10-Q 1 a12-19365_110q.htm 10-Q

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

T         QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2012

 

OR

 

£         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE TRANSITION PERIOD FROM                                TO                                 .

 

Commission file number: 333-179121

 

Hughes Satellite Systems Corporation

(Exact name of registrant as specified in its charter)

 

Colorado

 

45-0897865

(State or other jurisdiction of incorporation or
organization)

 

(I.R.S. Employer Identification No.)

 

 

 

100 Inverness Terrace East

 

 

Englewood, Colorado

 

80112-5308

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code: (303) 706-4000

 

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

 

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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer £

 

Accelerated filer £

 

 

 

Non-accelerated filer x

 

Smaller reporting company £

(Do not check if a smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes £ No x

 

As of November 1, 2012, the Registrant’s outstanding common stock consisted of 1,000 shares of common stock, $0.01 par value per share.

 

The Registrant meets the conditions set forth in General Instructions (H)(1)(a) and (b) of Form 10-Q and is therefore filing this Form 10-Q with the reduced disclosure format.

 

 

 



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TABLE OF CONTENTS

 

Disclosure Regarding Forward-Looking Statements

i

 

 

 

PART I—FINANCIAL INFORMATION

 

 

 

Item 1.

Financial Statements

1

 

 

 

 

Condensed Consolidated Balance Sheets as of September 30, 2012 (Unaudited) and December 31, 2011

1

 

 

 

 

Condensed Consolidated Statements of Operations and Comprehensive Income (Loss)
for the Three and Nine Months Ended September 30, 2012 and 2011 (Unaudited)

2

 

 

 

 

Condensed Consolidated Statements of Cash Flows
for the Nine Months Ended September 30, 2012 and 2011 (Unaudited)

3

 

 

 

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

4

 

 

 

Item 2.

Management’s Narrative Analysis of Results of Operations

33

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

*

 

 

 

Item 4.

Controls and Procedures

40

 

 

 

PART II —OTHER INFORMATION

 

 

 

Item 1.

Legal Proceedings

40

 

 

 

Item 1A.

Risk Factors

41

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

*

 

 

 

Item 3.

Defaults upon Senior Securities

*

 

 

 

Item 4.

Mine Safety Disclosures

None

 

 

 

Item 5.

Other Information

None

 

 

 

Item 6.

Exhibits

41

 

 

 

Signatures

 

42

 


*           This item has been omitted pursuant to the reduced disclosure format as set forth in General Instructions (H)(2) of Form 10-Q

 



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DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

 

We make “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 throughout this report.  Whenever you read a statement that is not simply a statement of historical fact (such as when we describe what we “believe,” “intend,” “plan,” “estimate,” “expect” or “anticipate” will occur and other similar statements), you must remember that our expectations may not be achieved, even though we believe they are reasonable.  We do not guarantee that any future transactions or events described herein will happen as described or that they will happen at all.  You should read this report completely and with the understanding that actual future results may be materially different from what we expect.  Whether actual events or results will conform with our expectations and predictions is subject to a number of risks and uncertainties.  The risks and uncertainties include, but are not limited to, the following:

 

General Risks Affecting Our Business

 

·                 Our EchoStar Satellite Services segment currently derives a substantial portion of its revenue from DISH Network Corporation (“DISH Network”).  The loss of, or a significant reduction in, orders from, or a decrease in selling prices of transponder leasing, provision of digital broadcast services and/or other products or services to DISH Network would significantly reduce our revenue and adversely impact our results of operations.

 

·                 Economic weakness, including high unemployment and reduced consumer spending, may adversely affect our ability to grow or maintain our business.

 

·                 If we are unable to properly respond to technological changes, our business could be significantly harmed.

 

·                 Certain of our sales to DISH Network could be terminated or substantially curtailed on short notice, which would have a detrimental effect on us.

 

·                 We may be required to raise and refinance indebtedness during unfavorable market conditions.

 

·                 We may experience significant financial losses on our existing investments.

 

·                 We may pursue acquisitions and other strategic transactions to complement or expand our business, which may not be successful and we may lose up to the entire value of our investment in these acquisitions and transactions.

 

·                 We may not be aware of certain foreign government laws or regulations or changes to them which could have a significant adverse impact on our business.

 

·                 Our international sales and operations are subject to applicable laws relating to trade, export controls and foreign corrupt practices, the violation of which could adversely affect our operations.

 

·                 Our business depends on certain intellectual property rights and on not infringing the intellectual property rights of others.  The loss of or infringement of our intellectual property rights could have a significant adverse impact on our business.

 

·                 Any failure or inadequacy of our information technology infrastructure or those of our third-party service providers could harm our business.

 

·                 We are party to various lawsuits which, if adversely decided, could have a significant adverse impact on our business, particularly lawsuits regarding intellectual property.

 

·                 We are a wholly-owned subsidiary of EchoStar Corporation (“EchoStar”) and do not operate as an independent company.

 

·                 EchoStar has not been an independent company for a significant amount of time and it may be unable to make, on a timely or cost-effective basis, the changes necessary to operate as an independent company.

 

·                 We rely on key personnel and the loss of their services may negatively affect our businesses.

 

·                 We have substantial debt outstanding and may incur additional debt.

 

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Risks Affecting Our Business Segments

 

·                 We currently face competition from established competitors in the satellite service business and may face competition from others in the future.

 

·                 Our owned and leased satellites in orbit are subject to significant operational and environmental risks that could limit our ability to utilize these satellites.

 

·                 Our satellites have minimum design lives ranging from 12 to 15 years, but could fail or suffer reduced capacity before then.

 

·                 Our satellites under construction are subject to risks related to construction and launch that could limit our ability to utilize these satellites.

 

·                 Our business is subject to risks of adverse government regulation.

 

·                 Our business depends on Federal Communications Commission (“FCC”) licenses that can expire or be revoked or modified and applications for FCC licenses that may not be granted.

 

·                 Our use of certain satellites is often dependent on satellite coordination agreements, which may be difficult to obtain.

 

·                 Our dependence on outside contractors could result in delays related to the design, manufacture and launch of our new satellites, which could in turn adversely affect our operating results.

 

·                 We generally do not have commercial insurance coverage on the satellites we use and could face significant impairment charges if one of our uninsured satellites fails.

 

·                 We currently have unused satellite capacity in our EchoStar Satellite Services segment, and our results of operations may be materially adversely affected if we are not able to lease more of this capacity to third parties.

 

·                 The enterprise network communications industry is highly competitive.  We may be unsuccessful in competing effectively against other terrestrial and satellite-based network providers in our enterprise groups.

 

·                 The consumer network communications market is highly competitive.  We may be unsuccessful in competing effectively against fiber, Digital Subscriber Line (“DSL”), cable service providers and other satellite broadband providers in the consumer market.

 

·                 We are dependent upon third-party providers for components, manufacturing, installation services, and customer support services, and our results of operations may be materially adversely affected if any of these third-party providers fail to appropriately deliver the contracted goods or services.

 

·                 The failure to adequately anticipate the need for transponder capacity or the inability to obtain transponder capacity for our Hughes segment could harm our results of operations.

 

·                 If our products contain defects, we could be subject to significant costs to correct such defects and our product and network service contracts could be delayed or cancelled, which could adversely affect our revenues.

 

·                 We may face difficulties in accurately assessing and collecting contributions towards the Universal Service Fund.

 

·                 Our foreign operations expose us to regulatory risks and restrictions not present in our domestic operations.

 

·                 Although we expect that the Hughes Acquisition (as defined below) will benefit us, those expected benefits may not occur because of the complexity of integration and other challenges.

 

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Other Risks

 

·                 We may have potential conflicts of interest with DISH Network due to EchoStar and DISH Network’s common ownership and management.

 

·                 We cannot assure you that there will not be deficiencies leading to material weaknesses in our internal control over financial reporting.

 

·                 Our parent, EchoStar, is controlled by one principal stockholder who is our Chairman.

 

·                 We may face other risks described from time-to-time in periodic and current reports we file with the Securities and Exchange Commission (“SEC”).

 

All cautionary statements made herein should be read as being applicable to all forward-looking statements wherever they appear.  Investors should consider the risks described herein and should not place undue reliance on any forward-looking statements.  We assume no responsibility for updating forward-looking information contained or incorporated by reference herein or in other reports we file with the SEC.

 

In this report, the words “HSS,” the “Company,” “we,” “our” and “us” refer to Hughes Satellite Systems Corporation and its subsidiaries, unless the context otherwise requires.  “EchoStar” refers to EchoStar Corporation and its subsidiaries, unless the context otherwise requires.  “DISH Network” refers to DISH Network Corporation and its subsidiaries, unless the context otherwise requires.

 

iii


 


Table of Contents

 

PART I—FINANCIAL INFORMATION

 

Item 1.   FINANCIAL STATEMENTS

 

HUGHES SATELLITE SYSTEMS CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except share amounts)

(Unaudited)

 

 

 

As of

 

 

 

September 30,

 

December 31,

 

 

 

2012

 

2011

 

Assets

 

 

 

 

 

Current Assets:

 

 

 

 

 

Cash and cash equivalents

 

$

140,419

 

$

125,003

 

Marketable investment securities

 

85,350

 

261,082

 

Trade accounts receivable, net of allowance for doubtful accounts of $14,033 and $16,769, respectively

 

194,932

 

171,917

 

Trade accounts receivable - DISH Network, net of allowance for doubtful accounts of zero

 

52,480

 

33,128

 

Advances to affiliates, net

 

6,543

 

4,217

 

Inventory

 

58,261

 

47,558

 

Deferred tax assets

 

21,160

 

21,222

 

Other current assets

 

51,655

 

52,917

 

Total current assets

 

610,800

 

717,044

 

Noncurrent Assets:

 

 

 

 

 

Restricted cash and cash equivalents

 

25,889

 

23,540

 

Property and equipment, net of accumulated depreciation of $1,489,118 and $1,281,930, respectively

 

2,130,819

 

2,021,905

 

Orbital rights, net

 

561,575

 

465,658

 

Goodwill

 

504,173

 

516,198

 

Other intangible assets, net

 

291,046

 

341,207

 

Other investment securities

 

27,801

 

22,466

 

Other noncurrent assets, net

 

156,041

 

140,819

 

Total noncurrent assets

 

3,697,344

 

3,531,793

 

Total assets

 

$

4,308,144

 

$

4,248,837

 

 

 

 

 

 

 

Liabilities and Shareholder’s Equity (Deficit)

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

Trade accounts payable

 

$

123,670

 

$

141,933

 

Trade accounts payable - DISH Network

 

3,172

 

10,100

 

Advances from affiliates, net

 

65,864

 

