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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-24710
CD RADIO INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 52-1700207
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
SIXTH FLOOR, 1001 22ND STREET, N.W. WASHINGTON, D.C. 20037
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (202) 296-6192
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
- ----------------------------------------------------------------------------------------------
None None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $0.001 PER SHARE
(TITLE OF CLASS)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
Aggregate market value of the Registrant's Common Stock held by
non-affiliate as of March 12, 1997 was approximately $39,867,376. The number of
shares of the Registrant's Common Stock outstanding as of March 12, 1997, was
10,300,391.
DOCUMENTS INCORPORATED BY REFERENCE
None.
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P A R T I
FORWARD-LOOKING STATEMENTS
Certain statements in this Annual Report on Form 10-K constitute
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. For example, the Company's service, CD Radio, is
in the planning and development stage and the descriptions set forth herein as
to how the Company plans to implement, market and operate the service are
forward-looking statements, and are subject to change based on future
developments, the Company's experience, and involve known and unknown risks,
uncertainties and other factors that may cause the actual results, performance
or achievements of the Company, or developments in the Company's industry, to
differ materially from the anticipated results, performance or achievements
expressed or implied by such forward-looking statements. Such factors include,
but are not limited to: risk of not receiving an FCC License in the scheduled
auction; potential risk of delay; increased costs of construction and launch of
necessary satellites; dependence on satellite construction and launch
contractors; risk of launch failure; unproven market acceptance of the Company's
services; the continuing losses of the Company; reliance on unproven technology;
need for substantial additional financing and other risks and uncertainties
described under "Business -- Risk Factors" in Part I of this Annual Report on
Form 10-K. Certain of the forward-looking statements contained in this Annual
Report are identified with cross references to this section and/or to specific
risks identified under "Business -- Risk Factors."
ITEM 1. BUSINESS
The Company is a pioneer in the emerging satellite-to-car broadcasting
industry ("satellite radio"). The Company is engaged in the development of a
subscription based satellite radio system for the nationwide broadcast of 30
channels of commercial-free, compact disc quality music programming and up to 20
channels of all-news, all-sports, and all-talk programming. The Company's
primary market is expected to be operators of cars and trucks throughout the
continental United States. Government statistics indicate that there will be
approximately 192 million registered vehicles in the United States in 1999,
rising to approximately 200 million vehicles by 2004. The Company plans to
broadcast its service, to be called CD Radio, via its own custom designed and
built satellite system utilizing technology developed by the Company.
CD Radio is designed to offer:
(i) A programming selection of finely focused formats. In most markets
radio broadcasters target their programming at broad audience segments, and
even in the largest metropolitan markets, station formats are limited.
(ii) Widespread signal coverage throughout the continental United
States. Terrestrial radio signal availability, in contrast, is generally
limited to distances of approximately 30 miles before fading and loss
occur.
(iii) Commercial-free music programming. Almost all radio stations are
advertiser supported and contain significant amounts of commercial
interruptions to programming.
(iv) CD quality stereo audio.
Upon commencing CD Radio service, the Company anticipates that it will
offer CD Radio to subscribers for a monthly subscription fee of $10 or less,
which would entitle the subscriber to receive all channels.
CD Radio is designed to be broadcast via satellites over a new radio band,
the S-band, which will augment the traditional AM/FM radio bands. In order to
receive CD Radio, subscribers will need satellite band radios which are not
currently commercially available. The Company anticipates that satellite radios
will be manufactured by existing manufacturers of consumer electronics and
automakers, and when manufactured in quantity will be somewhat more expensive
than today's car radios. See "Forward-Looking Statements." The Company expects
that satellite car radios will be similar in size and appearance to today's
AM/FM car radios, and will include the AM/FM bands, as well as the satellite
band. In addition, the Company expects these radios to include a digital display
capable of showing the CD Radio channel number, music format, song
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title, recording artist and album title. See "Forward-Looking Statements." Each
satellite radio will require a satellite dish antenna in order to receive the
satellite signal. The Company has developed what it believes is the world's
smallest satellite dish, which measures approximately 1/8 inch thick and 2
inches in diameter (approximately the size and shape of a silver dollar) and can
fit unobtrusively in a variety of locations on a vehicle. Although the Company
does not intend to manufacture or distribute satellite radios or dish antennas,
it intends to foster their development by communicating to such manufacturers
the specifications needed for the reception of CD Radio.
In order to provide CD Radio, the Company will need to build and launch
into geosynchronous orbit two fully dedicated satellites designed to operate at
special frequencies. The Company has entered into an agreement with Space
Systems/Loral, pursuant to which Space Systems/Loral has agreed to construct the
two satellites and, at the Company's option, a third spare satellite. The
Company has reserved launches with Arianespace for its two satellites during the
period extending from November 1, 1999 through April 30, 2000.
The Company has applied to the FCC for a license (the "FCC License") to
permit it to build, launch and operate its satellites to provide a satellite
radio service. The period for filing such applications expired in December 1992
and the Company is one of four remaining applicants. The FCC is scheduled to
auction two satellite radio licenses among the four applicants on April 1, 1997.
There can be no assurance that the Company will be a winning bidder in the
auction.
Since its formation in 1990, the Company has concentrated its activities on
pursuit of necessary regulatory approvals, strategic planning, technology
development and market research. The Company plans to continue these activities
and to work cooperatively with consumer electronics manufacturers and automakers
in order to foster the development of satellite radios. Once the Company obtains
its FCC License, it intends to begin construction of its satellites and
currently has targeted the second half of 1999 for launch of its two satellites
and commencement of operations. The Company's ability to meet that objective
will depend on several factors, including the timely receipt of necessary
governmental approvals, the successful financing, construction and launch into
orbit of two geosynchronous satellites, the rapid creation of an organization
and management of growth. See "Forward-Looking Statements."
THE RADIO MARKET
The potential market for CD Radio includes the owners of approximately 192
million motor vehicles expected to be registered in the United States in 1999,
rising to approximately 200 million vehicles by 2004. Other potential markets
include owners of portable, walkman, and home radios.
Broadcasting industry sources indicate that American adults listen to an
average of three hours of radio per day. In addition, such sources estimate that
automobile commuters spend 97% of their drivetime listening to the radio.
Music programming dominates the radio airwaves, with FM radio stations
exceeding AM stations in listenership. According to broadcasting industry
sources, in 1996, approximately 79% of total radio listening was to FM stations.
FM stations primarily concentrate on music programming, while AM stations have
an increased proportion of their programming devoted to talk and news.
CD Radio will be available in automobiles only to persons who install
satellite radios in their vehicles or purchase automobiles with factory
installed satellite radios. Accordingly, to assess potential initial demand for
CD Radio, the Company has examined data concerning consumer purchases of
aftermarket and new car autosound equipment and the commitment of consumers to
receiving high quality audio entertainment in their vehicles. According to
industry sources, U.S. consumers spend approximately $2.3 billion on aftermarket
autosound equipment for installation in their vehicles annually, which includes
approximately 5 million AM/FM radios. Additionally, automotive industry sources
report that over 14 million new cars and light trucks were sold in the United
States in 1996, almost all of which contained radios.
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THE CD RADIO SERVICE
The Company intends to offer 30 channels of commercial-free, all-music
programming and up to 20 additional channels of other formats that do not
require compact disc quality audio, such as all-news, all-sports and all-talk
programming. Each music channel will have a specific format, intended to cater
to a finely segmented subscriber taste. It is anticipated that upon commencement
of CD Radio the monthly subscription fee for the receipt of all CD Radio
channels will be $10 or less.
CD Radio will offer (i) multichannel "narrowcast" programming formats; (ii)
widespread signal coverage; (iii) commercial-free music programming; and (iv)
compact disc quality stereo audio.
