0001533758-18-000021.txt : 20181108 0001533758-18-000021.hdr.sgml : 20181108 20181107203832 ACCESSION NUMBER: 0001533758-18-000021 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 82 CONFORMED PERIOD OF REPORT: 20180930 FILED AS OF DATE: 20181108 DATE AS OF CHANGE: 20181107 FILER: COMPANY DATA: COMPANY CONFORMED NAME: Hughes Satellite Systems Corp CENTRAL INDEX KEY: 0001533758 STANDARD INDUSTRIAL CLASSIFICATION: COMMUNICATION SERVICES, NEC [4899] IRS NUMBER: 450897865 STATE OF INCORPORATION: CO FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 333-179121 FILM NUMBER: 181167918 BUSINESS ADDRESS: STREET 1: 100 INVERNESS TERRACE EAST CITY: ENGLEWOOD STATE: CO ZIP: 80112 BUSINESS PHONE: 303-706-4000 MAIL ADDRESS: STREET 1: 100 INVERNESS TERRACE EAST CITY: ENGLEWOOD STATE: CO ZIP: 80112 FORMER COMPANY: FORMER CONFORMED NAME: Hughes Satellites Systems Corp DATE OF NAME CHANGE: 20111028 10-Q 1 hssc9301810qdocument.htm 10-Q Document
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549
 
FORM 10-Q
 (Mark One) 
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2018.
 
OR 
o
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)
 
(303) 706-4000
(Registrant’s telephone number, including area code)
 
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 o  No ý
 
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).  Yes  ý  No  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.  (Check one):
 
Large accelerated filer o
Accelerated filer  o
Non-accelerated filer ý
Smaller reporting company o
 
Emerging growth company o
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o  No ý
 
As of October 31, 2018, the registrant’s outstanding common stock consisted of 1,078 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.
 
*       The registrant currently is not subject to the filing requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934 and is filing this Quarterly Report on Form 10-Q on a voluntary basis.  The registrant 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 as if it were subject to such filing requirements during the entirety of such period.




TABLE OF CONTENTS
 

 
 
 

 
 
 


 

 

 

 
Condensed Consolidated Statements of Changes in Shareholders’ Equity for the nine months ended September 30, 2018 and 2017 (unaudited)
4

 

 

Management’s Narrative Analysis of Results of Operations

Item 3.
Quantitative and Qualitative Disclosures about Market Risk
*


 
 
 

 
 
 



Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
*

Item 3.
Defaults Upon Senior Securities
*




 


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



DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
 
This Quarterly Report on Form 10-Q (“Form 10-Q”) contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including but not limited to statements about our estimates, expectations, plans, objectives, strategies, and financial condition, expected impact of regulatory developments and legal proceedings, opportunities in our industries and businesses and other trends and projections for the next fiscal quarter and beyond. All statements, other than statements of historical facts, may be forward-looking statements. Forward-looking statements may also be identified by words such as “anticipate,” “intend,” “plan,” “goal,” “seek,” “believe,” “estimate,” “expect,” “predict,” “continue,” “future,” “will,” “would,” “could,” “can,” “may” and similar terms. These forward-looking statements are based on information available to us as of the date of this Form 10-Q and represent management’s current views and assumptions. Forward-looking statements are not guarantees of future performance, events or results and involve potential known and unknown risks, uncertainties and other factors, many of which may be beyond our control and may pose a risk to our operating and financial condition. Accordingly, actual performance, events or results could differ materially from those expressed or implied in the forward-looking statements due to a number of factors including, but not limited to:  
 
significant risks related to the construction, launch and operation of our satellites, such as the risk of not being able to timely complete the construction of or material malfunction on one or more of our satellites, risks resulting from potentially missing our regulatory milestones, changes in the space weather environment that could interfere with the operation of our satellites and our general lack of commercial insurance coverage on our satellites;
our reliance on DISH Network Corporation and its subsidiaries (“DISH Network”) for a significant portion of our revenue;
our ability to realize the anticipated benefits of our current satellites and any future satellite we may construct or acquire;
our ability to implement and realize benefits of our domestic and/or international investments, commercial alliances, partnerships, joint ventures, acquisitions and other strategic initiatives;
the failure of third-party providers of components, manufacturing, installation services and customer support services to appropriately deliver the contracted goods or services;
our ability to bring advanced technologies to market to keep pace with our customers and competitors; and
risk related to our foreign operations and other uncertainties associated with doing business internationally, including changes in foreign exchange rates between foreign currencies and the United States (“U.S.”) dollar, economic instability and political disturbances.

