680                         |       | 1,177                             |       | —           |       | 222,259          |       |
|                                                                               |       |                      |       |                        |       |                              |       |             |       |             |       |
|  CASH FLOWS FROM INVESTING ACTIVITIES:                                        |       |                      |       |                        |       |                              |       |             |       |             |       |
| Capital  expenditures (including capitalized interest)                             |       | (83,886                   | )          | —                      |       | —                            |       | —           |       | (83,886          | )          |
| Insurance  proceeds from satellite recoveries                                      |       | 286,915                   |       | —                      |       | —                            |       |             |       | 286,915          |       |
| Sale of  short-term investments                                                    |       | 28,948                    |       | —                      |       | —                            |       | —           |       | 28,948           |       |
| Acquisitions,  net of cash acquired                                                |       | —                    |       | (522                        | )          | —                            |       | —           |       | (522             | )          |
|                                                                               |       |                      |       |                        |       |                              |       |             |       |             |       |
| NET CASH  PROVIDED BY (USED IN) INVESTING ACTIVITIES                               |       | 231,977                   |       | (522                        | )          | —                            |       | —           |       | 231,455          |       |
|                                                                               |       |                      |       |                        |       |                              |       |             |       |             |       |
|  CASH FLOWS FROM FINANCING ACTIVITIES:                                        |       |                      |       |                        |       |                              |       |             |       |             |       |
| Repayments of  debt                                                                |       | (350,000                  | )          | —                      |       | —                            |       | —           |       | (350,000         | )          |
| New incentive  obligations                                                         |       | 16,250                    |       | —                      |       | —                            |       | —           |       | 16,250           |       |
| Repayments of  incentive obligations                                               |       | (6,818                    | )          | —                      |       | —                            |       | —           |       | (6,818           | )          |
| Stock issued in  connection with employee benefit plans                            |       | 3,493                     |       | —                      |       | —                            |       | ––     |       | 3,493            |       |
|                                                                               |       |                      |       |                        |       |                              |       |             |       |             |       |
| NET CASH USED IN  FINANCING ACTIVITIES                                             |       | (337,075                  | )          | —                      |       | —                            |       | ––     |       | (337,075         | )          |
|                                                                               |       |                      |       |                        |       |                              |       |             |       |             |       |
| EFFECT OF  EXCHANGE RATE CHANGES ON CASH                                           |       | (136                      | )          | —                      |       | —                            |       | —           |       | (136             | )          |
|                                                                               |       |                      |       |                        |       |                              |       |             |       |             |       |
| NET INCREASE IN CASH  AND CASH EQUIVALENTS                                         |       | 115,168                   |       | 158                         |       | 1,177                             |       | —           |       | 116,503          |       |
| CASH AND CASH  EQUIVALENTS, BEGINNING OF PERIOD                                    |       | 509,524                   |       | 342                         |       | 1,382                             |       | ––     |       | 511,248          |       |
| CASH AND CASH  EQUIVALENTS, END OF PERIOD                                          |       | $                         | 624,692    |                        | $          | 500                               |       | $                | 2,559      |             | $          | — |   | $ | 627,751 |   |

 

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**ITEM 2. MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.**

** **

The followingmanagement’s discussion and analysis should be read in conjunction with ourmanagement’s discussion and analysis included in our Annual Report on Form 10-Kfor the year ended December 31, 2003 filed with the Securities and ExchangeCommission (“SEC”) on March 15, 2004, all amendments thereto, and all of ourother filings filed with the SEC from March 15, 2004 through the date of thisreport.

 

The DIRECTV Group,Inc. (“The DIRECTV Group,” formerly known as Hughes Electronics Corporation)owns 80.4% of our outstanding common stock. Fox Entertainment Group, Inc. (“Fox Entertainment”), a subsidiary of TheNews Corporation Limited (“News Corporation”), owns approximately 34% of TheDIRECTV Group’s outstanding common stock.

 

**PanAmSatMerger, Subsequent Sale and Related Transactions**

 

On April 20, 2004, we entered into a definitive transactionagreement with The DIRECTV Group, PAS Merger Sub, Inc. (“Merger Sub”), awholly-owned subsidiary of The DIRECTV Group, and Constellation, LLC(“Constellation”), an affiliate of Kohlberg Kravis Roberts & Co. L.P.(“KKR”) for the merger of our company with PAS Merger Sub (“Merger”) andsubsequent sale to Constellation (the “PanAmSat Sale”). On May 17, 2004,Constellation assigned the right to purchase a portion of the shares of ourcommon stock beneficially held by The DIRECTV Group to limited liabilitycompanies affiliated with The Carlyle Group (“Carlyle”) and Providence EquityPartners, Inc. (“Providence”) (collectively the “Sponsors”).  These transactions, the related financingtransactions and the anticipated new contractual arrangements with The DIRECTVGroup or its affiliates described below are referred to collectively as the“Transactions”.

 

Pursuant to the terms of the transaction agreement, Merger Sub willmerge with and into us, with us being the surviving entity in the Merger. As ofthe effective time of the Merger, holders of shares of our common stock (otherthan The DIRECTV Group, members of management who have agreed not to havecertain of their equity interests cashed out in the Merger and holders whoperfect their appraisal rights under Delaware law) will have no furtherownership interest in us. Instead, each holder of our common stock outstandingimmediately prior to the effective time of the Merger (other than The DIRECTVGroup, members of management who have agreed not to have certain of theirequity interests cashed out in the Merger and holders who perfect theirappraisal rights under Delaware law) will be entitled to receive $23.50 in cashper share of our common stock.

 

Subject to the satisfaction of certain closing conditions set forth inthe transaction agreement, two business days after the effective time of theMerger, a portion of the shares of our common stock beneficially owned by TheDIRECTV Group will be repurchased by us at a purchase price of $23.50 in cashper share. Following the repurchase, The DIRECTV Group will sell all of theremaining shares of our common stock that it owns to the Sponsors at a purchaseprice of $23.50 in cash per share, less any amounts withheld in accordance withthe transaction agreement.

 

Immediately following the PanAmSat Sale, each stock option issued andoutstanding under our 1997 Long-Term Incentive Plan, whether or not thenvested, will be canceled and converted into the right to receive a payment fromus (subject to any applicable withholding taxes) equal to the product of(a) the total number of shares of our common stock subject to such stockoption and (b) the excess of $23.50 over the option exercise price forsuch stock option, payable in cash. Immediately before the effective time ofthe Merger, all restrictions on restricted shares and restricted stock unitsgranted under our 1997 Long-Term Incentive Plan will lapse, and the unvestedrestricted shares and restricted stock units will vest and will be canceled andthe holders of those securities will be entitled to receive $23.50 per share,less applicable withholding taxes. Certain members of our management haveagreed not to have certain of their equity interests cashed out in the Mergerand PanAmSat Sale; existing options, restricted shares and restricted stock unitsgranted to such individuals are expected to remain outstanding as options andshares of the surviving corporation.

 

The Transactions are expected to be accounted for as a leveragedrecapitalization, whereby the historical basis of the assets and liabilities ofPanAmSat will be maintained.

 

The transaction agreement contains various covenants regarding theconduct of our business prior to the closing of the Transactions. In addition,the Transactions are subject to a number of conditions, including receipt ofcertain regulatory approvals and the consummation of the debt financingsdescribed in the following paragraphs, or other satisfactory financing.

 

In connection with the PanAmSat Sale, we intend to enter into newsenior secured credit facilities consisting of an $800.0 million Term LoanA Facility, a $1,860.0 million Term Loan B Facility and a$250.0 million revolving credit facility, and to incur $1,010.0 millionaggregate principal amount of senior unsecured indebtedness.

 

25

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We have commenced tender offers to purchase any and all of theoutstanding $800.0 million aggregate principal amount of our 8 1/2%Senior Notes due 2012 and any and all of the outstanding $275.0 millionaggregate principal amount of our 6 1/8% Senior Notes due 2005 for cash. Thetender offers are conditioned upon, among other things, the incurrence of the$1,010.0 million aggregate principal amount of senior unsecured indebtedness.

 

Concurrently with the execution of the transaction agreement, weentered into a tax separation agreement with The DIRECTV Group that willsupersede four earlier tax-related agreements among ourselves, The DIRECTVGroup and certain of its affiliates. We and The DIRECTV Group have agreed tohandle tax matters with respect to the tax periods covered by the taxseparation agreement, including tax return preparation, audits, appeals andlitigation, in a manner consistent with the past practice of The DIRECTV Groupand ourselves before the acquisition. In addition, we and The DIRECTV Grouphave agreed to cooperate in any tax audits, litigation or appeals that involve,directly or indirectly, periods ending on or prior to the day of the closing ofthe PanAmSat Sale.