In most markets, radio broadcasters target their programming at broad
audience segments. The Company's multichannel narrowcast programming is designed
to provide focused formats generally available only in major metropolitan areas,
and in many cases, unavailable even in these areas.
Regardless of area, terrestrial radio reception is limited to short
distances of approximately 30 miles, after which reception fades and is lost.
Additionally, terrestrial radio reception is subject to a fluctuating, broad
range of quality.
The Company's preliminary market research indicates that the principal
complaint of commuters interviewed about radio is commercials. When in the car,
many listeners attempt to avoid commercial interruptions by switching stations
at the outset of a string of commercials. The amount of radio advertising varies
with the time of day, station format and market size, but a broadcasting
industry source indicates that, on average, every hour of music programming
during morning and evening commutes is interrupted by 10 to 12 minutes of
commercials.
While terrestrial radio stations currently do not broadcast compact disc
quality stereo sound, the Company believes that FM radio stations may be in a
position to do so before the time the Company's service becomes operational.
Consumers would be unable to receive these new broadcasts on existing radios and
would require new digital radios to do so. The Company does not believe that
such a sound upgrade to digital broadcasting would affect conventional
broadcasters' ability to address the other advantages of CD Radio.
Programming will be managed by the Company's staff, with guidance from
continuous market research. The Company intends to recruit program managers from
the recording, broadcasting and entertainment industries to manage the
development of daily programming for each channel. Music programming will be
produced from the Company's music library and will be sourced from compact
discs. It is contemplated that this music library will consist of an extremely
broad range of recorded music, and will be updated as new recordings are
released. See "Forward-Looking Statements" and "Risk Factors -- Music Royalty
Payments."
The Company believes that CD Radio represents an opportunity for the
recording industry to expose, research, and promote new releases and artists to
targeted listener groups nationwide. The Company plans to solicit promotional
copies of new recordings, and contemplates showcasing these releases as part of
a service to be developed for record companies. The Company's intends to work
with the recording industry and performing artists to develop programming of
mutual benefit.
The Company believes that compact discs and cassettes are used in
automobiles as supplements to radio rather than as substitutes, and that these
media are used primarily as backup when radio reception is unavailable or
unsatisfactory, or when desired programming is unavailable or unsatisfactory.
Compact discs and cassettes lack the convenience of radio, as well as the
spontaneity and freshness that characterizes radio programming. According to
Arbitron, commuters spend 97% of their drivetime listening to radio.
Accordingly, the Company does not view its service as directly competitive with
these media.
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The following channel list (which employs terminology common to the music
industry) has been prepared by the Company to illustrate the manner in which the
Company's narrowcast programming might be marketed. The Company intends to vary
channel formats from time-to-time to reflect changing subscriber tastes.
1. Symphonic
Music from the masters, Bach, Mozart and Handel. The world's greatest
classical composers broadcast in brilliant CD fidelity.
2. Chamber Music
Elegant music performed by small ensembles of solo instruments such as the
cello, violin and woodwind.
3. Opera
Experience the drama and spectacle of the greats. Verdi, Puccini and
Wagner.
4. Today's Country
The down home sounds of today's country stars including Vince Gill, Alan
Jackson, Wynonna Judd and Garth Brooks.
5. Traditional Country
All of your favorite country & western legends are here. Stars like George
Strait, Loretta Lynn, Hank Williams, Jr. and George Jones.
6. Contemporary Jazz
The syncopated rhythms of today's jazz music. The cool sounds of Kenny G,
The Yellowjackets and David Sanborn.
7. Classical Jazz
Listen as musicians like Duke Ellington, Miles Davis and John Coltrane
experiment and expand the sounds of jazz.
8. Blues
The foundation of rock. B.B. King, Muddy Waters and Robert Cray.
9. Big Band/Swing
Relive the memories with the sounds of Tommy Dorsey, Glenn Miller and Artie
Shaw.
10. Top of the Charts
Today's hits from recording artists such as Whitney Houston, Mariah Carey
and Boyz II Men.
11. Classic Rock
The greatest hits from the 60's and 70's -- an entire generation of great
rock music. The Who, Rolling Stones and Eric Clapton.
12. 50's Oldies
Tune in and experience the 50's all over again with Chuck Berry, Little
Richard and Elvis Presley.
13. 60's Oldies
The great pop sounds of Motown, the British Invasion and Surfer Rock.
14. Folk Rock
Thoughtful, inspired melodies from performers like Joni Mitchell, James
Taylor and Joan Baez.
15. Latin Ballads
The romantic sounds of Latino vocalists. Julio Iglesias, Nino Bravo and
Roberto Carlos.
16. Latin Rhythms
Move to the music of Latino superstars such as Sergio Mendes, Juan Luis
Guerra and the legendary Tito Puente.
17. Reggae
Pulsating rhythm from the musically prolific island of Jamaica, from the
Skatelites through Bob Marley and Shabba Ranks.
18. Hip-Hop & Rap
The forefront of contemporary music. RUN-DMC, Cypress Hill and Dr. Dre.
19. Dance
Music by today's hottest artists, including Madonna, Janet Jackson and
George Michael.
20. Songs of Love
Romantic ballads and music from some of the world's most popular artists.
21. Singers & Strings
Legends like Frank Sinatra, Barbra Streisand and Nat King Cole.
22. Beautiful Instruments
Memorable melodies of contemporary music orchestrated with a full, lush and
easy sound.
23. Heavy Metal
Driving, hard charging rock-and-roll by bands such as Guns N' Roses,
Metallica and Danzig.
24. Album Rock
The best songs from today's top rock artists. Pearl Jam, U2 and John
Mellencamp.
25. Alternative Rock
Modern rock from such diverse bands as the Red Hot Chili Peppers, Midnight
Oil and Smashing Pumpkins.
26. New Age
Soft and soothing acoustics. Enjoy the relaxing music of Yanni, Kitaro and
Brian Eno.
27. Broadway's Best
Hits from the Great White Way. Rodgers and Hammerstein, Marvin Hamlisch and
Andrew Lloyd Webber.
28. Gospel
Soulful gospel sounds of joy. Mahalia Jackson, Al Green and the Winans.
29. Children's Entertainment
Songs and storytelling at their most magical. Disney classics and Sesame
Street.
30. World Beat
The Beat goes on . . all over the world. Follow the sun with the music of
Lucky Dube, Mahotella Queens and Outback.
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MARKETING STRATEGY
The Company plans to engage in extensive marketing, advertising and
promotional activities to increase consumer awareness of satellite radio and CD
Radio programming, to promote the sale of satellite radios and to generate
subscriptions to CD Radio.
The Company's market research program will assist the Company in refining
the design of its service, programming formats and content, and advertising and
promotional programs. Initial market research efforts will focus on further
defining the attitudes of different categories of consumers toward the various
attributes of CD Radio.
The Company plans to work closely with radio manufacturers, radio
retailers, and automakers to market CD Radio. Upon satellite launch, the Company
intends to commence a nationwide media campaign to advertise and promote CD
Radio and to implement a cooperative media campaign with satellite radio
manufacturers.
Some of the Company's promotional plans include: (i) extensive use of radio
commercial advertising; (ii) print advertisements; (iii) outdoor billboards;
(iv) cooperative radio and print advertising; (v) CD Radio service in rental
cars equipped with satellite radios; (vi) tie-ins with the recording industry
targeting compact disc purchasers of niche music categories; (vii) demonstration
kiosks in retail locations; and (viii) training programs and sales literature
developed for retail personnel. See "Forward-Looking Statements" and "Risk
Factors -- Unavailability of Satellite Radios."
As was the case with cellular telephone service in its early years, the
Company believes that satellite radio service will be symbolized by its antenna.
The Company believes that the proliferation of satellite radio dishes on cars
will create a significant amount of consumer awareness of satellite radio.