Other factors that could cause or contribute to such differences include, but are not limited to, those discussed under the caption Risk Factors in Part II, Item 1A of this Form 10-Q and in Part I, Item 1A of our most recent Annual Report on Form 10-K (“Form 10-K”) filed with the Securities and Exchange Commission (“SEC”), those discussed in Management’s Narrative Analysis of Results of Operations in Part I, Item 2 of this Form 10-Q and in Part II, Item 7 of our Form 10-K and those discussed in other documents we file with the 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 and uncertainties described herein and should not place undue reliance on any forward-looking statements. We do not undertake, and specifically disclaim, any obligation to publicly release the results of any revisions that may be made to any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

Although we believe that the expectations reflected in any forward-looking statements are reasonable, we cannot guarantee future results, events, levels of activity, performance or achievements. We do not assume responsibility for the accuracy and completeness of any forward-looking statements. We assume no responsibility for updating forward-looking information contained or incorporated by reference herein or in any documents we file with the SEC, except as required by law.

Should one or more of the risks or uncertainties described herein or in any documents we file with the SEC occur, or should underlying assumptions prove incorrect, our actual results and plans could differ materially from those expressed in any forward-looking statements.


i


PART I — FINANCIAL INFORMATION
 
Item 1.         FINANCIAL STATEMENTS
 
HUGHES SATELLITE SYSTEMS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
 
 
As of
 
 
September 30, 2018
 
December 31, 2017
Assets
 
(Unaudited)
 
(Audited)
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
1,361,555

 
$
1,822,561

Marketable investment securities, at fair value
 
1,202,490

 
455,602

Trade accounts receivable and contract assets, net (Note 3)
 
217,481

 
196,840

Trade accounts receivable - DISH Network
 
10,588

 
38,641

Inventory
 
70,061

 
83,595

Prepaids and deposits
 
41,834

 
38,797

Advances to affiliates, net
 
100,730

 
114,858

Other current assets
 
17,199

 
91,544

Total current assets
 
3,021,938

 
2,842,438

Noncurrent assets:
 
 
 
 
Property and equipment, net
 
2,643,471

 
2,753,098

Regulatory authorizations
 
465,658

 
465,658

Goodwill
 
504,173

 
504,173

Other intangible assets, net
 
47,609

 
58,582

Investments in unconsolidated entities
 
30,301

 
30,587

Other noncurrent assets, net
 
252,085

 
202,814

Total noncurrent assets
 
3,943,297

 
4,014,912

Total assets
 
$
6,965,235

 
$
6,857,350

Liabilities and Shareholders’ Equity
 
 
 
 
Current liabilities:
 
 
 
 
Trade accounts payable
 
$
116,741

 
$
102,816

Trade accounts payable - DISH Network
 
456

 
3,769

Current portion of long-term debt and capital lease obligations
 
1,030,088

 
40,631

Advances from affiliates, net
 
929

 
477

Contract liabilities
 
74,135

 
65,959

Accrued interest
 
57,156

 
46,834

Accrued compensation
 
30,702

 
36,924

Accrued taxes
 
9,276

 
8,198

Accrued expenses and other
 
66,728

 
77,312

Total current liabilities
 
1,386,211

 
382,920

Noncurrent liabilities:
 
 
 
 
Long-term debt and capital lease obligations, net
 
2,582,819

 
3,594,213

Deferred tax liabilities, net
 
479,671

 
439,631

Advances from affiliates
 
33,522

 
33,715

Other noncurrent liabilities
 
104,868

 
107,627

Total noncurrent liabilities
 
3,200,880

 
4,175,186

Total liabilities
 
4,587,091

 
4,558,106

Commitments and contingencies (Note 12)
 


 


 
 
 
 
 
Shareholders’ equity:
 
 
 
 
Preferred stock, $.001 par value, 1,000,000 shares authorized, none issued and outstanding at each of September 30, 2018 and December 31, 2017
 

 

Common stock, $0.01 par value; 1,000,000 shares authorized, 1,078 shares issued and outstanding at each of September 30, 2018 and December 31, 2017
 

 

Additional paid-in capital
 
1,765,336

 
1,754,561

Accumulated other comprehensive loss
 
(91,077
)
 
(52,822
)
Accumulated earnings
 
689,160

 
582,683

Total HSS shareholders’ equity
 
2,363,419

 
2,284,422

Noncontrolling interests
 
14,725

 
14,822

Total shareholders’ equity
 
2,378,144

 
2,299,244

Total liabilities and shareholders’ equity
 
$
6,965,235

 
$
6,857,350


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

1


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,
 
 
2018
 
2017
 
2018
 
2017
Revenue:
 
 
 
 
 
 

 
 