 

Deferred revenue and other

 

39,570

 

50,568

 

Accrued interest

 

41,585

 

6,348

 

Accrued expenses and other

 

118,282

 

118,643

 

Current portion of long-term debt and capital lease obligations

 

62,117

 

63,411

 

Total current liabilities

 

454,260

 

391,003

 

Noncurrent Liabilities:

 

 

 

 

 

Long-term debt and capital lease obligations, net of current portion

 

2,431,285

 

2,464,044

 

Deferred tax liabilities

 

276,754

 

290,287

 

Advances from affiliates

 

8,033

 

 

Long-term deferred revenue and other long-term liabilities

 

50,994

 

26,773

 

Total noncurrent liabilities

 

2,767,066

 

2,781,104

 

Total liabilities

 

3,221,326

 

3,172,107

 

 

 

 

 

 

 

Commitments and Contingencies (Note 10)

 

 

 

 

 

 

 

 

 

 

 

Shareholder’s Equity (Deficit):

 

 

 

 

 

Common stock, $0.01 par value; 1,000,000 shares authorized, 1,000 shares issued and outstanding

 

 

 

Additional paid-in capital

 

1,100,097

 

1,099,506

 

Accumulated other comprehensive income (loss)

 

(13,592

)

(7,914

)

Accumulated earnings (deficit)

 

(8,730

)

(23,972

)

Total HSS shareholder’s equity (deficit)

 

1,077,775

 

1,067,620

 

Noncontrolling interests

 

9,043

 

9,110

 

Total shareholder’s equity (deficit)

 

1,086,818

 

1,076,730

 

Total liabilities and shareholder’s equity (deficit)

 

$

4,308,144

 

$

4,248,837

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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HUGHES SATELLITE SYSTEMS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME (LOSS)

(In thousands)

(Unaudited)

 

 

 

For the Three Months
Ended September 30,

 

For the Nine Months
Ended September 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Revenue:

 

 

 

 

 

 

 

 

 

Services and other revenue

 

$

230,937

 

$

243,569

 

$

702,068

 

$

331,775

 

Services and other revenue - DISH Network

 

51,654

 

54,526

 

163,478

 

160,554

 

Equipment revenue

 

68,183

 

58,257

 

185,444

 

83,444

 

Total revenue

 

350,774

 

356,352

 

1,050,990

 

575,773

 

Costs and Expenses:

 

 

 

 

 

 

 

 

 

Cost of sales - services and other

 

118,625

 

125,380

 

356,901

 

185,277

 

Cost of sales - equipment

 

61,379

 

48,729

 

160,262

 

68,541

 

Selling, general and administrative expenses

 

54,125

 

64,123

 

165,963

 

86,123

 

Research and development expenses

 

5,255

 

5,610

 

15,417

 

6,906

 

Depreciation and amortization (Notes 6 and 7)

 

85,298

 

101,048

 

259,423

 

163,976

 

Total costs and expenses

 

324,682

 

344,890

 

957,966

 

510,823

 

Operating income (loss)

 

26,092

 

11,462

 

93,024

 

64,950

 

 

 

 

 

 

 

 

 

 

 

Other Income (Expense):

 

 

 

 

 

 

 

 

 

Interest income

 

373

 

1,538

 

1,921

 

1,823

 

Interest expense, net of amounts capitalized

 

(34,138

)

(33,791

)

(109,660

)

(50,904

)

Hughes Acquisition costs

 

7

 

(730

)

 

(35,230

)

Other, net

 

23,103

 

336

 

29,252

 

9,703

 

Total other income (expense)

 

(10,655

)

(32,647

)

(78,487

)

(74,608

)

Income (loss) before income taxes

 

15,437

 

(21,185

)

14,537

 

(9,658

)

Income tax (provision) benefit, net

 

(62

)

9,134

 

101

 

1,697

 

Net income (loss)

 

15,375

 

(12,051

)

14,638

 

(7,961

)

Less: Net income (loss) attributable to noncontrolling interests

 

(285

)

270

 

(604

)

357

 

Net income (loss) attributable to HSS

 

$

15,660

 

$

(12,321

)

$

15,242

 

$

(8,318

)

 

 

 

 

 

 

 

 

 

 

Comprehensive Income (Loss):

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

15,375

 

$

(12,051

)

$

14,638

 

$

(7,961

)

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments

 

1,208

 

(6,968

)

(3,143

)

(7,330

)

Unrealized holding gains (losses) on available-for-sale securities

 

284

 

1,955

 

10,988

 

950

 

Recognition of previously unrealized (gains) losses on available-for-sale securities included in net income (loss)

 

(13,154

)

 

(13,154

)

 

Total other comprehensive income (loss), net of tax

 

(11,662

)

(5,013

)

(5,309

)

(6,380

)

Comprehensive income (loss)

 

3,713

 

(17,064

)

9,329

 

(14,341

)

Less: Comprehensive income (loss) attributable to noncontrolling interests

 

192

 

(368

)

(235

)

(635

)

Comprehensive income (loss) attributable to HSS

 

$

3,521

 

$

(16,696

)

$

9,564

 

$

(13,706

)

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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HUGHES SATELLITE SYSTEMS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

 

 

For the Nine Months
Ended September 30,

 

 

 

2012

 

2011

 

Cash Flows From Operating Activities:

 

 

 

 

 

Net income (loss)

 

$

14,638

 

$

(7,961

)

Adjustments to reconcile net income (loss) to net cash flows from operating activities:

 

 

 

 

 

Depreciation and amortization

 

259,423

 

163,976

 

Equity in losses (earnings) of affiliates

 

(4,381

)

(1,500

)

Amortization of debt issuance costs

 

3,721

 

1,561

 

Non-cash, stock-based compensation

 

591

 

284

 

Deferred tax expense (benefit)

 

(7,270

)

2,431

 

Other, net

 

(22,973

)

(14,296

)

Change in noncurrent assets

 

(5,884

)

(4,260

)

Changes in current assets and current liabilities, net

 

(32,202

)

38,229

 

Net cash flows from operating activities

 

205,663

 

178,464

 

 

 

 

 

 

 

Cash Flows From Investing Activities:

 

 

 

 

 

Purchases of marketable investment securities

 

(70,235

)

(213,815

)

Sales and maturities of marketable investment securities

 

246,976

 

424,808

 

Purchases of property and equipment

 

(301,108

)

(184,993

)

Acquisition of orbital rights

 

(82,477

)

 

Acquisition of Hughes Communications, net of cash acquired of $98,900

 

 

(2,075,613

)

Change in restricted cash and cash equivalents

 

(2,349

)

2,046

 

Other, net

 

(8,036

)

(5,221

)

Net cash flows from investing activities

 

(217,229

)

(2,052,788

)

 

 

 

 

 

 

Cash Flows From Financing Activities:

 

 

 

 

 

Repayment of long-term debt and capital lease obligations

 

(46,263

)

(40,952

)

Debt issuance costs

 

(229

)

(57,597

)

Net proceeds from issuance of long-term debt

 

449

 

2,000,000

 

Contributions from parent

 

 

166,379

 

Advances from affiliates

 

73,711

 

 

Other

 

(764

)

(155

)

Net cash flows from financing activities

 

26,904

 

2,067,675

 

Effect of exchange rates on cash and cash equivalents

 

78

 

755

 

Net increase (decrease) in cash and cash equivalents

 

15,416

 

194,106

 

Cash and cash equivalents, beginning of period

 

125,003

 

106

 

Cash and cash equivalents, end of the period

 

$

140,419

 

$

194,212

 

 

 

 

 

 

 

Supplemental Disclosure of Cash Flow Information:

 

 

 

 

 

Cash paid for interest (including capitalized interest)

 

$

110,057

 

$

30,206

 

Capitalized interest

 

$

39,371

 

$

27,638

 

Cash received for interest

 

$

5,702

 

$

1,390

 

Cash paid to EchoStar for income taxes

 

$

1,007

 

$

203

 

Cash paid for income taxes

 

$

6,973

 

$

2,253

 

Satellites and other assets financed under capital lease obligations

 

$

24,355

 

$

25,788

 

In-orbit incentive obiligation for EchoStar XVII

 

$

24,950

 

$

 

Reduction of capital lease obligations for AMC-16

 

$

12,599

 

$

6,616

 

Marketable investment securities included in capital contributions

 

$

 

$

442,473

 

Changes in capital expenditures included in accounts payable

 

$

(33,277

)

$

14,423

 

Orbital rights obligation included in accrued liabilities

 

$

16,000

 

$

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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HUGHES SATELLITE SYSTEMS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1.         Organization and Business Activities

 

Principal Business

 

Hughes Satellite Systems Corporation, (together with its subsidiaries, “HSS,” the “Company,” “we,” “us” and/or “our”) is a holding company and a direct, wholly-owned subsidiary of EchoStar Corporation (“EchoStar”).  We were formed as a Colorado corporation in March 2011 to facilitate the acquisition (the “Hughes Acquisition”) of Hughes Communications, Inc. and its subsidiaries (“Hughes Communications”) and related financing transactions.  In connection with our formation, EchoStar contributed the assets and liabilities of its satellite services business, including its principal operating subsidiary of its satellite services business, EchoStar Satellite Services L.L.C., to us.  As a result, our historical financial statements, prior to June 9, 2011, reflect the historical consolidated financial position and operating results of EchoStar’s satellite services business.

 

Following the Hughes Acquisition, we operate two primary business segments:

 

·                  EchoStar Satellite Services which uses 9 of our 11 owned and leased in-orbit satellites and related Federal Communications Commission (“FCC”) licenses to lease capacity on a full-time and occasional-use basis primarily to DISH Network, and secondarily to Dish Mexico, S. de R.L. de C.V. (“Dish Mexico”), United States government service providers, state agencies, Internet service providers, broadcast news organizations, programmers and private enterprise customers.

 

·                  Hughes which provides satellite broadband Internet access to North American consumers and broadband network services and systems to the domestic and international enterprise markets.  The Hughes segment also provides managed services to large enterprises and networking systems solutions to customers for mobile satellite and wireless backhaul systems.  Hughes became a new segment as a result of the Hughes Acquisition and the operating results of Hughes Communications are included in our results effective June 9, 2011.  See Note 9 for further discussion of the Hughes Acquisition.

 

Effective January 1, 2008, DISH Network completed its distribution to EchoStar (the “Spin-off”) of its digital set-top box business and certain infrastructure and other assets, including certain of its satellites, uplink and satellite transmission assets, real estate and other assets and related liabilities.  Since the Spin-off, EchoStar and DISH Network have operated as separate publicly-traded companies, and neither entity has any ownership interest in the other.  However, a substantial majority of the voting power of the shares of both companies is owned beneficially by Charles W. Ergen, our Chairman, or by certain trusts established by Mr. Ergen for the benefit of his family.