THE CD RADIO DELIVERY SYSTEM
The Company has designed the CD Radio delivery system to transmit an
identical signal from two satellites to address the problem of signal blockage
caused by variations in terrain, buildings and other obstructions. The system is
designed to permit CD Radio to be received by motorists in nearly all outdoor
locations where the vehicle is on an unobstructed line-of-sight with one or both
of the Company's satellites. In certain areas with high concentrations of tall
buildings such as Manhattan, or in tunnels, signals from both satellites will be
blocked and reception will be adversely affected. In such cases, the Company may
implement terrestrial repeating transmitters. See "Risk Factors -- Reliance on
Unproven Technology."
The CD Radio delivery system will consist of three principal components:
(i) satellite radios; (ii) the satellites; and (iii) the national broadcast
studio.
SATELLITE RADIOS
In order to receive CD Radio, subscribers will need to obtain a new
generation of radios capable of receiving the satellite band. The Company
anticipates that these radios will initially be manufactured by existing radio
manufacturers and sold by consumer electronics outlets for automotive
aftermarket installation and later will be manufactured and installed in new
cars and trucks by automakers. See "Forward-Looking Statements." Although the
Company will not manufacture or distribute satellite band radios or their dish
antennas, it intends to communicate the required specifications to such
manufacturers and automakers. The availability and pricing of satellite radios
will be an important factor in determining the success of CD Radio. See "Risk
Factors -- Unavailability of Satellite Radios."
The Company anticipates that radios capable of receiving CD Radio will be
similar to conventional AM/FM radios in size and appearance, but will have the
added capability of receiving digital satellite transmissions as well as AM and
FM signals. In order to accommodate subscription satellite radio services, each
radio will contain a security circuit with an electronically encoded
identification number. Upon verification of subscriber billing information, the
Company will transmit a digital signal to activate the radio's
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satellite band operation. This feature will enable the Company to protect
against piracy of CD Radio and to discontinue the service to subscribers who are
delinquent in paying the monthly subscription fee. The Company expects that
these radios will include a digital display, which when tuned to the satellite
band, will indicate the channel and format the listener has selected, as well as
the title, recording artist and album title of the song being played. As is the
case currently, a number of these radios may also incorporate cassette or
compact disc players. See "Forward-Looking Statements."
Because less than 10% of the U.S. vehicle fleet turns over annually, the
Company expects aftermarket availability of satellite radios to be of prime
importance to the Company's market penetration for the first several years
following introduction of CD Radio. Representatives of the Company have held
discussions with a number of major radio manufacturers that have expressed an
interest in participating with the Company in planning and evaluating the
Company's further market research. The Company will endeavor to synchronize the
development of satellite radios with the Company's business planning so that
satellite radios will be available at the time the Company commences operations.
Failure of manufacturers to develop and market satellite radios at affordable
prices, or to develop and market such radios in advance of the date the Company
proposes to commence CD Radio service, would have a materially adverse effect on
the Company's business. The Company intends to license radio manufacturers to
use CD Radio design technology in their radios.
The Company also plans to work with automakers to support the development
of factory installed satellite radios in new cars. Representatives of the
Company have held discussions with a number of major automakers that have
expressed an interest in participating with the Company in planning and
evaluating the Company's further market research.
Each satellite radio will require a satellite dish antenna in order to
receive the satellite signal. The Company has developed what it believes is the
world's smallest satellite dish. The dish is approximately the size and shape of
a silver dollar, measuring 2" in diameter and 1/8" thick. The Company's dish
design is "non-directional" -- it does not need to be pointed directly at a
satellite in order to receive a satellite signal. All that is required is that
the dish be positioned upward on an unobstructed line-of-sight with the
Company's satellites. In the case of factory installed satellite radios in new
cars, the Company believes the dish can be integrated into the roof panel.
For aftermarket installations, the dish can be attached to a vehicle's rear
window in the same manner as a cellular antenna. In the event that a subscriber
already has a cellular antenna on the rear window of a car, the cellular antenna
could be unscrewed and the dish screwed on in its place. The dish then would
serve as both a cellular and satellite radio antenna so that only the dish on
the car is needed.
THE SATELLITES
The satellites to be used in the CD Radio system are scheduled to be built
by Space Systems/Loral, one of the largest satellite manufacturers in the world.
Although the satellites will be equipped with custom designed communications
equipment, the Company believes that the construction and development of its
satellites does not require the development of new technology.
Satellite control will be performed from the Company's national broadcast
studio. Uplink frequencies are currently planned to be located in X-band.
Downlink frequencies are planned to be in S-band. Each satellite will broadcast
a signal covering the entire continental United States from a single antenna in
a single beam. The expected life of each satellite is approximately 15 years.
Satellite Construction. The Company has entered into an agreement (the
"Construction Contract") with Space Systems/Loral pursuant to which Space
Systems/Loral has agreed to construct two satellites and, at the Company's
option, a third satellite in accordance with stipulated specifications.
Amendments to the Construction Contract are necessary to reflect technical
changes and other developments since the contract was originally entered into in
1993. The Company has extended the Construction Contract on a monthly basis
through April 30, 1997 while it negotiates with Space Systems/Loral to amend the
contract's technical specifications, pricing and delivery terms. The Company may
negotiate with Space Systems/Loral to extend
6
the Construction Contract further or it may permit the contract to expire. The
Company believes it will be able to negotiate a favorable contract with Space
Systems/Loral for the construction of the satellites, although there can be no
assurance that the Company will be able to do so.
Under the Construction Contract, Space Systems/Loral will not be liable for
indirect or consequential damages or lost revenues or profits resulting from
late delivery or other defaults. Title and risk of loss for each satellite is to
pass to the Company at the time of launch. The Company has agreed to indemnify
Space Systems/Loral for all costs and losses resulting from claims based upon
Space System/Loral's alleged responsibility or liability for loss of, or damage
to, the satellites occurring after launch, regardless of the cause. In the event
of any delay in the construction of the satellites that is caused by the
Company, the Construction Contract provides that the terms of the contract will
be equitably adjusted.
Upon delivery of the satellites to the launch site, Space Systems/Loral is
required to perform inspection and verification testing to insure that no damage
occurred in shipment. After such inspection and testing, the Company will
provide final acceptance of the satellites. Following their launch, Space
Systems/Loral will conduct in-orbit checks of both satellites. In the event that
such testing shows that a satellite is operating less than satisfactorily, Space
Systems/Loral and the Company will negotiate a reasonable reduction in the
amount paid by the Company. See "Forward-Looking Statements."
Launch Services. The Company has reserved two launch slots with
Arianespace during the period extending from November 1, 1999 through April 30,
2000. If the Company's satellites are not available for launch during this
period, the Company will arrange to launch the satellites on the first launch
dates available after the satellites are completed. See "Forward-Looking
Statements." While the Company has been able to reschedule launch dates with
Arianespace in the past, there can be no assurance that it will be able to do so
in the future. In order to maintain its launch slots, the Company will need to
enter into a definitive agreement with Arianespace by May 31, 1997, providing
for the launch of its satellites. The final terms and conditions of any launch
agreement are subject to negotiations between the Company and Arianespace.
Satellite launches are subject to significant risks, including satellite
destruction or damage during launch or failure to achieve proper orbital
placement. According to industry sources, approximately 15% of insured
commercial satellite launches by all launch contractors since 1965 have resulted
in total loss. Launch failure rates vary from period to period and from
contractor to contractor. Arianespace is one of the world's leading commercial
satellite launch service companies. Arianespace has advised the Company that as
of March 18, 1997 it has successfully completed 81 of 86 launches (approximately
94%), since beginning commercial operations in 1984. See "Risk
Factors -- Dependence upon Satellites and Contractors; Risk of Launch Failure."