Services and other revenue - DISH Network
 
$
84,789

 
$
108,264

 
$
282,543

 
$
330,675

Services and other revenue - other
 
393,220

 
310,973

 
1,132,669

 
866,251

Equipment revenue
 
56,846

 
59,125

 
150,134

 
173,819

Total revenue
 
534,855

 
478,362

 
1,565,346

 
1,370,745

 
 
 
 
 
 
 
 
 
Costs and expenses:
 
 
 
 
 
 

 
 

Cost of sales - services and other (exclusive of depreciation and amortization)
 
151,047

 
142,070

 
448,925

 
413,648

Cost of sales - equipment (exclusive of depreciation and amortization)
 
46,318

 
47,644

 
127,254

 
142,127

Selling, general and administrative expenses
 
97,675

 
83,512

 
285,700

 
244,005

Research and development expenses
 
6,544

 
8,302

 
20,328

 
23,444

Depreciation and amortization
 
138,951

 
127,915

 
409,377

 
364,878

Total costs and expenses
 
440,535

 
409,443

 
1,291,584

 
1,188,102

Operating income
 
94,320

 
68,919

 
273,762

 
182,643

 
 
 
 
 
 
 
 
 
Other income (expense):
 
 
 
 
 
 

 
 

Interest income
 
15,697

 
8,321

 
41,362

 
21,248

Interest expense, net of amounts capitalized
 
(65,090
)
 
(60,783
)
 
(193,625
)
 
(181,996
)
Gains and losses on investments, net
 
145

 

 
262

 
(1,575
)
Equity in earnings of unconsolidated affiliate
 
992

 
1,948

 
3,722

 
5,298

Other, net
 
(3,618
)
 
1,804

 
(3,764
)
 
229

Total other expense, net
 
(51,874
)
 
(48,710
)
 
(152,043
)
 
(156,796
)
Income before income taxes
 
42,446

 
20,209

 
121,719

 
25,847

Income tax provision
 
(13,526
)
 
(8,726
)
 
(31,725
)
 
(4,635
)
Net income
 
28,920

 
11,483

 
89,994

 
21,212

Less: Net income attributable to noncontrolling interests
 
450

 
532

 
1,292

 
1,006

Net income attributable to HSS
 
$
28,470

 
$
10,951

 
$
88,702

 
$
20,206

 
 
 
 
 
 
 
 
 
Comprehensive income:
 
 
 
 
 
 

 
 

Net income
 
$
28,920

 
$
11,483

 
$
89,994

 
$
21,212

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 

 
 
Foreign currency translation adjustments
 
(9,460
)
 
8,571

 
(39,874
)
 
13,956

Unrealized gains on available-for-sale securities and other
 
(117
)
 
(66
)
 
(199
)
 
(1,577
)
Amounts reclassified to net income:
 
 
 
 
 
 
 
 
Realized gains on available-for-sale securities
 
(1
)
 

 
(4
)


Other-than-temporary impairment loss on available-for-sale securities
 

 

 

 
3,298

Total other comprehensive income (loss), net of tax
 
(9,578
)
 
8,505

 
(40,077
)
 
15,677

Comprehensive income
 
19,342

 
19,988

 
49,917

 
36,889

Less: Comprehensive income (loss) attributable to noncontrolling interests
 
(140
)
 
532

 
(97
)
 
1,006

Comprehensive income attributable to HSS
 
$
19,482

 
$
19,456

 
$
50,014

 
$
35,883




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

2


HUGHES SATELLITE SYSTEMS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2018 AND 2017
(In thousands)
(Unaudited)

 
 
Additional
Paid-In
Capital
 
Accumulated
Other
Comprehensive
Loss
 
Accumulated
Earnings
 
Noncontrolling
Interests
 
Total
Balance, June 30, 2017
 
$
1,772,142

 
$
(53,547
)
 
$
295,968

 
$
13,304

 
$
2,027,867

Stock-based compensation
 
1,359

 

 

 

 
1,359

Other
 
(182
)
 

 

 

 
(182
)
Other comprehensive income
 

 
8,505

 

 

 
8,505

Net Income
 

 

 
10,951

 
532

 
11,483

Balance, September 30, 2017
 
$
1,773,319

 
$
(45,042
)
 
$
306,919

 
$
13,836

 
$
2,049,032

 
 
 
 
 
 
 
 
 
 
 
Balance, June 30, 2018
 
$
1,764,131

 
$
(82,089
)
 
$
660,690

 
$
14,865

 
$
2,357,597

Stock-based compensation
 
1,425

 

 

 

 
1,425

Other
 
(220
)
 

 

 

 
(220
)
Other comprehensive loss
 

 
(8,988
)
 

 
(590
)
 
(9,578
)
Net income
 

 