 

Pursuant to the tax separation agreement, The DIRECTV Group has agreedto indemnify us for all federal and consolidated state and local income taxes ataxing authority may attempt to collect from us regarding any liability for thefederal or consolidated state or local income taxes of General Motors (“GM”)and The DIRECTV Group, except those income taxes we are required to pay underthe tax separation agreement. In addition, The DIRECTV Group has agreed toindemnify us for any taxes (other than those taxes described in the precedingsentence) related to any periods or portions of such periods ending on or priorto the day of the closing of the PanAmSat Sale in amounts equal to 80% of thefirst $75 million of such other taxes and 100% of any other taxes inexcess of the first $75 million. In addition, our tax liability related tothese periods is capped at $15 million.

 

The tax separation agreement will be effective from the day of theclosing of the Transactions until the expiration of the statute of limitationswith respect to all taxes to which the tax separation agreement relates.

 

In connection with the transaction agreement, The DIRECTV Group hasagreed to, or to cause its affiliates to, enter into, amend or in some casesextend certain commercial arrangements with us. These commercial arrangements include the extension of transponder leaseagreements with Hughes Network Systems, Inc. (“HNS”), the extension of TheDIRECTV Group guarantees of our transponder lease agreements with DIRECTV LatinAmerica LLC (“DTVLA”), entering into an agreement for additional transpondercapacity for direct-to-home (“DTH”) services in Latin America, and theextension of telemetry tracking and control (“TT&C”) services agreementswith DIRECTV Operations LLC.  Inaddition, in connection with the Transactions (as defined below), we expect TheDIRECTV Group or News Corporation to pay us for certain past due receivablesfrom, and guarantee certain future obligations of, our customer SkyMulti-Country Partners, an affiliate of News Corporation.  Management believes that these anticipatedguarantees and other contractual arrangements will, when executed,substantially reduce credit risks associated with the two Latin American DTHplatforms in our contracted backlog and protect us against the possible impactof future consolidation of those platforms.

 

Certain of the new contractual arrangements we expect to enter into inconnection with the Transactions would have increased our contracted backlog byapproximately $659 million.  Of thisincremental contracted backlog, approximately $450 million related to acontractual arrangement that is not required to be in place at the time of thecompletion of the Transactions or at all. However, in the event this agreement is not entered into, the amountpayable to The DIRECTV Group under the transaction agreement would be reducedby $250 million, we would not borrow an equal amount under our new Term Loan AFacility, we would not be required to make any of the related capitalexpenditures and the related backlog would not materialize.  If this agreement is entered into by March31, 2005, we would pay $250 million to The DIRECTV Group, funded by borrowingsunder our new Term Loan A Facility.  Ifthis agreement is not executed, in addition to reducing our indebtedness by$250 million, we would not be required to make any of the related capitalexpenditures.

 

Certain of our executives have change-in-control severance agreementswhich provide for, among other things, the payment of severance and otherbenefits upon the termination of the executive without cause or for good reasonwithin three years after a change in control of PanAmSat, as defined in theirrespective agreements. In addition, our Severance Pay Plan allows for thepayment of enhanced severance to employees laid off or who resign for goodreason (as defined in such plan) as a result of, and within two years after, achange-in-control (See “ - Commitments and Contingencies” below).

 

26

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**ManagementOverview**

 

In evaluating ourfinancial condition and operating performance, we consider many factors.  The following updates certain subjects morecompletely discussed in “Management’s Discussion and Analysis of FinancialCondition and Results of Operations – Management Overview” of our Form 10-K forthe year ended December 31, 2003, filed with the SEC on March 15, 2004.

 

We believe theTransactions described above will give us the opportunity to enhance ourcompetitive position and expand our capabilities.  In furtherance of our mission of servicing astrong customer base in the entertainment, communications and governmentsectors, we believe the Sponsors will support our efforts to grow by developingnew products and services, forging strategic alliances and developing newmarkets.

 

In January 2004,we signed a multi-year, multi-satellite agreement with Fox Entertainment underwhich it will consolidate its entire suite of U.S. cable and broadcastprogramming onto our global fleet for 15 years and move a significant portionof its international traffic onto our fleet for the next decade.  Fox Entertainment will now be one of ourlargest media customers and one of our top five global customers.

 

In the firstquarter of 2004, we received an aggregate of $286.9 million in satelliteinsurance proceeds for claims filed in 2003 for Galaxy 11, PAS-1R and Galaxy4R.  These proceeds were classified asrestricted cash pursuant to the terms of our existing senior secured creditfacilities until the restrictions were lifted in June 2004.

 

During the fourthquarter of 2003, we entered into an agreement with DTVLA and The DIRECTV Groupthat restructured our prior agreements related to that DTH business.  That agreement became effective in February2004 upon DTVLA’s emergence from bankruptcy. As a result, we agreed to accept reduced cash payments in the earlyyears of our existing transponder agreements with this customer, most of whichwe expect to recapture in later years, and The DIRECTV Group has agreed toguarantee all of the transponder lease agreements with DTVLA for a period offive years.  We believe thissubstantially reduces credit risks associated with our contractual backlog.

 

On March 17, 2004,our PAS-6 satellite suffered an anomaly resulting in a loss of power.  On April 1, 2004, this satellite experiencedanother and more significant loss of power. Following that event, we commenced de-orbiting the satellite. As aresult of the March 17 event, we recorded a non-cash impairment charge of $99.9million within income from operations in the first quarter of 2004.  This resulted in an approximate $63.3 millionnon-cash charge to net income after taxes. PAS-6 had been previously replaced and was used as a backup for anothersatellite.  Accordingly, this event hasnot affected service to any of our customers and we anticipate that it will notaffect our revenues in 2004.  We do notplan to replace this satellite.

 

In June 2004, werepaid the $349.1 million outstanding balance under our Term B-1 Facility fromavailable cash on hand. In conjunction with this repayment, we recorded acharge of $5.5 million within interest expense as a result of the write-off ofrelated debt issuance costs and a charge of $0.5 million within interestexpense representing the amount accumulated within other comprehensive incomerelated to an interest rate hedge entered into in connection with the Term B-1Facility.  The hedge liability was notimpacted by the repayment of the Term B-1 Facility, as the interest rate hedgeagreement is in effect through August 30, 2005.

 

In July of 2004,we terminated our lease agreements with one of our customers due to non-paymentof the customer’s obligations to us through June 30, 2004. As a result, in thesecond quarter of 2004 we recorded a pre-tax charge of approximately $29.6million related to the write-off of current and long-term receivable balancesdue from this customer. Prior to the termination, contracted future backlog andremaining 2004 revenues related to this customer were $80.4 million and $5.0million, respectively.

 

We began reportingour operations in two operating segments during the three months ended March31, 2004: our traditional fixed satellite services (“FSS”) business andgovernment services, G2 Satellite Solutions (“G2”) business.  As G2 becomes a more significant portion ofour business, segment reporting will allow us to report in the way we manageour business.

 

Following is amore detailed discussion of these items and a comprehensive analysis of ourresults of operations, operating segments, contracted backlog, satellitetechnology, satellite deployment plans, liquidity and capital resources,commitments and contingencies, new accounting pronouncements and market risks.

 

27

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**Results ofOperations for the Three Months ended June 30, 2004**

 
| ** **                                                          | ** ** | **Three Months Ended June 30,**           | ** ** | **Dollar  Change** | ** ** | **Percentage  Change** | ** ** |
|---------------------------------------------------------------------|------------|-------------------------------------------|------------|--------------------|------------|------------------------|------------|
| **2004**                                                            | ** ** | **2003**                                  |
| ** **                                                          | ** ** | **(In thousands, except per share data)** | ** ** |
| **Revenues**                                                        |       |                                      |       |               |       |                   |       |   |   |
| Operating leases, satellite services and other                      |       | $                                         | 202,732    |               | $          | 199,400                |       | $ | 3,332 |   | 1.7 | % |
| Outright sales and sales-type leases                                |       | 4,093                                     |       | 4,193              |       | (100                   | )          | (2.4 | )% |
| Total revenues                                                      |       | 206,825                                   |       | 203,593            |       | 3,232                  |       | 1.6 | % |
| **Costs and expenses**                                              |       |                                      |       |               |       |                   |       |   |   |
| Depreciation and amortization expense                               |       | 71,312                                    |       | 74,909             |       | (3,597                 | )          | (4.8 | )% |
| Direct operating costs (exclusive of depreciation and amortization) |       | 40,167                                    |       | 32,232             |       | 7,935                  |       | 24.6 | % |
| Selling, general and administrative expenses                        |       | 50,256                                    |       | 21,338             |       | 28,918                 |       | 135.5 | % |
| Facilities restructuring and severance costs                        |       | 573                                       |       | 663                |       | (90                    | )          | (13.6 | )% |
| Total operating costs and expenses                                  |       | 162,308                                   |       | 129,142            |       | 33,166                 |       | 25.7 | % |
| Income from operations                                              |       | 44,517                                    |       | 74,451             |       | (29,934                | )          | (40.2 | )% |
| Interest expense, net                                               |       | 33,623                                    |       | 33,132             |       | 491                    |       | 1.5 | % |
| Income before income taxes                                          |       | 10,894                                    |       | 41,319             |       | (30,425                | )          | (73.6 | )% |
| Income tax expense                                                  |       | 228                                       |       | 11,021             |       | (10,793                | )          | (97.9 | )% |
| Net income                                                          |       | $                                         | 10,666     |               | $          | 30,298                 |       | $ | (19,632 | ) | (64.8 | )% |
| Earnings per share — basic and diluted                         |       | $                                         | 0.07       |               | $          | 0.20                   |       | $ | (0.13 | ) | (65.0 | )% |