Risk Management and Insurance. Two custom-designed, fully dedicated
satellites are required to broadcast CD Radio. A single satellite is incapable
of delivering the service. The Company has selected a launch service supplier
that has achieved the most reliable launch record in its class in the industry.
Each of the company's two operational satellites will be launched separately.
The Company intends to obtain launch insurance for each launch vehicle from its
launch vehicle provider. The Construction Contract provides for the construction
of a spare satellite, to be used in the event of loss of one of its two
operational satellites. If the Company is required to launch the spare satellite
due to failure of the launch of one of the operational satellites, its
operational timetable would be delayed for approximately six months or more. The
launch or in-orbit failure of two satellites would require the Company to
arrange for additional satellites to be built and could delay the commencement
or continuation of the Company's operations for three years or more. See "Risk
Factors -- Dependence upon Satellites and Contractors; Risk of Launch Failure."
Once properly deployed and operational, the historical risk of premature
total satellite failure has been less than one percent for U.S. geosynchronous
commercial satellites. Insurance against in-orbit failure is presently available
and is typically purchased after the satellite is checked out in orbit and prior
to the expiration of launch insurance. In recent years, annual premiums have
ranged from 1.3% to 2.5% of coverage.
Satellites are designed to minimize the adverse effects of transmission
component failure through the incorporation of redundant components which
activate automatically or by ground command upon failure. If
7
multiple component failures occur as the satellite ages, and the supply of
redundant components is exhausted, the satellite generally will continue to
operate at reduced capacity. In that event, signal quality may be preserved by
reducing the number of channels broadcast until a replacement satellite could be
launched.
NATIONAL BROADCAST STUDIO
The Company intends to establish its national broadcast studio to provide
origination and transmission of programming; transmission of commands to
activate/deactivate service of subscriber radios; and tracking, telemetry, and
control of the in-orbit satellites. The facility will incorporate redundant
electronics and backup power generators.
TESTS AND DEMONSTRATIONS
The Company conducted a series of tests and demonstrations from May through
December 1994, involving the transmission of S-band signals to a prototype
satellite radio installed in a car to simulate certain transmission techniques
the Company intends to employ. Since there are currently no commercial
satellites in orbit capable of transmitting S-band frequencies to the United
States, the Company constructed a terrestrial emulation of its planned system.
For this purpose, the Company selected a test range covering several kilometers
in suburban Washington, D.C. which included areas shadowed by buildings, trees
and overpasses. The Company placed S-band transmitters on the rooftops of a
number of tall buildings in such a way as to simulate the signal power and angle
of satellite transmissions to be used for its proposed service. The Company also
modified the standard factory installed sound system of a Lincoln Mark VIII
automobile to create a three-band radio covering AM, FM and S-band, and
integrated the Company's satellite dish into the car roof. The demonstrations
included the reception of 30 channels of CD quality stereo music by the
prototype radio while the car was driven throughout the range. The Company
believes that the results of these tests validated the technically significant
portions of the CD Radio system. Prior to testing with orbiting satellites and
satellite radios suitable for commercial production, however, there can be no
assurance that the CD Radio system will function as intended. See "Risk
Factors -- Reliance on Unproven Technology."
COMPETITION
The Company's satellite radio service will face competition from two
principal sources: (i) terrestrial AM/FM radio broadcasting, including, when
available, terrestrial digital radio broadcasting; and (ii) another satellite
radio broadcaster.
The AM/FM radio broadcasting industry is very competitive, and certain of
the Company's competitors in this industry have substantially greater financial,
management and technical resources than the Company. Unlike the Company, the
radio industry has a well established market for its services and generally
offers "free" reception paid for by commercial advertising rather than a
subscription fee. In addition, certain AM and FM stations, such as National
Public Radio, offer programming without commercial interruption. Many radio
stations also offer information programming of a local nature, such as local
news or traffic, which the Company will be unable to offer. CD Radio will
compete with conventional radio stations on the basis of the variety and focus
of its programming, its commercial-free formats, signal coverage throughout the
continental United States, and digital CD stereo sound quality.
Currently, radio stations broadcast by means of analog signals, as opposed
to digital transmission. The Company believes, however, that prior to the
commencement of CD Radio, broadcasters may be in a position to implement
technology that permits simultaneous transmission of both analog and digital
signals on the AM and FM bands that will permit digital AM broadcasts to achieve
monaural FM sound quality, and digital FM broadcasts to approach compact disc
stereo sound quality. See "Forward-Looking Statements." In order to receive
these digital AM/FM broadcasts, listeners would need to purchase new digital
radios which are not currently commercially available. As a result, while the
development of digital broadcasting would eliminate one of the advantages of CD
Radio over FM radio, the Company does not believe it would affect broadcasters'
ability to address the other advantages of CD Radio. In addition, the Company
views the growth of terrestrial
8
digital broadcasting as a positive force that would be likely to accelerate
radio replacement and thereby facilitate the proliferation of satellite radios.
Existing communications satellite operators are not capable of delivering
satellite radio for reception on tiny, non-directional automobile dishes.
Specially designed satellites operating at different frequencies are needed.
The Company expects to compete directly with one other satellite radio
broadcaster. Four applicants, including the Company, have applied for two FCC
licenses to operate a national satellite radio service. See
"Business -- Government Regulation." At least one of the applicants, a
subsidiary of American Mobile Satellite Corporation, which is principally owned
by the Hughes division of General Motors, has financial, management and
technical resources that greatly exceed those of the Company. In their license
applications to the FCC, two of the other applicants have stated an intention to
offer a satellite radio service based, at least in part, on subscription fees
and the remaining applicant intends to offer an advertiser supported "free"
service. The Company believes that at present its technical and business
planning is further advanced than the other applicants. There can be no
assurance, however, that this will permit the Company to initiate a satellite
radio service in advance of its competition. See "Risk Factors -- Competition."
The original satellite radio spectrum allocation internationally agreed
upon by the United States and other nations would have accommodated four
satellite radio licenses in the United States. The FCC subsequently allocated
only half of this spectrum specifically for satellite radio, thereby
accommodating only two licenses. The other half of the allocation is scheduled
to be auctioned on April 15, 1997 and may be used to provide a broad range of
services, including but not limited to satellite radio. The Company believes
this spectrum is unlikely to be used for satellite radio, although no assurance
can be made that this will be the case.
TECHNOLOGY, PATENTS AND TRADEMARKS
The Company has been granted certain U.S. patents on various types of
satellite radio technology. There can be no assurance, however, that any U.S.
patent issued to the Company will not be circumvented or infringed by others, or
that if challenged would be held to be valid. The Company has filed patent
applications covering CD Radio system technology in Argentina, Australia,
Brazil, Canada, China, France, Germany, India, Italy, Japan, South Korea,
Mexico, the Netherlands, Spain, Switzerland and the United Kingdom. There can be
no assurance that foreign patents will be awarded by all of such countries to
the Company or, if any such patents are granted, that the laws of foreign
countries will protect the Company's proprietary rights to its technology to the
same extent as the laws of the United States. Although the Company believes that
obtaining patent protection may provide benefits to the Company, the Company
does not believe that its business is dependent on obtaining patent protection
or successfully defending any such patents that may be obtained against
infringement by others.
Certain of the Company's know-how and technology are not the subject of
U.S. patents. To protect its rights, the Company requires certain employees,
consultants, advisors and collaborators to enter into confidentiality
agreements. There can be no assurance, however, that these agreements will
provide meaningful protection for the Company's trade secrets, know-how or other
proprietary information in the event of any unauthorized use or disclosure. In
addition, the Company's business may be adversely affected by competitors who
independently develop competing technologies.