 
28,470

 
450

 
28,920

Balance, September 30, 2018
 
$
1,765,336

 
$
(91,077
)
 
$
689,160

 
$
14,725

 
$
2,378,144





























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

3


HUGHES SATELLITE SYSTEMS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2018 AND 2017
(In thousands)
(Unaudited)

 
 
Additional
Paid-In
Capital
 
Accumulated
Other
Comprehensive
Loss
 
Accumulated
Earnings
 
Noncontrolling
Interests
 
Total
Balance, January 1, 2017
 
$
1,516,199

 
$
(60,719
)
 
$
286,713

 
$
12,830

 
$
1,755,023

Stock-based compensation
 
3,839

 

 

 

 
3,839

Transfer of launch service contracts to EchoStar
 
(145,114
)
 

 

 

 
(145,114
)
Contribution of EchoStar XIX satellite, net of deferred tax
 
369,263

 

 

 

 
369,263

Contribution of noncash net assets pursuant to Share Exchange Agreement (Note 1)
 
219,662

 

 

 

 
219,662

Exchange of noncash net assets for HSS Tracking Stock (Note 1)
 
(190,221
)
 

 

 

 
(190,221
)
Other comprehensive income
 

 
15,677

 

 

 
15,677

Net Income
 

 

 
20,206

 
1,006

 
21,212

Other
 
(309
)
 

 

 

 
(309
)
Balance, September 30, 2017
 
$
1,773,319

 
$
(45,042
)
 
$
306,919

 
$
13,836

 
$
2,049,032

 
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2017
 
$
1,754,561

 
$
(52,822
)
 
$
582,683

 
$
14,822

 
$
2,299,244

Cumulative effect of adoption of ASU 2014-09 and ASU 2016-01 as of January 1, 2018 (Note 2)
 

 
433

 
17,775

 

 
18,208

Balance, January 1, 2018
 
1,754,561

 
(52,389
)
 
600,458

 
14,822

 
2,317,452

Stock-based compensation
 
4,108

 

 

 

 
4,108

Capital contribution from EchoStar Corporation
 
7,125

 

 

 

 
7,125

Other comprehensive loss
 

 
(38,688
)
 


 
(1,389
)
 
(40,077
)
Net income
 

 

 
88,702

 
1,292

 
89,994

Other
 
(458
)
 

 

 

 
(458
)
Balance, September 30, 2018
 
$
1,765,336

 
$
(91,077
)
 
$
689,160

 
$
14,725

 
$
2,378,144














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

4


HUGHES SATELLITE SYSTEMS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited) 
 
 
For the nine months ended September 30,
 
 
2018
 
2017
Cash flows from operating activities:
 
 
 
 
Net income
 
$
89,994

 
$
21,212

Adjustments to reconcile net income to net cash flows from operating activities:
 
 
 
 
Depreciation and amortization
 
409,377

 
364,878

Equity in earnings of unconsolidated affiliate
 
(3,722
)
 
(5,298
)
Amortization of debt issuance costs
 
5,910

 
5,479

Gains and losses on investments, net
 
(259
)
 
1,575

Stock-based compensation
 
4,108

 
3,839

Deferred tax provision
 
29,345

 
2,202

Dividends received from unconsolidated entity
 
5,000

 
15,000

Proceeds from sale of trading securities
 

 
8,922

Changes in current assets and current liabilities, net:
 
 
 
 
Trade accounts receivable, net
 
(35,776
)
 
(7,792
)
Advances to and from affiliates, net
 
10,596

 
3,148

Trade accounts receivable - DISH Network
 
28,053

 
(26,645
)
Inventory
 
10,667

 
(30,313
)
Other current assets
 
(6,660
)
 
(2,330
)
Trade accounts payable
 
3,669

 
13,418

Trade accounts payable - DISH Network
 
(3,313
)
 

Accrued expenses and other
 
14,979

 
20,346

Changes in noncurrent assets and noncurrent liabilities, net
 
(13,561
)
 
(18,747
)
Other, net
 
7,223

 
952

Net cash flows from operating activities
 
555,630

 
369,846

Cash flows from investing activities:
 
 
 
 
Purchases of marketable investment securities
 
(1,546,479
)
 
(170,158
)
Sales and maturities of marketable investment securities
 
799,250

 
151,141

Expenditures for property and equipment
 
(286,223
)
 
(291,975
)
Refunds and other receipts related to property and equipment
 
77,524

 

Expenditures for externally marketed software
 
(24,568
)
 
(25,447
)
Payment for satellite launch services
 
(7,125
)
 

Other
 
(991
)
 

Net cash flows from investing activities
 
(988,612
)
 
(336,439
)
Cash flows from financing activities:
 