 

Note 2.         Basis of Presentation and Summary of Significant Accounting Policies

 

Basis of Presentation

 

The accompanying (a) condensed balance sheet as of December 31, 2011, which has been derived from our audited financial statements, and (b) unaudited interim condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and with the instructions to Form 10-Q and Article 10 of Regulation S-X for interim financial information.  Accordingly, these financial statements do not include all of the information and notes required for complete financial statements prepared under GAAP.  In our opinion, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.  Our results of operations for the interim periods presented are not necessarily indicative of the results that may be expected for the full year.  For further information, refer to the Consolidated Financial Statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2011.  Certain prior period amounts have been reclassified to conform to the current period presentation.

 

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Table of Contents

 

HUGHES SATELLITE SYSTEMS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—Continued

(Unaudited)

 

Our operating results for the period presented prior to March 2011 are presented on a combined basis and reflect the historical results of operations and cash flows of certain entities included in the consolidated financial statements and accounting records of EchoStar that principally represented its satellite services business.  The financial statements for all periods are labeled as condensed consolidated financial statements.  Our Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the nine months ended September 30, 2011 include the operating results of Hughes Communications after June 8, 2011, the date of the Hughes Acquisition.

 

Principles of Consolidation

 

We consolidate all majority owned subsidiaries, investments in entities in which we have controlling influence and variable interest entities where we are the primary beneficiary.  Non-majority owned investments are accounted for using the equity method when we have the ability to significantly influence the operating decisions of the investee.  When we do not have the ability to significantly influence the operating decisions of an investee, the cost method is used.  All significant intercompany accounts and transactions have been eliminated in consolidation.

 

Use of Estimates

 

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense for each reporting period.  Estimates are used in accounting for, among other things, deferred revenue and deferred subscriber acquisition cost amortization periods, percentage-of-completion related to revenue recognition, allowances for doubtful accounts, allowances for sales returns/rebates, warranty obligations, self-insurance obligations, deferred taxes and related valuation allowances, uncertain tax positions, loss contingencies, fair value of financial instruments, fair value of options granted under EchoStar’s stock-based compensation plans, fair value of assets and liabilities acquired in business combinations, capital leases, asset impairments, useful lives of property, equipment and intangible assets, and royalty obligations.  Weakened economic conditions may increase the inherent uncertainty in the estimates and assumptions indicated above.  We base our estimates and assumptions on historical experience and on various other factors that we believe to be reasonable under the circumstances.  Due to the inherent uncertainty involved in making estimates, actual results may differ from previously estimated amounts, and such differences may be material to our Condensed Consolidated Financial Statements.  Estimates and assumptions are reviewed periodically, and the effects of revisions are reflected prospectively in the period they occur.

 

Fair Value Measurements

 

We determine fair value based on the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants.  Market or observable inputs are the preferred source of values, followed by unobservable inputs or assumptions based on hypothetical transactions in the absence of market inputs.  We apply the following hierarchy in determining fair value:

 

·                  Level 1, defined as observable inputs being quoted prices in active markets for identical assets;

 

·                  Level 2, defined as observable inputs other than quoted prices included in Level 1, including quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which significant inputs and significant value drivers are observable in active markets; and

 

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HUGHES SATELLITE SYSTEMS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—Continued

(Unaudited)

 

·                  Level 3, defined as unobservable inputs for which little or no market data exists, consistent with reasonably available assumptions made by other participants therefore requiring assumptions based on the best information available.

 

As of September 30, 2012 and December 31, 2011, the carrying value of our cash and cash equivalents, current marketable investment securities, trade accounts receivable, net of allowance for doubtful accounts, and accrued liabilities were equal to or approximated fair value due to their short-term nature or proximity to current market rates.

 

Fair values for our publicly traded debt securities are based on quoted market prices.  The fair value of our private debt and orbital incentive obligations is estimated at their carrying value based on current rates (Level 2).  See Note 8 for the fair value of our long-term debt.  As of September 30, 2012 and December 31, 2011, the fair values of our orbital incentive obligations, based on measurements categorized within Level 2 of the fair value hierarchy, approximated their carrying values of $30 million and $6 million, respectively.

 

We use fair value measurements from time-to-time in connection with impairment testing and the assignment of purchase consideration to assets and liabilities of acquired companies.  Those fair value measurements typically include significant unobservable inputs and are categorized within Level 3 of the fair value hierarchy.

 

Note 3.          Other Comprehensive Income (Loss) and Related Tax Effects

 

We have not recognized any tax effects on foreign currency translation adjustments because they are not expected to result in future taxable income or deductions.  We have not recognized any tax effects on unrealized gains or losses on available-for-sale securities to the extent the gains or losses would affect the amount of existing capital loss carryforwards for which the related deferred tax asset has been fully offset by a valuation allowance.

 

Note 4.          Marketable Investment Securities and Other Investment Securities

 

Our marketable investment securities and other investment securities consisted of the following:

 

 

 

As of

 

 

 

September 30,
2012

 

December 31,
2011

 

 

 

(In thousands)

 

Marketable investment securities—current:

 

 

 

 

 

VRDNs

 

$

7,415

 

$

61,795

 

Strategic

 

 

6,426

 

Other

 

77,935

 

192,861

 

Total marketable investment securities—current

 

85,350

 

261,082

 

Other investment securities—noncurrent:

 

 

 

 

 

Cost method

 

15,557

 

15,557

 

Equity method

 

12,244

 

6,909

 

Total other investment securities—noncurrent

 

27,801

 

22,466

 

Total marketable and other investment securities

 

$

113,151

 

$

283,548

 

 

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Table of Contents

 

HUGHES SATELLITE SYSTEMS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—Continued

(Unaudited)

 

Marketable Investment Securities

 

Our marketable investment securities portfolio consists of various debt and equity instruments, all of which are classified as available-for-sale.

 

Variable rate demand notes (“VRDNs”)

 

VRDNs are long-term floating rate municipal bonds with embedded put options that allow the bondholder to sell the security at par plus accrued interest.  All of the put options are secured by a pledged liquidity source.  Our VRDN portfolio is comprised of investments in municipalities and corporations, which are backed by financial institutions or other highly rated companies that serve as the pledged liquidity source.  While they are classified as marketable investment securities, the put option allows VRDNs to be liquidated generally on a same day or on a five business day settlement basis.

 

Strategic

 

From time to time, we may acquire strategic investments in marketable equity securities.  As of December 31, 2011, our strategic investment portfolio consisted of shares of common stock of a single public company issuer with a carrying amount (at fair value) of $6.4 million with a cost basis of $3.2 million.  As a result of a merger agreement associated with the issuer of the equity securities, we received $16.2 million in August 2012 in exchange for our ownership of the shares of common stock. As a result, we recognized a $13 million of gain on sale of our investment in “Other, net” on our Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the three and nine months ended September 30, 2012.  As of September 30, 2012, we held no strategic marketable investment securities.

 

Other

 

Our other current marketable investment securities portfolio includes investments in various debt instruments, including corporate and government bonds.

 

Other Investment Securities—Noncurrent

 

We have two strategic investments in equity securities of certain privately held companies that are accounted for using the equity or the cost method of accounting.  Our ability to realize value from our strategic investments in companies that are not publicly traded depends on the success of those companies’ businesses and their ability to obtain sufficient capital to execute their business plans.  Because private markets are not as liquid as public markets, there is also increased risk that we will not be able to sell these investments, or that when we desire to sell them we will not be able to obtain fair value for them.

 

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Table of Contents

 

HUGHES SATELLITE SYSTEMS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—Continued

(Unaudited)

 

Unrealized Gains (Losses) on Marketable Investment Securities

 

The components of our available-for-sale investments are summarized in the table below.

 

 

 

As of

 

 

 

September 30, 2012

 

December 31, 2011

 

 

 

Marketable

 

 

 

 

 

 

 

Marketable

 

 

 

 

 

 

 

 

 

Investment

 

Unrealized

 

Investment

 

Unrealized

 

 

 

Securities

 

Gains

 

Losses

 

Net

 

Securities

 

Gains

 

Losses

 

Net

 

 

 

(In thousands)

 

Debt securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

VRDNs

 

$

7,415

 

$

 

$

 

$

 

$

61,795

 

$

 

$

 

$

 

Other

 

77,935

 

99

 

(43

)

56

 

192,861

 

68

 

(1,100

)

(1,032

)

Equity security - strategic

 

 

 

 

 

6,426

 

3,254

 

 

3,254

 

Total marketable investment securities

 

$

85,350

 

$

99

 

$

(43

)

$

56

 

$

261,082

 

$

3,322

 

$

(1,100

)

$

2,222

 

 

As of September 30, 2012, we had debt securities of $79 million with contractual maturities of one year or less and $6 million with contractual maturities greater than one year.  We may realize proceeds from certain investments prior to contractual maturity as a result of our ability to sell these securities prior to their contractual maturity.

 

Marketable Investment Securities in a Loss Position

 

The following table reflects the length of time that our available-for-sale debt securities have been in an unrealized loss position. We do not intend to sell these debt securities before they recover, and it is more likely than not that we will hold these debt securities until they recover or mature. In addition, we are not aware of any specific factors indicating that the underlying issuers of these debt securities would not be able to pay interest as it becomes due or repay the principal at maturity. Therefore, we believe that these changes in the estimated fair values of these debt securities are primarily related to temporary market fluctuations.

 

 

 

As of

 

 

 

September 30, 2012

 

December 31, 2011

 

 

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

 

 

Value

 

Losses

 

Value

 

Losses

 

 

 

(In thousands)

 

Less than 12 months

 

$

16,602

 

$

(32

)

$

154,891

 

$

(1,100

)

12 months or more

 

13,239

 

(11

)

 

 

Total

 

$

29,841

 

$

(43

)

$

154,891

 

$

(1,100

)

 

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Table of Contents

 

HUGHES SATELLITE SYSTEMS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—Continued

(Unaudited)

 

Fair Value Measurements

 

Our current marketable investment securities were measured at fair value on a recurring basis as summarized in the table below.  As of September 30, 2012 and December 31, 2011, we did not have investments that were categorized within Level 3 of the fair value hierarchy.