The Company's proprietary technology was developed by Robert D. Briskman,
the Company's Chief Technical Officer, and assigned to the Company. The Company
believes that Mr. Briskman independently developed the technology covered by the
Company's issued patents and that it does not violate the proprietary rights of
any person. There can be no assurance, however, that third parties will not
bring suit against the Company for patent infringement or for declaratory
judgment to have any patents which may be issued to the Company declared
invalid.
If a dispute arises concerning the Company's technology, litigation might
be necessary to enforce the Company's patents, to protect the Company's trade
secrets or know-how or to determine the scope of the proprietary rights of
others. Any such litigation could result in substantial cost to, and diversion
of effort by,
9
the Company, and adverse findings in any proceeding could subject the Company to
significant liabilities to third parties, require the Company to seek licenses
from third parties or otherwise adversely affect the Company's ability to
successfully develop and market CD Radio.
In May 1994, the Company received a letter claiming that the Company's logo
is confusingly similar to the registered trademark of a company engaged in the
sale of pre-recorded music, and that the Company's continued use of its logo may
constitute infringement of such mark. See "Business -- Legal Proceedings."
GOVERNMENT REGULATION
Communications Laws
As a proposed operator of a privately owned satellite system, the Company
is subject to the regulatory authority of the FCC under the Communications Act
of 1934 (the "Communications Act"). The FCC is the government agency with
primary authority in the United States over satellite radio communications. The
Company is currently subject to regulation by the FCC principally with respect
to (i) the licensing of its satellite system; (ii) preventing interference with
other users of radio frequencies; and (iii) compliance with rules that the FCC
has established specifically for United States satellites and rules that the FCC
has established for providing satellite radio service.
On May 18, 1990, the Company proposed that the FCC establish a satellite
radio service and applied for the FCC License. This application was opposed by
the National Association of Broadcasters, an industry trade group that seeks to
promote the interests of the television and AM/FM broadcast industries.
In the fall of 1992, the FCC called for license applications from any
parties other than the Company who might be interested in being licensed to
provide a satellite radio service. The cutoff date for these applications was
December 15, 1992. Five other applicants filed applications by that deadline,
two of which have subsequently been withdrawn, leaving the Company and three
other applicants. Petitions have been filed on behalf of third parties to deny
the applications filed by the Company and the three other applicants.
On March 3, 1997, the FCC adopted satellite radio licensing rules (the
"Licensing Rules") and implemented a spectrum plan that will accommodate only
two national satellite radio licenses, both of which are scheduled to be
auctioned among the Company and the other three applicants on April 1, 1997.
There can be no assurance that the Company will be successful in obtaining one
of the two licenses or that the cost of obtaining it would not be material to
the Company's operations. See "Risk Factors -- Government Regulation; No
Assurance of FCC License."
Pursuant to the Licensing Rules, the auction is scheduled to be held among
the four existing applicants on April 1, 1997. Prior to the commencement of the
auction each applicant must deposit $3 million with the FCC. The minimum opening
bid for each FCC License is $8 million. The bidding will continue until only two
bidders remain. Within 10 business days following the announcement of winning
bidders, each auction winner must deposit with the FCC twenty percent of its
winning bid. The $3 million initial deposit will be applied toward the twenty
percent down payment. The winning bidders will also be required to supplement
their applications on file with the FCC within 30 days after the close of
bidding. After the FCC has confirmed receipt of each winning bidder's twenty
percent payment and acceptance of each winning bidder's application, the FCC
will accept petitions to deny the winning bidders' applications. There can be no
assurance that the FCC will dismiss these and previously filed petitions. If the
FCC dismisses these petitions and previously filed petitions, the winning
bidders will have 10 business days to submit payment of the balance of their
winning bids.
Pursuant to the Licensing Rules, the winning bidder that receives an FCC
License will be required to meet certain progress milestones. Licensees would be
required to begin satellite construction within one year; to launch and begin
operating their first satellite within four years; and to begin operating their
entire system within six years. Failure to meet those milestones could result in
revocation of the FCC License. On March 27, 1997, a third party requested
reconsideration of the Licensing Rules, seeking, among other things, that the
time period allotted for these milestones be shortened.
10
On July 30, 1991, the Company filed a request for a Pioneer's Preference
and on January 23, 1992 and June 2, 1993, filed supplements to that request. A
Pioneer's Preference would have given the Company an exclusive right to an FCC
License without having to bid in an auction, although the Company would still
have had to pay for its license. In November 1996, an FCC appointed panel
recommended that no Pioneer's Preference be granted. The Company subsequently
withdrew its application for a Pioneer's Preference.
Satellite orbit locations are registered internationally for each country.
To the Company's knowledge, no other nations in the Western Hemisphere are
seeking to use the S-band for satellite radio, and the Company does not
anticipate any difficulty in obtaining international registration, or renewing
or extending such registrations. See "Forward-Looking Statements." However,
there can be no assurance that such registrations will be obtained.
The spectrum allocated for satellite radio is used in Canada and Mexico for
terrestrial microwave links, mobile telemetry, and other purposes. The United
States government must coordinate United States' use of this spectrum with the
Canadian and Mexican governments before any United States satellite may become
operational. The Company has performed analyses which show that its proposed use
will not cause undue interference to most Canadian stations and can be
coordinated with others by various techniques. The Licensing Rules require that
the licensees complete detailed frequency coordination with existing operations
in Canada and Mexico. There can be no assurance that the United States, Canadian
and Mexican governments can coordinate the use of this spectrum or will do so in
a timely manner.
In order to operate its satellites, the Company also will have to obtain a
license from the FCC to operate its uplink facility. Normally, such approval is
sought after issuance of the FCC License. Although there can be no assurances at
this time, if the Company obtains the FCC License, the Company would not expect
difficulties in obtaining a feeder link frequency and ground station approval in
the ordinary course.
The issuance by the Company of the Common Stock pursuant to the Company's
initial public offering, considered together with other transactions in the
stock of the Company since the cutoff date established by the FCC for satellite
radio service applications, could have resulted in the ownership of 50 percent
or more of the voting stock of the Company by parties who were not stockholders
on the cutoff date. Consequently, such stock issuance may have required the
filing of a "major amendment" to the Company's license application. As a result,
the Company requested and obtained from the FCC an exemption from the previously
established cutoff date, in order to avoid the assignment of a new file number
and the consequent loss of entitlement to processing concurrently with the other
three remaining applications that were filed on or before the cutoff date
("cut-off protection"). On June 8, 1994, the FCC released an order granting the
requested exemption conditioned on the current stockholders and officers of the
Company remaining in actual control of Satellite CD Radio, Inc. Additional
equity financings and sales of common stock by persons who were shareholders on
the cutoff date could require the Company to obtain an exemption from the FCC to
permit the Company's license application to be processed concurrently with those
of the other three applicants. If such an exemption were required and not
granted, the Company's application would not be considered concurrently with
those of the other three remaining applicants and could be dismissed.
The Communications Act prohibits the issuance of a license to a foreign
government or a representative thereof, and contains limitations on the
ownership of common carrier, broadcast, and certain other radio licenses by
non-U.S. citizens. Pursuant to the Licensing Rules, the licensees will be
permitted to choose whether they wish to be classified as broadcasters, common
carriers or private carriers. As a private carrier, the Company would not be
subject to the current provisions of the Communications Act restricting
ownership in the Company by non-U.S. private citizens or organizations. Further,
as a private carrier, the Company would be free to set its own prices and serve
customers according to its own business judgment, without economic regulation.
The foregoing discussion reflects the application of current communications
law, FCC regulations and international agreements to the Company's proposed
service in the United States. Changes in law, regulations or international
agreements relating to communications policy generally or to matters affecting
specifically the services proposed by the Company could adversely affect the
Company's ability to obtain its FCC License or
11
the manner in which its proposed service would be regulated. Further, actions of
the FCC are subject to judicial review and there can be no assurance that if
challenged, such actions would be upheld.