 

Revenues - The increase in total revenues was primarily attributable toadditional government services revenues related to our G2 operating segment andan increase in network services revenues related to data services within theMiddle East and VSAT applications in North America.  These increases were partially offset bylower video revenues recorded primarily as a result of customer credit relatedissues in international regions, some of which resulted in the second quarter2004 charge of $29.6 million, which is more fully described above (See“Operating Segments” below).

 

Depreciation andAmortization Expense- The decrease in depreciation and amortization for thethree months ended June 30, 2004, was due primarily to lower depreciation onGalaxy 11 and PAS-1R of $5.3 million, as a result of the allocation ofinsurance proceeds against the carrying values of these satellites duringDecember 2003 (See “- Commitments and Contingencies – Satellite Insurance”below), and lower depreciation of $2.9 million on PAS-6 due to the impairmentloss in the first quarter of 2004 (See “- Satellite Technology” below). Thesedecreases were partially offset by accelerated depreciation of $4.1 million dueto reduced end of life estimates for Galaxy 4R and PAS-6B for Xenon IonPropulsion Systems (“XIPS”) failures and depreciation of $2.0 million on Galaxy12 and Galaxy 13, which were recently placed in service.

 

Direct OperatingCosts (exclusive of depreciation and amortization) – The increase in directoperating costs was primarily due to additional direct operating costs of $5.2million related to our G2 operating segment resulting from the growth ofservices to the U.S. government, partially driven by the 2003 acquisitions ofHughes Global Services, Inc. and Esatel Communications, Inc. Further,additional direct operating costs were recorded during the second quarter of2004 related to Sonic Telecommunications International Ltd. (“Sonic”), whichwas acquired during 2003. These increases were partially offset by reducedsatellite insurance expense of $2.7 million.

 

Selling, General& Administrative Expenses – The increase in selling, general andadministrative expenses was primarily attributable to the $29.6 million pre-taxcharge recorded in relation to the write-off of a customer’s long andshort-term receivable balances during the second quarter of 2004 (See “- ManagementOverview” above).

 

FacilitiesRestructuring and Severance Costs – In the second quarter of 2004, we recordeda charge of $0.6 million related to our teleport consolidation plan. The $0.7million of charges recorded during the three months ended June 30, 2003represents severance costs related to our teleport consolidation. (See“Liquidity and Capital Resources - Facilities Restructuring and SeveranceCosts” below).

 

Income fromOperations - The decrease in income from operations was primarily due to the$29.6 million pre-tax charge described above and an increase in directoperating costs of $7.9 million related to our G2 operating segment.  These decreases to income from operationswere partially offset by the increase in revenues of $3.2 million describedabove.

 

28

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Interest Expense,Net – Interest Expense, net consisted of the following (in thousands):

 
| ** **                  | ** ** | **Three Months Ended June 30,** | ** ** | **Dollar  Change** | ** ** |
|-----------------------------|------------|---------------------------------|------------|--------------------|------------|
| ** **                  | ** ** | **2004**                        | ** ** | **2003**           |
| Gross interest expense      |       | $                               | 38,757     |               | $          | 42,417 |   | $ | (3,660 | ) |
| Less: Interest income       |       | 3,206                           |       | 5,734              |       | (2,528 | ) |
| Less: Capitalized interest  |       | 1,928                           |       | 3,551              |       | (1,623 | ) |
| Total interest expense, net |       | $                               | 33,623     |               | $          | 33,132 |   | $ | 491 |   |

 

Gross interest expense decreased primarily as a result of:

 

•                  OurJuly and December 2003 prepayments of $350 million and $300 million,respectively, under our Senior Secured Credit Facility

•                  OurOctober 2003 amendment to our Senior Secured Credit Facility which reduced ourinterest rate under the Term B-1 Facility to LIBOR plus 2.5%

•                  Therepayment of the $349.1 million outstanding balance under our Term B-1 Facilityon June 9, 2004

 

These decreases were partially offset by the pre-tax charge of $5.5million recorded within interest expense, as a result of the write-off of unamortizeddebt issuance costs for the Term B-1 Facility that was paid off during thesecond quarter of 2004.

 

Income Tax Expense (Benefit) - The decreasein income tax expense was due primarily to lower income from operations of$29.9 million. We estimate that our effective income tax rate will be a taxbenefit of approximately 10% for 2004, as compared to a tax expense ofapproximately 26% for 2003.  The changein our effective tax rate from 2003 to 2004 is primarily due to the income taxeffect of the PAS-6 impairment loss recorded during the first quarter of 2004and the write-off of the customer receivable balance in the second quarter of2004.

 

**Results ofOperations for the Six Months ended June 30, 2004**

 
| ** **                                                          | ** ** | **Six Months Ended June 30,**             | ** ** | **Dollar  Change** | ** ** | **Percentage  Change** | ** ** |
|---------------------------------------------------------------------|------------|-------------------------------------------|------------|--------------------|------------|------------------------|------------|
| **2004**                                                            | ** ** | **2003**                                  |
| ** **                                                          | ** ** | **(In thousands, except per share data)** | ** ** |
| **Revenues**                                                        |       |                                      |       |               |       |                   |       |   |   |
| Operating leases, satellite services and other                      |       | $                                         | 403,897    |               | $          | 394,820                |       | $ | 9,077 |   | 2.3 | % |
| Outright sales and sales-type leases                                |       | 8,358                                     |       | 8,529              |       | (171                   | )          | (2.0 | )% |
| Total revenues                                                      |       | 412,255                                   |       | 403,349            |       | 8,906                  |       | 2.2 | % |
| **Costs and expenses**                                              |       |                                      |       |               |       |                   |       |   |   |
| Depreciation and amortization expense                               |       | 146,647                                   |       | 147,176            |       | (529                   | )          | (0.4 | )% |
| Direct operating costs (exclusive of depreciation and amortization) |       | 79,835                                    |       | 65,420             |       | 14,415                 |       | 22.0 | % |
| Selling, general and administrative expenses                        |       | 67,805                                    |       | 39,364             |       | 28,441                 |       | 72.3 | % |
| PAS-6 impairment loss                                               |       | 99,946                                    |       | —             |       | 99,946                 |       |   |   |
| Facilities restructuring and severance costs                        |       | 2,428                                     |       | 663                |       | 1,765                  |       | 266.2 | % |
| Total operating costs and expenses                                  |       | 396,661                                   |       | 252,623            |       | 144,038                |       | 57.0 | % |
| Income from operations                                              |       | 15,594                                    |       | 150,726            |       | (135,132               | )          | (89.7 | )% |
| Interest expense, net                                               |       | 64,709                                    |       | 67,407             |       | (2,698                 | )          | (4.0 | )% |
| (Loss) income before income taxes                                   |       | (49,115                                   | )          | 83,319             |       | (132,434               | )          | (158.9 | )% |
| Income tax (benefit) expense                                        |       | (27,852                                   | )          | 22,163             |       | (50,015                | )          | (225.7 | )% |
| Net (loss) income                                                   |       | $                                         | (21,263    | )                  | $          | 61,156                 |       | $ | (82,419 | ) | (134.8 | )% |
| (Loss) earnings per share — basic and diluted                  |       | $                                         | (0.14      | )                  | $          | 0.41                   |       | $ | (0.55 | ) | (134.1 | )% |

 

Revenues - Theincrease in total revenues was primarily attributable to additional governmentservices revenues related to our G2 segment and an increase in network servicesrevenues related to data services within the Middle East and VSAT applicationsin North America.  These increases werepartially offset by lower video revenues recorded primarily as a result ofcustomer credit related issues in international regions, some of which resultedin the second quarter 2004 charge of $29.6 million, which is more fullydescribed above (See “Operating Segments” below).