 

 

 

As of

 

 

 

September 30, 2012

 

December 31, 2011

 

 

 

Total

 

Level 1

 

Level 2

 

Total

 

Level 1

 

Level 2

 

 

 

(In thousands)

 

Cash equivalents

 

$

80,804

 

$

1

 

$

80,803

 

$

71,940

 

$

110

 

$

71,830

 

Debt securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

VRDNs

 

7,415

 

 

7,415

 

61,795

 

 

61,795

 

Other (including restricted)

 

77,935

 

 

77,935

 

192,861

 

 

192,861

 

Equity securities - strategic

 

 

 

 

6,426

 

6,426

 

 

Total marketable investment securities

 

$

85,350

 

$

 

$

85,350

 

$

261,082

 

$

6,426

 

$

254,656

 

 

Note 5.          Inventory

 

Our inventory consisted of the following:

 

 

 

As of

 

 

 

September 30,
2012

 

December 31,
2011

 

 

 

(In thousands)

 

Finished goods

 

$

39,442

 

$

33,574

 

Work-in process

 

10,081

 

7,315

 

Raw materials

 

8,738

 

6,669

 

Total inventory

 

$

58,261

 

$

47,558

 

 

Note 6.          Property and Equipment

 

Depreciation and amortization expense consisted of the following:

 

 

 

For the Three Months
Ended September 30,

 

For the Nine Months
Ended September 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

(In thousands)

 

Satellites

 

$

35,442

 

$

29,455

 

$

109,560

 

$

77,015

 

Furniture, fixtures, equipment and other

 

31,248

 

31,474

 

94,472

 

40,678

 

Amortization of intangible assets and other

 

17,456

 

38,990

 

51,944

 

44,932

 

Buildings and improvements

 

1,152

 

1,129

 

3,447

 

1,351

 

Total depreciation and amortization

 

$

85,298

 

$

101,048

 

$

259,423

 

$

163,976

 

 

As a result of an accelerated amortization method used for certain of our intangible assets acquired in the Hughes Acquisition, higher amortization expense was recognized for the three months ended September 30, 2011 compared to the same period in 2012.  The increase in our depreciation and amortization expense for the nine months ended September 30, 2012 compared to the same period in 2011 was due to depreciation expense recognized on assets acquired in June 2011 in connection with the Hughes Acquisition.

 

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Table of Contents

 

HUGHES SATELLITE SYSTEMS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—Continued

(Unaudited)

 

Depreciation and amortization expense is reported separately from cost of sales and other expense categories included in our Condensed Consolidated Statements of Operations and Comprehensive Income (Loss).

 

Satellites

 

As of September 30, 2012, we utilized 10 of our 11 owned and leased satellites in geostationary orbit approximately 22,300 miles above the equator, including the SPACEWAY 3 satellite, which was added to our satellite fleet as a result of the Hughes Acquisition in 2011, and the recently launched EchoStar XVII satellite in July 2012.  Four of these satellites are accounted for as capital leases and are depreciated over the terms of the satellite service agreements.  Beginning October 2012, we introduced HughesNet Gen4 broadband Internet services to our customers in North America on the EchoStar XVII satellite.  We depreciate our owned satellites on a straight-line basis over the estimated useful life of each satellite.

 

In addition, we also own EchoStar XVI, which is currently under construction and is expected to be launched in the fourth quarter of 2012.

 

EchoStar XVII Orbital Incentives Obligation

 

Pursuant to the terms and conditions of the construction agreement for EchoStar XVII, we are obligated to commence payment of in-orbit incentives totalling $25 million (the “Orbital incentive”) upon the completion of the in-orbit testing, which occurred in September 2012. In addition, we are required to make interest payments on the Orbital incentive, at an annual rate of 10%, of approximately $33 million. The Orbital incentive payments, including interest, are required to be paid quarterly over a 15-year period, subject to prepayment at our option; however, these payments are subject to reduction in the event of future satellite failures.  As of September 30, 2012, the Orbital incentive was capitalized in “Property and equipment, net” and included in “Long-term deferred revenue and other long-term liabilities” on our Condensed Consolidated Balance Sheets.

 

Satellite Anomalies

 

Certain of our satellites have experienced anomalies, some of which have had a significant adverse impact on their remaining useful life and/or commercial operation.  There can be no assurance that future anomalies will not further impact the remaining useful life and commercial operation of any of the satellites in our fleet.  See “Long-Lived Satellite Assets” below for further discussion of evaluation of impairment.  In addition, there can be no assurance that we can recover critical transmission capacity in the event one or more of our in-orbit satellites were to fail.  We generally do not carry in-orbit insurance on any of our satellites, other than SPACEWAY 3, EchoStar XVI and EchoStar XVII, and therefore, we bear the risk of any uninsured in-orbit failures.  However, pursuant to the terms of the agreements governing certain portions of our indebtedness, we are required, subject to certain limitations on coverage, to maintain launch insurance for EchoStar XVI and to maintain in-orbit insurance for EchoStar XVI, EchoStar XVII and SPACEWAY 3.  Satellite anomalies with respect to certain of our satellites are discussed below.

 

Owned Satellites

 

EchoStar III.  EchoStar III, which is currently an in-orbit spare, was designed to meet a minimum 12-year useful life.  During the first quarter of 2012, EchoStar III experienced a solar array anomaly which did not impact commercial operation of the satellite; however, there can be no assurance that future anomalies will not impact its commercial operation.  EchoStar III was fully depreciated in 2009.

 

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HUGHES SATELLITE SYSTEMS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—Continued

(Unaudited)

 

EchoStar VI.  EchoStar VI was designed to meet a minimum 12-year useful life.  Prior to 2012, this satellite experienced solar array anomalies and the loss of traveling wave tube amplifiers (“TWTAs”) that did not reduce its useful life; however, the solar array anomalies impacted the commercial operation of the satellite.  During the first quarter of 2012, we determined that EchoStar VI experienced the loss of two additional TWTAs increasing the total number of TWTAs lost on the satellite to five.  During the second quarter of 2012, EchoStar VI lost an additional solar array string reducing the total power available for use by the spacecraft.  The recent losses of TWTAs and the solar array string did not reduce the estimated useful life of the satellite and did not impact the current commercial operation of the satellite; however, there can be no assurance that future anomalies will not reduce its useful life or impact its commercial operation.  EchoStar VI was fully depreciated in August 2012.

 

EchoStar XII.  Prior to 2012, EchoStar XII experienced anomalies resulting in the loss of electrical power available from its solar arrays.  During September 2012 and November 2012, EchoStar XII experienced additional solar array anomalies, which could further reduce the electrical power available to operate EchoStar XII.  An investigation of the anomalies is continuing.  We currently operate EchoStar XII in spot beam mode.  If we continue to operate the satellite in the spot beam mode, as a result of this loss of electrical power, we are still able to maintain our current operational requirements.  Additional solar array anomalies are likely to continue to degrade operational capability in all of the possible modes.  Since the number of useable transponders on EchoStar XII depends on, among other things, whether EchoStar XII is operated in CONUS, spot beam, or hybrid CONUS/spot beam mode, we are unable to determine at this time the actual number of transponders that will be available at any given time or how many transponders can be used during the remaining estimated life of the satellite.  Additionally, there can be no assurance that future anomalies will not cause further losses, which could impact the remaining useful life or commercial operation of EchoStar XII.

 

Leased Satellites

 

EchoStar I.  During 2009, we entered into a satellite capacity agreement pursuant to which we leased certain satellite capacity from DISH Network on EchoStar I.  During the first quarter of 2012, EchoStar I experienced a communications receiver anomaly, which had no impact on the commercial operation of the satellite. Effective July 1, 2012, we and DISH Network mutually agreed to terminate this satellite capacity agreement.

 

AMC-16.  In February 2012 and April 2012, AMC-16 experienced two solar-power anomalies, causing a partial power loss that reduced its capacity.  Pursuant to the governing satellite services agreement, we are entitled to a reduction of our monthly recurring payment in the event of a partial loss of satellite capacity.  In connection with the February 2012 anomaly, we reduced our capital lease obligation and recognized a corresponding gain of $5 million in the second quarter of 2012.  In connection with the April 2012 anomaly, we reduced our capital lease obligation and recognized a corresponding gain of approximately $8 million in the third quarter of 2012.  The gains were recorded in “Other, net” on our Condensed Consolidated Statements of Operations and Comprehensive Income (Loss).  There can be no assurance that these anomalies or any future anomalies will not reduce its useful life or further impact its commercial operations.

 

Long-Lived Satellite Assets

 

We evaluate our satellites for impairment and test for recoverability whenever events or changes in circumstances indicate that their carrying amount may not be recoverable.  This evaluation is performed at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities.  Certain of the anomalies discussed above, and previously disclosed, may be considered to represent a significant adverse change in the physical condition of a particular satellite.  However, based on the redundancy designed within each satellite, these anomalies are not considered to be significant events that would require a test of recoverability because the projected cash flows have not been significantly affected by these anomalies.

 

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HUGHES SATELLITE SYSTEMS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—Continued

(Unaudited)

 

Note 7.         Goodwill, Orbital Rights and Other Intangible Assets

 

Goodwill

 

Goodwill was recognized in connection with the Hughes Acquisition and has been assigned to reporting units of our Hughes segment.  In connection with our final purchase price allocation of the Hughes Acquisition, we made adjustments to increase deferred tax assets with a corresponding adjustment to goodwill in 2012 as summarized in the table below:

 

 

 

Amount

 

 

 

(In thousands)

 

Balance as of December 31, 2011

 

$

516,198

 

Adjustments

 

(12,025

)

Balance as of September 30, 2012

 

$

504,173

 

 

We performed step one of our annual two-step test of impairment of such goodwill as of April 1, 2012.  Step one involves a comparison of the estimated fair value of the reporting unit with its carrying amount, including goodwill.  We estimated fair value of the reporting units using discounted cash flow techniques, which included significant assumptions about prospective financial information, terminal value and discount rates.  Based on this quantitative test, we determined that the estimated fair values of the Hughes reporting units were in excess of the corresponding carrying amounts, including goodwill.  Accordingly, we concluded that goodwill assigned to the Hughes segment was not impaired and it was not necessary to perform step two of the two-step goodwill impairment test.

 

Orbital Rights

 

Orbital rights consisted of the following:

 

 

 

As of

 

 

 

September 30, 2012

 

December 31, 2011

 

 

 

Cost

 

Accumulated

 

Cost

 

Accumulated

 

 

 

Basis

 

Amortization

 

Basis

 

Amortization

 

 

 

 

 

(In thousands)

 

 

 

Indefinite lives

 

$

491,658

 

$

 

$

465,658

 

$

 

Definite lives

 

71,506

 

(1,589

)

 

 

Total orbital rights

 

$

563,164

 

$

(1,589

)

$

465,658

 

$

 

 

Most of our orbital rights have indefinite useful lives due to their non-depleting nature.  In May 2012, we acquired the right to use the 45 degree west longitude orbital location from ANATEL, the Brazilian communications regulatory authority (the “Brazil authorization”).  The Brazil authorization is amortized on a straight-line basis over the license term of 15 years.