 
 
 
Repayment of debt and capital lease obligations
 
(27,764
)
 
(25,787
)
Advances from (to) affiliates, net
 

 
(36
)
Capital contribution from EchoStar Corporation
 
7,125

 

Repayment of in-orbit incentive obligations
 
(4,048
)
 
(4,583
)
Other, net
 

 
1,072

Net cash flows from financing activities
 
(24,687
)
 
(29,334
)
Effect of exchange rates on cash and cash equivalents
 
(3,350
)
 
923

Net increase (decrease) in cash and cash equivalents, including restricted amounts
 
(461,019
)
 
4,996

Cash and cash equivalents, including restricted amounts, beginning of period
 
1,823,354

 
2,071,687

Cash and cash equivalents, including restricted amounts, end of period
 
$
1,362,335

 
$
2,076,683

 
 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
 
Cash paid for interest, net of amounts capitalized
 
$
176,228

 
$
163,661

Cash paid for income taxes
 
$
2,998

 
$
2,814


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

5


HUGHES SATELLITE SYSTEMS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
NOTE 1.    ORGANIZATION AND BUSINESS ACTIVITIES
 
Principal Business
 
Hughes Satellite Systems Corporation (which, together with its subsidiaries, is referred to as “HSS,” the “Company,” “we,” “us” and/or “our”) is a holding company and a subsidiary of EchoStar Corporation (“EchoStar”).  We are a global provider of broadband satellite technologies, broadband internet services for home and small office customers, satellite operations and satellite services. We also deliver innovative network technologies, managed services and various communications solutions for aeronautical, enterprise and government customers.
 
We primarily operate in the following two business segments:
 
Hughes — which provides broadband satellite technologies and broadband internet services to domestic and international home and small office customers and broadband network technologies, managed services, equipment, hardware, satellite services and communication solutions to domestic and international consumers and aeronautical, enterprise and government customers. The Hughes segment also designs, provides and installs gateway and terminal equipment to customers for other satellite systems. In addition, our Hughes segment designs, develops, constructs and provides telecommunication networks comprising satellite ground segment systems and terminals to mobile system operators and our enterprise customers.

EchoStar Satellite Services (“ESS”) — which uses certain of our owned and leased in-orbit satellites and related licenses to provide satellite operations and satellite services on a full-time and/or occasional-use basis primarily to DISH Network, Dish Mexico, S. de R.L. de C.V., a joint venture EchoStar entered into in 2008 (“Dish Mexico”), U.S. government service providers, internet service providers, broadcast news organizations, content providers and private enterprise customers.
 
Our operations also include various corporate departments (primarily Executive, Treasury, Strategic Development, Human Resources, IT, Finance, Real Estate, Accounting and Legal) and other activities that have not been assigned to our operating segments such as costs incurred in certain satellite development programs and other business development activities, and gains or losses from certain of our investments. These activities, costs and income, as well as eliminations of intersegment transactions, are accounted for in Corporate and Other in our segment reporting.

We were formed as a Colorado corporation in March 2011 to facilitate the acquisition by EchoStar of Hughes Communications, Inc. and its subsidiaries and related financing transactions.  In connection with our formation, EchoStar contributed the assets and liabilities of its satellite services business to us, including the principal operating subsidiary of its satellite services business, EchoStar Satellite Services L.L.C.  A substantial majority of the voting power of the shares of each of EchoStar and DISH Network Corporation (“DISH”) is owned beneficially by Charles W. Ergen, our Chairman, and by certain entities established by Mr. Ergen for the benefit of his family.

On January 31, 2017, EchoStar and certain of its and our subsidiaries entered into a Share Exchange Agreement (the “Share Exchange Agreement”) with DISH and certain of its subsidiaries. Pursuant to the Share Exchange Agreement, on February 28, 2017, among other things, EchoStar and certain of its and our subsidiaries received all of the shares of the Hughes Retail Preferred Tracking Stock issued by EchoStar (the “EchoStar Tracking Stock”) and the Hughes Retail Preferred Tracking Stock issued by us (the “HSS Tracking Stock”, together with the EchoStar Tracking Stock, the “Tracking Stock”) in exchange for 100% of the equity interests of certain EchoStar subsidiaries that held substantially all of EchoStar’s former EchoStar Technologies businesses and certain other assets (collectively, the “Share Exchange”). The EchoStar Technologies businesses designed, developed and distributed secure end-to-end video technology solutions including digital set-top boxes and related products and technology, primarily for satellite TV service providers and telecommunication companies, and provided digital broadcast operations, including satellite uplinking/downlinking, transmission services, signal processing, conditional access management and other services. The Tracking Stock tracked the economic performance of the residential retail satellite broadband business of our

6

HUGHES SATELLITE SYSTEMS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued
(Unaudited)

Hughes segment, including certain operations, assets and liabilities attributed to such business (collectively, the “Hughes Retail Group”), and represented an aggregate 80.0% economic interest in the Hughes Retail Group. Following the consummation of the Share Exchange, EchoStar no longer operates the EchoStar Technologies businesses, the Tracking Stock was retired and is no longer outstanding, and all agreements, arrangements and policy statements with respect to the Tracking Stock terminated.