Other Regulatory Matters
The Company's business operations as presently contemplated may require a
variety of permits, licenses and authorizations from governmental authorities
other than the FCC, but the Company has not identified any such permit, license
or authorization that it believes could not be obtained in the ordinary course
of business.
PERSONNEL
As of December 31, 1996, the Company had three employees, of whom one was
involved in technology development, one in business development and one in
administration. In addition, the Company relies upon a number of consultants and
other advisors. After receipt of the FCC License, the Company expects to
increase the number of its employees to approximately twenty-five, of whom nine
are expected to be involved in technical development, ten in business
development and six in administration. See "Forward-Looking Statements." The
extent and timing of the increase in staffing will depend on the availability of
qualified personnel and other developments in the Company's business. None of
the Company's employees are represented by a labor union, and the Company
believes that its relationship with its employees is good.
FINANCIAL CONSULTANTS
Pursuant to an agreement dated October 21, 1992 (the "Agreement"), the
Company retained the services of Batchelder & Partners, Inc., a financial
advisory firm ("Batchelder"), to provide certain financial consulting services
to the Company. The Agreement provides, among other things, for the payment in
cash to Batchelder of (i) $25,000 per month during the term of the Agreement and
(ii) fees equal to (A) two percent (2%) of the gross proceeds from each equity
financing (other than equity financings to existing shareholders of the Company
on the date of the Agreement and certain equity financings before December 15,
1992) and (B) one percent (1%) of the gross proceeds from each debt financing,
during the term of the Agreement and for a period of two years following
termination of the Agreement by the Company. During the three-month period
ending December 31, 1994, Batchelder agreed to waive all financial consulting
fees payable under the Agreement. In addition, pursuant to the Agreement, the
Company has granted an option to Batchelder to purchase 260,000 shares of Common
Stock at a price of $6.25 per share as follows: 60,000 shares upon execution of
the Agreement and four 50,000 share increments upon the successful completion of
equity and/or debt financings of certain specified amounts during the term of
the Agreement and for a period of two years following termination of the
Agreement by the Company. Each option expires three years from the date such
option becomes exercisable. The option to purchase 60,000 shares granted to
Batchelder upon execution of the Agreement expired unexercised on October 21,
1995. The Agreement is terminable by either the Company or Batchelder upon
notice to the other party. Since inception of the Agreement, Batchelder has
earned $1,178,063 in consulting fees. Additionally, Batchelder has earned equity
financing fees of $149,400 in connection with private placements of 1,494,000
shares of Common Stock of the Company at an aggregate offering price of
$7,470,000, fees of $129,194 in connection with the Company's public offering of
units in 1994 and fees of $92,261 in 1996 in connection with the exercise of
warrants to purchase the Company's Common Stock. No additional options to
purchase shares of Common Stock became exercisable by Batchelder on the closing
of the Company Offering. Batchelder purchased 200,000 shares in the Company's
initial public offering at the initial public offering price.
The foregoing is a summary of the principal terms of the agreement
described above and does not purport to be complete. Reference is made to the
copies of such agreement, which is filed as an exhibit hereto.
RISK FACTORS
Prospective investors should consider carefully the following factors, as
well as all of the other information set forth herein, in evaluating an
investment in the Company's Common Stock.
12
Development Stage Company; Continuing Losses
The Company's proposed service, CD Radio, is in its initial stage of
development. Since its inception, the Company's activities have been
concentrated on applying for necessary licenses, technology development,
strategic planning, and market research. The Company has incurred aggregate net
losses of approximately $18,535,860, from its inception on May 17, 1990 through
December 31, 1996, including net losses of approximately $2,830,595 or $0.29 per
share, during the year ended December 31, 1996. The Company anticipates that it
will not achieve any revenue from operations until the second half of 1999 at
the earliest, and that revenue from operations, if and when achieved, will not
be sufficient to cover operating expenses until the second half of 2000 at the
earliest. The ability of the Company to begin to achieve profitability will
depend upon a number of factors, including timely receipt of all necessary FCC
authorizations, successful and timely construction and deployment of its
satellite system, the development and manufacture of satellite radios by
consumer electronics manufacturers and the successful marketing of CD Radio.
There can be no assurance that any of the foregoing will be accomplished, that
CD Radio will be placed in operation, that the Company will attain a
satisfactory market share or that the Company will achieve profitability. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
Need for Substantial Additional Financing
The FCC has scheduled an auction among the four existing applicants to
auction two FCC Licenses on April 1, 1997. The Company believes it has
sufficient working capital to fund its planned operations through the receipt of
the FCC License. From the date the FCC License is received, approximately $500
million or more will be required to complete the construction and launch of the
Company's satellite system and to fund its first full year of operations,
assuming the FCC License is received in the first half of 1997. See "Forward-
Looking Statements." The amount does not include the amount to be paid by the
Company for the FCC License in the auction. Additional funds, however, would be
required in the event of delay, cost overruns, launch failure or other adverse
developments. The Company anticipates funding its projected cash requirements
through the completion of additional public or private equity and debt
financings. The Company does not have financing commitments in place sufficient
to fund the implementation of CD Radio service, and there can be no assurance
that the Company will be able to obtain additional financing on favorable terms,
if at all, or that it will be able to do so on a timely basis. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources." Failure to secure necessary
financing on a timely basis could result in delays and increases in the cost of
satellite construction or launch or other activities necessary to put CD Radio
in operation, could cause the Company to default on its commitments to its
satellite construction or launch contractors or others, could render the Company
unable to put CD Radio in operation and could force the Company to discontinue
operations or seek a purchaser. See "-- Risk of Delay; Effect of Delay on
Financing Requirements." The issuance by the Company of additional equity
securities could cause substantial dilution of the existing stockholders'
interest in the Company.
Risk of Delay; Effect of Delay on Financing Requirements
The Company is currently targeting the second half of 1999 for the
commencement of CD Radio. The Company's ability to meet that objective will
depend on several factors, including receipt of the FCC License by the first
half of 1997. There can be no assurance as to whether or at what date the FCC
License will be received. A significant delay in the timely development,
construction, launch and commencement of operation of CD Radio could have a
material adverse effect on the Company. Delay could result from a variety of
causes, including delays associated with FCC authorizations, inability to obtain
necessary financing in a timely manner, delays in design, development,
construction or testing of satellites, the national broadcast studio or other
aspects of the CD Radio system, changes of technical specifications, delay in
commercial availability of satellite radios, failure of the Company's vendors to
perform as anticipated or a delayed or unsuccessful satellite launch. During any
period of delay, the Company would continue to have significant cash
requirements, including capital expenditures, administrative and overhead costs,
contractual obligations and debt service that could materially increase the
aggregate amount of funding required to complete the
13
preparations necessary to permit the Company to commence operating CD Radio.
Financing may not be available on favorable terms or at all during periods of
delay. Delay also could cause the Company to be placed at a competitive
disadvantage in relation to competitors who succeed in beginning operations
earlier than the Company, or prevent the Company from putting CD Radio into
service.
Government Regulation; No Assurance of FCC License
The receipt of an FCC License to construct, launch and operate its
satellites is a prerequisite to the Company's ability to offer CD Radio. The
Company must bid in an auction for the FCC License and there is no assurance
that the Company will be successful in the auction or that the cost of the FCC
License will not be material.
Changes in ownership of the Company's stock since the cutoff date for
satellite radio license applications, including the sale of the shares of Common
Stock in the Company's initial public offering, required the Company to obtain
an exemption from the FCC to permit the Company's license application to be
processed concurrently with those of the other three applicants. The Company
applied for such an exemption on February 2, 1994, and the FCC released a ruling
granting the request on June 8, 1994, conditioned on the current stockholders
and officers of the Company remaining in actual control of Satellite CD Radio,
Inc. Additional equity financings and sales of common stock by persons who were
shareholders on the cutoff date could also result in further changes in
ownership of the Company's stock and could require the Company to obtain an
exemption from the FCC to permit the Company's license application to be
processed concurrently with those of the other three applicants. If such an
exemption were required and not granted, the Company's application would not be
considered concurrently with those of the other three remaining applicants and
could be dismissed.