 

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HUGHES SATELLITE SYSTEMS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—Continued

(Unaudited)

 

Other Intangible Assets

 

Other intangible assets, which are subject to amortization, consisted of the following:

 

 

 

As of

 

 

 

September 30, 2012

 

December 31, 2011

 

 

 

Cost

 

Accumulated

 

Cost

 

Accumulated

 

 

 

Basis

 

Amortization

 

Basis

 

Amortization

 

 

 

 

 

(In thousands)

 

 

 

Customer relationships

 

$

270,300

 

$

(80,855

)

$

270,300

 

$

(52,556

)

Contract-based

 

64,800

 

(34,040

)

64,800

 

(20,602

)

Technology-based

 

51,417

 

(11,434

)

51,417

 

(5,007

)

Trademark portfolio

 

29,700

 

(1,980

)

29,700

 

(866

)

Favorable leases

 

4,707

 

(1,569

)

4,707

 

(686

)

Total

 

$

420,924

 

$

(129,878

)

$

420,924

 

$

(79,717

)

 

These intangible assets are amortized on a straight-line basis over periods primarily ranging from approximately one to twenty years or in relation to the estimated cash flows over the life of the intangible asset.  Amortization expense, including the Brazil authorization, was $17 million and $52 million for the three and nine months ended September 30, 2012, respectively, and was $39 million and $45 million for the three and nine months ended September 30, 2011, respectively.

 

Future Amortization

 

Estimated future amortization of our intangible assets, including the Brazil authorization, as of September 30, 2012 is as follows:

 

For the Years Ending December 31, 

 

Amount

 

 

 

(In thousands)

 

2012 (remaining three months)

 

$

17,324

 

2013

 

49,488

 

2014

 

59,284

 

2015

 

49,227

 

2016

 

40,441

 

Thereafter

 

145,199

 

Total

 

$

360,963

 

 

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Table of Contents

 

HUGHES SATELLITE SYSTEMS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—Continued

(Unaudited)

Note 8.         Debt

 

Fair Value

 

The following table summarizes the carrying and fair values of our debt:

 

 

 

As of

 

 

 

September 30, 2012

 

December 31, 2011

 

 

 

Carrying

 

 

 

Carrying

 

 

 

 

 

Value

 

Fair Value

 

Value

 

Fair Value

 

 

 

 

 

(In thousands)

 

 

 

6 1/2% Senior Secured Notes due 2019

 

$

1,100,000

 

$

1,193,500

 

$

1,100,000

 

$

1,138,500

 

7 5/8% Senior Notes due 2021

 

900,000

 

1,003,500

 

900,000

 

936,000

 

Other

 

501

 

501

 

858

 

858

 

Subtotal

 

2,000,501

 

$

2,197,501

 

2,000,858

 

$

2,075,358

 

Capital lease obligations (1)

 

492,901

 

 

 

526,597

 

 

 

Total debt and capital lease obligations

 

$

2,493,402

 

 

 

$

2,527,455

 

 

 

 


(1) Disclosure regarding fair value of capital leases is not required.

 

We estimated the fair value of our publicly traded long-term debt using market prices in less active markets (Level 2).

 

Note 9.         Hughes Acquisition

 

On June 8, 2011, EchoStar completed the Hughes Acquisition, pursuant to an agreement and plan of merger (the “Hughes Agreement”) by and between EchoStar, certain of its subsidiaries, including EchoStar Satellite Services L.L.C. and Hughes Communications, Inc. Pursuant to the Hughes Agreement, 100% of the issued and outstanding shares of common stock and vested stock options of Hughes Communications, Inc. were converted into the right to receive $60.70 (minus any applicable exercise price) in cash and substantially all of the outstanding debt of Hughes Communications, Inc. was repaid.  In addition, each share of unvested restricted stock and unvested stock option of Hughes Communications, Inc. was converted into the right to receive $60.70 (minus any applicable exercise price) in cash on the vesting date of the stock award.

 

A summary of the purchase price and opening balance sheet for the Hughes Acquisition at the June 8, 2011 acquisition date is presented in the following table.  The opening balance sheet presented below reflects our final purchase price allocation.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—Continued

(Unaudited)

 

 

 

Amount

 

 

 

(In thousands)

 

Cash

 

$

98,900

 

Marketable investment securities

 

22,148

 

Other current assets

 

282,471

 

Property and equipment

 

930,426

 

Other intangibles assets

 

420,907

 

Goodwill (non-deductible)

 

504,173

 

Orbital rights

 

400,000

 

Other noncurrent assets

 

61,463

 

Current liabilities

 

(293,029

)

Deferred tax liabilities

 

(220,928

)

Long-term liabilities

 

(22,239

)

Noncontrolling interests

 

(9,679

)

Total purchase price

 

$

2,174,613

 

 

Our unaudited pro forma revenue and net income were $356 million and $10 million, respectively, for the three months ended September 30, 2011.  Our unaudited pro forma revenue and net loss were $1 billion and $9 million, respectively, for the nine months ended September 30, 2011.  Our pro forma information gives effect to the Hughes Acquisition as if it occurred on January 1, 2010.  These pro forma amounts are not necessarily indicative of the operating results that would have occurred if the Hughes Acquisition had occurred on such date and should not be used as a predictive measure of our future financial position, results of operations or liquidity.  The pro forma adjustments are based on currently available information and certain assumptions that we believe are reasonable.

 

Effective June 9, 2011, revenue and expenses associated with the Hughes Acquisition are included within the Hughes segment in our Condensed Consolidated Statements of Operations and Comprehensive Income (Loss).

 

Note 10.  Commitments and Contingencies

 

Commitments

 

EchoStar XVI.  During November 2009, we entered into a contract for the construction of EchoStar XVI, a direct broadcast satellite (“DBS”), which is expected to be launched in the fourth quarter of 2012 and will operate at the 61.5 degree west longitude orbital location.  DISH Network has agreed to lease all of the capacity on this satellite from us for a portion of its useful life.  As of September 30, 2012, the remaining obligation related to EchoStar XVI was approximately $42.9 million, which includes the launch contract, launch insurance and one year of in-orbit insurance.

 

EchoStar XVII.  We successfully launched EchoStar XVII in July 2012 and introduced HughesNet Gen4 broadband Internet services to our customers in North America in October 2012.  Pursuant to the terms and conditions of the construction agreement for EchoStar XVII, we are obligated to commence payment of in-orbit incentives totalling $25 million plus interest at an annual rate of 10% of approximately $33 million.  The Orbital incentive payments, including interest, are required to be paid quarterly over a 15-year period, subject to prepayment at our option; however, these payments are subject to reduction in the event of future satellite failures.  In addition, as of September 30, 2012, we had other remaining obligations of $28.3 million related to the construction and launch of EchoStar XVII.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—Continued

(Unaudited)

 

Contingencies

 

Separation Agreement

 

In connection with the Spin-off, EchoStar entered into a separation agreement with DISH Network that provides, among other things, for the division of certain liabilities, including liabilities resulting from litigation.  Under the terms of the separation agreement, EchoStar has assumed certain liabilities that relate to its business including certain designated liabilities for acts or omissions that occurred prior to the Spin-off.  Certain specific provisions govern intellectual property related claims under which, generally, EchoStar will only be liable for its acts or omissions following the Spin-off and DISH Network will indemnify EchoStar for any liabilities or damages resulting from intellectual property claims relating to the period prior to the Spin-off as well as DISH Network’s acts or omissions following the Spin-off.

 

Litigation

 

We are involved in a number of legal proceedings (including those described below) concerning matters arising in connection with the conduct of our business activities.  Many of these proceedings are at preliminary stages, and many of these proceedings seek an indeterminate amount of damages.  We regularly evaluate the status of the legal proceedings in which we are involved to assess whether a loss is probable or there is a reasonable possibility that a loss or an additional loss may have been incurred and to determine if accruals are appropriate.  If accruals are not appropriate, we further evaluate each legal proceeding to assess whether an estimate of the possible loss or range of possible loss can be made.

 

For certain cases described below, management is unable to provide a meaningful estimate of the possible loss or range of possible loss because, among other reasons, (i) the proceedings are in various stages; (ii) damages have not been sought; (iii) damages are unsupported and/or exaggerated; (iv) there is uncertainty as to the outcome of pending appeals or motions; (v) there are significant factual issues to be resolved; and/or (vi) there are novel legal issues or unsettled legal theories to be presented or a large number of parties (as with many patent-related cases).  For these cases, however, management does not believe, based on currently available information, that the outcomes of these proceedings will have a material adverse effect on our financial condition, though the outcomes could be material to our operating results for any particular period, depending, in part, upon the operating results for such period.

 

E-Contact Technologies, LLC

 

On February 22, 2012, E-Contact Technologies, LLC (“E-Contact”) filed suit against two of our subsidiaries, Hughes Communications, Inc. and Hughes Network Systems, LLC, in the United States District Court for the Eastern District of Texas alleging infringement of United States Patent No. 5,347,579, which is entitled “Personal Computer Diary.”  E-Contact appears to assert that some portion of HughesNet email services infringe that patent.  HughesNet email services are provided by a third-party service provider, who has assumed indemnification obligations for the case.  On May 31, 2012, E-Contact filed a first amended complaint.  The amended complaint removed the original complaint’s requests for a finding of willfulness and entry of an injunction.

 

We, along with the third-party service provider, intend to vigorously defend this case. In the event that a court ultimately determines that we infringe the asserted patent, we may be subject to substantial damages.  We cannot predict with any degree of certainty the outcome of the suit or determine the extent of any potential liability or damages.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—Continued

(Unaudited)

 

Semiconductor Ideas to the Market BV

 

On March 16, 2012, Semiconductor Ideas to the Market BV (“ITOM”) filed suit against our subsidiary Hughes Network Systems, LLC, as well as Texas Instruments, Inc., Qualcomm, Inc., Broadcom Corp., Samsung Electronics America, Inc., Samsung Telecommunications America, LLC, Dell Inc., Apple Inc., Ford Motor Company, Buffalo Technology (USA) Inc., Amazon.com, Inc., Hughes Telematics, Inc., Motorola Mobility, Inc., Motorola Solutions, Inc., Honeywell International Inc., Koninklijke Philips Electronics N.V., and Philips Consumer Lifestyle International B.V.  The suit was brought in the United States District Court for the Eastern District of Texas alleging infringement of United States Patent No. 7,299,018 which is entitled “Receiver comprising a digitally controlled capacitor bank” and United States Patent No. 7,072,614 which is entitled “Communication device.” ITOM alleged infringement through use of various third-party chipsets in unspecified products and/or systems.  A joint motion to dismiss Hughes Network Systems, LLC was granted on July 13, 2012.