 

29

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Depreciation andAmortization Expense - The decrease in depreciation and amortization for thesix months ended June 30, 2004, was due primarily to lower depreciation onGalaxy 11 and PAS-1R of $10.7 million, as a result of the allocation ofinsurance proceeds against the carrying values of these satellites duringDecember 2003 (See “- Commitments and Contingencies – Satellite Insurance”below), and lower depreciation of $3.4 million on PAS-6 due to the impairmentloss in the first quarter of 2004 (See “- Satellite Technology” below). Thesedecreases were significantly offset by accelerated depreciation of $9.3 milliondue to reduced end of life estimates for Galaxy 4R and PAS-6B as a result ofXIPS failures and depreciation of $5.1 million on Galaxy 12 and Galaxy 13,which were recently placed in service.

 

Direct OperatingCosts (exclusive of depreciation and amortization) – The increase in directoperating costs was primarily due to additional direct operating costs of ourG2 operating segment of $16.1 million due to the growth of services to the U.S.government, partially driven by the 2003 acquisitions of HGS and Esatel.Further, additional direct operating costs were recorded during the second quarterof 2004 related to Sonic, which was acquired during 2003.  These increases were partially offset byreduced satellite insurance expense of $5.3 million and a $3.1 millionwrite-off of deferred charges as a result of the termination of certain vendorcontracts during the first quarter of 2003.

 

Selling, General& Administrative Expenses – The increase in selling, general andadministrative expenses was due primarily to the $29.6 million pre-tax chargerecorded in relation to the write-off of a customer’s long and short-termreceivable balances during the second quarter of 2004 (See “- ManagementOverview” above).

 

PAS-6 ImpairmentLoss – In the first quarter of 2004, we recorded a non-cash charge of $99.9million related to the impairment of our PAS-6 satellite (See “-SatelliteTechnology “ below).

 

FacilitiesRestructuring and Severance Costs – In the first six months of 2004, werecorded a non-cash charge of $1.4 million related to our facilitiesrestructuring plan and $1.0 million related to our teleport consolidationplan.  For the six months endedJune 30, 2003, these amounts represent severance costs related to ourteleport consolidation of $2.0 million offset partially by$1.3 million of restructuring credits related to the signing of subleaseagreements for amounts higher than originally estimated. (See “Liquidity andCapital Resources - Facilities Restructuring and Severance Costs” below).

 

Income (Loss) fromOperations - The decrease in income from operations was primarily due to the$99.9 million impairment loss for our PAS-6 satellite and the $29.6 millionpre-tax charge described above.  Thesedecreases were partially offset by an increase in revenues of approximately$8.9 million.

 

Interest Expense,Net – Interest Expense, net consisted of the following (in thousands):

 
| ** **                  | ** ** | **Six Months Ended June 30,** | ** ** | **Dollar  Change** | ** ** |
|-----------------------------|------------|-------------------------------|------------|--------------------|------------|
| ** **                  | **2004**   | ** **                    | **2003**   | ** **         |
| Gross interest expense      |       | $                             | 71,997     |               | $          | 84,865 |   | $ | (12,868 | ) |
| Less: Interest income       |       | 5,087                         |       | 8,978              |       | (3,891 | ) |
| Less: Capitalized interest  |       | 2,201                         |       | 8,480              |       | (6,279 | ) |
| Total interest expense, net |       | $                             | 64,709     |               | $          | 67,407 |   | $ | (2,698 | ) |

 

Gross interest expense for the six monthsended June 30, 2004 decreased primarily as a result of the following:

 

•                  OurJuly and December 2003 prepayments of $350 million and $300 million,respectively, under our Senior Secured Credit Facility

•                  OurOctober 2003 amendment to our Senior Secured Credit Facility which reduced ourinterest rate under the Term B-1 Facility to LIBOR plus 2.5%

•                  Therepayment of the $349.1 million outstanding balance under our Term B-1 Facilityon June 9, 2004

 

These decreases to interest expense were partially offset by thefollowing:

 

•                  Thepre-tax charge of $5.5 million recorded within interest expense, as a result ofthe write-off of debt issuance costs for the Term B-1 Facility that was paidoff during the second quarter of 2004

 

30

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•                  A$3.9 million decrease in interest income as a result of lower average cashbalances in the six months ended June 30, 2004, as compared to the same periodin 2003

•                  Lowercapitalized interest in the six months ended June 30, 2004 due primarily toGalaxy 12 and Galaxy 13 being placed in-service in April 2003 and January 2004,respectively

 

Income Tax Expense (Benefit) - The decreasein income tax expense was due primarily to the PAS-6 impairment loss recordedduring the first quarter of 2004, which resulted in an income tax benefit ofapproximately $36.6 million and the write-off of the customer receivablebalance in the second quarter of 2004. We estimate that our effective incometax rate will be a tax benefit of approximately 10% for 2004, as compared to atax expense of approximately 26% for 2003. The change in our effective tax rate from 2003 to 2004 is primarily dueto the income tax effects of the PAS-6 impairment loss recorded during thefirst quarter of 2004 and the write-off of the customer receivable balance inthe second quarter of 2004.

 

**OperatingSegments**

 

##### **Selected Segment Data:**

 
| ** **                          | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                          | ** ** | **2004**                         | ** ** | **2003**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                          | ** ** | **(In thousands)**               | ** ** |
| **Revenues**                        | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| FSS                                 |       | $                                | 188,782    |                           | $          | 193,582 |   | $ | 378,209 |   | $ | 389,254 |   |
| G2                                  |       | 22,605                           |       | 15,402                         |       | 44,421 |   | 25,033 |   |
| Eliminations                        |       | (4,562                           | )          | (5,391                         | )          | (10,375 | ) | (10,938 | ) |
| Total revenues                      |       | $                                | 206,825    |                           | $          | 203,593 |   | $ | 412,255 |   | $ | 403,349 |   |
|                                |       |                             |       |                           |       |   |   |   |   |
| **Income from operations**          | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| FSS                                 |       | $                                | 40,942     |                           | $          | 72,205 |   | $ | 10,269 |   | $ | 146,619 |   |
| G2                                  |       | 3,575                            |       | 2,246                          |       | 5,325 |   | 4,107 |   |
| Eliminations                        |       | —                           |       | —                         |       | — |   | — |   |
| Total income (loss) from operations |       | $                                | 44,517     |                           | $          | 74,451 |   | $ | 15,594 |   | $ | 150,726 |   |
|                                |       |                             |       |                           |       |   |   |   |   |
| **EBITDA  (a)**                     | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| FSS                                 |       | $                                | 111,912    |                           | $          | 147,072 |   | $ | 156,136 |   | $ | 293,743 |   |
| G2                                  |       | 3,917                            |       | 2,288                          |       | 6,105 |   | 4,159 |   |
| Eliminations                        |       | —                           |       | —                         |       | — |   | — |   |
| Total EBITDA                        |       | $                                | 115,829    |                           | $          | 149,360 |   | $ | 162,241 |   | $ | 297,902 |   |

 

(See reconciliation of Income fromoperations to Earnings Before Net Interest expense, Income tax expense(benefit) and Depreciation and Amortization (“EBITDA”) for our FSS OperatingSegment and our G2 Operating Segment and the definition of EBITDA within Note15 “Operating Segments” to our unaudited consolidated financial statements.Management encourages readers to use GAAP disclosures within this Form 10-Q toevaluate the Company’s results of operations. This non-GAAP information is included to aid the reader in understandingour GAAP financial statements.

 

Ouroperations are comprised of the following two segments:

 

*FixedSatellite Services (“FSS”) –*Through FSS, we leasetransponder capacity to customers for various applications, includingbroadcasting, news gathering, Internet access and transmission, private voiceand data networks, business television, distance learning and DTH televisionand provide TT&C and network services to customers.

 

*Government Services (G2 Satellite Solutions or “G2”) –*ThroughG2, we provide global satellite and related telecommunications services to theFederal government, international government entities, and their contractors.

 

31

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***FSS Segment:***

 

***FSS Revenue by Service-Type***

 
| ** **         | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **         | ** ** | **2004**                         | ** ** | **2003**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **         | ** ** | **(In thousands)**               | ** ** |
| FSS Revenues       |       |                             |       |                           |       |   |   |   |   |
| Video              |       | $                                | 115,561    |                           | $          | 124,754 |   | $ | 231,237 |   | $ | 251,534 |   |
| Network            |       | 55,857                           |       | 52,729                         |       | 110,936 |   | 103,151 |   |
| Government         |       | 4,562                            |       | 5,391                          |       | 10,375 |   | 10,938 |   |
| Other              |       | 12,802                           |       | 10,708                         |       | 25,661 |   | 23,631 |   |
| Total FSS revenues |       | $                                | 188,782    |                           | $          | 193,582 |   | $ | 378,209 |   | $ | 389,254 |   |

 

Revenues - Thedecrease in FSS revenues for the three months and six months ended June 30,2004, was primarily due to lower program distribution and DTH video revenuespartially offset by higher network services revenues as further describedbelow.