In addition to its general authority over satellite operations, the FCC
regulates two types of satellite communications activities: common carriage and
broadcasting. Common carriers offer their customers the ability to transmit
messages of the customer's own choosing and are subject to economic regulation
and alien ownership rules. Broadcasters are not subject to economic regulation,
but are subject to certain content, reporting and alien ownership rules.
Pursuant to the Licensing Rules, the licensees will be permitted to choose
whether they wish to be classified as broadcasters, common carriers or private
carriers. As a private carrier, the current provisions of the Communications Act
restricting ownership in the Company by non-U.S. private citizens or
organizations would not apply to the Company, and the Company would not be
subject to economic regulation.
Changes in law, FCC regulations or international agreements relating to
communications policy generally or to matters relating specifically to the
services proposed by the Company could affect the Company's ability to obtain
its FCC License or the manner in which its proposed service would be regulated.
See "Business -- Government Regulation."
Proposed 5% Delayed Convertible Preferred Stock
The Company's Board of Directors has authorized the sale of 5% Delayed
Convertible Preferred Stock ("5% Preferred Stock") and the Company has received
commitments to purchase a substantial amount of 5% Preferred Stock, subject to
certain conditions, including conditions involving the results of the auction
for the FCC license. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations." The terms of the 5% Preferred Stock
provide that it is convertible to Common Stock at discounts from future market
prices of the Common Stock, which could result in substantial dilution to
holders of Common Stock. The terms of issuance of the 5% Preferred Stock also
require payments in the amount of 3% of the aggregate liquidation preference per
month if the Company fails within certain prescribed periods, to increase the
number of authorized shares of Common Stock; to reserve a number of shares of
Common Stock for issuance upon conversion of the 5% Preferred Stock equal to 1.5
times the number of shares into which the 5% Preferred Stock is convertible from
time to time; to obtain any governmental approvals necessary for the conversion
of 5% Preferred Stock; or to maintain an effective registration statement under
the Securities Act of 1933 with respect to the resale of Common Stock issuable
upon conversion of the 5% Preferred Stock. The
14
terms of the 5% Preferred Stock also require the Company to repurchase some or
all of the 5% Preferred Stock upon the occurrence of certain specified events.
If payment or repurchase obligations were to arise under the terms of the 5%
Preferred Stock, the Company's financial condition could be materially adversely
affected.
Reliance on Unproven Technology
The CD Radio system is designed to use two satellites in geosynchronous
orbit that transmit identical signals to a new generation of satellite radios in
cars and trucks. The Company has conducted satellite simulation testing and
demonstrations of CD Radio with a prototype satellite receiver installed in an
automobile. The satellite system and other aspects of the CD Radio service,
however, will use certain technology that has yet to be tested using orbiting
satellites or a satellite radio suitable for commercial production. While
management believes that the technology developed by the Company will allow the
service to operate as planned, there can be no assurance that the CD Radio
system will function as currently contemplated. See "Business -- Satellite
Radios" "Business -- The Satellites" and "Business -- Technology Trademarks and
Patents."
Dependence upon Satellites and Contractors; Risk of Launch Failure
The Company's business will depend upon the successful construction and
launch of its satellites which will be used to transmit CD Radio. The Company
will rely upon its satellite vendor, Space Systems/Loral, for the timely
delivery of its satellites. Failure of Space Systems/Loral to deliver
functioning satellites in a timely manner could materially adversely affect the
Company's business.
The Company is also dependent on its satellite launch vendor, Arianespace,
for the construction of launch vehicles and the successful launch of its
satellites. Satellite launches are subject to significant risks, including
satellite destruction or damage during launch or failure to achieve proper
orbital placement. According to an insurance industry source, approximately 15%
of insured commercial satellite launches by all launch contractors since 1965
have resulted in total loss. Launch failure rates vary from period to period and
from contractor to contractor. While past experience is not necessarily
indicative of future performance, Arianespace has advised the Company that as of
March 18, 1997 it has successfully completed 81 of 86 launches (approximately
94%) since beginning commercial operations in 1984. See "Business -- The
Satellites." Satellites also could be defective or could be damaged or fail in
orbit. As part of its risk management program, the Company plans to construct a
third (back-up) satellite and to obtain insurance covering failed launch vehicle
replacement. The launch of a replacement satellite would delay the commencement
or continuation of the Company's operations for not less than six months, which
could have an adverse effect on the demand for the Company's services, as well
as the Company's revenues and results of operations. The launch or in-orbit
failure of two of the Company's satellites could delay the commencement or
continuation of the Company's operations for three years or more, which would
have a material adverse effect on the Company.
Uncertain Market Acceptance
There are currently no satellite radio services such as CD Radio in
commercial operation in the United States. As a result, the extent of the
potential demand for such services and the degree to which the Company's
proposed service will meet that demand cannot be estimated with certainty, and
there can be no assurance that there will be sufficient demand for CD Radio
service to enable the Company to achieve profitable operations. The success of
CD Radio in gaining market acceptance will be affected by a number of factors
beyond the Company's control, including consumers' willingness to pay
subscription fees to obtain satellite radio broadcasts, the cost, availability
and consumer acceptance of satellite radios, marketing and pricing strategies of
competitors, development of alternative technologies and general economic
conditions. See "Business -- The Radio Market" and "Business -- Competition."
Unavailability of Satellite Radios
The Company's business strategy requires that subscribers to CD Radio
purchase satellite radios to receive the service. See "Business -- Satellite
Radios." Satellite radios are not currently commercially
15
available and the Company is unaware of any manufacturer currently developing
such radios for commercial sale. The ultimate success of the Company's service
will therefore depend in significant part on the willingness of at least one
consumer electronics manufacturer to develop and manufacture these radios.
Although the Company intends to foster the development of commercially available
satellite radios, there can be no assurance that a manufacturer will develop
such radios in a timely manner or at all, or that if commercially developed such
radios will be affordable in price. The failure of one or more consumer
electronics manufacturers to develop satellite radios for commercial sale in a
timely manner would have a material adverse effect on the Company's business.
See "Business -- Satellite Radios" and "Business -- Technology Patents and
Trademarks".
Music Royalty Payments
In connection with its proposed music programming, the Company will be
required to negotiate and enter into royalty arrangements with copyright owners
of sound recordings and with performing rights societies, such as the American
Society of Composers, Authors and Publishers ("ASCAP"), Broadcast Music, Inc.
("BMI"), SESAC, Inc. ("SESAC"), and with recording owners under the Digital
Recordings Act of 1995. The amount of these royalties is yet to be negotiated
and there can be no assurance that any royalty arrangements negotiated by the
Company will be on terms favorable to the Company. See "Business -- The CD Radio
Service."
Development of Business and Management of Growth
The Company has not yet commenced CD Radio service. To operate
successfully, the Company must develop and implement systems for operational and
financial management, programming, marketing, subscriber registration and
management, billing and collection of subscriber fees and other functions, and
must hire and train personnel to perform these functions. The Company expects to
experience significant and rapid growth in the scope and complexity of its
business as it proceeds with the development of its satellite radio system and
the commencement of CD Radio service. Growth is likely to place a substantial
strain on the Company's management, operational, financial and accounting
resources. Failure to develop and implement effective systems for the
performance of all of the functions necessary to the effective provision of its
service and management of its subscriber base and business, and failure to
manage growth effectively, would have a material adverse effect on the Company's
business.