 

Note 11.   Segment Reporting

 

Operating segments are components of an enterprise for which separate financial information is available and regularly evaluated by the chief operating decision-maker(s) of an enterprise.  Total assets by segment have not been specified because the information is not provided to our chief operating decision-maker on a regular basis.  Under this definition, we operate two primary business segments.

 

·                  EchoStar Satellite Services — which uses 9 of our 11 owned and leased in-orbit satellites and related FCC licenses to lease capacity on a full-time and occasional-use basis primarily to DISH Network, and secondarily to Dish Mexico, United States government service providers, state agencies, Internet service providers, broadcast news organizations, programmers and private enterprise customers.

 

·                  Hughes — which provides satellite broadband Internet access to North American consumers and broadband network services and systems to the domestic and international enterprise markets.  The Hughes segment also provides managed services to large enterprises and networking systems solutions to customers for mobile satellite and wireless backhaul systems.  Hughes became a new segment as a result of the Hughes Acquisition and the operating results of Hughes Communications are included in our results effective June 9, 2011.  See Note 9 for further discussion of the Hughes Acquisition.

 

The “All Other and Eliminations” category consists of revenue and net income (loss) attributable to HSS from other operations including our corporate investment portfolio for which segment disclosure requirements do not apply.  In addition, this category includes interest expense related to our 6 1/2% Senior Secured Notes due 2019 and our 7 5/8% Senior Notes due 2021 (collectively, the “Notes”), net of capitalized interest.  Transactions between segments were not significant.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—Continued

(Unaudited)

 

The following table reports our operating segment results and reconciles earnings before interest, taxes, depreciation and amortization (“EBITDA”) to reported “Net income (loss) attributable to HSS” in our Condensed Consolidated Statements of Operations and Comprehensive Income (Loss):

 

 

 

EchoStar
Satellite
Services

 

Hughes

 

All Other
and
Eliminations

 

Consolidated
Total

 

 

 

(In thousands)

 

For the Three Months Ended September 30, 2012

 

 

 

 

 

 

 

 

 

Total revenue

 

$

65,682

 

$

285,974

 

$

(882

)

$

350,774

 

EBITDA (1)

 

$

57,065

 

$

75,633

 

$

2,087

 

$

134,785

 

Interest income

 

(57

)

89

 

341

 

373

 

Interest expense, net of amounts capitalized

 

(12,569

)

(110

)

(21,459

)

(34,138

)

Income tax benefit (provision), net

 

(6,242

)

(7,896

)

14,076

 

(62

)

Depreciation and amortization

 

(29,838

)

(55,460

)

 

(85,298

)

Net income (loss) attributable to HSS

 

$

8,359

 

$

12,256

 

$

(4,955

)

$

15,660

 

For the Three Months Ended September 30, 2011

 

 

 

 

 

 

 

 

 

Total revenue

 

$

68,491

 

$

287,861

 

$

 

$

356,352

 

EBITDA (1)

 

$

44,371

 

$

67,294

 

$

181

 

$

111,846

 

Interest income

 

 

789

 

749

 

1,538

 

Interest expense, net of amounts capitalized

 

(9,781

)

(685

)

(23,325

)

(33,791

)

Income tax benefit (provision), net

 

7,694

 

1,440

 

 

9,134

 

Depreciation and amortization

 

(23,686

)

(77,362

)

 

(101,048

)

Net income (loss) attributable to HSS

 

$

18,598

 

$

(8,524

)

$

(22,395

)

$

(12,321

)

For the Nine Months Ended September 30, 2012

 

 

 

 

 

 

 

 

 

Total revenue

 

$

210,703

 

$

843,017

 

$

(2,730

)

$

1,050,990

 

EBITDA (1)

 

$

162,737

 

$

215,059

 

$

4,507

 

$

382,303

 

Interest income

 

(35

)

312

 

1,644

 

1,921

 

Interest expense, net of amounts capitalized

 

(39,603

)

(325

)

(69,732

)

(109,660

)

Income tax benefit (provision), net

 

(11,601

)

(18,598

)

30,300

 

101

 

Depreciation and amortization

 

(92,716

)

(166,707

)

 

(259,423

)

Net income (loss) attributable to HSS

 

$

18,782

 

$

29,741

 

$

(33,281

)

$

15,242

 

For the Nine Months Ended September 30, 2011

 

 

 

 

 

 

 

 

 

Total revenue

 

$

205,989

 

$

369,784

 

$

 

$

575,773

 

EBITDA (1)

 

$

149,255

 

$

87,527

 

$

(33,740

)

$

203,042

 

Interest income

 

38

 

789

 

996

 

1,823

 

Interest expense, net of amounts capitalized

 

(29,583

)

(687

)

(20,634

)

(50,904

)

Income tax benefit (provision), net

 

(5,799

)

(171

)

7,667

 

1,697

 

Depreciation and amortization

 

(70,581

)

(93,395

)

 

(163,976

)

Net income (loss) attributable to HSS

 

$

43,330

 

$

(5,937

)

$

(45,711

)

$

(8,318

)

 


(1)          EBITDA is not a measure determined in accordance with GAAP and should not be considered a substitute for operating income, net income or any other measure determined in accordance with GAAP.  Conceptually, EBITDA measures the amount of income generated each period that could be used to service debt, pay taxes and fund capital expenditures.  EBITDA should not be considered in isolation or as a substitute for measures of performance prepared in accordance with GAAP.  EBITDA is used by our management as a measure of operating efficiency and overall financial performance for benchmarking against our peers and competitors.  Management believes EBITDA provides meaningful supplemental information regarding liquidity and the underlying operating performance of our business.  Management also believes that EBITDA is useful to investors because it is frequently used by securities analysts, investors and other interested parties to evaluate companies in our industries.

 

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(Unaudited)

 

Geographic Information and Transactions with Major Customers

 

Geographic Information. Revenue is attributed to geographic regions based upon the location where the goods and services are provided. North American revenue includes transactions with North American customers. All other revenue includes transactions with customers in Asia, Africa, Australia, Europe, South America and the Middle East. The following table summarizes total long-lived assets, which include property and equipment; goodwill; orbital rights and other intangible assets, and revenue attributed to the North American and other foreign locations.

 

 

 

As of

 

Long-lived assets:

 

September 30,
2012

 

December 31,
2011

 

 

 

(In thousands)

 

North America

 

$

3,390,149

 

$

3,321,620

 

Other

 

97,464

 

23,348

 

Total long-lived assets

 

$

3,487,613

 

$

3,344,968

 

 

 

 

For the Three Months
Ended September 30,

 

For the Nine Months
Ended September 30,

 

Revenue:

 

2012

 

2011

 

2012

 

2011

 

 

 

(In thousands)

 

North America

 

$

291,574

 

$

297,897

 

$

876,825

 

$

497,625

 

Other

 

59,200

 

58,455

 

174,165

 

78,148

 

Total revenue

 

$

350,774

 

$

356,352

 

$

1,050,990

 

$

575,773

 

 

Transactions with Major Customers. During the three and nine months ended September 30, 2012 and 2011, our revenue included sales to DISH Network, our major customer. The following table summarizes sales to DISH Network and its percentage of total revenue.

 

 

 

For the Three Months
Ended September 30,

 

For the Nine Months
Ended September 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

(In thousands)

 

Total revenue:

 

 

 

 

 

 

 

 

 

DISH Network:

 

 

 

 

 

 

 

 

 

EchoStar Satellite Services segment

 

$

46,931

 

$

53,597

 

$

154,441

 

$

159,625

 

Hughes segment

 

4,723

 

929

 

9,037

 

929

 

Total DISH Network

 

51,654

 

54,526

 

163,478

 

160,554

 

All other

 

299,120

 

301,826

 

887,512

 

415,219

 

Total revenue

 

$

350,774

 

$

356,352

 

$

1,050,990

 

$

575,773

 

Percentage of total revenue:

 

 

 

 

 

 

 

 

 

DISH Network

 

14.7

%

15.3

%

15.6

%

27.9

%

All other

 

85.3

%

84.7

%

84.4

%

72.1

%

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—Continued

(Unaudited)

 

Note 12.   Related Party Transactions

 

EchoStar

 

We and EchoStar have agreed that we shall have the right, but not the obligation, to receive from EchoStar certain corporate services, including among other things: treasury, tax, accounting and reporting, risk management, legal, internal audit, human resources, and information technology.  In addition, we occupy certain office space in buildings owned by EchoStar and pay a portion of the taxes, insurance, utilities and maintenance of the premises in accordance with the percentage of the space we occupy.  These services are provided at cost.  We may terminate a particular service we receive from EchoStar for any reason upon at least 30 days notice.  We recorded expenses for these services of $2 million for each of the three months ended September 30, 2012 and 2011 and $9 million and $6 million for the nine months ended September 30, 2012 and 2011, respectively.  For each of the three and nine months ended September 30, 2012, we recognized $8 million of equipment revenue from the sales of satellite broadband equipment and related equipment to EchoStar.

 

DISH Network

 

Following the Spin-off, EchoStar and DISH Network have operated as separate public companies and DISH Network has no ownership interest in EchoStar or us.  However, a substantial majority of the voting power of the shares of EchoStar and DISH Network is owned beneficially by Charles W. Ergen, our Chairman, or by certain trusts established by Mr. Ergen for the benefit of his family.

 

EchoStar and DISH Network have entered into certain agreements pursuant to which EchoStar and we obtain certain products, services and rights from DISH Network, DISH Network obtains certain products, services and rights from us and EchoStar, and we and DISH Network have indemnified each other against certain liabilities arising from our respective businesses.  EchoStar also may enter into additional agreements with DISH Network in the future.

 

Generally, the amounts DISH Network pays for products and services provided under the agreements are based on our cost plus a fixed margin (unless noted differently below), which varies depending on the nature of the products and services provided.

 

The following is a summary of the terms of the principal agreements that EchoStar or we have entered into with DISH Network that may have an impact on our financial position and results of operations.