NOTE 2.    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
Basis of Presentation
 
The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the U.S. (“U.S. 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 in conformity with U.S. GAAP. In our opinion, all adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation have been included. However, 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 Form 10-K for the year ended December 31, 2017.
 
Principles of Consolidation
 
We consolidate all entities in which we have a controlling financial interest. We are deemed to have a controlling financial interest in variable interest entities where we are the primary beneficiary. We are deemed to have a controlling financial interest in other entities when we own more than 50% of the outstanding voting shares and other shareholders do not have substantive rights to participate in management. For entities we control but do not wholly own, we record a noncontrolling interest within shareholders’ equity for the portion of the entity’s equity attributed to the noncontrolling ownership interests. All significant intercompany balances and transactions have been eliminated in consolidation.

Reclassification

Certain prior period amounts have been reclassified to conform with the current period presentation.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires us to make certain estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the balance sheets, the reported amounts of revenue and expense for each reporting period and certain information disclosed in the notes to our financial statements. Estimates are used in accounting for, among other things, (i) amortization periods for deferred contract acquisition costs, (ii) inputs used to recognize revenue over time, (iii) allowances for doubtful accounts, (iv) warranty obligations, (v) self-insurance obligations, (vi) deferred taxes and related valuation allowances, (vii) uncertain tax positions, (viii) loss contingencies, (ix) fair value of financial instruments, (x) fair value of EchoStar’s stock-based compensation awards, (xi) fair value of assets and liabilities acquired in business combinations, (xii) lease classifications, (xiii) asset impairment testing and (xiv) useful lives and methods for depreciation and amortization of long-lived assets.

We base our estimates and assumptions on historical experience, observable market inputs and on various other factors that we believe to be relevant 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 financial statements. Additionally, changing economic conditions may increase the inherent uncertainty in the estimates and assumptions indicated above. We review our estimates and assumptions periodically and the effects of revisions thereto are reflected in the period they occur or prospectively if the revised estimate affects future periods.


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HUGHES SATELLITE SYSTEMS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued
(Unaudited)

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 utilize the highest level of inputs available according to 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
Level 3 - Defined as unobservable inputs for which little or no market data exists, consistent with characteristics of the asset or liability that would be considered by market participants in a transaction to purchase or sell the asset or liability.

Fair values of our marketable investment securities are based on a variety of observable market inputs. For our investments in publicly traded equity securities and U.S. government securities, fair value ordinarily is determined based on Level 1 measurements that reflect quoted prices for identical securities in active markets. Fair values of our investments in other marketable debt securities are generally based on Level 2 measurements, as the markets for such debt securities are less active. We consider trades of identical debt securities on or near the measurement date as a strong indication of fair value and matrix pricing techniques that consider par value, coupon rate, credit quality, maturity and other relevant features may also be used to determine fair value of our investments in marketable debt securities. Fair values for our outstanding debt (see Note 10) are based on quoted market prices in less active markets and are categorized as Level 2 measurements. Additionally, we use fair value measurements from time to time in connection with asset 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.

Transfers between levels in the fair value hierarchy are considered to occur at the beginning of the quarterly accounting period. There were no transfers between levels for each of the nine month periods ended September 30, 2018 and 2017.
 
As of September 30, 2018 and December 31, 2017, the carrying amounts of our cash and cash equivalents, trade and other receivables, net of allowance for doubtful accounts, accounts payable and accrued liabilities were equal to or approximated their fair value due to their short-term nature or proximity to current market rates.

Revenue Recognition

Overview

We account for our sales and services revenue in accordance with Accounting Standards Codification Topic 606, Revenue from Contracts with Customers (“Topic 606”), which we adopted on January 1, 2018, using the modified retrospective approach to contracts not completed as of the adoption date. Topic 606 provides a five-step revenue recognition model that we apply to our customer contracts. Under this model we (i) identify the contract with the customer, (ii) identify our performance obligations in the contract, (iii) determine the transaction price for the contract, (iv) allocate the transaction price to our performance obligations and (v) recognize revenue when or as we satisfy our performance obligations.