Competition
The Company will be seeking market acceptance of its proposed service in a
new, untested market and will compete with established conventional radio
stations, which do not rely on subscription fees for their operations. Many
radio stations also offer information programming of a local nature such as
local news or traffic which the Company will be unable to offer. The Company
also expects to compete directly with one other satellite radio operator. See
"Forward-Looking Statements." A total of four proposed satellite radio
operators, including the Company, have applied to be licensed by the FCC. See
"Business -- Government Regulation." At least one of these prospective satellite
radio operators, American Mobile Satellite Corporation, which is principally
owned by the Hughes division of General Motors has financial, management and
technical resources which greatly exceed those of the Company. See
"Business -- Competition."
Dependence on Chief Executive Officer
The Company is highly dependent during its development phase on the
services of David Margolese, Chairman and Chief Executive Officer, who is
responsible for the Company's operations and strategic planning. The loss of the
services of Mr. Margolese during the development stage of the Company could have
a material adverse effect upon the business and prospects of the Company. See
"Business -- Government Regulation" and "Directors and Executive Officers of the
Company."
16
Proposed Business Dependent Upon Regulatory Approval
The Company has concentrated its efforts on the development and preparation
of its proposed service, CD Radio. The timely receipt of an FCC License to
construct, launch and operate its satellites is a prerequisite to the Company's
ability to offer CD Radio. If the Company is not a winning bidder in the
auction, the Company would be forced to identify an alternative business plan
and use for any remaining capital resources. Such an alternative plan could
involve a change in focus to a related or unrelated business activity, or
dissolution of the Company. No consideration has been given to any alternative
activity or use of funds. There can be no assurance that the Company would be
able to identify or effectively pursue any such alternative in a manner that
would benefit the Company or its stockholders.
Uncertain Patent Protection
The Company has been granted certain U.S. patents covering various types of
satellite radio technology. There can be no assurance, however, that the
Company's U.S. patents will not be challenged, invalidated or circumvented by
others. Litigation, which could result in substantial cost to the Company, may
be necessary to enforce the Company's patents or to determine the scope and
validity of other parties' proprietary rights, and there can be no assurance of
success in any such litigation.
Although the Company believes that patent protection may provide benefits
to the Company, the Company does not believe that its business is dependent on
obtaining patent protection or successfully defending any such patents against
infringement by others.
Limited Prior Public Market; Potential Volatility of Stock Price
The Company's Common Stock has been traded on the NASDAQ Small Cap Market
since September 13, 1994. There can be no assurance that an active public market
will continue for the Common Stock, or that the market price for the Common
Stock will not decline below its current price. Such price may be influenced by
many factors, including, but not limited to, investor perception of the Company
and its industry and general economic and market conditions. The trading price
of the Common Stock could be subject to wide fluctuations in response to
announcements of business and technical developments by the Company or its
competitors, quarterly variations in operating results, and other events or
factors. In addition, stock markets have experienced extreme price volatility in
recent years. This volatility has had a substantial effect on the market prices
of development stage companies, at times for reasons unrelated to their
operating performance. Such broad market fluctuations may adversely affect the
price of the Common Stock.
Possible Delisting of Common Stock from NASDAQ; Possible Adverse Effect on
Trading Market
The Common Stock is quoted on the NASDAQ Small Cap Market. There are a
number of continuing requirements that must be met in order for the Common Stock
to remain eligible for quotation on the NASDAQ Small Cap Market. In order to
continue to be quoted on NASDAQ, a company must maintain $2 million in total
assets, a $200,000 market value of the public float and $1 million in total
capital and surplus. In addition, continued quotation requires two marketmakers
and a minimum bid price of $1.00 per share; provided, however, that if a company
falls below such a minimum bid, it will remain eligible for continued quotation
on NASDAQ if the market value of the public float is at least $3 million and the
company has $2 million in capital and surplus. The failure to meet these
maintenance criteria in the future could result in the delisting of the
Company's Common Stock from NASDAQ. In such event, trading, if any, in the
Common Stock may then continue to be conducted in the non-NASDAQ
over-the-counter market. As a result, an investor may find it more difficult to
dispose of, or to obtain accurate quotations as to the market value of, the
Company's Common Stock. In November 1996, NASDAQ approved changes to its
quantitative and qualitative standards for issuers listing on NASDAQ, subject to
public comment and approval by the Commission. Among the proposed changes are
the elimination of the alternative test for issuers failing to meet the minimum
bid price of $1.00, an increase in the quantitative standards for both the
NASDAQ National Market and the NASDAQ SmallCap Market, and the corporate
governance requirements applicable to the NASDAQ National Market would be
applicable to the NASDAQ SmallCap Market.
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In addition, if the Common Stock were delisted from trading on NASDAQ and
the trading price of the Common Stock were less than $5.00 per share, trading in
the Common Stock would also be subject to the requirements of certain rules
promulgated under the Securities Exchange Act of 1934, which require additional
disclosure by broker dealers in connection with any trades involving a stock
defined as a penny stock (generally, any non-NASDAQ equity security that has a
market price of less than $5.00 per share, subject to certain exceptions). Such
rules require the delivery, prior to any penny stock transaction, of a
disclosure schedule explaining the penny stock market and the risks associated
therewith, and impose various sales practice requirements on broker-dealers who
sell penny stocks to persons other than established customers and accredited
investors (generally institutions). For these types of transactions, the
broker-dealer must make a special suitability determination for the purchaser
and have received the purchaser's written consent to the transaction prior to
sale. The additional burdens imposed upon broker-dealers may discourage
broker-dealers from effecting transactions in penny stocks, which could reduce
the liquidity of the shares of Common Stock and thereby have a material adverse
effect on the trading market for the securities.
Possible Adverse Effect of State Blue Sky Restrictions on Secondary Trading of
Common Shares
The Company believes that its Common Stock is eligible for sale on a
secondary market basis in most states based on various exemptions to state
qualification requirements. Limitations on, or the absence of those exemptions,
will under certain circumstances restrict the ability of a holder to transfer
the Common Stock to non-institutional buyers in some states. This could
adversely affect the liquidity of the Common Stock.
Anti-takeover Provisions
The Company's Board of Directors has the authority to issue up to
10,000,000 shares of Preferred Stock in one or more series and to determine the
price, rights, preferences and privileges of those shares without any further
vote or action by the stockholders. Any issuance of Preferred Stock with voting
and conversion rights may adversely affect the voting power of the holders of
Common Stock. The Company has received commitments to purchase convertible
preferred stock, convertible into shares of common stock. and such issuance
could have the effect of making it more difficult for a third party to acquire a
majority of the outstanding voting stock of the Company. In addition, the
Company may become subject to the anti-takeover provisions of Section 203 of the
Delaware General Corporation Law, which could have the effect of delaying or
preventing a change of control of the Company or adversely affect the market
price of the Company's Common Stock. In addition, the severance provisions of
employment agreements with certain members of the Company's management provide
for payments that could discourage an attempted change in control of the
Company.
ITEM 2. PROPERTIES
The Company's executive offices are located at Sixth Floor, 1001 22nd
Street, N.W., Washington, D.C. 20037, and are leased pursuant to a lease
agreement that will expire October 31, 1998.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any material litigation.
In May 1994, the Company received a letter claiming that the Company's logo
is confusingly similar to the registered trademark of a company engaged in the
sale of pre-recorded music, and that the Company's continued use of its logo may
constitute infringement of such mark. No claim of damages has been asserted and
the Company knows of no basis for the assertion of any damages with respect to
the use of its logo. At the present time, the Company does not have sufficient
information to assess the likelihood of success in any action that may arise in
connection with the claim. If the claim is adversely determined, the Company
does not believe that the loss of its logo would have a material adverse effect
on the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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