 

“Services and other revenue — DISH Network”

 

Satellite Capacity Agreements.  Since the Spin-off, we have entered into certain satellite capacity agreements pursuant to which DISH Network leases satellite capacity on certain satellites owned or leased by us.  The fees for the leases provided under these satellite capacity agreements depend, among other things, upon the orbital location of the applicable satellite and the length of the lease.  The term of each lease is set forth below:

 

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(Unaudited)

 

EchoStar VI, VIII and XII.  DISH Network leases certain satellite capacity from us on EchoStar VI, VIII and XII.  The leases generally terminate upon the earlier of: (i) the end of life or replacement of the satellite (unless DISH Network determines to renew on a year-to-year basis); (ii) the date the satellite fails; (iii) the date the transponders on which service is being provided fails; or (iv) a certain date, which depends upon, among other things, the estimated useful life of the satellite, whether the replacement satellite fails at launch or in orbit prior to being placed into service, and the exercise of certain renewal options.  DISH Network generally has the option to renew each lease on a year-to-year basis through the end of the respective satellite’s life.  There can be no assurance that any options to renew such agreements will be exercised.

 

EchoStar IX.  DISH Network leases certain satellite capacity from us on EchoStar IX.  Subject to availability, DISH Network generally has the right to continue to lease satellite capacity from us on EchoStar IX on a month-to-month basis.

 

EchoStar XVI.  DISH Network will lease certain satellite capacity from us on EchoStar XVI after its service commencement date, and this lease generally terminates upon the earlier of: (i) the end of life or replacement of the satellite; (ii) the date the satellite fails; (iii) the date the transponder(s) on which service is being provided under the agreement fails; or (iv) ten years following the actual service commencement date.  Upon expiration of the initial term, DISH Network has the option to renew on a year-to-year basis through the end of life of the satellite.  There can be no assurance that any options to renew this agreement will be exercised.  EchoStar XVI is expected to be launched in the fourth quarter of 2012.

 

EchoStar XV.  EchoStar XV is owned by DISH Network and is operated at the 61.5 degree west longitude orbital location.  The FCC has granted us an authorization to operate the satellite at the 61.5 degree west longitude orbital location.  For so long as EchoStar XV remains in service at the 61.5 degree west longitude orbital location, DISH Network is obligated to pay us a fee for the use of the orbital right which varies depending on the number of frequencies being used by EchoStar XV.

 

Nimiq 5 Agreement.  During 2009, we entered into a fifteen-year satellite service agreement with Telesat Canada (“Telesat”) to receive service on all 32 DBS transponders on the Nimiq 5 satellite at the 72.7 degree west longitude orbital location (the “Telesat Transponder Agreement”).  During 2009, DISH Network also entered into a satellite service agreement (the “DISH Nimiq 5 Agreement”) with us, pursuant to which they receive service from us on all 32 of the DBS transponders covered by the Telesat Transponder Agreement.

 

Under the terms of the DISH Nimiq 5 Agreement, DISH Network makes certain monthly payments to us that commenced in 2009 when the Nimiq 5 satellite was placed into service and continue through the service term.  Unless earlier terminated under the terms and conditions of the DISH Nimiq 5 Agreement, the service term will expire ten years following the date it was placed into service.  Upon expiration of the initial term, DISH Network has the option to renew the DISH Nimiq 5 Agreement on a year-to-year basis through the end of life of the Nimiq 5 satellite.  Upon in-orbit failure or end of life of the Nimiq 5 satellite, and in certain other circumstances, DISH Network has certain rights to receive service from us on a replacement satellite.  There can be no assurance that any options to renew the DISH Nimiq 5 Agreement will be exercised or that DISH Network will exercise its option to receive service on a replacement satellite.

 

QuetzSat-1 Agreement.  During 2008, we entered into a ten-year satellite service agreement with SES, which provides, among other things, for the provision by SES to us of service on 32 DBS transponders on the QuetzSat-1 satellite.  QuetzSat-1 was launched on September 29, 2011 and was placed into service during the fourth quarter of 2011 at the 67.1 degree west longitude orbital location while we and DISH Network explore alternative uses for the QuetzSat-1 satellite.  In the interim, we are providing DISH Network with alternate capacity at the 77 degree west longitude orbital location.  We commenced payments under our agreement with SES upon the placement of the QuetzSat-1 satellite at the 67.1 degree west longitude orbital location.  During 2008, we also entered into a transponder service agreement with DISH Network pursuant to which DISH Network was entitled to receive service from us on 24 of the DBS transponders on QuetzSat-1, which will replace certain other transponders leased from us.  During the third quarter of 2012, we and DISH Network entered into an agreement pursuant to which effectively reduced the number of DBS transponders on the QuetzSat-1 satellite leased to DISH Network to 19 transponders.

 

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(Unaudited)

 

Under the terms of our contractual arrangements with DISH Network, we will recognize revenue for the QuetzSat-1 satellite when it is placed into service at the 77 degree west longitude orbital location and continuing through the remainder of the service term.  Unless extended or earlier terminated under the terms and conditions of our agreement with DISH Network for the QuetzSat-1 satellite, the initial service term will expire in November 2021.  Upon expiration of the initial service term, DISH Network has the option to renew the agreement for the QuetzSat-1 satellite on a year-to-year basis through the end of life of the QuetzSat-1 satellite.  Upon an in-orbit failure or end of life of the QuetzSat-1 satellite, and in certain other circumstances, DISH Network has certain rights to receive service from us on a replacement satellite.  There can be no assurance that any options to renew this agreement will be exercised or that DISH Network will exercise its option to receive service on a replacement satellite.

 

TT&C Agreement.  In connection with the Spin-off, we entered into a telemetry, tracking and control (“TT&C”) agreement pursuant to which we provided TT&C services to DISH Network for a period ending on January 1, 2012 (the “Prior TT&C Agreement”).  The fees for services provided under the Prior TT&C Agreement were calculated at cost plus a fixed margin.  DISH Network was able to terminate the Prior TT&C Agreement for any reason upon 60 days notice.

 

On January 1, 2012, we entered into a TT&C agreement pursuant to which we will continue to provide TT&C services to DISH Network and its subsidiaries for a period ending on December 31, 2016 (the “2012 TT&C Agreement”).  The material terms of the 2012 TT&C Agreement are substantially the same as the material terms of the Prior TT&C Agreement, except that the fees for services provided under the 2012 TT&C Agreement are calculated at either: (i) a fixed fee; or (ii) cost plus a fixed margin, which will vary depending on the nature of the services provided.

 

Blockbuster.  On April 26, 2011, DISH Network acquired substantially all of the assets of Blockbuster, Inc. (the “Blockbuster Acquisition”).  On June 8, 2011, we completed the Hughes Acquisition.  Hughes provided certain broadband products and services to Blockbuster pursuant to an agreement that was entered into prior to the Blockbuster Acquisition and the Hughes Acquisition.  Subsequent to both the Blockbuster Acquisition and the Hughes Acquisition, Blockbuster entered into a new agreement with Hughes pursuant to which Blockbuster may continue to purchase broadband products and services from Hughes.  The term of the agreement is through October 31, 2014 and Blockbuster has the option to renew the agreement for an additional one year period.

 

RUS Implementation Agreement.  In September 2010, DISH Broadband L.L.C. (“DISH Broadband”), DISH Network’s wholly owned subsidiary, was selected by the Rural Utilities Service (“RUS”) of the United States Department of Agriculture to receive up to approximately $14 million in broadband stimulus grant funds (the “Grant Funds”).  Effective November 2011, Hughes Communications and DISH Broadband entered into a RUS Implementation Agreement (the “RUS Agreement”) pursuant to which Hughes Communications provides certain portions of the equipment and broadband service used to implement DISH Broadband’s RUS program.  The initial term of the RUS Agreement shall continue until the earlier of: (i) September 24, 2013; or (ii) the date that the Grant Funds have been exhausted.  In addition, DISH Broadband may terminate the RUS Agreement for convenience upon 45 days prior written notice to Hughes Communications.

 

TerreStar Agreement.  On March 9, 2012, DISH Network completed its acquisition of substantially all the assets of TerreStar.  Prior to DISH Network’s acquisition of substantially all the assets of TerreStar and our completion of the Hughes Acquisition, TerreStar and HNS entered into various agreements pursuant to which our Hughes segment provides, among other things, hosting, operations and maintenance services for TerreStar’s satellite gateway and associated ground infrastructure.  These agreements generally may be terminated by DISH Network at any time for convenience.

 

Hughes Broadband Distribution Agreement.  Effective October 1, 2012, HNS and dishNet Satellite Broadband L.L.C. (“dishNET Satellite Broadband”), a wholly-owned subsidiary of DISH Network, entered into a Distribution Agreement (the “Distribution Agreement”) pursuant to which dishNET Satellite Broadband has the right, but not the obligation, to market, sell and distribute the HNS satellite Internet service (the “Service”) under the dishNET brand.  dishNET Satellite Broadband pays HNS a monthly per subscriber wholesale service fee for the Service based upon the subscriber’s service level, and, beginning January 1, 2014, certain volume subscription thresholds.  The Distribution Agreement has a term of five years with automatic renewal for successive one year terms unless either party gives written notice of its intent not to renew to the other party at least 180 days before the expiration of the then-current term.  Upon expiration or termination of the Distribution Agreement, the parties will continue to provide the Service to the then-current dishNET subscribers pursuant to the terms and conditions of the Distribution Agreement.

 

“General and administrative expenses — DISH Network”

 

Management Services Agreement.  EchoStar entered into a Management Services Agreement with DISH Network pursuant to which DISH Network makes certain of its officers available to provide services (which are primarily legal and accounting services) to us and EchoStar.  Specifically, Paul W. Orban remains employed by DISH Network, but also served as EchoStar’s Senior Vice President and Controller through April 2012.  In addition, R. Stanton Dodge remains employed by DISH Network, but also served as EchoStar’s and our Executive Vice President, General Counsel and Secretary through November 2011.  EchoStar makes payments to DISH Network

 

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(Unaudited)

 

based upon an allocable portion of the personnel costs and expenses incurred by DISH Network with respect to such DISH Network officers (taking into account wages and fringe benefits).  These allocations are based upon the estimated percentages of time to be spent by the DISH Network executive officers performing services for us and EchoStar under the Management Services Agreement.  EchoStar also reimburses DISH Network for direct out-of-pocket costs incurred by DISH Network for management services provided to us and EchoStar.  EchoStar and DISH Network evaluate all charges for reasonableness at least annually and make any adjustments to these charges as EchoStar and DISH Network mutually agree upon.  A portion of these costs and expenses has been allocated to us in the manner described above under the caption “EchoStar.”

 

The Management Services Agreement automatically renewed on January 1, 2012 for an additional one-year period until January 1, 2013 and renews automatically for successive one-year periods thereafter, unless terminated earlier: (i) by us at any time upon at least 30 days notice; (ii) by DISH Network at the end of any renewal term, upon at least 180 days notice; or (iii) by DISH Network upon notice to us, following certain changes in control.