 

*Video Services* –We provide video services that are primarily full-time, part-time andoccasional satellite services for the transmission of news, sports,entertainment and educational programming worldwide.  The decrease in video revenues for the threeand six months ended June 30, 2004 is due primarily to customer credit relatedissues in international regions, some of which resulted in the second quarter2004 charge of $29.6 million, which is more fully described above.

 

*Network Services* –We provide network services, which support satellite-based networks that relayvoice, video and data communications within individual countries, throughoutregions and on a global basis.  Theincrease in revenues from network services for the three months ended June 30,2004 was primarily related to data services within the Middle East and VSATapplications in North America.  Theincrease in revenue from network services for the six months ended June 30,2004 was related to network resellers, data services within the Middle East andadditional revenues related to VSAT applications in North America.

 

*Government Services*– Our FSS segment provides our G2 segment with satellite capacity.  This revenue eliminates in consolidation.

 

*Other* - We provideTT&C, in-orbit back-up service and other services for our customers.

 

Income fromoperations and EBITDA - The decrease in FSS income from operations and EBITDAfor the three months ended June 30, 2004, was primarily due the $29.6 millionpre-tax charge recorded in relation to the write-off of a customer’s long andshort-term receivable balances during the second quarter of 2004 (See “-Management Overview” above).  Thedecrease in FSS income from operations and EBITDA for the six months ended June30, 2004, was primarily due to the loss on the impairment of PAS-6 and the$29.6 million pre-tax charge described above.

 

***G2 Segment:***

 

Revenue - Theincrease in G2 segment revenues of $7.2 million for the three months ended June30, 2004, as compared to the same period in 2003, was due to an increase of$4.3 million in revenue earned from our long-term construction arrangement witha customer to construct an L-Band navigational payload on our Galaxy 1Rreplacement satellite (Galaxy 15).  Theincrease in revenue was also due to an increase in equipment-based andnon-satellite bandwidth sales as compared to the same period in 2003.  The increase in G2 segment revenues of $19.4million for the six months ended June 30, 2004, as compared to the six monthsended June 30, 2003, reflectsa full six months of operations in 2004 for the HGS and Esatel acquisitionsmade during 2003, as well as an increase in equipment-based and non-satellitebandwidth sales, as compared to the same period in 2003.  The increase was also due to an increase of$6.7 million in revenues earned from our long-term construction arrangementwith a customer to construct an L-Band navigational payload on our Galaxy 1Rreplacement satellite (Galaxy 15). This construction of the L-Band navigationalpayload began in October 2003.

 

32

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Income from operations and EBITDA – Income from operations and EBITDAincreased $1.3 million and $1.2 million for the three and six months ended June30, 2004, respectively, as compared to the same periods in 2004.  These increases for both 2004 periods were primarily a result of thehigher revenues earned during these periods, as discussed above, partiallyoffset by the related cost of sales.  TheG2 segment’s gross margins remained relatively flat period over period.

 

**ContractedBacklog**

 

Contracted backlog represents the actual dollar amount (withoutdiscounting for present value) of the expected future cash payments to bereceived from customers under all contractual agreements, including operatingleases, sales-type leases and related service agreements, which may extend tothe end of the life of the satellite or beyond to a replacement satellite.Contracted backlog is attributable to both satellites currently in orbit andthose planned for future launch. As of June 30, 2004, we had contracted backlogfor future services of $4.52 billion, which was down from $4.73 billion as ofMarch 31, 2004. This decrease was due to an $80.4 million reduction tocontracted backlog as a result of the customer termination described below anda $135 million net reduction to contracted backlog as a result of customeractivity during the three months ended June 30, 2004 (primarily resulting fromcustomer billings during the quarter, partially offset by net new contractedbacklog recorded as a result of the execution of customer contracts) (See Note12 “Related Party Transactions” within our Consolidated Financial Statements).

 

**SatelliteTechnology**

 

On March 17, 2004, our PAS-6 satellite, anFS 1300 model satellite built by Space Systems/Loral, suffered an anomalyresulting in a loss of power.  Followingthat event, we moved the satellite to a storage orbit while we evaluated theproblem with the manufacturer.  On April1, 2004, this satellite experienced another anomaly and more significant lossof power.  Neither of these losses wasanticipated.  We maintainedcommunications with, and control of, this satellite and, as a result of thesecond anomaly, took the necessary steps to de-orbit it.

 

PAS-6 had previously been taken out of primary service and was used as abackup for another satellite, PAS-6B. Accordingly, these events did not affect service to any of our customersand we anticipate that they will not affect our revenues in 2004.  We do not plan to replace this satellite.** **Asa result of the March 17 event, we recorded a non-cash impairment charge withinincome from operations of approximately $99.9 million in the first quarter of2004.  This resulted in a non-cash chargeto net income after taxes of approximately $63.3 million.  PAS-6 was uninsured and we will not collectinsurance proceeds as a result of these events. Further, as a result of this impairment, we will no longerdepreciate this asset and will not record $6.2 million of depreciation expenseduring the remainder of 2004.

 

Galaxy 8-i was fully depreciated in July 2002 and was deorbited inFebruary 2004.

 

**SatelliteDeployment Plans**

 

We expect to launch three satellites by the end of 2006. We arescheduled to launch Galaxy 14 in the fourth quarter of 2004 to replace Galaxy12 as an in-orbit spare at 74 degrees west longitude. We plan to replace Galaxy5 at 125 degrees west longitude with Galaxy 12. We plan to launch Galaxy 15 inthe first quarter of 2005 to replace Galaxy 1R at 133 degrees west longitude.This satellite will includean additional L-band payload.  We plan to launch Galaxy 16 in the secondquarter of 2006 to replace Galaxy 4R at 99 degrees west longitude.  In addition, we plan to construct and launcha replacement satellite for PAS-6B prior to the end of its useful life,although no commitment has been made for the procurement of this satellite atthis time.

 

In April 2004, we committed to acquire a new satellite from SpaceSystems/Loral, which would replace our Galaxy 4R satellite and would be knownas Galaxy 16. In June 2004, we paid The DIRECTV Group $28.5 million toreimburse them in full for amounts previously paid on our behalf to themanufacturer of this satellite.  Also inJune 2004, we committed to purchase Galaxy 17, an on-ground spare for Galaxy11, which will also serve as a spare to protect against launch failure of Galaxy16. The aggregate commitment related to these construction agreements isapproximately $200 million and will be paid over the next two years (See“Commitments and Contingencies” below).

 

Assumingsatellites under development are successfully launched and services on thesatellites commence on schedule, we believe that amounts available under theRevolving Facility, vendor financing, future cash flows from operations andcash on hand will be sufficient to fund our operations and our remaining costsfor the construction and launch of satellites currently under development.  There can be no assurance, however, that ourassumptions with respect to costs for future construction and launch of oursatellites will be correct, or that amounts available under the RevolvingFacility, vendor financing, future cash flows from operations and cash on 

 

33

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hand will besufficient to cover any shortfalls in funding for (i) launches caused byuninsured launch or in-orbit failures, (ii) cost overruns, (iii) delays, (iv)capacity shortages, or (v) other unanticipated expenses.

 

**Liquidityand Capital Resources**

 

***Cash and CashEquivalents***

 

At June 30, 2004,we had cash and cash equivalents of $627.8 million, compared to $511.2 millionat December 31, 2003.  During the sixmonths ended June 30, 2004 we recorded the following significant transactionsimpacting cash and cash equivalents:

 

•                  Generated $222.3 million of cashflows from operations

 

•                  Made $83.9 million of capitalexpenditures

 

•                  Repaid $350 million of debt

 

•                  Received $286.9 million of insuranceproceeds

 

•                  Included in the increase in cashflows from operations is $64.9 million of interest payments made during thefirst six months of 2004 relating to our debt and incentive obligations

 
| ** **                                          | ** ** | **Six Months Ended****    June 30, 2004** | ** ** | **Six Months Ended**** June 30, 2003** | ** ** | **DollarChange** | ** ** |
|-----------------------------------------------------|------------|------------------------------------------------|------------|---------------------------------------------|------------|------------------|------------|
| ** **                                          | ** ** | **(In thousands)**                             | ** ** |
| Net cash provided by operating activities           |       | $                                              | 222,259    |                                        | $          | 229,166          |       | $ | (6,907 | ) |
| Net cash provided by (used in) investing activities |       | 231,455                                        |       | (19,392                                     | )          | 250,847          |       |
| Net cash provided by (used in) financing activities |       | (337,075                                       | )          | (198,655                                    | )          | (138,420         | )          |
|                                                     |            |                                                |            |                                             |            |                  |            |  |  |  |

 

The decrease in the net cash provided byoperating activities was primarily attributable to a $21.5 change in prepaidexpenses and other assets as a result of the recording our 1997 federal incometax refund of $18.6 million in 2002. This decrease in cash flows from operations was partially offset by adecrease in cash used within accounts payable and accrued liabilities of $11.5million.  The decrease in cash usedwithin accounts payable and accrued liabilities was primarily a result ofchanges in accrued interest and scheduled interest payments after the repaymentof $850 million and $350 million of debt during 2003 and the six months endedJune 30, 2004, respectively.