Revenue is recognized upon transfer of control of the promised goods or our performance of the services to our customers in an amount that reflects the consideration we expect to receive in exchange for those goods or services. We enter into contracts that may include various combinations of products and services, which are generally distinct and accounted for as separate performance obligations.


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HUGHES SATELLITE SYSTEMS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued
(Unaudited)

Additionally, a significant portion of our revenue is derived from leases of property and equipment that is reported in Services and other revenue - other and Services and other revenue - DISH Network in our Condensed Consolidated Statements of Operations and Comprehensive Income (Loss). Certain of our customer contracts contain embedded equipment leases, which we separate from non-lease components of the contract based on the relative standalone selling prices of the lease and non-lease components.

Hughes

Our Hughes segment provides various communication and networking services to consumer and enterprise customers in both domestic and international markets. Our service contracts typically obligate us to provide substantially the same services on a recurring basis in exchange for fixed recurring fees over the term of the contract. We satisfy such performance obligations over time and generally recognize revenue ratably as services are rendered over the service period. Certain of our contracts with service obligations provide for fees based on usage, capacity or volume. We satisfy these performance obligations and generally recognize the related revenue at the point in time or over the period when the services are rendered. Our Hughes segment also sells and leases communications equipment to its customers. Revenue from equipment sales generally is recognized upon shipment of the equipment. Our equipment sales contracts typically include standard product warranties, but generally do not provide for returns or refunds. Revenue for extended warranties is generally recognized ratably over the extended warranty period. For contracts with multiple performance obligations, we typically allocate the contract’s transaction price to each performance obligation based on their relative standalone selling prices. When the standalone selling price is not observable, our primary method used to estimate standalone selling price is the expected cost plus a margin. Our contracts generally require customer payments to be made at or shortly after the time we transfer control of goods or perform the services.

In addition to equipment and service offerings, our Hughes segment also enters into long-term contracts to design, develop, construct and install complex telecommunication networks to customers in its enterprise and mobile satellite systems markets. Revenue from such contracts is generally recognized over time at a measure of progress that depicts the transfer of control of the goods or services to the customer. Depending on the nature of the arrangement, we measure progress toward contract completion using an appropriate input method or output method. Under the input method, we recognize the transaction price as revenue based on the ratio of costs incurred to estimated total costs at completion. Under the output method, revenue and cost of sales are recognized as products are delivered based on the expected profit for the entire agreement. Profit margins on long-term contracts generally are based on estimates of revenue and costs at completion. We review and revise our estimates periodically and recognize related adjustments in the period in which the revisions are made. Estimated losses on contracts are recorded in the period in which they are identified. We generally receive interim payments as work progresses, although for some contracts, we may be entitled to receive an advance payment.
 
ESS

Our ESS segment provides satellite operations through leasing arrangements and satellite services on a full-time and/or occasional-use basis to DISH Network and Dish Mexico, as well as government service providers, internet service providers, broadcast news organizations, content providers and private enterprise customers. Our ESS segment also provides telemetry, tracking and control (“TT&C”) services for satellites owned by DISH Network and technical consulting services that are billed by the hour. Generally, our service contracts with customers contain a single performance obligation and therefore there is no need to allocate the transaction price. We transfer control and recognize revenue for satellite services at the point in time or over the period when the services are rendered.

Other

Sales and Value Added Taxes, Universal Service Fees and other taxes that we collect concurrent with revenue producing activities are excluded from revenue.

Shipping and handling costs associated with outbound freight are accounted for as a fulfillment cost after control over a product has transferred to the customer and are included in Cost of sales - equipment at the time of shipment.


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HUGHES SATELLITE SYSTEMS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued
(Unaudited)

Contract Balances

Trade Accounts Receivable

Trade accounts receivable includes amounts billed and currently due from customers and represents our unconditional rights to consideration arising from our performance under our customer contracts. Trade accounts receivable also includes amounts due from customers under our leasing arrangements. We make ongoing estimates relating to the collectibility of our trade accounts receivable and maintain an allowance for estimated losses resulting from the inability of our customers to make the required payments. In determining the amount of the allowance, we consider historical levels of credit losses and make judgments about the creditworthiness of our customers based on ongoing credit evaluations. Past due trade accounts receivable balances are written off when our internal collection efforts have been unsuccessful. Bad debt expense related to our trade accounts receivable and other contract assets is included in Selling, general and administrative expenses in our Condensed Consolidated Statements of Operations and Comprehensive Income (Loss).

Contract Assets and Contract Liabilities

Contract assets represent revenue that we have recognized in advance of billing the customer and are included in Trade accounts receivable and contract assets, net or Other noncurrent assets, net in our Condensed Consolidated Balance Sheets based on the expected timing of customer payment. Our contract assets include amounts that we referred to as Contracts in Process in prior periods. Our contract assets typically relate to our long-term contracts where we recognize revenue using the cost-based input method and the revenue recognized exceeds the amount billed to the customer.