 

Professional Services Agreement.  Prior to 2010, in connection with the Spin-off, EchoStar entered into various agreements with DISH Network including the Transition Services Agreement, Satellite Procurement Agreement and Services Agreement, which all expired on January 1, 2010 and were replaced by a Professional Services Agreement.  During 2009, EchoStar and DISH Network agreed that EchoStar shall continue to have the right, but not the obligation, to receive the following services from DISH Network, among others, certain of which were previously provided under the Transition Services Agreement: information technology, travel and event coordination, internal audit, legal, accounting and tax, benefits administration, program acquisition services and other support services.  Additionally, EchoStar and DISH Network agreed that DISH Network shall continue to have the right, but not the obligation, to engage us to manage the process of procuring new satellite capacity for DISH Network (previously provided under the Satellite Procurement Agreement) and receive logistics, procurement and quality assurance services from EchoStar (previously provided under the Services Agreement).  A portion of these costs and expenses has been allocated to us in the manner described above under the caption “EchoStar.” The Professional Services Agreement automatically renewed on January 1, 2012 for an additional one-year period until January 1, 2013 and renews automatically for successive one-year periods thereafter, unless terminated earlier by either party upon at least 60 days notice.  However, either party may terminate the Professional Services Agreement in part with respect to any particular service it receives for any reason upon at least 30 days notice.

 

Other Agreements — DISH Network

 

Satellite Capacity Leased from DISH Network.  During 2009, we entered into a satellite capacity agreement pursuant to which we leased certain satellite capacity from DISH Network on EchoStar I.  The fee for the services provided under this satellite capacity agreement depends, among other things, upon the orbital location of the satellite and the length of the lease.  Effective as of July 1, 2012, EchoStar and DISH Network mutually agreed to terminate this satellite capacity agreement.  The amount of those fees included in “Cost of sales — services and other” on our Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) was none and $6 million for the three months ended September 30, 2012 and 2011, respectively, and $8 million and $17 million for the nine months ended September 30, 2012 and 2011, respectively.

 

Tax Sharing Agreement.  As a subsidiary of EchoStar, we are an indirect party to EchoStar’s tax sharing agreement with DISH Network that was entered into in connection with the Spin-off.  This agreement governs EchoStar and DISH Network’s respective rights, responsibilities and obligations after the Spin-off with respect to taxes for the periods ending on or before the Spin-off.  Generally, all pre-Spin-off taxes, including any taxes that are incurred as a result of restructuring activities undertaken to implement the Spin-off, are borne by DISH Network, and DISH Network will indemnify EchoStar for such taxes.  However, DISH Network is not liable for and will not indemnify EchoStar for any taxes that are incurred as a result of the Spin-off or certain related transactions failing to qualify as tax-free distributions pursuant to any provision of Section 355 or Section 361 of the Internal Revenue Code of 1986, as amended because of: (i) a direct or indirect acquisition of any of EchoStar’s stock, stock options or assets; (ii) any action that EchoStar takes or fails to take; or (iii) any action that EchoStar takes that is inconsistent with the

 

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(Unaudited)

 

information and representations furnished to the IRS in connection with the request for the private letter ruling, or to counsel in connection with any opinion being delivered by counsel with respect to the Spin-off or certain related transactions.  In such case, EchoStar will be solely liable for, and will indemnify DISH Network for, any resulting taxes, as well as any losses, claims and expenses.  The tax sharing agreement will only terminate after the later of the full period of all applicable statutes of limitations, including extensions, or once all rights and obligations are fully effectuated or performed.

 

DBSD North America Agreement.  On March 9, 2012, DISH Network completed its acquisition of 100% of the equity of reorganized DBSD North America.  Prior to DISH Network’s acquisition of DBSD North America and our completion of the Hughes Acquisition, DBSD North America and Hughes Network Systems, LLC (“HNS”), a wholly-owned subsidiary of Hughes, entered into an agreement pursuant to which our Hughes segment provides, among other things, hosting, operations and maintenance services of DBSD North America’s satellite gateway and associated ground infrastructure.  This agreement was renewed for a one year period ending on February 15, 2013, and renews for four successive one-year periods unless terminated by DBSD North America upon at least 30 days notice prior to the expiration of any renewal term.

 

Hughes Systique Corporation (“Hughes Systique”)

 

We contract with Hughes Systique for software development services.  In addition to our 45% ownership in Hughes Systique, Mr. Pradman Kaul, the President of Hughes Communications, Inc. and a member of EchoStar’s Board of Directors and his brother, who is the CEO and President of Hughes Systique, in the aggregate, owned approximately 26%, on an undiluted basis, of Hughes Systique’s outstanding shares as of September 30, 2012.  Furthermore, Mr. Pradman Kaul serves on the board of directors of Hughes Systique.  We are considered the “primary beneficiary” of Hughes Systique and as a result, we are required to consolidate Hughes Systique’s financial statements in our consolidated financial statements.  During the three and nine months ended September 30, 2012, Hughes Systique provided $0.1 million and $0.6 million, respectively, of software development services to EchoStar.

 

Dish Mexico

 

During 2008, EchoStar entered into a joint venture for a direct-to-home (“DTH”) satellite service in Mexico known as Dish Mexico.  Pursuant to these arrangements, we provide satellite capacity to Dish Mexico.  We recognized $4.5 million and $2.1 million for the three months ended September 30, 2012 and 2011, respectively, and $8.8 million and $6.4 million for the nine months ended September 30, 2012 and 2011, respectively, of satellite services revenue from Dish Mexico.  As of each of September 30, 2012 and December 31, 2011, our accounts receivable balance due from Dish Mexico was $4.5 million and $1 million, respectively.

 

Note 13.  Supplemental Guarantor and Non-Guarantor Financial Information

 

Certain of the Company’s wholly-owned subsidiaries (together, the “Guarantor Subsidiaries”) have fully and unconditionally guaranteed, on a joint and several basis, the obligations of the Company under the Notes, which were issued on June 1, 2011.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—Continued

(Unaudited)

 

In lieu of separate financial statements of the Guarantor Subsidiaries, condensed consolidating financial information prepared in accordance with Rule 3-10(f) of Regulation S-X is presented below, including the condensed balance sheet information, the condensed statement of operations and comprehensive income (loss) information and the condensed statement of cash flows information of the Company, the Guarantor Subsidiaries on a combined basis and the non-guarantor subsidiaries of the Company on a combined basis and the eliminations necessary to arrive at the corresponding information of the Company on a consolidated basis.

 

The indentures governing the Notes contain restrictive covenants that, among other things, impose limitations on the ability of the Company and certain of its restricted subsidiaries to pay dividends or make distributions, incur additional debt, make certain investments, create liens or enter into sale and leaseback transactions, merge or consolidate with another company, transfer and sell assets, or enter into transactions with affiliates.

 

The condensed consolidating financial information should be read in conjunction with the Company’s consolidated financial statements and notes thereto included herein.

 

Condensed Consolidating Balance Sheet as of September 30, 2012

(In thousands)

 

 

 

 

 

Guarantor

 

Non-Guarantor

 

 

 

 

 

 

 

HSS

 

Subsidiaries

 

Subsidiaries

 

Eliminations

 

Total

 

Assets

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

79,239

 

$

42,650

 

$

18,530

 

$

 

$

140,419

 

Marketable investment securities

 

85,350

 

 

 

 

85,350

 

Trade account receivables, net

 

 

141,299

 

53,633

 

 

194,932

 

Trade account receivables - DISH Network, net

 

 

52,350

 

130

 

 

52,480

 

Inventory

 

 

45,869

 

12,392

 

 

58,261

 

Advances to affiliates, net

 

496,030

 

 

 

(489,487

)

6,543

 

Intercompany interest receivables

 

54,379

 

168

 

2,081

 

(56,628

)

 

Other current assets

 

10,348

 

39,956

 

22,511

 

 

72,815

 

Total current assets

 

725,346

 

322,292

 

109,277

 

(546,115

)

610,800

 

Restricted cash and cash equivalents

 

9,890

 

15,036

 

963

 

 

25,889

 

Property and equipment, net

 

 

2,105,655

 

25,164

 

 

2,130,819

 

Orbital rights, net

 

 

491,658

 

69,917

 

 

561,575

 

Goodwill

 

 

504,173

 

 

 

504,173

 

Other intangible assets, net

 

 

291,046

 

 

 

291,046

 

Investment in subsidiaries

 

 

59,774

 

 

(59,774

)

 

Intercompany note receivables

 

2,354,030

 

1,716

 

 

(2,355,746

)

 

Other noncurrent assets, net

 

51,565

 

131,913

 

6,790

 

(6,426

)

183,842

 

Total assets

 

$

3,140,831

 

$

3,923,263

 

$

212,111

 

$

(2,968,061

)

$

4,308,144

 

Liabilities and Shareholder’s Equity (Deficit)

 

 

 

 

 

 

 

 

 

 

 

Trade accounts payable

 

$

355

 

$

107,554

 

$

15,761

 

$

 

$

123,670

 

Trade accounts payable - DISH Network

 

5

 

3,167

 

 

 

3,172

 

Accrued expenses and other

 

52,795

 

118,973

 

27,669

 

 

199,437

 

Advances from affiliates, net

 

 

513,371

 

85,094

 

(532,601

)

65,864

 

Intercompany interest payables

 

 

54,369

 

2,259

 

(56,628

)

 

Current portion of long-term debt and capital lease obligations

 

 

61,108

 

1,009

 

 

62,117

 

Total current liabilities

 

53,155

 

858,542

 

131,792

 

(589,229

)

454,260

 

Long-term debt and capital lease obligations, net of current portion

 

2,000,000

 

430,347

 

938

 

 

2,431,285

 

Advances from affiliates

 

 

 

8,033

 

 

8,033

 

Intercompany note payables

 

 

2,353,680

 

2,066

 

(2,355,746

)

 

Other long-term liabilities

 

9,901

 

323,808

 

465

 

(6,426

)

327,748

 

Total HSS shareholder’s equity (deficit)

 

1,077,775

 

(43,114

)

59,774

 

(16,660

)

1,077,775

 

Noncontrolling interests

 

 

 

9,043

 

 

9,043

 

Total liabilities and shareholder’s equity (deficit)

 

$

3,140,831

 

$

3,923,263

 

$

212,111

 

$

(2,968,061

)

$

4,308,144

 

 

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HUGHES SATELLITE SYSTEMS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—Continued

(Unaudited)

 

Condensed Consolidating Balance Sheet as of December 31, 2011

(In thousands)

 

 

 

 

 

Guarantor

 

Non-Guarantor

 

 

 

 

 

 

 

HSS

 

Subsidiaries

 

Subsidiaries

 

Eliminations

 

Total

 

Assets

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

70,603

 

$

40,854

 

$

13,546

 

$

 

$

125,003