 

The increase in net cash provided byinvesting activities was primarily due to the receipt of $286.9 million ofinsurance proceeds during 2004.  Thisincrease was partially offset by:

 

•                  Anincrease in capital expenditures of $29.1 million

 

•                  Achange of $14.8 million related to short-term investments.  During the six months ended June 30, 2003, wehad net sales of short-term investments of $43.7 million as compared to netsales of short-term investments of $28.9 million during the six months endedJune 30, 2004.

 

The increase in cash used within financing activities was primarily dueto an increase of $150.0 million of debt repaid during the six months endedJune 30, 2004 as compared to the six months ended June 30, 2003.  This increase in cash used within financing activitieswas partially offset by new satellite incentive obligations related to theGalaxy 13/Horizons 1 satellite of $16.3 million recorded in January 2004.

 

***Long-term Debt***

 

At June 30, 2004, we had total debt outstanding of approximately $1.35billion, including current maturities of $275 million related to our 6 1/8%Senior Notes due 2005.

 

In June 2004, we repaid the $349.1 million outstandingbalance under our Term B-1 Facility from available cash on hand. In conjunctionwith this repayment, we recorded a charge of $5.5 million within interestexpense as a result of the write-off of unamortized debt issuance costs relatedto the Term B-1 Facility and a charge of $0.5 million within interestexpense representing the amount accumulated within other comprehensive incomerelated to our $100.0 million interest rate hedge on our Term B-1Facility. The hedge liability was not impacted by the repayment of the Term B-1Facility. The fair value of the outstanding interest-rate hedge agreement as of June 30, 2004,based upon quoted market prices from the counterparty, reflected a hedgeliability of approximately 

 

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$0.8 million.  Upon expiration ofthe current agreement on August 30, 2005, we will not be required to enter intoan interest rate hedge agreement under the Senior Secured Credit Facility.

 

Our Senior Secured Credit Facility is comprised of a $250.0 millionrevolving credit facility,which is currently undrawn and will terminate on December 31, 2007 (the“Revolving Facility”). We are also required to pay a commitment fee for theunused commitments under the Revolving Facility, which, as of June 30, 2004, onan annualized basis was 0.375%.  We hadoutstanding letters of credit totaling $1.1 million, which reduce our ability to borrow against the Revolving Facilityby such amount.  Any amounts borrowedunder the Revolving Facility would bear interest at LIBOR plus 2.25% as of June30, 2004, although this interest rate is subject to adjustment based on our totalleverage ratio.

 

As of June 30, 2004, we also had outstanding $800 million 8 1⁄2% SeniorNotes due 2012 with a stated interest rate of 8.5% (the “Senior Notes”).  Obligations under the 8 1⁄2% Senior Notes due2012 are, or will be, as the case may be, unconditionally guaranteed by each ofour existing and subsequently acquired or organized domestic and, to the extentno adverse tax consequences would result therefrom, foreign restrictedsubsidiaries.

 

We also had outstanding seven, ten and thirty-year fixed rate notestotaling $550 million issued in January 1998. The outstanding principalbalances, interest rates and maturity dates for these notes as of June 30, 2004 were $275million at 6 1/8% due January 2005, $150 million at 6 3/8% due 2008 and $125million at 6 7/8% due 2028, respectively. Principal on these notes is payable at maturity, while interest ispayable semi-annually.

 

In connection with the PanAmSat Sale, we intend to enter into newsenior secured credit facilities, consisting of an $800.0 million Term Loan AFacility, a $1,860.0 million Term Loan B Facility and a $250.0 millionrevolving credit facility, and to incur $1,010.0 million aggregate principalamount of senior unsecured indebtedness.

 

We have commenced tender offers to purchase any and all of theoutstanding $800.0 million aggregate principal amount of our 81⁄2% Senior Notesdue 2012 and any and all of the outstanding $275.0 million aggregate principalamount of our 61/2 % Senior Notes due 2005 for cash.  The tender offers are conditioned upon, amongother things, the incurrence of the $1,010.0 million aggregate principal amountof senior unsecured indebtedness.

 

We are required to maintain certain financial covenants and are also subject to restrictivecovenants under our borrowings.  As ofJune 30, 2004, we were in compliance with all such covenants.

 

***CapitalExpenditures***

 

We expect oursignificant cash outlays will continue to be primarily capital expendituresrelated to the construction and launch of satellites and debt service costs. Wehave satellites in various stages of development, for which we have budgetedcapital expenditures.  We currentlyexpect to spend between $165 million and $195 million on capital expendituresduring 2004, which will primarily be comprised of costs to construct, insureand launch satellites.

 

***FacilitiesRestructuring and Severance Costs***

 

In January 2003,our management approved a plan to consolidate certain of our teleports in orderto improve customer service and reduce operating costs.  This teleport consolidation plan includes theclosure of certain owned teleports and the reduction of services at ourFillmore and Castle Rock teleports. Under this plan, our Homestead, Florida teleport was closed in 2003 andin June 2004 we closed our Spring Creek, New York teleport. We expect to sellour Spring Creek Teleport later in 2004 (see below).  During the year ended December 31, 2003 andthe six months ended June 30, 2004, we recorded charges of $4.2 million and$1.0 million, respectively, related to this teleport consolidation plan,primarily representing severance costs.

 

In the second quarter of 2004, we reached agreement with one of ourcustomers to move their teleport service from our Spring Creek teleportfacility to one of our other teleport facilities. This agreement allowed us toclose the Spring Creek teleport facility at the end of the second quarter of2004 and proceed with its planned sale. We plan on selling this teleportfacility and related assets for approximately $14.4 million, net of associatedselling costs. As a result, we have reflected the assets of the Spring CreekTeleport of $3.3 million as “Assets Held for Sale” on our balance sheet as ofJune 30, 2004. The sale of this teleport is expected to close later in 2004 andis expected to result in a pre-tax gain of approximately $11.2 million, whichwill be recorded during that period.

 

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We estimate that this teleport consolidation plan will result inapproximately $7 million of costs through the end of 2004 and a gain on thedisposal of land, buildings, and equipment of approximately $11 million thatwill be recorded upon the sale.  Thesecosts primarily consist of severance-related costs for which the employees willbe required to perform future services. Severance-related costs associated with this consolidation plan includecompensation and benefits, outplacement services and legal and consultingexpenses related to the reduction in workforce of approximately 40 employees.

 

In an effort to furtherstreamline our operations, in the first quarter of 2004, we consolidated ourManhattan Beach, El Segundo and Long Beach, California facilities.  As a result, we recorded a non-cash charge of$1.4 million reflecting future lease costs related to approximately 18,000square feet of unused facilities in Manhattan Beach (See Note 9 “Facilities Restructuring and Severance Costs” within ourConsolidated Financial Statements).

 

**Commitments and Contingencies**

 

***Satellite IncentiveObligations***

 

Satellite contracts typically require thatwe make progress payments during the period of the satellite’s construction andorbital incentive payments (plus interest) over the orbital life of thesatellite. The incentive obligations may be subject to reduction or refund ifthe satellite fails to meet specific technical operating standards. As of June30, 2004, we had $134.7 million of liabilities recorded in relation to thesesatellite incentive obligations.

 

***SatelliteCommitments***

 

As of June 30, 2004, we had approximately $163.8 million ofexpenditures remaining under existing satellite construction contracts and$36.3 million remaining under existing satellite launch contracts.  Satellite launch and in-orbit insurancecontracts related to future satellites to be launched are cancelable up to thirty days prior tothe satellite’s launch. As of June 30, 2004, we did not have any non-cancelablecommitments related to existing launch insurance or in-orbit insurancecontracts for satellites to be launched.

 

Through June 30, 2004, we had made approximately $154.8 million ofcapital expenditures in relation to Galaxy 14 and Galaxy 15. We also spent$65.8 million for launch costs originally intended for Galaxy 8-iR and$6.0 million for another future launch. As a result of the termination ofthe Galaxy 8-iR construction contract, we now expect to use this launch inearly 2006 to replace our Galaxy 4R satellite.