Contract liabilities consist of advance payments and billings in excess of revenue recognized under customer contracts and are included in Contract liabilities or Other noncurrent liabilities in our Condensed Consolidated Balance Sheets based on the timing of when we expect to recognize revenue. Contract liabilities include amounts that we referred to as deferred revenue in prior periods. We recognize contract liabilities as revenue after all revenue recognition criteria have been met.

Contract Acquisition and Fulfillment Costs

Contract Acquisition Costs

Our contract acquisition costs represent incremental direct costs of obtaining a contract and consist primarily of sales incentives paid to employees and third-party representatives. When we determine that our contract acquisition costs are recoverable, we defer and amortize the costs over the contract term, or over the estimated life of the customer relationship if anticipated renewals are expected and the incentives payable upon renewal are not commensurate with the initial incentive. We amortize contract acquisition costs in proportion to the revenue to which the costs relate. We expense sales incentives as incurred if the expected amortization period is one year or less. Unamortized contract acquisition costs are included in Other noncurrent assets, net in our Condensed Consolidated Balance Sheets and related amortization expense is included in Selling, general and administrative expenses in our Condensed Consolidated Statements of Operations and Comprehensive Income (Loss).

Contract Fulfillment Costs

We recognize costs to fulfill a contract as an asset when the costs relate directly to a specific contract, the costs generate or enhance our resources that will be used in satisfying future performance obligations and the costs are expected to be recovered. We may incur such costs on certain contracts that require initial setup activities in advance of the transfer of goods or services to the customer. We amortize these costs in proportion to the revenue to which the costs relate. Unamortized contract fulfillment costs are included in Other noncurrent assets, net in our Condensed Consolidated Balance Sheets and related amortization expense is included in Cost of sales - services and other in our Condensed Consolidated Statements of Operations and Comprehensive Income (Loss).

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HUGHES SATELLITE SYSTEMS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued
(Unaudited)


Capitalized Software Costs

Internal-Use Software

Costs related to the procurement and development of software for internal-use are capitalized and amortized using the straight-line method over the estimated useful life of the software, not in excess of five years. Capitalized costs of internal-use software are included in Property and equipment, net in our Condensed Consolidated Balance Sheets.

Externally Marketed Software

Costs related to the procurement and development of software for externally marketed software are capitalized and amortized using the straight-line method over the estimated useful life of the software, not in excess of five years. Capitalized costs of externally marketed software are included in Other noncurrent assets, net in our Condensed Consolidated Balance Sheets. Externally marketed software generally is installed in the equipment we sell to customers. We conduct software program reviews for externally marketed capitalized software costs at least annually, or as events and circumstances warrant such a review, to determine if capitalized software development costs are recoverable and to ensure that costs associated with programs that are no longer generating revenue are expensed.

Marketable Investment Securities

Our marketable investment securities portfolio consists of investments in debt and equity instruments with readily determinable fair values.

Debt Securities

We classify all of our debt securities as available for sale based on our investment strategy for the securities. Generally, we recognize periodic changes in the difference between fair value and amortized cost in Unrealized gains on available-for-sale securities and other in our Condensed Consolidated Statements of Operations and Comprehensive Income (Loss). Realized gains and losses upon sales of debt securities are reclassified from other comprehensive income (loss) and recognized on the trade date in Gains and losses on investments, net in our Condensed Consolidated Statements of Operations and Comprehensive Income (Loss). We use the first-in, first out method to determine the cost basis on sales of debt securities. Interest income from debt securities is reported in Interest income in our Condensed Consolidated Statements of Operations and Comprehensive Income (Loss). We could realize proceeds from certain investments prior to their contractual maturity if we actually sell these securities before such maturity.

We evaluate our available-for-sale debt securities portfolio periodically to determine whether declines in the fair value of these securities are other than temporary. Our evaluation considers, among other things, the length of time and the extent to which the fair value of such security has been lower than amortized cost, market and company-specific factors related to the security and our intent and ability to hold the investment to maturity or when it recovers its value. We generally consider a decline to be other than temporary when: (i) we intend to sell the security, (ii) it is more likely than not that we will be required to sell the security before maturity or when it recovers its value, or (iii) we do not expect to recover the amortized cost of the security at maturity. Declines in the fair value of available-for-sale debt securities that are determined to be other than temporary are reclassified from other comprehensive income (loss) and recognized in net income, thus establishing a new cost basis for the investment.

Additionally, from time to time we make strategic investments in corporate debt securities.