 

In April 2004, we committed to acquire a new satellite from SpaceSystems/Loral, which would replace our Galaxy 4R satellite and would be knownas Galaxy 16. In June 2004, we paid The DIRECTV Group $28.5 millionto reimburse them in full for amounts they previously paid on our behalf to themanufacturer of this satellite. Also in June 2004, we executed a definitiveagreement for the procurement of Galaxy 17 an on-ground spare for Galaxy 11,which will also serve as a spare to protect against launch failure of Galaxy16. The aggregate commitment related to these construction agreements isapproximately $200 million, which will be paid over the next two years.

 

***Satellite Insurance***

 

On February 19, 2003, we filed proofs of loss under the insurancepolicies for two of our BSS 702 spacecraft, Galaxy 11 and PAS-1R, forconstructive total losses based on degradation of the solar panels. On December29, 2003, we reached a settlement of these insurance claims for payment of $260million with no future revenueshare.  We offset the proceeds from thissettlement against the carrying value of the satellites. In the first quarterof 2004, we received the $260 million settlement amount.

 

On July 31, 2003, we filed a proof of loss under the insurance policy for our Galaxy 4R spacecraftafter the secondary Xenon Ion Propulsion System (“XIPS”) on this satelliteceased working.  In 2003, we settled withand received $102.6 million from insurers representing approximately 83 percentof the insurance coverage on the satellite. In March 2004, we reached an agreement with and received $26.9 millionfrom the insurer representing the remaining 17 percent of the insurancecoverage on this satellite.  Thesettlement with the insurer representing 17 percent coverage includes a futuresharing of revenues actually received from the satellite.  We proportionately offset the proceeds fromthese settlements against the insured carrying value of the satellite and thenet investment in sales-type lease.  Weare planning on replacing this satellite with Galaxy 16 prior to the end of itsuseful life using the insurance proceeds and a prepaid launch service contractthat we had purchased previously.

 

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During the first quarter of 2004 we received $286.9 million ofinsurance proceeds under the insurance policies for Galaxy 11, PAS-1R andGalaxy 4R satellites.  These proceedswere held in a collateral account and were classified as restricted cashpursuant to the terns of our existing senior secured credit facilities untilrestrictions were lifted in June 2004.

 

As of June 30, 2004, we had in effect launch and in-orbit insurancepolicies covering seven satellites in the aggregate amount of approximately$846.1 million.  As of such date, theseinsured satellites had an aggregate net book value and other insurable costs of$927.2 million.  We have 17 uninsuredsatellites in orbit.  The uninsuredsatellites are: PAS-4, which is used as a backup satellite; PAS-5 and PAS-7,for which we received insurance proceeds for constructive total losses; Galaxy 1R,Galaxy 3R, Galaxy 5 and SBS-6, which are approaching the ends of their usefullives; Galaxy 11 and PAS-1R, for which we received insurance proceeds forpartial losses; PAS-2, PAS-3R, PAS-6B, PAS-8 and Galaxy 9, for which wedetermined that insurance was not available on commercially reasonable terms;and HGS-3, HGS-5 and Leasat, which have an aggregate book value of less than$1.0 million.  Our Galaxy 12 and Galaxy 9satellites currently serve as in-orbit backups for the C-band portions ofGalaxy 1R, Galaxy 4R, Galaxy 5, Galaxy 10R, Galaxy 11 and Galaxy 13/Horizons 1(See “Satellite Deployment Plans” above).

 

Of the insured satellites, as of June 30, 2004, three were covered bypolicies with substantial exclusions or exceptions to coverage for failures ofspecific components identified by the underwriters as at risk for possible failure(“Significant Exclusion Policies”).  Theexclusions reduce the probability of an insurance recovery in the event of aloss on these satellites.  One of thesatellites, PAS-9, has operational redundancies available for the systems onwhich exclusions have been imposed.  Webelieve that this redundancy allows for uninterrupted operation of thesatellite in the event of a failure of the component subject to the insuranceexclusion.  The second such satellite,Galaxy 4R, for which we have received insurance proceeds, has a remainingpolicy covering $20.0 million of investments in sales-type leases that also hasa policy exclusion for XIPS related anomalies. Galaxy 4R is currently operatingon its backup bi-propellant propulsion system. The third satellite, Galaxy 13/Horizons 1, which was placed in servicein January 2004 and is insured by a policy with an exclusion for XIPS relatedanomalies, continues to have fully redundant XIPS as its primary propulsionsystem.  Certain enhancements have beenmade to the XIPS on this satellite to make the systems more robust.  In addition, this satellite has availablebackup bi-propellant of approximately 11.9 years.

 

At June 30, 2004, the uninsured satellites and the satellites insuredby Significant Exclusion Policies had a total net book value and otherinsurable costs of approximately $1.1 billion. Of this amount, $800.0 millionrelated to uninsured satellites and $281.7 million related to satellitesinsured by Significant Exclusion Policies.

 

***Change-in-ControlObligations***

 

Upon consummation of the PanAmSat Sale, all outstanding employee stockoptions which have not yet vested will vest and become exercisable, and alloutstanding restricted shares and restricted stock units will vest immediatelyprior to the Merger.  We currentlyestimate that upon the consummation of the PanAmSat Sale, we will be requiredto record a charge of approximately $6 million in relation to the accelerationof vesting of these options, restricted shares and restricted stock units.Holders of options and restricted stock units will be entitled to receive (i)with respect to in-the-money options, cash equal to the difference between theexercise price and the $23.50 per share price to be paid in the PanAmSat Sale,and (ii) with respect to restricted shares and restricted stock units cash inthe amount of $23.50 per share, except for any stock options, restricted sharesand restricted stock units held by certain employees who have agreed not tohave their equity interests cashed out in the Merger or the PanAmSat Sale, asapplicable.  All out-of-the-money stockoptions will be cancelled without payment. In addition, our Severance Pay Plan allows for the payment of enhancedseverance to employees laid off or who resign for good reason (as defined in suchplan) as a result of, and within two years after, a change-in-control.

 

One of our executives is party to an employment agreement whichprovides for, among other things, the payment of severance and other benefitsupon the termination of the executive without cause or for good reason (asdefined in such agreement) or if we decline to extend such agreement.  Certain other senior executives are party tochange-in-control severanceagreements, which provide for payment of severance and other benefits in theevent of an involuntary termination of the executive’s employment (as definedin such agreements) within three years after a change in control of The DIRECTVGroup.  As a change in control of TheDIRECTV Group occurred on December 22, 2003, these agreements will apply if aninvoluntary termination of the executive occurs on or before December 22,2006.  Based upon current compensationlevels, if all of these executives receive the termination related benefits asspecified by their respective agreements, the aggregate cost to us would be inthe range of $9.0 million to $11.0 million.

 

Certain of our other executives have change-in-control severanceagreements which provide for, among other things, the payment of severance andother benefits upon the termination of the executive without cause or for goodreason within three years after a change in control of PanAmSat, as defined intheir respective agreements.The PanAmSat Sale would result in a change-in-control under these 

 

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agreements.  Based upon currentcompensation levels, if all of these executives receive the termination relatedbenefits as specified by their respective agreements, the aggregate cost to uswould be approximately $5 million in addition to the costs described above withrespect to our senior executives.  Theseagreements expire if no change in control of PanAmSat has occurred by December31, 2004.

 

In addition, our Severance Pay Plan allows for the payment of enhancedseverance to employees laid off or who resign for good reason (as defined insuch plan) as a result of, and within two years after, a change-in-control.

 

***Foreign WithholdingTaxes***

 

We have outstanding tax claims related to withholding taxes assessed onrevenues derived from broadcasters inside and outside of India who broadcastfrom or into India.  The Indiangovernment has assessed approximately $7.3 million (reduced from an initialassessment of $15.2 million) against one of our subsidiaries for the Indian taxyear ended March 31, 1997.  Thisassessment is being appealed to the Income Tax Appeals Tribunal.  For Indian tax years ended March 31, 1996,1998, 1999, 2000 and 2001, the Indian government has assessed approximately$34.5 million in the aggregate against us. This assessment has been appealed to the Commissioner of Income Tax(Appeals).  We are contesting theimposition of such taxes.  While thiscontest proceeds, we may be required to advance cash or provide a bankguarantee for amounts up to the total assessment.  If unsuccessful in our contest, we could besubject to comparable claims for subsequent years. The DIRECTV Group has agreedto indemnify us for certain of our tax obligations, including foreignwithholding tax obligations (See “PanAmSat Merger, Subsequent Sale and RelatedTransactions” above).

 

**NewAccounting Pronouncements**

 

There are noissued statements awaiting implementation that are expected to have a materialimpact on our financial statements.

 

**MarketRisks**

 

We manage ourexposure to market risks through internally established policies and proceduresand, when we deem appropriate, through the use of derivative financialinstruments. We use derivative financial instruments, including interest ratehedges, to manage market risks. Additional information regarding our interestrate hedge is contained within “Liquidity and Capital Resources – Long-termDebt” above. The objective of our policies is to mitigate potential incomestatement, cash flow and fair value exposures resulting from possible future adversefluctuations in interest rates. We evaluate our exposure to market risks byassessing the anticipated near-term and long-term fluctuations in interestrates on a daily basis. This evaluation includes the review of leading marketindicators, discussions with financial analysts and investment bankersregarding current and future economic conditions and the review of marketprojections as to expected future interest rates. We utilize this informationto determine our own investment strategies as well as to determine if the useof derivative financial instruments is appropriate to mitigate any potentialfuture interest rate exposure that we may face. Our policy does not allowspeculation in derivative instruments for profit or execution of derivativeinstrument contracts for which there are no underlying exposures. We do not usefinancial instruments for trading purposes and are not a party to any leveragedderivatives.

 

We determine theimpact of changes in interest rates on the fair value of our financial instrumentsbased on a hypothetical 10% adverse change in interest rates from the rates ineffect as of the end of the period for these financial instruments. We useseparate methodologies to determine the impact of these hypothetical changes onour sales-type leases, fixed rate public debt and variable rate debt asfollows:

 

•                  For our sales-type leases, a discountrate based on a 10-year U.S. Treasury bond is applied to future cash flows fromsales-type leases to arrive at a base rate present value for sales-type leases.This discount rate is then adjusted for a negative 10% change and then appliedto the same cash flows from sales-type leases to arrive at a present valuebased on the negative change. The base rate present value and the present valuebased on the negative change are then compared in order to arrive at thepotential negative fair value change as a result of the hypothetical change ininterest rates.

 

•                  For our fixed rate public debt, thecurrent market price, coupon and maturity are used to determine the yield foreach public debt instrument as of the end of the period. The yield is thenadjusted by a factor of 10% and this revised yield is then compared to theoriginal yield to determine the potential negative fair value change as aresult of the hypothetical change in interest rates.

 

The only potentiallimitations of the respective models are in the assumptions utilized in themodels such as the hypothetical adverse

 

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fluctuation rateand the discount rate. We believe that these models and the assumptionsutilized are reasonable and sufficient to yield proper market risk disclosure.

 

We did notexperience any material changes in interest rate exposures during the sixmonths ended June 30, 2004.  Based uponeconomic conditions and leading market indicators at June 30, 2004, we do notforesee a significant adverse change in interest rates in the near future. As aresult, our strategies and procedures to manage exposure to interest rates havenot changed in comparison to the prior year.

 

As of June 30,2004, long-term debt consisted of fixed-rate borrowings of approximately $1.35billion, and a fixed interest rate hedge obligation in a notional amount of$100 million (refer to “Liquidity and Capital Resources – Long-term Debt”above). Fluctuations in interest rates may affect the fair values of fixed-rateborrowings and fixed-rate net investments in sales-type lease receivables. Anychanges in interest rates would impact results of operations and cash flows. AtJune 30, 2004, outstanding fixed-rate borrowings bore interest at rates rangingfrom 6 1/8% to 8 1/2%, and sales type lease receivables bore interest between 8% and 12 %. The potential fair value change resulting from a hypothetical 10%adverse fluctuation in interest rates related to our outstanding fixed-ratedebt and fixed-rate net investment in sales-type lease receivable balanceswould be approximately $42.9 million and $3.0 million as of June 30, 2004.

 

**ITEM3.  QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK.**

 

See “Item 2.Management’s Discussion and Analysis of Financial Condition and Results ofOperations - Market Risks.”

 

**ITEM 4.  CONTROLS AND PROCEDURES.**

** **

Based upon therequired evaluation of our disclosure controls and procedures (as defined inRules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, asamended (the “Exchange Act”)), our Chief Executive Officer and our ExecutiveVice President and Chief Financial Officer concluded that our disclosure controlsand procedures were effective as of June 30, 2004.

 

There has been no change in our internal control over financialreporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act)that occurred during our fiscal quarter ended June 30, 2004, that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

 

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**PANAMSAT CORPORATION**

 

**PART II - OTHER INFORMATION**

 

**ITEM1.  LEGAL PROCEEDINGS.**

 

We haveoutstanding tax claims related to withholding taxes assessed on revenuesderived from broadcasters inside and outside of India who broadcast from orinto India.  The Indian government hasassessed approximately $7.3 million (reduced from an initial assessment of$15.2 million) against one of our subsidiaries for the Indian tax year endedMarch 31, 1997.  This assessment is beingappealed to the Income Tax Appeals Tribunal. For Indian tax years ended March 31, 1996, 1998, 1999, 2000 and 2001, theIndian government has assessed approximately $34.5 million in the aggregateagainst us.  This assessment has beenappealed to the Commissioner of Income Tax (Appeals).  We are contesting the imposition of suchtaxes.  While this contest proceeds, wemay be required to advance cash or provide a bank guarantee for amounts up tothe total assessment.  If unsuccessful inour contest, we could be subject to comparable claims for subsequent years.

 

We periodicallybecome involved in various claims and lawsuits that are incidental to ourbusiness. Other than the matter described above, we believe that no matterscurrently pending would, in the event of an adverse outcome, be material.

 

**ITEM 6. EXHIBITS AND REPORTS ON FORM8-K.**

** **
| (a)               |   | 2.1                                                                                                                                          |   | Transaction  Agreement, dated as of April 20, 2004, by and among The DIRECTV Group, Inc.,  PAS Merger Sub, Inc., PanAmSat Corporation and Constellation, LLC is  incorporated herein by reference to Exhibit 1 to PanAmSat Corporation’s  Schedule 13D/A filed on April 22, 2004. |
|-------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|              |   |                                                                                                                                         |   |                                                                                                                                                                                                                                                                                   |
|              |   | 31.1                                                                                                                                         |   | Certification of  the Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) of the  Securities Exchange Act of 1934, as amended. *                                                                                                                                         |
|              |   |                                                                                                                                         |   |                                                                                                                                                                                                                                                                                   |
|              |   | 31.2                                                                                                                                         |   | Certification of  the Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) of the  Securities Exchange Act of 1934, as amended. *                                                                                                                                         |
|              |   |                                                                                                                                         |   |                                                                                                                                                                                                                                                                                   |
|              |   | 32.1                                                                                                                                         |   | Certification by  Chief Executive Officer pursuant to 18 U.S.C. Section 1350. *                                                                                                                                                                                                        |
|              |   |                                                                                                                                         |   |                                                                                                                                                                                                                                                                                   |
|              |   | 32.2                                                                                                                                         |   | Certification by  Chief Financial Officer pursuant to 18 U.S.C. Section 1350. *                                                                                                                                                                                                        |
|              |   |                                                                                                                                         |   |                                                                                                                                                                                                                                                                                   |
|                   |
| * Filed herewith. |
|              |   |                                                                                                                                         |   |                                                                                                                                                                                                                                                                                   |
| (b)               |   | Reports on Form  8-K.                                                                                                                        |
|              |   |                                                                                                                                         |   |                                                                                                                                                                                                                                                                                   |
|              |   | On May 11, 2004,  we furnished a Current Report on Form 8-K with Items 7, 9 and 12 disclosures  with the Securities and Exchange Commission. |
|              |   |                                                                                                                                         |   |                                                                                                                                                                                                                                                                                   |
|              |   | On July 12,  2004, we filed a Current Report on Form 8-K with Item 7 and 11 disclosures  with the Securities and Exchange Commission.        |
|              |   |                                                                                                                                         |   |                                                                                                                                                                                                                                                                                   |
|              |   | On July 15,  2004, we furnished a Current Report on Form 8-K with Items 7 and 9  disclosures with the Securities and Exchange Commission.    |
|              |   |                                                                                                                                         |   |                                                                                                                                                                                                                                                                                   |
|              |   | On July 22,  2004, we furnished a Current Report on Form 8-K with Item 12 disclosures with  the Securities and Exchange Commission.          |
|              |   |                                                                                                                                         |   |                                                                                                                                                                                                                                                                                   |
|              |   | On July 22,  2004, we furnished a Current Report on Form 8-K with Items 7 and 9  disclosures with the Securities and Exchange Commission.    |

 

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**SIGNATURE**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
| PanAmSat Corporation |   |   |                                                                                                 |
|----------------------|--------|--------|------------------------------------------------------------------------------------------------------|
|                 |   |   |                                                                                                 |
| July 29, 2004        |   |   | /s/ Michael J.  Inglese                                                                              |   |
|                 |   |   | Michael J.  Inglese                                                                                  |
|                 |   |   | Executive Vice President and  Chief Financial Officer  and a Duly Authorized  Officer of the Company |

 

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